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, 2004. 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,
|-------------------------- | ------------------------------------------------------------------------ | -----------------------------------------
|
|
|STATEMENT OF CONDITION     |                                                                          |                                          
|                           | Assets                                                                   |                                          
|                           | Net loans                                                                |                                          
|                           | Deposits                                                                 |                                          
|                           | Other borrowed funds                                                     |                                          
|                           | Junior subordinated deferrable interest debentures                       |                                          
|                           | Shareholders' equity                                                     |                                          
|INCOME STATEMENT           |                                                                          |                                          
|                           | Interest income                                                          |                                          
|                           | Interest expense                                                         |                                          
|                           |                                                                          |                                          
|                           | Net interest income                                                      |                                          
|                           | Provision for possible loan losses                                       |                                          
|                           | Non-interest income                                                      |                                          
|                           | Non-interest expense                                                     |                                          
|                           |                                                                          |                                          
|                           | Income before income taxes and cumulative change in accounting principle |                                          
|                           | Income taxes                                                             |                                          
|                           | Cumulative effect of a change in accounting principle, net of taxes      |                                          
|                           |                                                                          |                                          
|                           | Net income                                                               |                                          
|                           |                                                                          |                                          
|                           | Adjusted net income                                                      |                                          
|                           |                                                                          |                                          
|Per common share:          |                                                                          |                                          
|                           | Basic                                                                    |                                          
|                           | Diluted                                                                  |                                          
|Adjusted per common share: |                                                                          |                                          
|                           | Basic                                                                    |                                          
|                           | Diluted                                                                  |                                          

Note 1:
See note 1 of notes to the consolidated financial statements regarding the adoption of SFAS No. 142. On January 1, 2002, the Company
adopted the remaining provisions of SFAS No. 142, which discontinued amortization of goodwill. Accordingly, adjusted net income and per common share data for the years ended December 31,
2004, 2003 and 2002 is the same as actual numbers.

Note
2: See note 11 of notes to the consolidated financial statements regarding the adoption of FIN 46, as revised. The Company early-adopted the provisions of FIN 46, as revised,
as of December 31, 2003 and thus deconsolidated its investment in eight special purpose business trusts established for the issuance of trust preferred securities.

1

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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, 2004. The following discussion
should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2004, 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 Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by these sections. Although the
Company believes such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached. The words "estimate," "expect," "intend,"
"believe" and "project," as well as other words or expressions of a similar meaning are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on
forward-looking statements, which speak only as of the date of this report. Such statements are based on current expectations, are inherently uncertain, are subject to risks and should be viewed with
caution. Actual results and experience may differ materially from the forward-looking statements as a result of many factors.

Factors
that could cause actual results to differ materially from any results that are projected, forecasted, estimated or budgeted by the Company in forward-looking statements include,
among others, the following possibilities:



2

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It
is not possible to foresee or identify all such factors. The Company makes no commitment to update any forward-looking statement, or to disclose any facts, events or circumstances
after the date hereof that may affect the accuracy of any forward-looking statement, unless required by law.

Overview

The Company, which is headquartered in Laredo, Texas, with more than 160 facilities and more than 250 ATMs, provides banking services for commercial, consumer and
international customers of South, Central and Southeast Texas and the State of Oklahoma. The Company is the second largest
independent commercial bank holding company headquartered in Texas. The Company, through its bank subsidiaries, is in the business of gathering funds from various sources and investing those funds in
order to earn a return. The Company either directly or through a bank subsidiary owns two insurance agencies, a broker/dealer and a majority interest in an investment banking unit that owns a
broker/dealer. The Company's primary earnings come from the spread between the interest earned on interest-bearing assets and the interest paid on interest-bearing liabilities. In addition, the
Company generates income from fees on products offered to commercial, consumer and international customers.

A
primary goal of the Company is to grow net interest income and non-interest income while adequately managing credit risk, interest rate risk and expenses. Effective
management of capital is a critical objective of the Company. A key measure of the performance of a banking institution is the return on average common equity ("ROE"). The Company's ROE for the year
ended December 31, 2004 was 18.17% as compared to 22.68% for the year ended December 31, 2003.

The
Company is very active in facilitating trade along the United States border with Mexico. The Company does a significant amount of business with customers domiciled in Mexico.
Deposits from persons and entities domiciled in Mexico comprise a significant 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.

Expense
control is another essential element in the Company's long-term profitability. As a result, one of the key ratios the Company monitors is the efficiency ratio, which
is a measure of non-interest expense to net-interest income plus non-interest income. The Company's efficiency ratio has been under 53% for each of the last five
years, which the Company believes is better than average compared to its national peer group. One of the benefits derived from such operating efficiencies is that the Company is not subject to undue
pressure to generate interest income from high-risk loans.

During
the fourth quarter of 2003, the Company reduced its assets by approximately $1 billion dollars in anticipation of the Local Financial Corporation ("LFIN") acquisition. The
Company also increased its overnight liquidity in the form of fed funds sold to prepare for the cash payment required as part of the

3

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transaction.
On June 18, 2004, the Company completed its acquisition of LFIN. The Company paid consideration totaling approximately $276.6 million in cash and 2.11 million shares
of Company stock. As a result of the strategic management of earning assets in anticipation of the LFIN acquisition, net interest income for the first, second and third quarters of 2004 was negatively
affected.

Results of Operations

Summary

Consolidated
Statements of Condition Information

|                     |  | December 31, 2004 |           | December 31, 2003 |   | Percent Increase
(Decrease) | 
|-------------------- |  | ----------------- | --------- | ----------------- | - | --------------------------- | 
|
|Assets               |  | $                 | 9,917,951 |                   | $ | 6,578,310                   | 
|Net loans            |  |                   | 4,804,069 |                   |   | 2,700,354                   | 
|Deposits             |  |                   | 6,571,104 |                   |   | 4,435,699                   | 
|Other borrowed funds |  |                   | 1,670,199 |                   |   | 845,272                     | 
|Shareholders' equity |  |                   | 753,090   |                   |   | 577,383                     | 

Consolidated
Statements of Income Information

|                                   |         | Year Ended
December 31,
2004 |         | Year Ended
December 31,
2003 |   | Percent Increase (Decrease)
2004 vs. 2003 |      | Year ended
December 31,
2002 |      | Percent Increase (Decrease)
2003 vs. 2002 |        
|---------------------------------- | ------- | ---------------------------- | ------- | ---------------------------- | - | ----------------------------------------- | ---- | ---------------------------- | ---- | ----------------------------------------- | -------
|
|Interest income                    |         | $                            | 352,378 |                              | $ | 318,051                                   |      | 10.8                         | %    | $                                         | 353,928
|Interest expense                   |         |                              | 108,602 |                              |   | 94,725                                    |      | 14.6                         |      |                                           | 116,415
|Net interest income                |         |                              | 243,776 |                              |   | 223,326                                   |      | 9.2                          |      |                                           | 237,513
|Provision for possible loan losses |         |                              | 6,500   |                              |   | 8,291                                     |      | (21.6                        | )    |                                           | 8,541  
|Non-interest income                |         |                              | 134,816 |                              |   | 127,273                                   |      | 5.9                          |      |                                           | 85,645 
|Non-interest expense               |         |                              | 195,180 |                              |   | 159,754                                   |      | 22.6                         |      |                                           | 154,843
|Net income                         |         |                              | 119,032 |                              |   | 122,128                                   |      | (2.5                         | )    |                                           | 100,631
|Per common share:                  |         |                              |         |                              |   |                                           |      |                              |      |                                           |        
|                                   | Basic   |                              | $       | 2.39                         |   | $                                         | 2.53 |                              | (5.5 | )%                                        | $      
|                                   | Diluted |                              |         | 2.35                         |   |                                           | 2.48 |                              | (5.2 | )                                         |        
|Efficiency Ratio                   |         |                              | 51.6    | %                            |   | 45.6                                      | %    | 13.2                         | %    |                                           | 47.9   

Net Income

Net income decreased for the year ended December 31, 2004 as compared to the year ended December 31, 2003 primarily because of differences created
by the Company's recognition of securities gains in 2003 as compared to 2004 and the Company's strategic management of earning assets in anticipation of the Local Financial Corporation ("LFIN")
acquisition. During the fourth quarter of 2003, the Company reduced its assets by approximately $1 billion in anticipation of the LFIN acquisition. The Company also increased its overnight
liquidity in the form of fed funds sold to prepare for the cash payment required as part of the transaction. On June 18, 2004, the Company completed its acquisition of LFIN. As a result of the
strategic management of earning assets, net interest income for the first, second and third quarters of 2004 was negatively affected. Net income for 2004 was positively affected by certain gains on
sales of Company-owned property in the amount of $2,080,000, net of tax. Additionally, net income for 2003 was positively affected by gains recognized on bond sales, which were made to reposition a
portion of the Company's bond portfolio to realize the equity that was eroding in the portfolio due to rapid

4

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principal
repayments. The Company recorded gains on the bond portfolio of $15,203,000 in 2003 compared to $5,775,000, net of tax in 2004.

Net
income for 2002 was negatively affected by an impairment charge of $3,953,000 relating to the Company's investment in the Aircraft Finance Trust ("AFT"), net of tax. The Company
accounts for its investment in AFT under the equity method of accounting. AFT utilizes derivative instruments to manage the interest rate on bonds that it has issued. The derivatives qualify as cash
flow hedges and are reported at fair value. The Company records its proportionate share of the fair value of the derivatives as an increase or decrease in the investment in AFT and accumulated other
comprehensive income, net of tax. The Company's proportionate share of earnings or losses of AFT were losses of $0, $616,000 and $4,419,000 for the years ended December 31, 2004, 2003 and 2002,
respectively, net of tax. Because of the losses from operations that AFT had reported as a result of the events of September 11 and the resulting impact on the airline industry, the Company
evaluated its investment, and recorded the impairment charge in 2002. At December 31, 2004 and 2003, the Company's investment in AFT, with and without the proportionate share of the fair value
of the AFT derivatives, was $0.

Net
income for 2002 was also negatively affected by a write-off of $753,000, net of tax, relating to the closure of several in-store branches previously located
in Albertson's supermarkets. On March 13, 2002, Albertson's, Inc. announced its intention to exit substantially all of the Company's markets. The Company began its relationship with
Albertson's in 1995. Thirty nine Albertson's supermarkets and the related in-store branches of the Company located in Houston, San Antonio, Brownsville, Corpus Christi, Laredo, Edinburg,
San Juan, Pharr, Mission, Weslaco and Harlingen were closed. On June 7, 2002, H-E-B agreed to purchase certain former Albertson's locations in San Antonio and the Rio
Grande Valley. The Company subsequently agreed with H-E-B to open in four of the Company's previous in-store locations and the Company also agreed to open an
in-store branch in another former Albertson's store that was not occupied by the
Company. On May 10, 2002, Kroger Co. agreed to purchase certain former Albertson's locations in Houston. The Company subsequently agreed with Kroger to open in three of the Company's previous
in-store locations. During the third quarter 2002, the Company concluded that the remaining in-store locations would not be re-opened and wrote off $753,000, net of
tax of its investment in the related in-store branches. The Company continues to maintain one Albertson's in-store branch in the New Braunfels market that was not closed by
Albertson's. The Company does not believe that the Albertson's closures had any negative effects on its deposit base, consolidated financial condition or results of operations.

Additionally,
net income was negatively affected in 2002 by the adoption of Statement of Financial Accounting Standards Number 142, "Goodwill and Other Intangible Assets" ("SFAS
No. 142"). As part of the adoption, the Company concluded that it was probable that its investment services reporting unit was impaired. The amount of the impairment was $5,130,000, net of tax,
and was reported as a cumulative effect of a change in accounting principle.

On
August 1, 2002, the Company completed its sale of three bank branches in Rockdale, Taylor and Giddings, Texas to Citizens National Bank located in Cameron, Texas. The branches
were previously acquired by the Company as part of its acquisition of National Bancshares Corporation in the fourth quarter of 2001 and represented approximately $36.3 million in loans and
$93.1 million in deposits. As a result of the sale, the Company recorded a gain of $2.0 million, net of tax in 2002. The Company sold these branches because they did not fit into the
long-term strategic plans of the Company.

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

5

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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, |      
|----------------------------- | -------------------------------------------------- | -------------------------------- | -----
|
|                              | Assets                                             |                                  |      
|Interest earning assets:      |                                                    |                                  |      
|                              | Loan, net of unearned discounts:                   |                                  |      
|                              |                                                    | Domestic                         |      
|                              |                                                    | Foreign                          |      
|                              | Investment securities:                             |                                  |      
|                              |                                                    | Taxable                          |      
|                              |                                                    | Tax-exempt                       |      
|                              | Time deposits with banks                           |                                  | 1.69 
|                              | Federal funds sold                                 |                                  | 1.22 
|                              | Other                                              |                                  | 7.59 
|                              |                                                    |                                  |      
|                              |                                                    |                                  |      
|                              | Liabilities                                        |                                  |      
|Interest bearing liabilities: |                                                    |                                  |      
|                              | Savings and interest bearing demand deposits       |                                  | .75  
|                              | Time deposits:                                     |                                  |      
|                              |                                                    | Domestic                         |      
|                              |                                                    | Foreign                          |      
|                              | Securities sold under repurchase agreements        |                                  | 3.64 
|                              | Other borrowings                                   |                                  | 1.55 
|                              | Junior subordinated deferrable interest debentures |                                  | 6.38 
|                              | Senior notes                                       |                                  | 11.47
|                              |                                                    |                                  |      
|                              |                                                    |                                  |      

Due
to decreasing market interest rates in 2003 and 2002, the Company accordingly lowered interest rates on loans and deposits, which in turn affected the yield on interest earning
assets and interest bearing liabilities. In 2004, as short term interest rates began to increase, the Company accordingly increased interest rates on loans and deposits. The yield on average interest
earning assets decreased 5.6% from 5.16% in 2003 to 4.87% in 2004, and the rates paid on average interest bearing liabilities decreased 2.3% from 1.73% in 2003 to 1.69% in 2004. The yield on average
interest earning assets decreased 16.2% from 6.16% in 2002 to 5.16% in 2003 and the rates paid on average interest bearing liabilities decreased 23.8% from 2.27% in 2002 to 1.73% in 2003.

6

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The following table analyzes the changes in net interest income during 2004 and 2003 and the relative effect of changes in interest rates and volumes for each major classification of
interest-earning assets and interest-bearing liabilities. Nonaccrual loans have been included in assets for the purpose of this analysis, which reduces the resulting yields:

|                      |                                                    | 2004 compared to 2003
Net increase (decrease) due to |        | 2003 compared to 2002
Net increase (decrease) due to |       
|--------------------- | -------------------------------------------------- | ---------------------------------------------------- | ------ | ---------------------------------------------------- | ------
|
|
|Interest earned on:   |                                                    |                                                      |        |                                                      |       
|                      | Loans, net of unearned discounts:                  |                                                      |        |                                                      |       
|                      |                                                    | Domestic                                             |        | $                                                    | 74,455
|                      |                                                    | Foreign                                              |        |                                                      | (6    
|                      | Investment securities:                             |                                                      |        |                                                      |       
|                      |                                                    | Taxable                                              |        |                                                      | (9,438
|                      |                                                    | Tax-exempt                                           |        |                                                      | 223   
|                      | Time deposits with banks                           |                                                      |        | 94                                                   |       
|                      | Federal funds sold                                 |                                                      |        | 741                                                  |       
|                      | Other                                              |                                                      |        | 202                                                  |       
|                      |                                                    |                                                      |        |                                                      |       
|                      | Total interest income                              |                                                      | $      | 66,271                                               |       
|                      |                                                    |                                                      |        |                                                      |       
|Interest incurred on: |                                                    |                                                      |        |                                                      |       
|                      | Savings and interest bearing demand deposits       |                                                      | $      | 3,897                                                |       
|                      | Time deposits:                                     |                                                      |        |                                                      |       
|                      |                                                    | Domestic                                             |        |                                                      | 1,658 
|                      |                                                    | Foreign                                              |        |                                                      | 9,433 
|                      | Securities sold under repurchase agreements        |                                                      |        | 2,731                                                |       
|                      | Other borrowings                                   |                                                      |        | (2,928                                               | )     
|                      | Junior subordinated deferrable interest debentures |                                                      |        | 3,570                                                |       
|                      | Senior notes                                       |                                                      |        | 383                                                  |       
|                      |                                                    |                                                      |        |                                                      |       
|                      | Total interest expense                             |                                                      | $      | 18,744                                               |       
|                      |                                                    |                                                      |        |                                                      |       
|Net interest income   |                                                    | $                                                    | 47,527 |                                                      | $     
|                      |                                                    |                                                      |        |                                                      |       

(Note 1)
The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

As
part of its strategy to manage interest rate risk, the Company strives to manage both assets and liabilities so that interest sensitivities match. One method of calculating interest
rate sensitivity is through gap analysis. A gap is the difference between the amount of interest rate sensitive assets and interest rate sensitive liabilities that re-price or mature in a
given time period. Positive gaps occur when interest rate sensitive assets exceed interest rate sensitive liabilities, and negative gaps occur when interest rate sensitive liabilities exceed interest
rate sensitive assets. A positive gap position in a period of rising interest rates should have a positive effect on net interest income as assets will re-price faster than liabilities.
Conversely, net interest income should contract somewhat in a period of falling interest rates. Management can quickly change the Company's interest rate position at any given point in time as market
conditions dictate. Additionally, interest rate changes do not affect all categories of assets and liabilities equally or at the same 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

7

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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 when needed.
Management currently believes that the Company is properly positioned for interest rate changes; however, if management determines at any time that the Company is not properly positioned, it will
strive to adjust the interest rate sensitive assets and liabilities in order to manage the effect of interest rate changes.

At
December 31, 2004, based on these simulations, a rate shift of 200 basis points in interest rates up or a rate shift of 100 basis points down will not vary earnings by more
than 3 percent of projected 2005 net interest income. The basis point shift in interest rates is a hypothetical rate scenario used to calibrate risk, and does not necessarily represent
management's current view of future market developments. The Company believes that it is properly positioned for a potential interest rate increase or decrease.

Allowance for Possible Loan Loss

The following table presents information concerning the aggregate amount of non-accrual, past due and restructured domestic loans; certain loans may
be classified in one or more category:

|                                                                                      |  | December 31,
|------------------------------------------------------------------------------------- |  | ------------
|
|
|Loans accounted for on a non-accrual basis                                            |  | $           
|Loans contractually past due ninety days or more as to interest or principal payments |  |             
|Loans accounted for as "troubled debt restructuring"                                  |  |             

The
allowance for possible loan losses increased 74.5% to $84,905,000 at December 31, 2004 from $48,646,000 at December 31, 2003. The increase in the allowance for possible
loan losses can be primarily attributed to the additional allowance for possible loan losses related to the LFIN acquisition, totaling $33,865,000. On October 29, 2004, an approximately
$9.6 million original loan relationship was refinanced by the borrower with a non-affiliated third party lender and as a result the
Company recovered approximately $3.05 million of interest and principal. This recovery positively affected the Company's 2004 provision for possible loan losses. The increase in
non-accrual loans from 2003 to 2004 can be attributed to certain non-accrual loans acquired as a result of the LFIN acquisition.

The
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,
|------------------------------------------------------------------------------------- |  | ------------
|
|
|Loans accounted for on a non-accrual basis                                            |  | $           
|Loans contractually past due ninety days or more as to interest or principal payments |  |             

The
gross income that would have been recorded during 2004 and 2003 on non-accrual and restructured loans in accordance with their original contract terms was $962,000 and
$1,814,000 on domestic loans and $241,000 and $56,000 on foreign loans, respectively. The amount of interest income on such loans that was recognized in 2004 and 2003 was $195,000 and $1,086,000 on
domestic loans and $41,000 and $5,000 for foreign loans, respectively.

The
non-accrual loan policy of the bank subsidiaries is to discontinue the accrual of interest on loans when management determines that it is probable that future interest
accruals will be uncollectible. Interest

8

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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 $1,406,598,000 and $770,896,000
at December 31, 2004 and 2003, respectively. The increase in loan commitments can be attributed to the LFIN acquisition. See Note 20 to the Consolidated Financial Statements.

The
following table summarizes loan balances at the end of each year and average loans outstanding during the year; changes in the allowance for possible loan losses arising from loans
charged-off and

9

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recoveries
on loans previously charged-off by loan category; and additions to the allowance which have been charged to expense:

|                                                                                                     |           | 2004                                   |           | 2003 |        | 2002      |   | 2001   |           | 2000 |       
|---------------------------------------------------------------------------------------------------- | --------- | -------------------------------------- | --------- | ---- | ------ | --------- | - | ------ | --------- | ---- | ------
|
|Loans, net of unearned discounts, outstanding at December 31                                         |           | $                                      | 4,888,974 |      | $      | 2,749,000 |   | $      | 2,769,562 |      | $     
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Average loans outstanding during the year (Note 1)                                                   |           | $                                      | 3,982,580 |      | $      | 2,756,003 |   | $      | 2,664,856 |      | $     
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Balance of allowance at December 31                                                                  |           | $                                      | 48,646    |      | $      | 44,213    |   | $      | 40,065    |      | $     
|Provision charged to expense                                                                         |           |                                        | 6,500     |      |        | 8,291     |   |        | 8,541     |      |       
|Loans charged off:                                                                                   |           |                                        |           |      |        |           |   |        |           |      |       
|                                                                                                     | Domestic: |                                        |           |      |        |           |   |        |           |      |       
|                                                                                                     |           | Commercial, financial and agricultural |           |      | (5,732 | )         |   | (2,174 | )         |      | (2,490
|                                                                                                     |           | Real estatemortgage                   |           |      | (1,179 | )         |   | (489   | )         |      | (240  
|                                                                                                     |           | Real estateconstruction               |           |      | (295   | )         |   |       |           |      |      
|                                                                                                     |           | Consumer                               |           |      | (2,034 | )         |   | (2,173 | )         |      | (2,412
|                                                                                                     |           | Foreign                                |           |      | (273   | )         |   | (107   | )         |      | (115  
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Total loans charged off:                                                                             |           |                                        | (9,513    | )    |        | (4,943    | ) |        | (5,257    | )    |       
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Recoveries credited to allowance:                                                                    |           |                                        |           |      |        |           |   |        |           |      |       
|                                                                                                     | Domestic: |                                        |           |      |        |           |   |        |           |      |       
|                                                                                                     |           | Commercial, financial and agricultural |           |      | 4,841  |           |   | 313    |           |      | 495   
|                                                                                                     |           | Real estatemortgage                   |           |      | 93     |           |   | 41     |           |      | 247   
|                                                                                                     |           | Real estateconstruction               |           |      | 17     |           |   |       |           |      |      
|                                                                                                     |           | Consumer                               |           |      | 451    |           |   | 287    |           |      | 553   
|                                                                                                     |           | Foreign                                |           |      | 5      |           |   | 444    |           |      | 34    
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Total recoveries                                                                                     |           |                                        | 5,407     |      |        | 1,085     |   |        | 1,329     |      |       
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Net loans charged off                                                                                |           |                                        | (4,106    | )    |        | (3,858    | ) |        | (3,928    | )    |       
|Allowance acquired (disposed) in purchase or sale transactions                                       |           |                                        | 33,865    |      |        |          |   |        | (465      | )    |       
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Balance of allowance at December 31                                                                  |           | $                                      | 84,905    |      | $      | 48,646    |   | $      | 44,213    |      | $     
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Ratio of net loans charged-off during the year to average loans outstanding during the year (Note 1) |           |                                        | .10       | %    |        | .14       | % |        | .15       | %    |       
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       
|Ratio of allowance to loans, net of unearned discounts, outstanding at December 31                   |           |                                        | 1.74      | %    |        | 1.77      | % |        | 1.60      | %    |       
|                                                                                                     |           |                                        |           |      |        |           |   |        |           |      |       

(Note 1)
The average balances for purposes of the above table are calculated on the basis of month-end balances.

10

---



The
allowance for possible loan losses has been allocated based on the amount management has deemed to be reasonably necessary to provide for the probable losses incurred within the
following categories of loans at the dates indicated and the percentage of loans to total loans in each category:

|                                       |  | At December 31, |       
|-------------------------------------- |  | --------------- | ------
|
|
|
|Commercial, Financial and Agricultural |  | $               | 48,132
|Real estateMortgage                   |  |                 | 17,060
|Real estateConstruction               |  |                 | 13,314
|Consumer                               |  |                 | 4,072 
|Foreign                                |  |                 | 2,327 
|                                       |  |                 |       
|                                       |  | $               | 84,905
|                                       |  |                 |       

The allowance for possible loan losses consists of the aggregate loan loss allowances of the bank subsidiaries. The allowances are established
through charges to operations in the form of provisions for possible loan losses. Loan losses or recoveries are charged or credited directly to the allowances.

The
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 so indicate. Generally, unsecured consumer loans are charged off when 90 days past due.

While
management of the Company considers that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers
carefully, there is no precise method of predicting loan losses. The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged off as a loss is an
exercise of judgment. Similarly, the determination of the adequacy of the allowance for possible loan losses can be made only on a subjective basis. It is the judgment of the Company's management that
the allowance for possible loan losses at December 31, 2004 was adequate to absorb probable losses from loans in the portfolio at that date. See Critical Accounting Policies on page 23.

11

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Non-Interest Income

|                                            |                           | Year Ended
December 31,
2004 |        | Year Ended
December 31,
2003 |   | Percent Increase
(Decrease)
2004 vs. 2003 |         | Year Ended
December 31,
2002 |       | Percent
Increase
(Decrease)
2003 vs. 2002 |       
|------------------------------------------- | ------------------------- | ---------------------------- | ------ | ---------------------------- | - | ----------------------------------------- | ------- | ---------------------------- | ----- | ----------------------------------------- | ------
|
|Service charges on deposit accounts         |                           | $                            | 73,877 |                              | $ | 60,022                                    |         | 23.1                         | %     | $                                         | 52,648
|Other service charges, commissions and fees |                           |                              |        |                              |   |                                           |         |                              |       |                                           |       
|                                            | Banking                   |                              |        | 19,320                       |   |                                           | 14,104  |                              | 37.0  |                                           |       
|                                            | Non-banking               |                              |        | 7,083                        |   |                                           | 11,801  |                              | (40.0 | )                                         |       
|Investment securities transactions, net     |                           |                              | 8,884  |                              |   | 23,390                                    |         | (62.0                        | )     |                                           | 2,303 
|Other investments, net                      |                           |                              | 13,012 |                              |   | 8,606                                     |         | 51.2                         |       |                                           | (2,598
|Other income                                |                           |                              | 12,640 |                              |   | 9,350                                     |         | 35.2                         |       |                                           | 14,623
|                                            |                           |                              |        |                              |   |                                           |         |                              |       |                                           |       
|                                            | Total non-interest income |                              | $      | 134,816                      |   | $                                         | 127,273 |                              | 5.9   | %                                         | $     
|                                            |                           |                              |        |                              |   |                                           |         |                              |       |                                           |       

Non-interest
income for 2004 was positively affected by the Company's expansion into the state of Oklahoma through its acquisition of LFIN. The Company
recorded investment securities gains of $8,884,000 in 2004 compared to gains of $23,390,000 for 2003 and gains of $2,303,000 in 2002. These gains in 2003 occurred due to a program to reposition a
portion of the Company's bond portfolio to realize the equity that was eroding in the portfolio due to rapid principal repayments, the result of which, in effect, accelerated future earnings. The
decreases in non-banking service charges for 2004 can be attributed to a decrease in fees earned by the Company's investment services unit. Non-interest income also includes
income on other investments. Income on other investments increased to $13,012,000 in 2004 compared to $8,606,000 in 2003, and $(2,598,000) in 2002. The increase in 2004 can be attributed to the LFIN
acquisition. The decrease in 2002 can be attributed to losses taken by the Company on its investment in AFT. Other income for 2002 was positively affected by the sale of three bank branches in
Rockdale, Taylor and Giddings, Texas to Citizen's National Bank located in Cameron, Texas. The branches were previously acquired by the
Company in 2001 as part of its acquisition of National Bancshares Corporation. The gain recognized on the sale totaled $3,100,000.

Non-Interest Expense

|                                             |                            | Year Ended
December 31,
2004 |        | Year Ended
December 31,
2003 |   | Percent
Increase
(Decrease)
2004 vs. 2003 |         | Year Ended
December 31,
2002 |      | Percent
Increase
(Decrease)
2003 vs. 2002 |       
|-------------------------------------------- | -------------------------- | ---------------------------- | ------ | ---------------------------- | - | ----------------------------------------- | ------- | ---------------------------- | ---- | ----------------------------------------- | ------
|
|Employee compensation and benefits           |                            | $                            | 83,631 |                              | $ | 72,860                                    |         | 14.8                         | %    | $                                         | 65,907
|Occupancy                                    |                            |                              | 18,403 |                              |   | 12,050                                    |         | 52.7                         |      |                                           | 13,211
|Depreciation of bank premises and equipment  |                            |                              | 18,975 |                              |   | 18,105                                    |         | 4.8                          |      |                                           | 16,153
|Professional fees                            |                            |                              | 6,513  |                              |   | 7,545                                     |         | (13.7                        | )    |                                           | 6,089 
|Stationery and supplies                      |                            |                              | 5,075  |                              |   | 3,855                                     |         | 31.6                         |      |                                           | 4,079 
|Amortization of identified intangible assets |                            |                              | 3,681  |                              |   | 1,276                                     |         | 188.5                        |      |                                           | 1,812 
|Advertising                                  |                            |                              | 10,082 |                              |   | 7,011                                     |         | 43.8                         |      |                                           | 6,010 
|Other                                        |                            |                              | 48,820 |                              |   | 37,052                                    |         | 31.8                         |      |                                           | 41,582
|                                             |                            |                              |        |                              |   |                                           |         |                              |      |                                           |       
|                                             | Total non-interest expense |                              | $      | 195,180                      |   | $                                         | 159,754 |                              | 22.2 | %                                         | $     
|                                             |                            |                              |        |                              |   |                                           |         |                              |      |                                           |       

12

---



Expense control is an essential element in the Company's profitability. This is achieved through maintaining optimum staffing levels, an effective budgeting process, and internal
consolidation of bank functions. The increases in non-interest expense for the three years ended 2004 were due to the expanded operations of the Company's bank subsidiaries (including the
acquisition of LFIN in June 2004, which added approximately 700 employees, 52 branches and $42,188,000 in identified intangible assets) and increased fees paid by the Company's investment
banking unit, the GulfStar Group in 2003.

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, 2004, 2003 and 2002:

|                                                 |                    | December 31,
|------------------------------------------------ | ------------------ | ------------
|
|
|U.S. Treasury and Government Securities          |                    |             
|                                                 | Available for sale |             
|Mortgage-backed securities                       |                    |             
|                                                 | Available for sale |             
|Obligations of states and political subdivisions |                    |             
|                                                 | Available for sale |             
|Equity securities                                |                    |             
|                                                 | Available for sale |             
|Other securities                                 |                    |             
|                                                 | Held to maturity   |             
|                                                 | Available for sale |             
|                                                 |                    |             
|                                                 |                    | Total       
|                                                 |                    |             

The
following tables set forth the contractual maturities of investment securities, based on amortized cost, at December 31, 2004 and the average yields of such securities, except
for the totals, which reflect the

13

---



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 |      
|--------------------------------------------------------- | ----- | --------------------------- | -----
|
|
|
|
|U.S. Treasury and obligations of U.S. Government agencies |       | $                           | 9,285
|Mortgage-backed securities                                |       |                             | 353  
|Obligations of states and political subdivisions          |       |                             |     
|Other securities                                          |       |                             |     
|Equity securities                                         |       |                             | 325  
|                                                          |       |                             |      
|                                                          | Total |                             | $    
|                                                          |       |                             |      

|                 |  | Held to Maturity
Maturing
|---------------- |  | -------------------------
|
|
|
|
|Other securities |  | $                        
|                 |  |                          
|Total            |  | $                        
|                 |  |                          

Mortgage-backed securities are securities primarily issued by the Federal Home Loan Mortgage Corporation ("Freddie Mac"), Federal National
Mortgage Association ("Fannie Mae"), and the Government National Mortgage Association ("Ginnie Mae").

Loans

The amounts of loans outstanding, by classification, at December 31, 2004, 2003, 2002, 2001 and 2000 are shown in the following table:

|                                       |                                 | December 31, |          
|-------------------------------------- | ------------------------------- | ------------ | ---------
|
|
|Commercial, financial and agricultural |                                 | $            | 2,710,270
|Real estatemortgage                   |                                 |              | 960,599  
|Real estateconstruction               |                                 |              | 749,689  
|Consumer                               |                                 |              | 229,302  
|Foreign                                |                                 |              | 239,622  
|                                       |                                 |              |          
|                                       | Total loans                     |              |          
|Unearned discount                      |                                 |              | (508     
|                                       |                                 |              |          
|                                       | Loans, net of unearned discount |              | $        
|                                       |                                 |              |          

The following table shows the amounts of loans (excluding real estate mortgages and consumer loans) outstanding as of December 31, 2004,
which based on remaining scheduled repayments of principal are

14

---



due
in the years indicated. Also, the amounts due after one year are classified according to the sensitivity to changes in interest rates:

|                                       |       | Maturing
|-------------------------------------- | ----- | --------
|
|
|                                       |       |         
|Commercial, financial and agricultural |       | $       
|Real estateconstruction               |       |         
|Foreign                                |       |         
|                                       |       |         
|                                       | Total |         
|                                       |       |         

Interest sensitivityFixed Rate

Variable Rate(Dollars in Thousands)Due after one but within five years

$
401,705

$
1,584,976Due after five years


95,862


352,019Total

$
497,567

$
1,936,995


International Operations

On December 31, 2004, the Company had $239,622,000 (2.4% of total assets) in loans outstanding to borrowers domiciled in foreign countries. The loan
policies of the Company's bank subsidiaries generally require that loans to borrowers domiciled in foreign countries be primarily secured by assets located in the United States or have credit
enhancements, in the form of guarantees, from significant United States corporations. The composition of such loans and the related amounts of allocated allowance for possible loan losses as of
December 31, 2004 is presented below.

|                                                                                   |  | Amount of Loans |         | Related
Allowance for
Possible Losses
|---------------------------------------------------------------------------------- |  | --------------- | ------- | -------------------------------------
|
|                                                                                   |  |                 |         |                                      
|Secured by certificates of deposits in United States banks                         |  | $               | 131,140 |                                      
|Secured by United States real estate                                               |  |                 | 33,440  |                                      
|Secured by other United States collateral (securities, gold, silver, etc.)         |  |                 | 26,692  |                                      
|Foreign real estate guaranteed under lease obligations primarily by U.S. companies |  |                 | 1,213   |                                      
|Direct unsecured Mexican sovereign debt (principally former FICORCA debt)          |  |                 | 3,071   |                                      
|Other (principally Mexico real estate)                                             |  |                 | 44,066  |                                      
|                                                                                   |  |                 |         |                                      
|                                                                                   |  | $               | 239,622 |                                      
|                                                                                   |  |                 |         |                                      

15

---



The
transactions for the year ended December 31, 2004, in that portion of the allowance for possible loan losses related to foreign debt were as follows:

|                             |                                 | (Dollars in Thousands) |      
|---------------------------- | ------------------------------- | ---------------------- | -----
|                             |                                 |                        |      
|Balance at December 31, 2003 |                                 | $                      | 1,058
|                             | Chargeoffs                      |                        |      
|                             | Recoveries                      |                        |      
|                             |                                 |                        |      
|                             | Net chargeoffs                  |                        |      
|                             | Provision charged to operations |                        |      
|                             |                                 |                        |      
|Balance at December 31, 2004 |                                 | $                      | 2,327
|                             |                                 |                        |      

Deposits

|          |                                           | 2004                |          | 2003     
|--------- | ----------------------------------------- | ------------------- | -------- | ---------
|
|
|Deposits: |                                           |                     |          |          
|          | Demandnon-interest bearing               |                     |          |          
|          |                                           |                     | Domestic |          
|          |                                           |                     | Foreign  |          
|          |                                           |                     |          |          
|          | Total demand non-interest bearing         |                     |          | 988,659  
|          |                                           |                     |          |          
|          | Savings and interest bearing demand       |                     |          |          
|          |                                           |                     | Domestic |          
|          |                                           |                     | Foreign  |          
|          |                                           |                     |          |          
|          | Total savings and interest bearing demand |                     |          | 1,832,714
|          |                                           |                     |          |          
|          | Time certificates of deposit              |                     |          |          
|          |                                           | $100,000 or more:   |          |          
|          |                                           |                     | Domestic |          
|          |                                           |                     | Foreign  |          
|          |                                           | Less than $100,000: |          |          
|          |                                           |                     | Domestic |          
|          |                                           |                     | Foreign  |          
|          |                                           |                     |          |          
|          | Total time, certificates of deposit       |                     |          | 2,769,004
|          |                                           |                     |          |          
|          | Total deposits                            |                     | $        | 5,590,377
|          |                                           |                     |          |          

16

---



|                                   |                                                | 2004     |        | 2003   |        | 2002  
|---------------------------------- | ---------------------------------------------- | -------- | ------ | ------ | ------ | ------
|
|Interest expense:                  |                                                |          |        |        |        |       
|                                   | Savings and interest bearing demand            |          |        |        |        |       
|                                   |                                                | Domestic |        | $      | 11,991 |       
|                                   |                                                | Foreign  |        |        | 1,806  |       
|                                   |                                                |          |        |        |        |       
|                                   | Total savings and interest bearing demand      |          |        | 13,797 |        |       
|                                   |                                                |          |        |        |        |       
|                                   | Time, certificates of deposit $100,000 or more |          |        |        |        |       
|                                   |                                                | Domestic |        |        | 10,483 |       
|                                   |                                                | Foreign  |        |        | 17,327 |       
|                                   | Less than $100,000                             |          |        |        |        |       
|                                   |                                                | Domestic |        |        | 12,396 |       
|                                   |                                                | Foreign  |        |        | 4,453  |       
|                                   |                                                |          |        |        |        |       
|                                   | Total time, certificates of deposit            |          |        | 44,659 |        |       
|                                   |                                                |          |        |        |        |       
|Total interest expense on deposits |                                                | $        | 58,456 |        | $      | 51,181
|                                   |                                                |          |        |        |        |       

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 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, 2004 were $6,571,104,000, an increase of 48.1% over $4,435,699,000 at December 31, 2003. The increase in
deposits from 2003 to 2004 is primarily the result of the LFIN acquisition completed on June 18, 2004, and the Company's increased sales efforts.

Return on Equity and Assets

Certain key ratios for the Company for the years ended December 31, 2004, 2003 and 2002 follows (Note 1):

|                                                                   |                              | Years ended December 31, |      
|------------------------------------------------------------------ | ---------------------------- | ------------------------ | -----
|
|Percentage of net income to:                                       |                              |                          |      
|                                                                   | Average shareholders' equity |                          | 18.17
|                                                                   | Average total assets         |                          | 1.46 
|Percentage of average shareholders' equity to average total assets |                              | 8.05                     |      
|Percentage of cash dividends per share to net income per share     |                              | 38.42                    |      

(Note 1)
The average balances for purposes of the above table are calculated on the basis of month-end balances.

17

---



Liquidity and Capital Resources

Liquidity

The maintenance of adequate liquidity provides the Company's bank subsidiaries with the ability to meet potential depositor withdrawals, provide for customer
credit needs, maintain adequate statutory reserve levels and take full advantage of high-yield investment opportunities as they arise. Liquidity is afforded by access to financial markets
and by holding appropriate amounts of liquid assets. The bank subsidiaries of the Company 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 28%, 39% and 41% of the Company's bank subsidiaries' total deposits as of December 31, 2004, 2003 and 2002, respectively. The
decline in the concentration of Mexico based deposits can be attributed to recent acquisitions, including LFIN, and the growth in the Company's deposit base in Texas. Other important funding sources
for the Company's bank subsidiaries have been wholesale liabilities with the Federal Home Loan Bank ("FHLB") and large certificates of deposit, requiring management to closely monitor its
asset/liability mix in terms of both rate sensitivity and maturity distribution. Primary liquidity of the Company and its subsidiaries has been maintained by means of increased investment in
shorter-term securities, certificates of deposit and loans. As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of
rate-sensitive assets and liabilities, and respond accordingly to anticipated fluctuations in interest rates over reasonable periods of time.

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, 2004, 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

18

---



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.

|                                                                  |  | INTEREST RATE SENSITIVITY
(Dollars in Thousands)
|----------------------------------------------------------------- |  | ------------------------------------------------
|
|
|
|Rate sensitive assets                                             |  |                                                 
|Federal funds sold                                                |  | $                                               
|Time deposits with banks                                          |  |                                                 
|Investment securities                                             |  |                                                 
|Loans, net of non-accruals                                        |  |                                                 
|                                                                  |  |                                                 
|Total earning assets                                              |  | $                                               
|                                                                  |  |                                                 
|Cumulative earning assets                                         |  | $                                               
|                                                                  |  |                                                 
|Rate sensitive liabilities                                        |  |                                                 
|Time deposits                                                     |  | $                                               
|Other interest bearing deposits                                   |  |                                                 
|Fed funds purchased and securities old under repurchase agreement |  |                                                 
|Other borrowed funds                                              |  |                                                 
|Junior subordinated deferrable interest debentures                |  |                                                 
|                                                                  |  |                                                 
|Total interest bearing liabilities                                |  | $                                               
|                                                                  |  |                                                 
|Cumulative sensitive liabilities                                  |  | $                                               
|                                                                  |  |                                                 
|Repricing gap                                                     |  | $                                               
|Cumulative repricing gap                                          |  |                                                 
|Ratio of interest-sensitive assets to liabilities                 |  |                                                 
|Ratio of cumulative, interest- sensitive assets to liabilities    |  |                                                 

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

19

---



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, 2004, based on these simulations, a rate shift of 200 basis points in interest rates up or 100 basis points down will not vary earnings by more than 3% of
projected 2005 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 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 21 to the Consolidated Financial Statements. At December 31, 2004,
the aggregate amount legally available to be distributed to the Company from bank subsidiaries as dividends was approximately $61,000,000, assuming that each bank subsidiary continues to be classified
as "well capitalized" under the applicable regulations and excluding certified surplus. Pursuant to Texas law, a Texas state bank's lending limit is twenty-five percent of the bank's
capital and certified surplus. The board of directors of the bank determines how much surplus will be certified. Except to absorb losses in excess of undivided profits and uncertified surplus,
certified surplus may not be reduced without the prior written approval of the Texas banking commissioner. The restricted capital (capital, surplus and certified surplus) of the bank subsidiaries was
approximately $863,604,000 as of December 31, 2004. The undivided profits of the bank subsidiaries were approximately $417,388,000 as of December 31, 2004.

At
December 31, 2004, the Company has outstanding $1,670,199,000 in other borrowed funds and $235,395,000 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.

The
Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders. At December 31, 2004, shareholders' equity was $753,090,000 compared
to $577,383,000 at December 31, 2003, an increase of $175,706,000, or 30.4%. The increase in shareholders' equity can be attributed to the retention of earnings and the issuance of 2,114,558
shares of the Company's Common Stock as part of the LFIN acquisition. 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 6.91% at December 31, 2004 and 8.75% at December 31, 2003. The core deposit intangibles and goodwill of $333,662,000 as of December 31, 2004, recorded in
connection with financial institution acquisitions of the Company after February 1992, are deducted from the sum of core capital elements when determining the capital ratios of the Company. The
substantial increase in core deposit intangibles and goodwill and the resulting decrease in the Company's leverage ratio can be attributed to the LFIN acquisition.

20

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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 10.74% and 17.30% and risk weighted total capital ratios of 11.99% and 19.33% as of December 31, 2004 and 2003, respectively, which are well
above the minimum regulatory requirements and exceed the well capitalized ratios (see note 21 to notes to Consolidated Financial Statements).

During
the past few years the Company has expanded its banking facilities. Among the activities and commitments the Company funded during 2004 and 2003 were certain capital expenditures
relating to the modernization and improvement of several existing bank facilities and the expansion of the bank branch network.

Junior Subordinated Deferrable Interest Debentures

In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities." The intention of FIN 46 was to clarify the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain entities in which equity investors do
not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support
from other parties. FIN 46 requires an enterprise considered to be a variable interest entity ("VIE") to be consolidated by the primary beneficiary, which represents the enterprise that will absorb
the majority of the VIE's expected losses if they occur, receive a majority of the VIE's residual
returns if they occur, or both. In December 2003, the FASB issued Staff Interpretation No. 46R ("FIN 46R"), "Consolidation of Variable Interest Entities, an interpretation of ARB
51 (revised December 2003)," which replaces FIN 46, in order to clarify the guidance in the original interpretation. FIN 46 applies to variable interest entities created after
January 31, 2003. FIN 46 also applies to all variable interest entities created prior to February 1, 2003 that are considered to be special-purpose entities, as defined in FIN 46R, as of
December 31, 2003. FIN 46R must be applied to all variable interest entities no later than the end of the first reporting period that ends after March 15, 2004. The Company early adopted
the provisions of FIN 46R as of December 31, 2003.

The
Company has formed eight statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. As part of the LFIN acquisition,
the Company acquired three additional statutory business trusts previously formed by LFIN for the purpose of issuing trust preferred securities. The eight statutory business trusts formed by the
Company and the three business trusts acquired in the LFIN transaction (the "Trusts") have each issued Capital and Common Securities and invested the proceeds thereof in an equivalent amount of junior
subordinated debentures (the "Debentures") issued by the Company or LFIN, as appropriate. The Company has succeeded to the obligations of LFIN under the LFIN Debentures, which have an outstanding
principal balance of $62,115,000. The Debentures will mature on various dates; however the Debentures may be redeemed at specified prepayment prices, in whole or in part after the optional redemption
dates specified in the respective indentures or in whole upon the occurrence of any one of certain legal, regulatory or tax events specified in respective indentures. As of December 31, 2004,
the principal amount of debentures outstanding totaled $235,395,000.

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 passuwith one

21

---



another.
The interest rate payable on, and the payment terms of the Debentures are the same as the distribution rate and payment terms of the respective issues of Capital and Common Securities issued
by the Trusts. The Company has fully and unconditionally guaranteed the obligations of each of the Trusts with respect to the Capital and Common Securities. The Company has the right, unless an Event
of Default (as defined in the Indentures) has occurred and is continuing, to defer payment of interest on the Debentures for up to ten consecutive semi-annual periods on Trusts I through
IV and LFIN Trust II and for up to twenty consecutive quarterly periods on Trusts V through VIII and LFIN Trusts I and III. If interest payments on any of the Debentures are deferred, distributions on
both the Capital and Common Securities related to that Debenture would also be deferred. The redemption prior to maturity of any of the Debentures may require the prior approval of the Federal Reserve
and/or other regulatory bodies.

For
financial reporting purposes, the Trusts are treated as non-banking subsidiaries of the Company and consolidated in the consolidated financial statements prior to
December 31, 2003. Since the Company's adoption of FIN 46R on December 31, 2003, the Trusts are treated as investments of the Company and not consolidated in the consolidated financial
statements. Although the Capital Securities issued by each of the Trusts are not included as a component of shareholders' equity on the consolidated statement of condition, the Capital Securities are
treated as capital for regulatory
purposes. Specifically, under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital on an aggregate basis.
Any amount that exceeds the 25% threshold would qualify as Tier 2 capital. For December 31, 2004, the total $235,395,000 of the Capital Securities outstanding qualified as Tier 1 capital.

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

The
following table illustrates key information about each of the Debentures and their interest rates at December 31, 2004:

|               |  | Junior
Subordinated
Deferrable
Interest
Debentures |         | Repricing
Frequency |               | Interest Rate |       | Interest Rate
Index |               | Maturity Date |                | Optional
Redemption
Date
|-------------- |  | -------------------------------------------------- | ------- | ------------------- | ------------- | ------------- | ----- | ------------------- | ------------- | ------------- | -------------- | ------------------------
|
|               |  |                                                    |         |                     |               |               |       |                     |               |               |                |                         
|Trust I        |  | $                                                  | 10,183  |                     | Fixed         |               | 10.18 | %                   | Fixed         |               | June 2031      |                         
|Trust II       |  | $                                                  | 25,597  |                     | Semi-Annually |               | 5.74  | %                   | LIBOR + 3.75  |               | July 2031      |                         
|Trust III      |  | $                                                  | 33,789  |                     | Semi-Annually |               | 6.44  | %                   | LIBOR + 3.75  |               | December 2031  |                         
|Trust IV       |  | $                                                  | 22,405  |                     | Semi-Annually |               | 6.00  | %                   | LIBOR + 3.70  |               | April 2032     |                         
|Trust V        |  | $                                                  | 20,319  |                     | Quarterly     |               | 5.72  | %                   | LIBOR + 3.65  |               | July 2032      |                         
|Trust VI       |  | $                                                  | 25,361  |                     | Quarterly     |               | 5.74  | %                   | LIBOR + 3.45  |               | November 2032  |                         
|Trust VII      |  | $                                                  | 10,310  |                     | Quarterly     |               | 5.41  | %                   | LIBOR + 3.25  |               | April 2033     |                         
|Trust VIII     |  | $                                                  | 25,316  |                     | Quarterly     |               | 5.12  | %                   | LIBOR + 3.05  |               | October 2033   |                         
|LFIN Trust I   |  | $                                                  | 41,495  |                     | Fixed         |               | 9.00  | %                   | Fixed         |               | September 2031 |                         
|LFIN Trust II  |  | $                                                  | 10,310  |                     | Semi-Annually |               | 5.61  | %                   | LIBOR + 3.625 |               | July 2032      |                         
|LFIN Trust III |  | $                                                  | 10,310  |                     | Quarterly     |               | 5.74  | %                   | LIBOR + 3.45  |               | November 2032  |                         
|               |  |                                                    |         |                     |               |               |       |                     |               |               |                |                         
|               |  | $                                                  | 235,395 |                     |               |               |       |                     |               |               |                |                         
|               |  |                                                    |         |                     |               |               |       |                     |               |               |                |                         

22

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Contractual Obligations and Commercial Commitments

The following table presents contractual cash obligations of the Company (other than deposit liabilities) as of December 31, 2004:

|                                                   |  | Payments due by Period
|-------------------------------------------------- |  | ----------------------
|
|
|Securities sold under repurchase agreements        |  | $                     
|Federal Home Loan Bank borrowings                  |  |                       
|Junior subordinated deferrable interest debentures |  |                       
|                                                   |  |                       
|Total Contractual Cash Obligations                 |  | $                     
|                                                   |  |                       

The
following table presents contractual commercial commitments of the Company (other than deposit liabilities) as of December 31, 2004:

|                                                    |                              | Amount of Commitment Expiration Per Period
|--------------------------------------------------- | ---------------------------- | ------------------------------------------
|
|
|Financial and Performance Standby Letters of Credit |                              | $                                         
|Commercial Letters of Credit                        |                              |                                           
|Credit Card Lines                                   |                              |                                           
|Other Commercial Commitments                        |                              |                                           
|                                                    |                              |                                           
|                                                    | Total Commercial Commitments |                                           
|                                                    |                              |                                           

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 footnotes to the consolidated financial statements. Certain accounting policies involve significant subjective judgments
and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies.

The
Company considers its Allowance for Possible Loan Losses as a policy critical to the sound operations of the bank subsidiaries. The allowance for possible loan losses consists of the
aggregate loan loss allowances of the bank subsidiaries. The allowances are established through charges to operations in the form of provisions for possible loan losses. Loan losses or recoveries are
charged or credited directly to the allowances. The allowance for possible loan losses of each bank subsidiary is maintained at a level considered appropriate by management, based on estimated
probable losses in the loan portfolio. The allowance is derived from the following elements: (i) allowances established on specific loans and (ii) allowances based on historical loss
experience on the Company's remaining loan portfolio, which includes general economic conditions and other qualitative risk factors both internal and external to the Company. See also discussion
regarding the allowance for possible loan losses and provision for possible

23

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loan
losses included in the results of operations and "Provision and Allowance for Possible Loan Losses" included in Notes 1 and 5 of the Notes to Consolidated Financial Statements for further
information regarding the Company's provision and allowance for possible loan losses policy.

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

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

The
allowance, based on historical loss experience on the Company's remaining loan portfolio, which includes the "Pass Credits," "Special Review Credits," "Watch List
Credits-Pass Credits," and "Watch List Credits-Substandard and Doubtful Credits" is determined by segregating the remaining loan portfolio into certain categories such as commercial loans,
installment loans, international loans, loan concentrations and overdrafts. Installment loans are then further segregated by number of days past due. A historical loss percentage, adjusted for
(i) management's evaluation of changes in lending policies and procedures, (ii) current economic conditions in the market area served by the Company, (iii) other risk factors,
(iv) the effectiveness of the internal loan review function, (v) changes in loan portfolios, and (vi) the composition and concentration of credit volume is applied to each
category. Each category is then added together to determine the allowance allocated under Statement of Financial Accounting Standards No. 5.

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

24

---



Recent Accounting Standards Issued

See Note 1New Accounting Standards in the accompanying notes to the consolidated financial statements for details of recently issued and
recently adopted accounting standards and their impact on the Company's consolidated financial statements.

Common Stock and Dividends

The Company had issued and outstanding 50,899,550 shares of $1.00 par value Common Stock held by approximately 2,447 holders of record at March 7, 2005.
The book value of the stock, adjusted for stock dividends, at December 31, 2004 was $16.49 per share compared with $12.94 per share at December 31, 2003.

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,
adjusted for stock dividends during 2003 and 2004, as quoted on the NASDAQ National Market for each of the quarters in the two year period ended December 31, 2004. Some of the quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The closing sales price of the Company's
Common Stock was $36.75 per share at March 7, 2005.

High

Low2004:

First quarter

$
44.17

$
36.80Second quarter


43.52


32.20Third quarter


40.42


32.96Fourth quarter


41.52


35.36


High

Low2003:

First quarter

$
33.57

$
28.60Second quarter


39.39


27.40Third quarter


35.66


28.01Fourth quarter


38.18


33.20


The
Company paid cash dividends to the shareholders in 2004 of $.50 ($.40, adjusted for the effect of stock dividends) and $.40 per share on April 30, 2004 and November 1,
2004, respectively to all holders of record on April 15, 2004 and October 15, 2004, respectively, or $39,767,000 in the aggregate during 2004. In 2003, the Company paid cash dividends of
$.27 per share on April 15, and $.40 per share on October 15, adjusted for stock dividends, or $32,625,000 in the aggregate. The Company has no set schedule for paying cash or stock
dividends and does not guarantee that they will be declared in the future. In addition, the Company has issued stock dividends during the last five-year period as follows:

Date

Stock DividendMay 18, 2000

25
%May 17, 2001

25
%May 20, 2002

25
%May 19, 2003

25
%May 3, 2004

25
%


The
Company's principal source of funds to pay cash dividends on its Common Stock is cash dividends from its bank subsidiaries. There are certain statutory limitations on the payment of
dividends from the subsidiary banks. For a discussion of the limitations, please see Note 21 of notes to Consolidated Financial Statements.

25

---



Stock Repurchase Program

The Company expanded its formal stock repurchase program on December 16, 2004. Under the expanded stock repurchase program, the Company is authorized to
repurchase up to $175,000,000 of its Common Stock through December 31, 2005. Stock repurchases may be made from time to time on the open market or through private transactions. Shares
repurchased in this program will be held in treasury for reissue for various corporate purposes, including employee stock option plans. As of March 7, 2005, a total of 3,663,577 shares
had been repurchased under this program at a cost of $145,650,000, which shares are now reflected as 7,253,456 shares of treasury stock as adjusted for stock dividends. Stock repurchases are
reviewed quarterly at the Company's Board of Directors meetings and the Board of Directors has stated that the aggregate investment in treasury stock should not exceed $195,973,000. In the past, the
Board of Directors has increased previous caps on treasury stock once they were met, but there are no assurances that an increase of the $195,973,000 cap will occur in the future. As of
March 7, 2005, the Company has approximately $166,624,000 invested in treasury shares, which amount has been accumulated since the inception of the Company.

Share
repurchases are only conducted under publicly announced repurchase programs approved by the Board of Directors. The following table includes information about share repurchases for
the quarter ended December 31, 2004.

|                             |  | Total
Number of
Shares
Purchased |  | Average
Price Paid
Per Share |       | Shares
Purchased as
Part of a
Publicly-
Announced
Program |   | Approximate
Dollar Value of
Shares Available
for Repurchase(1)
|---------------------------- |  | -------------------------------- |  | ---------------------------- | ----- | --------------------------------------------------------- | - | --------------------------------------------------------------
|October 1October 31, 2004   |  |                                 |  | $                            |      |                                                           |  |                                                               
|November 1November 30, 2004 |  |                                 |  |                              |      |                                                           |  |                                                               
|December 1December 31, 2004 |  | 7,324                            |  |                              | 39.90 |                                                           |  |                                                               
|                             |  |                                  |  |                              |       |                                                           |   |                                                               
|                             |  | 7,324                            |  | $                            | 39.90 |                                                           |  |                                                               
|                             |  |                                  |  |                              |       |                                                           |   |                                                               

---

Recent Sales of Unregistered Securities

On December 31, 2004, 7,324 shares of unregistered Common Stock were issued pursuant to the exercise of options at an exercise price of $13.32, adjusted
for stock dividends, by certain employees of the GulfStar Group, who are not executive officers of the Company. Neither the options nor the shares of Common Stock of the Company underlying these
options were registered under the Company's 1996 Stock Option Plan. The shares were issued in a transaction by the Company not involving a public offering, which was exempted from registration
pursuant to Section 4(2) of the Securities Act of 1933. The shares of Company Common Stock issued are restricted securities and are subject to resale restrictions.

26

---



Equity Compensation Plan Information

The following table sets forth information as of December 31, 2004, with respect to the Company's equity compensation plans:

|                                                              |       | (A)       |           | (B) |       | (C)  
|------------------------------------------------------------- | ----- | --------- | --------- | --- | ----- | -----
|
|Equity Compensation plans approved by security holders        |       | 1,298,745 |           | $   | 14.90 |      
|Equity Compensation plans not approved by security holders(1) |       | 139,160   |           |     | 13.32 |      
|                                                              |       |           |           |     |       |      
|                                                              | Total |           | 1,437,905 |     | $     | 14.75
|                                                              |       |           |           |     |       |      

---

27

---





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Shareholders
International Bancshares Corporation:

We
have audited the accompanying consolidated statements of condition of International Bancshares Corporation and subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2004. These
consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of International Bancshares Corporation and
subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31,
2004, in conformity with U.S. generally accepted accounting principles.

As
discussed in notes 1 and 11 to the consolidated financial statements, effective December 31, 2003, the Company changed its method of accounting for its investment in its
statutory business trusts, and as discussed in note 1 to the consolidated financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill and
other intangible assets.

We
also have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of International Bancshares Corporation and
subsidiaries' internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control  Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2005 expressed an unqualified opinion on management's assessment of, and the effective
operation of, internal control over financial reporting.

/s/
KPMG LLP

San
Antonio, Texas
March 15, 2005

28

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Condition        December 31, 2004 and 2003        (Dollars in Thousands, Except Per Share
Amounts)

|                                  |                                                                                                            | 2004 |                                 | 2003      |  
|--------------------------------- | ---------------------------------------------------------------------------------------------------------- | ---- | ------------------------------- | --------- | -
|Assets                            |                                                                                                            |      |                                 |           |  
|Cash and due from banks           |                                                                                                            | $    | 174,770                         |           | $
|Federal funds sold                |                                                                                                            |      | 21,000                          |           |  
|                                  |                                                                                                            |      |                                 |           |  
|                                  |                                                                                                            |      | Total cash and cash equivalents |           |  
|Time deposits with banks          |                                                                                                            |      | 396                             |           |  
|Investment securities:            |                                                                                                            |      |                                 |           |  
|                                  | Held to maturity (Market value of $2,385 on December 31, 2004 and $2,160 on December 31, 2003)             |      |                                 | 2,385     |  
|                                  | Available for sale (Amortized cost of $3,851,741 on December 31, 2004 and $3,019,584 on December 31, 2003) |      |                                 | 3,874,833 |  
|                                  |                                                                                                            |      |                                 |           |  
|                                  |                                                                                                            |      | Total investment securities     |           |  
|Loans, net of unearned discounts  |                                                                                                            |      | 4,888,974                       |           |  
|                                  | Less allowance for possible loan losses                                                                    |      |                                 | (84,905   | )
|                                  |                                                                                                            |      |                                 |           |  
|                                  |                                                                                                            |      | Net loans                       |           |  
|Bank premises and equipment, net  |                                                                                                            |      | 302,230                         |           |  
|Accrued interest receivable       |                                                                                                            |      | 41,140                          |           |  
|Other investments                 |                                                                                                            |      | 301,578                         |           |  
|Identified intangible assets, net |                                                                                                            |      | 44,400                          |           |  
|Goodwill, net                     |                                                                                                            |      | 289,262                         |           |  
|Other assets                      |                                                                                                            |      | 61,888                          |           |  
|                                  |                                                                                                            |      |                                 |           |  
|                                  |                                                                                                            |      | Total assets                    |           | $
|                                  |                                                                                                            |      |                                 |           |  

See accompanying notes to consolidated financial statements.

29

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Condition, continued        December 31, 2004 and 2003        (Dollars in Thousands, Except
Per Share Amounts)

|                                                                                                                   |                                                                                                                                                          | 2004 |                                            | 2003      |  
|------------------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------- | ---- | ------------------------------------------ | --------- | -
|Liabilities                                                                                                        |                                                                                                                                                          |      |                                            |           |  
|Deposits:                                                                                                          |                                                                                                                                                          |      |                                            |           |  
|                                                                                                                   | Demandnon-interest bearing                                                                                                                              |      | $                                          | 1,150,999 |  
|                                                                                                                   | Savings and interest bearing demand                                                                                                                      |      |                                            | 2,232,102 |  
|                                                                                                                   | Time                                                                                                                                                     |      |                                            | 3,188,003 |  
|                                                                                                                   |                                                                                                                                                          |      |                                            |           |  
|                                                                                                                   |                                                                                                                                                          |      | Total deposits                             |           |  
|Federal funds purchased and securities sold under repurchase agreements                                            |                                                                                                                                                          |      | 619,806                                    |           |  
|Other borrowed funds                                                                                               |                                                                                                                                                          |      | 1,670,199                                  |           |  
|Junior subordinated deferrable interest debentures                                                                 |                                                                                                                                                          |      | 235,395                                    |           |  
|Other liabilities                                                                                                  |                                                                                                                                                          |      | 68,357                                     |           |  
|                                                                                                                   |                                                                                                                                                          |      |                                            |           |  
|                                                                                                                   |                                                                                                                                                          |      | Total liabilities                          |           |  
|                                                                                                                   |                                                                                                                                                          |      |                                            |           |  
|Shareholders' equity:                                                                                              |                                                                                                                                                          |      |                                            |           |  
|                                                                                                                   | Common shares of $1.00 par value. Authorized 75,000,000 shares; issued 68,431,225 shares on December 31, 2004 and 52,774,176 shares on December 31, 2003 |      |                                            | 68,431    |  
|                                                                                                                   | Surplus                                                                                                                                                  |      |                                            | 130,597   |  
|                                                                                                                   | Retained earnings                                                                                                                                        |      |                                            | 705,642   |  
|                                                                                                                   | Accumulated other comprehensive income                                                                                                                   |      |                                            | 15,010    |  
|                                                                                                                   |                                                                                                                                                          |      |                                            |           |  
|                                                                                                                   |                                                                                                                                                          |      | 919,680                                    |           |  
|Less cost of shares in treasury, 17,610,126 shares on December 31, 2004 and 14,068,296 shares on December 31, 2003 |                                                                                                                                                          |      | (166,590                                   | )         |  
|                                                                                                                   |                                                                                                                                                          |      |                                            |           |  
|                                                                                                                   | Total shareholders' equity                                                                                                                               |      |                                            | 753,090   |  
|                                                                                                                   |                                                                                                                                                          |      |                                            |           |  
|                                                                                                                   |                                                                                                                                                          |      | Total liabilities and shareholders' equity |           | $
|                                                                                                                   |                                                                                                                                                          |      |                                            |           |  

See accompanying notes to consolidated financial statements.

30

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Income        Years ended December 31, 2004, 2003 and 2002        (Dollars in Thousands,
Except Per Share Amounts)

|                                   |                                                                         | 2004                                                         |       | 2003    |         | 2002  |        
|---------------------------------- | ----------------------------------------------------------------------- | ------------------------------------------------------------ | ----- | ------- | ------- | ----- | -------
|Interest income:                   |                                                                         |                                                              |       |         |         |       |        
|                                   | Loans, including fees                                                   |                                                              | $     | 236,079 |         | $     | 176,800
|                                   | Time deposits with banks                                                |                                                              |       | 92      |         |       | 9      
|                                   | Federal funds sold                                                      |                                                              |       | 1,577   |         |       | 594    
|                                   | Investment securities:                                                  |                                                              |       |         |         |       |        
|                                   |                                                                         | Taxable                                                      |       |         | 109,092 |       |        
|                                   |                                                                         | Tax-exempt                                                   |       |         | 5,071   |       |        
|                                   | Other interest income                                                   |                                                              |       | 467     |         |       | 370    
|                                   |                                                                         |                                                              |       |         |         |       |        
|                                   |                                                                         | Total interest income                                        |       |         | 352,378 |       |        
|                                   |                                                                         |                                                              |       |         |         |       |        
|Interest expense:                  |                                                                         |                                                              |       |         |         |       |        
|                                   | Savings deposits                                                        |                                                              |       | 13,797  |         |       | 10,168 
|                                   | Time deposits                                                           |                                                              |       | 44,659  |         |       | 41,013 
|                                   | Federal funds purchased and securities sold under repurchase agreements |                                                              |       | 19,865  |         |       | 18,770 
|                                   | Other borrowings                                                        |                                                              |       | 16,746  |         |       | 15,839 
|                                   | Junior subordinated deferrable interest debentures                      |                                                              |       | 13,152  |         |       | 8,935  
|                                   | Senior notes                                                            |                                                              |       | 383     |         |       |       
|                                   |                                                                         |                                                              |       |         |         |       |        
|                                   |                                                                         | Total interest expense                                       |       |         | 108,602 |       |        
|                                   |                                                                         |                                                              |       |         |         |       |        
|                                   |                                                                         | Net interest income                                          |       |         | 243,776 |       |        
|Provision for possible loan losses |                                                                         |                                                              | 6,500 |         |         | 8,291 |        
|                                   |                                                                         |                                                              |       |         |         |       |        
|                                   |                                                                         | Net interest income after provision for possible loan losses |       |         | 237,276 |       |        
|                                   |                                                                         |                                                              |       |         |         |       |        
|Non-interest income:               |                                                                         |                                                              |       |         |         |       |        
|                                   | Service charges on deposit accounts                                     |                                                              |       | 73,877  |         |       | 60,022 
|                                   | Other service charges, commissions and fees                             |                                                              |       |         |         |       |        
|                                   |                                                                         | Banking                                                      |       |         | 19,320  |       |        
|                                   |                                                                         | Non-banking                                                  |       |         | 7,083   |       |        
|                                   | Investment securities transactions, net                                 |                                                              |       | 8,884   |         |       | 23,390 
|                                   | Other investments, net                                                  |                                                              |       | 13,012  |         |       | 8,606  
|                                   | Other income                                                            |                                                              |       | 12,640  |         |       | 9,350  
|                                   |                                                                         |                                                              |       |         |         |       |        
|                                   |                                                                         | Total non-interest income                                    |       |         | 134,816 |       |        
|                                   |                                                                         |                                                              |       |         |         |       |        

See accompanying notes to consolidated financial statements.

31

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Income, continued        Years ended December 31, 2004, 2003 and 2002        (Dollars in
Thousands, Except Per Share Amounts)

|                                                                  |                                                                     | 2004                                                                |        | 2003       |         | 2002   |           
|----------------------------------------------------------------- | ------------------------------------------------------------------- | ------------------------------------------------------------------- | ------ | ---------- | ------- | ------ | ----------
|Non-interest expense:                                             |                                                                     |                                                                     |        |            |         |        |           
|                                                                  | Employee compensation and benefits                                  |                                                                     | $      | 83,631     |         | $      | 72,860    
|                                                                  | Occupancy                                                           |                                                                     |        | 18,403     |         |        | 12,050    
|                                                                  | Depreciation of bank premises and equipment                         |                                                                     |        | 18,975     |         |        | 18,105    
|                                                                  | Professional fees                                                   |                                                                     |        | 6,513      |         |        | 7,545     
|                                                                  | Stationery and supplies                                             |                                                                     |        | 5,075      |         |        | 3,855     
|                                                                  | Amortization of identified intangible assets                        |                                                                     |        | 3,681      |         |        | 1,276     
|                                                                  | Advertising                                                         |                                                                     |        | 10,082     |         |        | 7,011     
|                                                                  | Other                                                               |                                                                     |        | 48,820     |         |        | 37,052    
|                                                                  |                                                                     |                                                                     |        |            |         |        |           
|                                                                  |                                                                     | Total non-interest expense                                          |        |            | 195,180 |        |           
|                                                                  |                                                                     |                                                                     |        |            |         |        |           
|                                                                  |                                                                     | Income before income taxes                                          |        |            | 176,912 |        |           
|Provision for income taxes                                        |                                                                     |                                                                     | 57,880 |            |         | 60,426 |           
|                                                                  |                                                                     |                                                                     |        |            |         |        |           
|                                                                  |                                                                     | Income before cumulative effect of a change in accounting principle |        |            | 119,032 |        |           
|Cumulative effect of a change in accounting principle, net of tax |                                                                     |                                                                     |       |            |         |       |           
|                                                                  |                                                                     |                                                                     |        |            |         |        |           
|                                                                  |                                                                     | Net income                                                          |        | $          | 119,032 |        | $         
|                                                                  |                                                                     |                                                                     |        |            |         |        |           
|Basic earnings per common share:                                  |                                                                     |                                                                     |        |            |         |        |           
|                                                                  | Weighted average number of shares outstanding:                      |                                                                     |        | 49,707,319 |         |        | 48,362,449
|                                                                  | Income before cumulative effect of a change in accounting principle |                                                                     | $      | 2.39       |         | $      | 2.53      
|                                                                  | Cumulative effect of a change in accounting principle, net of tax   |                                                                     |        |           |         |        |          
|                                                                  |                                                                     |                                                                     |        |            |         |        |           
|                                                                  | Net income                                                          |                                                                     | $      | 2.39       |         | $      | 2.53      
|                                                                  |                                                                     |                                                                     |        |            |         |        |           
|Fully diluted earnings per common share:                          |                                                                     |                                                                     |        |            |         |        |           
|                                                                  | Weighted average number of shares outstanding:                      |                                                                     |        | 50,704,445 |         |        | 49,334,313
|                                                                  | Income before cumulative effect of a change in accounting principle |                                                                     | $      | 2.35       |         | $      | 2.48      
|                                                                  | Cumulative effect of a change in accounting principle, net of tax   |                                                                     |        |           |         |        |          
|                                                                  |                                                                     |                                                                     |        |            |         |        |           
|                                                                  | Net income                                                          |                                                                     | $      | 2.35       |         | $      | 2.48      
|                                                                  |                                                                     |                                                                     |        |            |         |        |           

See accompanying notes to consolidated financial statements.

32

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Comprehensive Income        Years ended December 31, 2004, 2003, and 2002        (Dollars in
Thousands)

|                                        |                                                                                               | 2004 |         | 2003   |   | 2002    |        
|--------------------------------------- | --------------------------------------------------------------------------------------------- | ---- | ------- | ------ | - | ------- | -------
|Net income                              |                                                                                               | $    | 119,032 |        | $ | 122,128 |        
|Other comprehensive income, net of tax: |                                                                                               |      |         |        |   |         |        
|                                        | Net unrealized (losses) gains on securities available for sale arising during the year        |      |         | (6,361 | ) |         | (82,728
|                                        | Reclassification adjustment for gains on securities available for sale included in net income |      |         | 8,529  |   |         | 44,997 
|                                        | Change in fair value of equity method investee's derivatives                                  |      |         |       |   |         | 616    
|                                        |                                                                                               |      |         |        |   |         |        
|Comprehensive income                    |                                                                                               | $    | 121,200 |        | $ | 85,013  |        
|                                        |                                                                                               |      |         |        |   |         |        

See accompanying notes to consolidated financial statements.

33

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Shareholders' Equity        Years ended December 31, 2004, 2003 and 2002        (in Thousands)

|                             |                                           | Number of Shares                                                                                               |       | Common Stock |        | Surplus |        | Retained Earnings |        | Accumulated Other Comprehensive Income (Loss) |         | Treasury Stock |         | Total  |  
|---------------------------- | ----------------------------------------- | -------------------------------------------------------------------------------------------------------------- | ----- | ------------ | ------ | ------- | ------ | ----------------- | ------ | --------------------------------------------- | ------- | -------------- | ------- | ------ | -
|Balance at December 31, 2001 |                                           | 33,214                                                                                                         |       | $            | 33,214 |         | $      | 27,564            |        | $                                             | 490,328 |                | $       | 18,221 |  
|                             | Net income                                |                                                                                                                |      |              |        |        |        |                   |       |                                               |         | 100,631        |         |        | 
|                             | Dividends:                                |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|                             |                                           | Shares issued                                                                                                  |       | 8,331        |        |         | 8,331  |                   |        |                                              |         |                | (8,331  | )      |  
|                             |                                           | Cash                                                                                                           |       |             |        |         |       |                   |        |                                              |         |                | (22,015 | )      |  
|                             | Purchase of treasury stock                |                                                                                                                |      |              |        |        |        |                   |       |                                               |         |               |         |        | 
|                             | Exercise of stock options                 |                                                                                                                | 221   |              |        | 221     |        |                   | 3,257  |                                               |         |               |         |        | 
|                             | Other comprehensive income, net of tax:   |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|                             |                                           | Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustment |       |             |        |         |       |                   |        |                                              |         |                |        |        |  
|                             |                                           | Change in fair value of equity method investee's derivatives                                                   |       |             |        |         |       |                   |        |                                              |         |                |        |        |  
|                             |                                           |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|Balance at December 31, 2002 |                                           | 41,766                                                                                                         |       |              | 41,766 |         |        | 30,821            |        |                                               | 560,613 |                |         | 49,957 |  
|                             | Net income                                |                                                                                                                |      |              |        |        |        |                   |       |                                               |         | 122,128        |         |        | 
|                             | Dividends:                                |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|                             |                                           | Shares issued                                                                                                  |       | 10,510       |        |         | 10,510 |                   |        |                                              |         |                | (10,510 | )      |  
|                             |                                           | Cash                                                                                                           |       |             |        |         |       |                   |        |                                              |         |                | (32,625 | )      |  
|                             | Purchase of treasury stock                |                                                                                                                |      |              |        |        |        |                   |       |                                               |         |               |         |        | 
|                             | Exercise of stock options                 |                                                                                                                | 498   |              |        | 498     |        |                   | 6,956  |                                               |         |               |         |        | 
|                             | Other comprehensive income, net of tax:   |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|                             |                                           | Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustment |       |             |        |         |       |                   |        |                                              |         |                |        |        |  
|                             |                                           | Change in fair value of equity method investee's derivatives                                                   |       |             |        |         |       |                   |        |                                              |         |                |        |        |  
|                             |                                           |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|Balance at December 31, 2003 |                                           | 52,774                                                                                                         |       |              | 52,774 |         |        | 37,777            |        |                                               | 639,606 |                |         | 12,842 |  
|                             | Net income                                |                                                                                                                |      |              |        |        |        |                   |       |                                               |         | 119,032        |         |        | 
|                             | Dividends:                                |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|                             |                                           | Shares issued                                                                                                  |       | 13,229       |        |         | 13,229 |                   |        |                                              |         |                | (13,229 | )      |  
|                             |                                           | Cash                                                                                                           |       |             |        |         |       |                   |        |                                              |         |                | (39,767 | )      |  
|                             | Purchase of treasury stock                |                                                                                                                |      |              |        |        |        |                   |       |                                               |         |               |         |        | 
|                             | Exercise of stock options                 |                                                                                                                | 313   |              |        | 313     |        |                   | 3,761  |                                               |         |               |         |        | 
|                             | Tax benefit for exercise of stock options |                                                                                                                |      |              |        |        |        |                   | 1,192  |                                               |         |               |         |        | 
|                             | Stock issued in acquisition               |                                                                                                                | 2,115 |              |        | 2,115   |        |                   | 87,867 |                                               |         |               |         |        | 
|                             | Other comprehensive income, net of tax:   |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|                             |                                           | Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustment |       |             |        |         |       |                   |        |                                              |         |                |        |        |  
|                             |                                           |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  
|Balance at December 31, 2004 |                                           | 68,431                                                                                                         |       | $            | 68,431 |         | $      | 130,597           |        | $                                             | 705,642 |                | $       | 15,010 |  
|                             |                                           |                                                                                                                |       |              |        |         |        |                   |        |                                               |         |                |         |        |  

See accompanying notes to consolidated financial statements.

34

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Cash Flows        Years ended December 31, 2004, 2003 and 2002        (Dollars in Thousands)

|                      |                                                                                   | 2004                                                            |                                           | 2003    |            | 2002     |        
|--------------------- | --------------------------------------------------------------------------------- | --------------------------------------------------------------- | ----------------------------------------- | ------- | ---------- | -------- | -------
|Operating activities: |                                                                                   |                                                                 |                                           |         |            |          |        
|                      | Net income:                                                                       |                                                                 | $                                         | 119,032 |            | $        | 122,128
|                      | Adjustments to reconcile net income to net cash provided by operating activities: |                                                                 |                                           |         |            |          |        
|                      |                                                                                   | Impairment charges and write downs on investments               |                                           |         |           |          |        
|                      |                                                                                   | Provision for possible loan losses                              |                                           |         | 6,500      |          |        
|                      |                                                                                   | Depreciation of bank premises and equipment                     |                                           |         | 18,975     |          |        
|                      |                                                                                   | (Gain) Loss on sale of bank premises and equipment              |                                           |         | (3,230     | )        |        
|                      |                                                                                   | Depreciation and amortization of leasing assets                 |                                           |         | 1,687      |          |        
|                      |                                                                                   | Gain on sale of branch banks                                    |                                           |         |           |          |        
|                      |                                                                                   | Accretion of investment securities discounts                    |                                           |         | (611       | )        |        
|                      |                                                                                   | Amortization of investment securities premiums                  |                                           |         | 29,215     |          |        
|                      |                                                                                   | Investment securities transactions, net                         |                                           |         | (8,884     | )        |        
|                      |                                                                                   | Accretion of junior subordinated debenture discounts            |                                           |         | 1,026      |          |        
|                      |                                                                                   | Amortization of identified intangible assets                    |                                           |         | 3,681      |          |        
|                      |                                                                                   | Equity in (earnings) loss from affiliates and other investments |                                           |         | (11,993    | )        |        
|                      |                                                                                   | Deferred tax expense (benefit)                                  |                                           |         | 11,353     |          |        
|                      |                                                                                   | (Increase) decrease in accrued interest receivable              |                                           |         | (3,983     | )        |        
|                      |                                                                                   | Decrease (increase) in other assets                             |                                           |         | 20,341     |          |        
|                      |                                                                                   | Net decrease in other liabilities                               |                                           |         | (24,840    | )        |        
|                      |                                                                                   |                                                                 |                                           |         |            |          |        
|                      |                                                                                   |                                                                 | Net cash provided by operating activities |         |            | 158,269  |        
|                      |                                                                                   |                                                                 |                                           |         |            |          |        
|Investing activities: |                                                                                   |                                                                 |                                           |         |            |          |        
|                      |                                                                                   | Proceeds from maturities of securities                          |                                           |         | 29,558     |          |        
|                      |                                                                                   | Proceeds from sales of available for sale securities            |                                           |         | 875,816    |          |        
|                      |                                                                                   | Purchases of available for sale securities                      |                                           |         | (2,223,915 | )        |        
|                      |                                                                                   | Principal collected on mortgage-backed securities               |                                           |         | 791,425    |          |        
|                      |                                                                                   | Proceeds from matured time deposits with banks                  |                                           |         | 87,400     |          |        
|                      |                                                                                   | Purchases of time deposits with banks                           |                                           |         | (296       | )        |        
|                      |                                                                                   | Net decrease (increase) in loans                                |                                           |         | 55,697     |          |        
|                      |                                                                                   | Purchases of other investments                                  |                                           |         | (5,161     | )        |        
|                      |                                                                                   | Distributions from other investments                            |                                           |         | 53,227     |          |        
|                      |                                                                                   | Purchases of bank premises and equipment                        |                                           |         | (51,866    | )        |        
|                      |                                                                                   | Proceeds from sales of bank premises and equipment              |                                           |         | 4,648      |          |        
|                      |                                                                                   | Cash paid in purchase transaction                               |                                           |         | (276,555   | )        |        
|                      |                                                                                   | Cash acquired in purchase transaction                           |                                           |         | 66,009     |          |        
|                      |                                                                                   | Cash disposed in sale transactions                              |                                           |         |           |          |        
|                      |                                                                                   |                                                                 |                                           |         |            |          |        
|                      |                                                                                   |                                                                 | Net cash used in investing activities     |         |            | (594,013 | )      
|                      |                                                                                   |                                                                 |                                           |         |            |          |        

See accompanying notes to consolidated financial statements.

35

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|                                                 |                                                                              | 2004                                      |         | 2003       |         | 2002    |           
|------------------------------------------------ | ---------------------------------------------------------------------------- | ----------------------------------------- | ------- | ---------- | ------- | ------- | ----------
|Financing activities:                            |                                                                              |                                           |         |            |         |         |           
|                                                 | Net increase (decrease) in non-interest bearing demand deposits              |                                           |         | 103,547    |         |         | 130,504   
|                                                 | Net increase in savings and interest bearing demand deposits                 |                                           |         | 70,306     |         |         | 132,711   
|                                                 | Net increase (decrease) in time deposits                                     |                                           |         | 24,361     |         |         | (67,415   
|                                                 | Net increase (decrease) in securities sold under repurchase agreements       |                                           |         | 74,372     |         |         | 43,381    
|                                                 | Proceeds from issuance of other borrowed funds and long term debt            |                                           |         | 2,335,000  |         |         | 3,140,000 
|                                                 | Principal payments on other borrowed funds                                   |                                           |         | (2,134,455 | )       |         | (3,345,585
|                                                 | Principal payments on senior notes                                           |                                           |         | (21,295    | )       |         |          
|                                                 | Proceeds from issuance of junior subordinated deferrable interest debentures |                                           |         |           |         |         | 36,402    
|                                                 | Purchase of treasury stock                                                   |                                           |         | (974       | )       |         | (29,723   
|                                                 | Proceeds from stock transactions                                             |                                           |         | 4,690      |         |         | 7,454     
|                                                 | Payments of cash dividends                                                   |                                           |         | (39,729    | )       |         | (32,599   
|                                                 | Payments of cash dividends in lieu of fractional shares                      |                                           |         | (38        | )       |         | (26       
|                                                 |                                                                              |                                           |         |            |         |         |           
|                                                 |                                                                              | Net cash provided by financing activities |         |            | 415,785 |         |           
|                                                 |                                                                              |                                           |         |            |         |         |           
|Increase (decrease) in cash and cash equivalents |                                                                              |                                           | (19,959 | )          |         | 61,525  |           
|                                                 |                                                                              |                                           |         |            |         |         |           
|Cash and cash equivalents at beginning of year   |                                                                              |                                           | 215,729 |            |         | 154,204 |           
|                                                 |                                                                              |                                           |         |            |         |         |           
|Cash and cash equivalents at end of year         |                                                                              | $                                         | 195,770 |            | $       | 215,729 |           
|                                                 |                                                                              |                                           |         |            |         |         |           
|Supplemental cash flow information:              |                                                                              |                                           |         |            |         |         |           
|                                                 | Interest paid                                                                |                                           | $       | 96,709     |         | $       | 93,337    
|                                                 | Income taxes paid                                                            |                                           |         | 36,277     |         |         | 54,866    

See accompanying notes to consolidated financial statements.

36

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Notes to Consolidated Financial Statements

(1) Summary of Significant Accounting Policies

The accounting and reporting policies of International Bancshares Corporation ("Corporation") and Subsidiaries (the Corporation and Subsidiaries collectively
referred to herein as the "Company") conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following is a
description of the more significant of those policies.

Consolidation and Basis of Presentation

The consolidated financial statements include the accounts of the Corporation and its wholly-owned bank subsidiaries, International Bank of Commerce, Laredo
("IBC"), Commerce Bank, International Bank of Commerce, Zapata, International Bank of Commerce, Brownsville, and the Corporation's wholly-owned non-bank subsidiaries, IBC Subsidiary
Corporation, IBC Life Insurance Company, IBC Trading Company and IBC Capital Corporation. All significant inter-company balances and transactions have been eliminated in consolidation.

The
Company early adopted the provisions of FIN 46R as of December 31, 2003 and deconsolidated its investment in eight statutory business trusts formed for the purpose of issuing
trust preferred securities. Three statutory business trusts that were acquired in the Company's acquisition of Local Financial Corporation are also deconsolidated under the provisions of FIN 46R.

The
Company, through its subsidiaries, is primarily engaged in the business of banking, including the acceptance of checking and savings deposits and the making of commercial, real
estate, personal, home improvement, automobile and other installment and term loans. The primary markets of the Company are South, Central, and Southeast Texas and the state of Oklahoma. Each bank
subsidiary is very active in facilitating international trade along the United States border with Mexico and elsewhere. Although the Company's loan portfolio is diversified, the ability of the
Company's debtors to honor their contracts is primarily dependent upon the economic conditions in the Company's trade area. In addition, the investment portfolio is directly impacted by fluctuations
in market interest rates. The Company and its bank subsidiaries are subject to the regulations of certain Federal agencies as well as the Texas Department of Banking and undergo periodic examinations
by those regulatory authorities. Such agencies may require certain standards or impose certain limitations based on their judgments or changes in law and regulations.

The
preparation of the consolidated financial statements in conformity with accounting policies generally accepted in the United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities as of the dates of the statement of condition and income and expenses for the periods. Actual results could differ
significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for possible
loan losses.

Per Share Data

All share and per share information has been restated giving retroactive effect to stock dividends distributed.

Investment Securities

The Company classifies debt and equity securities into one of these categories: held-to-maturity,
available-for-sale, or trading. Such classifications are reassessed for appropriate classification at each reporting date. Securities classified as
"held-to-maturity" are carried at amortized cost for financial statement reporting, while securities classified as "available-for-sale" and "trading"
are carried at their fair

37

---



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 two year period ended December 31, 2004.

Mortgage-backed
securities held at December 31, 2004 and 2003 represent participating interests in pools of long-term first mortgage loans originated and serviced by
the issuers of the securities. Premiums and discounts are amortized using the straight-line method over the contractual maturity of the loans adjusted for anticipated prepayments. Income
recognized under the straight-line method is not materially different from income that would be recognized under the level yield or "interest method". Mortgage-backed securities are either
issued or guaranteed by the U.S. Government or its agencies. Market interest rate fluctuations can affect the prepayment speed of principal and the yield on the security.

Unearned Discounts

Consumer loans are frequently made on a discount basis. The amount of the discount is subsequently included in interest income ratably over the term of the
related loans to approximate the effective interest method.

Provision and Allowance for Possible Loan Losses

The allowance for possible loan losses is maintained at a level considered adequate by management to provide for probable loan losses. The allowance is increased
by provisions charged to operating expense
and reduced by net charge-offs. The provision for possible loan losses is the amount, which, in the judgment of management, is necessary to establish the allowance for probable loan losses
at a level that is adequate to absorb known and inherent risks in the loan portfolio.

Management
believes that the allowance for possible loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance
may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's bank
subsidiaries' allowances for possible loan losses. Such agencies may require the Company's bank subsidiaries to recognize additions or reductions to their 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.

Non-Accrual Loans

The non-accrual loan policy of the Company's bank subsidiaries is to discontinue the accrual of interest on loans when management determines that it
is probable that future interest accruals will be un-collectible. Interest income on non-accrual loans is recognized only to the extent payments are received

38

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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. Other real estate is carried at the lower of the
recorded investment in the property or its fair value less estimated costs to sell such property (as determined by independent appraisal). Prior to
foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan possible losses, if necessary. Any subsequent
write-downs are charged against other non-interest expense. Operating expenses of such properties and gains and losses on their disposition are included in other non-interest
expense.

Bank Premises and Equipment

Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on straight-line and accelerated methods over
the estimated useful lives of the assets. Repairs and maintenance are charged to operations as incurred and expenditures for renewals and betterments are capitalized.

Income Taxes

Deferred income tax assets and liabilities are determined using the asset and liability method. Under this method, the net deferred tax asset or liability is
determined based on the tax effects of the differences between the book and tax basis of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and
laws. The Company files a consolidated federal income tax return with its subsidiaries.

Recognition
of deferred tax assets is based on management's belief that the benefit related to certain temporary differences, tax operating loss carryforwards, and tax credits are more
likely than not to be realized. A valuation allowance is recorded for the amount of the deferred tax items for which it is more likely than not that the tax benefits will not be realized.

Stock Options

In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 148 ("SFAS
No. 148"), "Accounting for Stock-Based CompensationTransition and Disclosure, an amendment of FASB Statement No. 123." SFAS No. 148 amends Statement of Financial
Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirement of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the fair value based method of accounting for stock-based employee compensation for those companies that have elected to continue to apply Accounting Principles
Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R ("SFAS
No. 123R"), "Share-Based Payment (Revised 2004)." SFAS 123R eliminates the ability to account for stock-based compensation using Accounting Principles Board Opinion No. 25 ("APB
25"), "Accounting for Stock Issued to Employees,"

39

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and
requires that such transactions be recognized as compensation expense in the consolidated statement of income based on their fair values on the date of the grant. The Company will be required to
adopt the provisions of SFAS No. 123R on July 1, 2005. See further discussion in this note under the heading "New Accounting Standards."

At
December 31, 2004, the Company had one stock-based employee compensation plan and certain options granted outside the plan. The Company accounts for options under the
recognition and measurement principles of APB 25, and related interpretations. No stock-based employee cost is reflected in net income, as all options granted had an exercise price equal to the market
value of the underlying common stock on the date of grant. The following table, as prescribed by SFAS No. 148, illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123 to stock based employee compensation.

|                                                                                                                                   |             | Years Ended December 31, |        
|---------------------------------------------------------------------------------------------------------------------------------- | ----------- | ------------------------ | -------
|
|
|                                                                                                                                   |             |                          |        
|Net income, as reported                                                                                                            |             | $                        | 119,032
|Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of tax related effects |             |                          | (473   
|                                                                                                                                   |             |                          |        
|Pro forma net income                                                                                                               |             | $                        | 118,559
|                                                                                                                                   |             |                          |        
|Earnings per share:                                                                                                                |             |                          |        
|Basic earnings                                                                                                                     |             |                          |        
|                                                                                                                                   | As reported |                          | $      
|                                                                                                                                   | Pro forma   |                          |        
|Diluted earnings                                                                                                                   |             |                          |        
|                                                                                                                                   | As reported |                          | $      
|                                                                                                                                   | Pro forma   |                          |        

Advertising

Advertising costs are expensed as incurred.

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 Intangible Assets

Goodwill represents the excess of the purchase price over the estimated fair value of identifiable net assets associated with acquisition transactions. Through
2001, the Company amortized goodwill related to acquisitions prior to July 1, 2001 on a straight-line basis over 15 years and identifiable intangibles on a

40

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straight-line
basis over their estimated periods of benefit. In addition, the Company reviewed its intangible assets periodically for other-than-temporary
impairments. If such impairments were indicated, recoverability of the asset was assessed based on expected undiscounted net cash flows.

In
June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141 ("SFAS No. 141"), "Business Combinations",
and SFAS No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets." SFAS No. 141 requires that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets
acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions in SFAS No. 142. SFAS No. 142 requires that intangible assets with
definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets".

On
July 1, 2001, the Company adopted the provisions of SFAS 141 and certain provisions of SFAS 142 as required for goodwill and intangible assets resulting from
business combinations consummated after June 30, 2001.

The
Company fully adopted the remaining provisions of SFAS No. 142 as of January 1, 2002 and discontinued amortizing goodwill relating to business combinations consummated
before July 1, 2001. As of the date of the adoption, the Company had unamortized goodwill in the amount of $69,639,000 and unamortized identifiable intangible assets in the amount of
$21,978,000. The Company evaluated its existing intangible assets and goodwill that were acquired in prior purchase business combinations and determined that no reclassifications were necessary in
order to conform with the new classification criteria in SFAS No. 141 for recognition apart from goodwill. The Company reassessed the useful lives
and residual values of all intangible assets acquired in purchase business combinations and determined that no amortization adjustments were necessary and no intangible assets had indefinite lives.

As
of January 1, 2002, the Company performed an assessment of whether there was an indication that goodwill was impaired. The Company concluded that it was probable that the
goodwill related to its investment services reporting unit was impaired. The amount of the impairment was $7,893,000 or $5,130,000, net of tax, which has been reported as a cumulative effect of a
change in accounting principle, net of tax for the year ended December 31, 2002. The fair value of the investment services unit was estimated using a combination of capitalized cash flows,
discounted cash flows and multiples based on publicly traded companies' market capitalization to sales.

In
October 2002, the Financial Accounting Standards Board issued SFAS No. 147 ("SFAS No. 147"), "Acquisitions of Certain Financial Institutions, an amendment of FASB
Statements No 72 and 144 and FASB Interpretation No. 9". SFAS No. 72 required that in acquisitions of financial institutions, any excess of the fair value of liabilities assumed over the
fair value of tangible and intangible assets acquired be accounted for as an unidentifiable intangible asset and subsequently amortized. SFAS No. 72 unidentified intangible assets were excluded
from the scope of SFAS No. 141 and SFAS No. 142. Except for transactions between two or more mutual companies, SFAS No. 147 removes acquisitions of financial institutions from the
scope of SFAS No. 72 and FASB Interpretation No. 9 and requires that those transactions be accounted for in accordance with SFAS No. 141 and SFAS No. 142. SFAS
No. 147 was effective October 1,

41

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2002
and requires that if the transaction that gave rise to the unidentified intangible asset was a business combination, the carrying amount of that asset shall be reclassified to goodwill as of the
later of the date of acquisition or the date of the full application of SFAS No. 142. SFAS No. 147 also requires that any interim or annual financial statements that reflect the
amortization of the unidentified intangible asset subsequent to the full application of SFAS 142 shall be restated to remove that amortization expense. The Company adopted SFAS No. 147
as of October 1, 2002. Upon the adoption of SFAS No. 147, the Company reclassified $10,487,000 from intangible assets to goodwill and reversed $792,000 of amortization expense recognized
during 2002 related to the SFAS 72 unidentified intangible asset.

Impairment of Long-Lived Assets

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses
financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," it retains many of the fundamental provisions of SFAS No 121, establishes a single accounting model for
long-lived assets to be disposed of by sale, and resolves certain implementation issues not previously addressed by SFAS No. 121. SFAS
No. 144 also supercedes the accounting and reporting provisions of Financial Accounting Standards Board Opinion No. 30, ("Opinion No. 30") "Reporting the Results of
OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a
business; however, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends the reporting to a component of an entity, rather than a segment of a
business, that either has been disposed of or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company adopted SFAS
No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not have an impact on the Company's consolidated financial statements. In accordance with SFAS No. 144,
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 balance sheet 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 with other financial institutions, customer time deposits and loans to customers on a net basis.

42

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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.

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 statements presented in this report. The Company has four active operating subsidiaries, namely, the bank subsidiaries, otherwise known as
International Bank of Commerce, Laredo, Commerce Bank, International Bank of Commerce, Zapata and International Bank of Commerce, Brownsville. The Company applies the provisions of SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information," in determining its reportable segments and related disclosures. None of the Company's other subsidiaries meets
the 10% threshold for disclosure under SFAS No. 131.

Derivative Instruments

The Company currently does not directly engage in hedging activities and does not directly hold any derivative instruments or embedded derivatives. However, the
Company's equity method investee, Aircraft Finance Trust ("AFT"), uses derivative instruments to manage the interest rate on the bonds that AFT has issued. The derivative instruments qualify as cash
flow hedges under the provisions of SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" and as such, the Company's proportionate share of changes in fair value of the
derivative instruments are included in comprehensive income and accumulated other comprehensive income, net of tax.

Guarantor's Accounting and Disclosure Requirements for Guarantees

In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34." FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. This Interpretation also incorporates, without
change, the guidance in Financial Accounting Standards Board Interpretation No. 34 ("FIN 34"), "Disclosure of Indirect Guarantees of Indebtedness of Others," which has been superceded. FIN 45
also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee, including its ongoing obligations
to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The initial recognition and initial measurement provisions of FIN 45
were applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. The disclosure requirements were
effective for financial statements of interim or annual periods ending after December 15, 2002, and are included in the notes to the Company's consolidated financial statements. The adoption of
FIN 45 did not have a significant impact on the Company's consolidated financial statements.

43

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Reclassifications

Certain amounts in the prior year's presentations have been reclassified to conform to the current presentation. These reclassifications have no effect on
previously reported net income.

New Accounting Standards

In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, ("SFAS No. 150"), "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies, measures and discloses in its financial statements certain financial
instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify financial instruments that are within its scope as liabilities, in most
circumstances. Such financial instruments include (i) financial instruments that are issued in the form of shares that are mandatorily redeemable; (ii) financial instruments that embody
an obligation to repurchase the issuer's equity shares, or are indexed to such an obligation, and that require the issuer to settle the obligation by transferring assets; (iii) financial
instruments that embody an obligation that the issuer may settle by issuing a variable number of its equity shares if, at inception, the monetary value of the obligation is predominantly based on a
fixed amount, variations in something other than the fair value of the issuer's equity shares or variations inversely related to changes in the fair value of the issuer's equity shares; and
(iv) certain freestanding financial instruments. SFAS No. 150 was originally effective for contracts entered into or modified after May 31, 2003, and was otherwise effective at
the beginning of the first interim period beginning after June 15, 2003. At its October 29, 2003, meeting, the Financial Accounting Standards Board decided to defer the effective date of
SFAS No. 150, as it relates to classification and measurement requirements for manditorily redeemable financial instruments that become subject to SFAS No. 150 solely as a result of
consolidation. Adoption of the remaining provisions of SFAS No. 150 on July 1, 2003 did not have an impact on the Company's consolidated financial statements.

In
April 2003, the Financial Accounting Standards Board issued SFAS No. 149, ("SFAS No. 149"), "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." SFAS No. 149 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and clarifies financial accounting and reporting for derivative instruments
including certain derivative instruments embedded in other contracts and for hedging activities. SFAS No. 149 improves financial reporting by requiring that contracts with comparable
characteristics to be accounted for similarly. In particular, SFAS No. 149 clarifies under what circumstances a contract with an initial net investments meets the characteristics of a
derivative, clarifies when a derivative contains a financing component, amends the definition of underlying to conform to the language in Financial Accounting Standards Board Interpretation
No. 45, and amends certain other existing pronouncements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003; however, the provisions of SFAS No. 149 that relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began
prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. The adoption of SFAS No. 149 did not have a significant impact on the Company's
consolidated financial statements.

In
December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, ("SFAS No. 123R"), "Share-Based Payment, an
Amendment of Statements No. 123 and 95." The revision to the existing SFAS No. 123 eliminates the ability of public companies to account for stock-based compensation using Accounting
Principles Board Opinion No. 25

44

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("APB
25"), "Accounting for Stock Issues to Employees" and requires such transactions be recognized as compensation expense in the Company's consolidated financial statements based on the fair value
of the options issued as of their grant date. Companies transitioning to the fair value method of accounting for stock-based compensation are required to do so under the "modified prospective method."
Under this transitional method, SFAS No. 123R applies to new awards and to awards modified, repurchased, or cancelled after the required effective date. Compensation expense for that portion of
existing options for which the requisite service period has not been met and are still outstanding, shall be recognized as the service is rendered on or after the required effective date. The
compensation cost for those awards shall be based on the fair value on the grant date of those awards as calculated for either recognition or pro-forma disclosures under SFAS
No. 123. SFAS No. 123R would be effective for the Company for interim and reporting periods after June 15, 2005. Based on the stock-based compensation awards outstanding as of
December 31, 2004 for which the requisite service is not expected to be fully rendered prior to July 1, 2005, the Company expects to recognize additional pre-tax quarterly
compensation cost of $97,000 beginning in the third quarter of 2005 as a result of the adoption of SFAS No. 123R. Future levels of compensation cost recognized related to stock-based
compensation awards (including the aforementioned expected costs during the period of adoption) may be impacted by new awards and/or modifications, repurchases and cancellations of existing awards
before and after the adoption of SFAS No. 123R.

In
December 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-3 ("SOP 03-3"), "Accounting for Certain Loans or Debt Securities
Acquired in a Transfer." SOP 03-3 addresses accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when
loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP 03-3 applies to loans and debt securities
acquired individually, in pools or as part of a business
combination and does not apply to originated loans. The application of SOP 03-3 limits the interest income, including the accretion of purchase price discounts, that may be recognized for
certain loans and debt securities. Additionally, SOP 03-3 does not allow the excess of contractual cash flows over cash flows expected to be collected to be recognized as an adjustment of
yield, loss accrual or valuation allowance, such as the allowance for possible loan losses. SOP 03-3 requires that increases in expected cash flows subsequent to the initial investment be
recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. In the case of loans
acquired in a business combination where the loans show signs of credit deterioration, SOP 03-3 represents a significant change from current purchase accounting practice whereby the acquiree's
allowance for loan losses is typically added to the acquirer's allowance for loan losses. SOP 03-3 is effective for loans and debt securities acquired by the Company beginning January 1,
2005. The adoption of this new standard is not expected to have a significant impact on the Company's consolidated financial statements.

In
December 2003, SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," was issued. SFAS No. 132 (revised) prescribes employers'
disclosures about pension plans and other postretirement benefit plans; it does not change the measurement or recognition of those plans. The Statement revises the disclosure requirements contained in
the original SFAS No. 132. It also requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. The Statement generally is effective for fiscal years ending after December 15, 2003. The adoption of SFAS No. 132 did not have an impact on the Company's
consolidated financial statements.

45

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In
January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51." The intention of FIN 46 was to clarify the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to certain
entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 requires an enterprise considered to be a variable interest entity ("VIE"), to be consolidated by the primary beneficiary, which
represents the enterprise that will absorb the majority of the VIE's expected losses if they occur, receive a majority of the VIE's residual returns if they occur, or both. In December 2003,
the FASB issued Staff Interpretation No. 46R ("FIN 46R"), "Consolidation of Variable Interest Entities, an interpretation of ARB 51 (revised December 2003)," which replaces FIN 46, in
order to clarify the guidance in the original interpretation. FIN 46 applies to variable interest entities created after January 31, 2003. FIN 46 also applies to all variable interest entities
created prior to February 1, 2003 that are considered to be special-purpose entities, as defined in FIN 46R, as of December 31, 2003. FIN 46R must be applied to all variable interest
entities no later than the end of the first reporting period that ends after March 15, 2004.

The
Company early adopted FIN 46R in connection with its consolidated financial statements as of December 31, 2003. The implementation of FIN 46R requires the Company to
de-consolidate the statutory business trusts formed for the purpose of issuing trust preferred securities as of December 31, 2003.

(2) Acquisition

On June 18, 2004, the Company acquired Local Financial Corporation ("LFIN"), an Oklahoma based bank holding company with approximately $3.0 billion
in assets. The acquisition was effected pursuant to the Agreement and Plan of Merger dated as of January 22, 2004 (the "Merger Agreement"). The Company paid consideration totaling approximately
$276.6 million in cash and 2.11 million shares of Company common stock. The aggregate purchase price was $367.4 million. Under the terms of the Merger Agreement, LFIN shareholders
were entitled to elect to receive either cash or Company common stock in the merger, subject to the requirement that 75% of LFIN's shares be exchanged for cash and 25% be exchanged for Company common
stock. Based on the elections of LFIN shareholders and the terms of the Merger Agreement, LFIN shares held by LFIN shareholders who elected to receive shares of Company common stock in the Merger and
LFIN shareholders who did not timely make a cash/stock election were exchanged entirely for shares of Company common stock. As to those LFIN shares for which an election to receive cash was timely
made, each such share was exchanged for approximately $20.59 in cash and 0.033 shares of Company common stock. The exchange rate for those LFIN shareholders receiving Company common stock in the
Merger was 0.5170 shares of Company common stock for each share of LFIN.

46

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The
following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of the acquisition, in thousands. The Company has completed its
valuations of certain intangible assets, and as a result the allocation of the purchase price has been completed.

As of June 18, 2004(Dollars in thousands)AssetsCash and cash equivalents

$
66,009Time deposits with banks


87,400Investment securities


331,656Net loans


2,152,912Bank premises and equipment


50,155Accrued interest receivable


8,266Other investments


93,538Identified intangible asset


42,188Goodwill


221,814Other assets


30,230Total assets acquired


3,084,168LiabilitiesDemand deposits


232,982Savings deposits


766,178Time deposits


938,031Securities sold under repurchase agreements


44,138Other borrowed funds


624,382Senior notes


21,295Other liabilities


89,764Total liabilities assumed


2,716,770Net assets acquired

$
367,398


47

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The
following table reflects the pro forma results of operations for the years ended December 31, 2004 and 2003, as though the acquisition had been completed as of
January 1, 2003 (dollars in thousands, except per share data):

|                                   |         | Year Ended
December 31, 2004 |         | Year Ended
December 31, 2003
|---------------------------------- | ------- | ---------------------------- | ------- | ----------------------------
|Interest income                    |         | $                            | 417,945 |                             
|Interest expense                   |         |                              | 136,886 |                             
|                                   |         |                              |         |                             
|Net interest income                |         |                              | 281,059 |                             
|Provision for possible loan losses |         |                              | 18,000  |                             
|Non-interest income                |         |                              | 150,917 |                             
|Non-interest expense               |         |                              | 267,923 |                             
|                                   |         |                              |         |                             
|Income before income taxes         |         |                              | 146,053 |                             
|Income taxes                       |         |                              | 47,962  |                             
|                                   |         |                              |         |                             
|Net income                         |         | $                            | 98,091  |                             
|                                   |         |                              |         |                             
|Per common share:                  |         |                              |         |                             
|                                   | Basic   |                              | $       | 1.97                        
|                                   | Diluted |                              | $       | 1.93                        

Included
in the non-interest expense of the combined operations for the year ended December 31, 2004 are certain costs associated with contractual obligations related
to the closing of the transaction.

48

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(3) Investment Securities

The amortized cost and estimated fair value by type of investment security at December 31, 2004 are as follows:

|                            |  | Held to Maturity
|--------------------------- |  | ----------------
|
|
|                            |  |                 
|Other securities            |  | $               
|                            |  |                 
|Total investment securities |  | $               
|                            |  |                 

|                                                 |  | Available for Sale
|------------------------------------------------ |  | ------------------
|
|
|                                                 |  |                   
|U.S. Treasury securities                         |  | $                 
|Mortgage-backed securities                       |  |                   
|Obligations of states and political subdivisions |  |                   
|Other securities                                 |  |                   
|Equity securities                                |  |                   
|                                                 |  |                   
|Total investment securities                      |  | $                 
|                                                 |  |                   

The
amortized cost and estimated fair value of investment securities at December 31, 2004, by contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

|                                       |  | Held to Maturity |       | Available for Sale
|-------------------------------------- |  | ---------------- | ----- | ------------------
|
|
|                                       |  |                  |       |                   
|Due in one year or less                |  | $                | 235   |                   
|Due after one year through five years  |  |                  | 2,150 |                   
|Due after five years through ten years |  |                  |      |                   
|Due after ten years                    |  |                  |      |                   
|Mortgage-backed securities             |  |                  |      |                   
|Equity securities                      |  |                  |      |                   
|                                       |  |                  |       |                   
|Total investment securities            |  | $                | 2,385 |                   
|                                       |  |                  |       |                   

49

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The
amortized cost and estimated fair value by type of investment security at December 31, 2003 are as follows:

|                            |  | Held to Maturity
|--------------------------- |  | ----------------
|
|
|                            |  |                 
|Other securities            |  | $               
|                            |  |                 
|Total investment securities |  | $               
|                            |  |                 

|                                                 |  | Available for Sale
|------------------------------------------------ |  | ------------------
|
|
|                                                 |  |                   
|U.S. Treasury securities                         |  | $                 
|Mortgage-backed securities                       |  |                   
|Obligations of states and political subdivisions |  |                   
|Other securities                                 |  |                   
|Equity securities                                |  |                   
|                                                 |  |                   
|Total investment securities                      |  | $                 
|                                                 |  |                   

Mortgage-backed
securities are primarily securities issued by the Federal Home Loan Mortgage Corporation ("Freddie Mac"), the Federal National Mortgage Association ("Fannie Mae") and the
Government National Mortgage Association ("Ginnie Mae").

The
amortized cost and fair value of available for sale investment securities pledged to qualify for fiduciary powers, to secure public monies as required by law, repurchase agreements
and short-term fixed borrowings was $1,887,879,000 and $1,904,736,000, respectively, at December 31, 2004.

Proceeds
from the sale of securities available-for-sale were $875,816,000, $1,239,766,000 and $330,152,000 during 2004, 2003 and 2002, respectively. Gross gains
of $12,818,000, $29,517,000 and $2,396,000 and gross losses of $3,934,000, $6,127,000 and $93,000 were realized on the sales in 2004, 2003 and 2002, respectively.

50

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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, 2004 were as follows:

|                    |                                                  | Less than 12 months |         | 12 months or more |   | Total  |       
|------------------- | ------------------------------------------------ | ------------------- | ------- | ----------------- | - | ------ | ------
|
|
|Available for sale: |                                                  |                     |         |                   |   |        |       
|                    | U.S. Treasury securities                         |                     | $       | 7,979             |   | $      | (9    
|                    | Mortgage-backed securities                       |                     |         | 590,883           |   |        | (2,164
|                    | Obligations of states and political subdivisions |                     |         |                  |   |        |      
|                    | Other securities                                 |                     |         | 9,765             |   |        | (376  
|                    |                                                  |                     |         |                   |   |        |       
|                    |                                                  | $                   | 608,627 |                   | $ | (2,549 | )     
|                    |                                                  |                     |         |                   |   |        |       

The
unrealized losses on investments in mortgage-backed securities and U.S. treasury securities are caused by changes in market interest rates. The contractual cash obligations of the
securities are guaranteed by Freddie Mac, Fannie Mae, Ginnie Mae and the U.S. Treasury. The decrease in fair value is due to market interest rates and not other factors, and because the Company has
the ability to hold these investments until a market price recovery, maturity of the securities, or a modification of the Company's investment strategy, it is the conclusion of the Company that the
investments are not considered other-than-temporarily impaired.

The
unrealized losses on investments in obligations of state and political subdivisions and other securities are caused by fluctuations in market interest rates. The underlying cash
obligations of the securities are guaranteed by the municipality or entity underwriting the debt instrument. It is the belief of the Company that the municipality or entity issuing the debt will honor
its interest payment schedule, as well as the full debt at maturity. The securities are purchased by the Company for their economic value. The decrease in fair value is primarily due to market
interest rates and not other factors, and because the Company has the ability to hold these investments until a market price recovery, maturity of the securities, or a modification of the Company's
investment strategy, it is the conclusion of the Company that the investments are not considered other-than-temporarily impaired.

51

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(4) Loans

A summary of net loans, by loan type at December 31, 2004 and 2003 is as follows:

|                                       |                                 | December 31, |          
|-------------------------------------- | ------------------------------- | ------------ | ---------
|
|
|                                       |                                 |              |          
|Commercial, financial and agricultural |                                 | $            | 2,710,270
|Real estatemortgage                   |                                 |              | 960,599  
|Real estateconstruction               |                                 |              | 749,689  
|Consumer                               |                                 |              | 229,302  
|Foreign                                |                                 |              | 239,622  
|                                       |                                 |              |          
|                                       | Total loans                     |              |          
|Unearned discount                      |                                 |              | (508     
|                                       |                                 |              |          
|                                       | Loans, net of unearned discount |              | $        
|                                       |                                 |              |          

(5) Allowance for Possible Loan Losses

A summary of the transactions in the allowance for possible loan losses for the years ended December 31, 2004, 2003 and 2002 is as follows:

|                        |                                                      | 2004 |        | 2003   |   | 2002   |       
|----------------------- | ---------------------------------------------------- | ---- | ------ | ------ | - | ------ | ------
|
|                        |                                                      |      |        |        |   |        |       
|Balance at December 31, |                                                      | $    | 48,646 |        | $ | 44,213 |       
|                        |                                                      |      |        |        |   |        |       
|                        | Losses charged to allowance                          |      |        | (9,513 | ) |        | (4,943
|                        | Recoveries credited to allowance                     |      |        | 5,407  |   |        | 1,085 
|                        |                                                      |      |        |        |   |        |       
|                        | Net losses charged to allowance                      |      |        | (4,106 | ) |        | (3,858
|                        | Provision charged to operations                      |      |        | 6,500  |   |        | 8,291 
|                        | Acquired (disposed) in purchase or sale transactions |      |        | 33,865 |   |        |      
|                        |                                                      |      |        |        |   |        |       
|Balance at December 31, |                                                      | $    | 84,905 |        | $ | 48,646 |       
|                        |                                                      |      |        |        |   |        |       

Loans
accounted for on a non-accrual basis at December 31, 2004, 2003 and 2002 amounted to $30,773,000, $20,960,000 and $3,649,000, respectively. The effect of such
non-accrual loans reduced interest income by $1,203,000, $1,870,000 and $567,000 for the years ended December 31, 2004, 2003 and 2002, respectively. Amounts received on
non-accruals are applied, for financial accounting purposes, first to principal and then to interest after all principal has been collected.

The
increase in non-accrual loans from 2003 to 2004 can be attributed to certain loans the Company acquired in the LFIN acquisition. The increase in non-accrual
loans from 2002 to 2003 can be attributed to two fully secured credits the Company placed on non-accrual status, totaling approximately $17,800,000. On January 7, 2004, management
determined that one of the fully secured credits be returned to accrual status and on March 1, 2004, management determined that the second of the two fully secured credits also be returned to
accrual status.

52

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Impaired
loans are those loans where it is probable that all amounts due according to contractual terms of the loan agreement will not be collected. The Company has identified these
loans through its normal loan review procedures. Impaired loans are measured based on (1) the present value of expected future cash flows discounted at the loan's effective interest rate;
(2) the loan's observable market price; or (3) the fair value of the collateral if the loan is collateral dependent. Substantially all of the Company's impaired loans are measured at the
fair value of the collateral. In limited cases the Company may use other methods to determine the level of impairment of a loan if such loan is not collateral dependent.

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

|                                                                            |                                       | 2004 |        | 2003   |   | 2002  
|--------------------------------------------------------------------------- | ------------------------------------- | ---- | ------ | ------ | - | ------
|
|                                                                            |                                       |      |        |        |   |       
|Balance of impaired loans where there is a related allowance for loan loss  |                                       | $    | 37,037 |        | $ | 24,216
|Balance of impaired loans where there is no related allowance for loan loss |                                       |      |       |        |   |      
|                                                                            |                                       |      |        |        |   |       
|                                                                            | Total impaired loans                  |      | $      | 37,037 |   | $     
|                                                                            |                                       |      |        |        |   |       
|                                                                            | Allowance allocated to impaired loans |      | $      | 15,666 |   | $     

The
impaired loans included in the table above were primarily comprised of collateral dependent commercial loans, which have not been fully charged off. The average recorded investment
in impaired loans was $34,226,000, $13,090,000, and $4,289,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The increase in impaired loans can be attributed to the LFIN
acquisition. The interest recognized on impaired loans was not significant.

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

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

While
management of the Company considers that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers
carefully, there is no precise method of predicting loan losses. The determination that a loan is likely to be un-collectible and that it should be wholly or partially
charged-off as a loss is an exercise of judgment. Similarly, the determination of the adequacy of the allowance for possible loan losses can be made only on a subjective basis. It is the
judgment of the Company's management that the allowance for possible loan losses at December 31, 2004 was adequate to absorb probable losses from loans in the portfolio at that date.

53

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(6) Bank Premises and Equipment

A summary of bank premises and equipment, by asset classification, at December 31, 2004 and 2003 were as follows:

|                                       |                                                  | Estimated useful lives           |              | 2004 |          | 2003 |        
|-------------------------------------- | ------------------------------------------------ | -------------------------------- | ------------ | ---- | -------- | ---- | -------
|
|                                       |                                                  |                                  |              |      |          |      |        
|Bank buildings and improvements        |                                                  | 5 - 40 years                     |              | $    | 229,007  |      | $      
|Furniture, equipment and vehicles      |                                                  | 1 - 20 years                     |              |      | 159,289  |      |        
|Land                                   |                                                  |                                  |              |      | 52,701   |      |        
|Real estate held for future expansion: |                                                  |                                  |              |      |          |      |        
|                                       | Land, building, furniture, fixture and equipment |                                  | 7 - 27 years |      |          | 970  |        
|Less: accumulated depreciation         |                                                  |                                  |              |      | (139,737 | )    |        
|                                       |                                                  |                                  |              |      |          |      |        
|                                       |                                                  | Bank premises and equipment, net |              |      |          | $    | 302,230
|                                       |                                                  |                                  |              |      |          |      |        

(7) Goodwill and Other Intangible Assets

The Company's identified intangibles are all in the form of amortizable core deposit premium. The Company acquired $42,188,000 in identified intangibles in the
form of core deposit premium in the LFIN acquisition, which will be amortized over a ten year period. Information on the Company's identified intangible assets follows:

|                   |                      | Carrying Amount |   | Accumulated Amortization |  | Net
|------------------ | -------------------- | --------------- | - | ------------------------ |  | ---
|
|                   |                      |                 |   |                          |  |    
|December 31, 2004  |                      |                 |   |                          |  |    
|                   | Core deposit premium |                 | $ | 56,338                   |  | $  
|                   |                      |                 |   |                          |  |    
|December 31, 2003: |                      |                 |   |                          |  |    
|                   | Core deposit premium |                 | $ | 14,150                   |  | $  
|                   |                      |                 |   |                          |  |    

Amortization
expense of intangible assets for the years ended December 31, 2004, 2003 and 2002, was $3,681,000, $1,276,000 and $1,812,000, respectively. Estimated
amortization expense for each of the five succeeding fiscal years, and thereafter, is as follows:

Fiscal
year ending:

|           |  | Total
|---------- |  | -----
|
|2005       |  | $    
|2006       |  |      
|2007       |  |      
|2008       |  |      
|2009       |  |      
|Thereafter |  |      
|           |  |      
|Total      |  | $    
|           |  |      

54

---



There
were no changes in the carrying amount of goodwill for the year ended December 31, 2003. Changes in the carrying amount of goodwill for the year ended
December 31, 2004 were as follows:

|Balance at December 31, 2003    |                                                                               | $ | 67,442 
|------------------------------- | ----------------------------------------------------------------------------- | - | -------
|                                | Adjustments to deferred tax asset and goodwill relating to a 2004 acquisition |   |        
|                                | Acquisition of goodwill related to the acquisition of LFIN (note 2)           |   |        
|                                |                                                                               |  
|Balance as of December 31, 2004 |                                                                               | $ | 289,262
|                                |                                                                               |  

(8) Deposits

Deposits as of December 31, 2004 and 2003 and related interest expense for the years ended December 31, 2004, 2003 and 2002 were as follows:

|                                          |                                   | 2004     |           | 2003     
|----------------------------------------- | --------------------------------- | -------- | --------- | ---------
|
|Deposits:                                 |                                   |          |           |          
|                                          | Demandnon-interest bearing       |          |           |          
|                                          |                                   | Domestic |           | $        
|                                          |                                   | Foreign  |           |          
|                                          |                                   |          |           |          
|                                          | Total demand non-interest bearing |          |           | 1,150,999
|                                          |                                   |          |           |          
|Savings and interest bearing demand       |                                   |          |           |          
|                                          |                                   | Domestic |           |          
|                                          |                                   | Foreign  |           |          
|                                          |                                   |          |           |          
|Total savings and interest bearing demand |                                   |          | 2,232,102 |          
|                                          |                                   |          |           |          
|Time, certificates of deposit             |                                   |          |           |          
|                                          | $100,000 or more                  |          |           |          
|                                          |                                   | Domestic |           |          
|                                          |                                   | Foreign  |           |          
|                                          | Less than $100,000                |          |           |          
|                                          |                                   | Domestic |           |          
|                                          |                                   | Foreign  |           |          
|                                          |                                   |          |           |          
|Total time, certificates of deposit       |                                   |          | 3,188,003 |          
|                                          |                                   |          |           |          
|Total deposits                            |                                   | $        | 6,571,104 |          
|                                          |                                   |          |           |          

55

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|                                   |                                           | 2004     |        | 2003   |        | 2002  
|---------------------------------- | ----------------------------------------- | -------- | ------ | ------ | ------ | ------
|
|Interest expense:                  |                                           |          |        |        |        |       
|                                   | Savings and interest bearing demand       |          |        |        |        |       
|                                   |                                           | Domestic |        | $      | 11,991 |       
|                                   |                                           | Foreign  |        |        | 1,806  |       
|                                   |                                           |          |        |        |        |       
|                                   | Total savings and interest bearing demand |          |        | 13,797 |        |       
|                                   |                                           |          |        |        |        |       
|                                   | Time, certificates of deposit             |          |        |        |        |       
|                                   | $100,000 or more                          |          |        |        |        |       
|                                   |                                           | Domestic |        |        | 10,483 |       
|                                   |                                           | Foreign  |        |        | 17,327 |       
|                                   | Less than $100,000                        |          |        |        |        |       
|                                   |                                           | Domestic |        |        | 12,396 |       
|                                   |                                           | Foreign  |        |        | 4,453  |       
|                                   | Total time, certificates of deposit       |          |        | 44,659 |        |       
|                                   |                                           |          |        |        |        |       
|Total interest expense on deposits |                                           | $        | 58,456 |        | $      | 51,181
|                                   |                                           |          |        |        |        |       

(9) Federal Funds Purchased and Securities Sold Under Repurchase Agreements

The Company's bank subsidiaries have entered into repurchase agreements with Salomon Brothers and individual customers of the bank subsidiaries. The purchasers
have agreed to resell to the bank subsidiaries identical securities upon the maturities of the agreements. Securities sold under repurchase agreements were mortgage-backed book entry securities and
averaged $526,447,000 and $473,365,000 during 2004 and 2003, respectively, and the maximum amount outstanding at any month end during 2004 and 2003 $572,320,000 and $501,296,000, respectively.

56

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Further
information related to repurchase agreements at December 31, 2004 and 2003 is set forth in the following table:

|                        |                      | Collateral Securities |   | Repurchase Borrowing | 
|----------------------- | -------------------- | --------------------- | - | -------------------- | 
|
|
|December 31, 2004 term: |                      |                       |   |                      | 
|                        | Overnight agreements |                       | $ | 129,589              | 
|                        | 1 to 29 days         |                       |   |                     | 
|                        | 30 to 90 days        |                       |   | 55,771               | 
|                        | Over 90 days         |                       |   | 619,040              | 
|                        |                      |                       |   |                      | 
|                        | Total                |                       | $ | 804,400              | 
|                        |                      |                       |   |                      | 
|December 31, 2003 term: |                      |                       |   |                      | 
|                        | Overnight agreements |                       | $ | 46,561               | 
|                        | 1 to 29 days         |                       |   | 1,239                | 
|                        | 30 to 90 days        |                       |   | 19,520               | 
|                        | Over 90 days         |                       |   | 496,241              | 
|                        |                      |                       |   |                      | 
|                        | Total                |                       | $ | 563,561              | 
|                        |                      |                       |   |                      | 

The
book value and fair value of securities sold includes the entire book value and fair value of securities partially or fully pledged under repurchase agreements.

(10) Other Borrowed Funds

Other borrowed funds include Federal Home Loan Bank borrowings, which are short and long term fixed borrowings issued by the Federal Home Loan Bank of Dallas at
the market price offered at the time of funding. These borrowings are secured by mortgage-backed investment securities and a portion of the Company's loan portfolio.

57

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Further
information regarding the Company's other borrowed funds at December 31, 2004 and 2003 is set forth in the following table:

|                                           |                                             | December 31 |  
|------------------------------------------ | ------------------------------------------- | ----------- | -
|
|
|Federal Home Loan Bank advancesshort term |                                             |             |  
|                                           | Balance at year end                         |             | $
|                                           | Rate on balance outstanding at year end     |             |  
|                                           | Average daily balance                       |             | $
|                                           | Average rate                                |             |  
|                                           | Maximum amount outstanding at any month end |             | $
|Federal Home Loan Bank advanceslong term  |                                             |             |  
|                                           | Balance at year end                         |             | $
|                                           | Rate on balance outstanding at year end     |             |  
|                                           | Average daily balance                       |             | $
|                                           | Average rate                                |             |  
|                                           | Maximum amount outstanding at any month end |             | $

(11) Junior Subordinated Deferrable Interest Debentures

The Company has formed eight statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. As part of
the LFIN acquisition, the Company acquired three additional statutory business trusts previously formed by LFIN for the purpose of issuing trust preferred securities. The eight statutory business
trusts formed by the Company and the three business trusts acquired in the LFIN transaction (the "Trusts") have each issued Capital and Common Securities and invested the proceeds thereof in an
equivalent amount of junior subordinated debentures (the "Debentures") issued by the Company or LFIN, as appropriate. The Company has succeeded to the obligations of LFIN under the LFIN Debentures,
which have an outstanding principal balance of $62,115,000. The Debentures will mature on various dates; however the Debentures may be redeemed at specified prepayment prices, in whole or in part
after the optional redemption dates specified in the respective indentures or in whole upon the occurrence of any one of certain legal, regulatory or tax events specified in respective indentures. As
of December 31, 2004, the principal amount of debentures outstanding totaled $235,395,000.

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 passuwith one another.
The interest rate payable on, and the payment terms of the Debentures are the same as the distribution rate and payment
terms of the respective issues of Capital and Common Securities issued by the Trusts. The Company has fully and unconditionally guaranteed the obligations of each of the Trusts with respect to the
Capital and Common Securities. The Company has the right, unless an Event of Default (as defined in the Indentures) has occurred and is continuing, to defer payment of interest on the Debentures for
up to ten consecutive semi-annual periods on Trusts I through IV and LFIN Trust II and for up to twenty consecutive quarterly periods on Trusts V through VIII and LFIN Trusts I and III. If
interest payments on any of the Debentures are deferred, distributions on both the Capital and Common

58

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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 non-banking subsidiaries of the Company and consolidated in the consolidated financial statements prior to
December 31, 2003. Since the Company's adoption of FIN 46R on December 31, 2003, the Trusts are treated as investments of the Company and not consolidated in the consolidated financial
statements. Although the Capital Securities issued by each of the Trusts are not included as a component of shareholders' equity on the consolidated statement of condition, the Capital Securities are
treated as capital for regulatory purposes. Specifically, under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of Tier 1
capital on an aggregate basis. Any amount that exceeds the 25% threshold would qualify as Tier 2 capital. For December 31, 2004, the total $235,395,000 of the Capital Securities outstanding
qualified as Tier 1 capital.

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

The
following table illustrates key information about each of the Capital Securities and their interest rate at December 31, 2004:

|               |  | Junior
Subordinated
Deferrable
Interest
Debentures |         | Repricing
Frequency |               | Interest
Rate |       | Interest Rate
Index |               | Maturity Date |                | Optional
Redemption
Date
|-------------- |  | -------------------------------------------------- | ------- | ------------------- | ------------- | ------------- | ----- | ------------------- | ------------- | ------------- | -------------- | ------------------------
|
|               |  |                                                    |         |                     |               |               |       |                     |               |               |                |                         
|Trust I        |  | $                                                  | 10,183  |                     | Fixed         |               | 10.18 | %                   | Fixed         |               | June 2031      |                         
|Trust II       |  | $                                                  | 25,597  |                     | Semi-Annually |               | 5.74  | %                   | LIBOR + 3.75  |               | July 2031      |                         
|Trust III      |  | $                                                  | 33,789  |                     | Semi-Annually |               | 6.44  | %                   | LIBOR + 3.75  |               | December 2031  |                         
|Trust IV       |  | $                                                  | 22,405  |                     | Semi-Annually |               | 6.00  | %                   | LIBOR + 3.70  |               | April 2032     |                         
|Trust V        |  | $                                                  | 20,319  |                     | Quarterly     |               | 5.72  | %                   | LIBOR + 3.65  |               | July 2032      |                         
|Trust VI       |  | $                                                  | 25,361  |                     | Quarterly     |               | 5.74  | %                   | LIBOR + 3.45  |               | November 2032  |                         
|Trust VII      |  | $                                                  | 10,310  |                     | Quarterly     |               | 5.41  | %                   | LIBOR + 3.25  |               | April 2033     |                         
|Trust VIII     |  | $                                                  | 25,316  |                     | Quarterly     |               | 5.12  | %                   | LIBOR + 3.05  |               | October 2033   |                         
|LFIN Trust I   |  | $                                                  | 41,495  |                     | Fixed         |               | 9.00  | %                   | Fixed         |               | September 2031 |                         
|LFIN Trust II  |  | $                                                  | 10,310  |                     | Semi-Annually |               | 5.61  | %                   | LIBOR + 3.625 |               | July 2032      |                         
|LFIN Trust III |  | $                                                  | 10,310  |                     | Quarterly     |               | 5.74  | %                   | LIBOR + 3.45  |               | November 2032  |                         
|               |  |                                                    |         |                     |               |               |       |                     |               |               |                |                         
|               |  | $                                                  | 235,395 |                     |               |               |       |                     |               |               |                |                         
|               |  |                                                    |         |                     |               |               |       |                     |               |               |                |                         

Prior to the issuance of FIN No. 46R, the eight statutory business trusts formed by the Company were considered fully consolidated
subsidiaries of the Company and reported on the consolidated statement of

59

---



condition
under the heading "Other borrowed funds." With the early adoption of FIN 46R, the Company deconsolidated the eight statutory business trusts and as a result the Debentures issued by the
trust are reported in a separate line item, "Junior subordinated deferrable interest debentures."

(12) Earnings per Share

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, 2004, 2003,
and 2002 is set forth in the following table:

|                   |                                  | Net
Income
(Numerator) |         | Shares
(Denominator) |            | Per Share
Amount
|------------------ | -------------------------------- | ---------------------- | ------- | -------------------- | ---------- | ----------------
|
|December 31, 2004: |                                  |                        |         |                      |            |                 
|Basic EPS          |                                  |                        |         |                      |            |                 
|                   | Net income                       |                        | $       | 119,032              |            | 49,707,319      
|                   | Potential dilutive common shares |                        |         |                     |            | 997,126         
|                   |                                  |                        |         |                      |            |                 
|Diluted EPS        |                                  | $                      | 119,032 |                      | 50,704,445 |                 
|                   |                                  |                        |         |                      |            |                 
|December 31, 2003: |                                  |                        |         |                      |            |                 
|Basic EPS          |                                  |                        |         |                      |            |                 
|                   | Net income                       |                        | $       | 122,128              |            | 48,362,449      
|                   | Potential dilutive common shares |                        |         |                     |            | 971,864         
|                   |                                  |                        |         |                      |            |                 
|Diluted EPS        |                                  | $                      | 122,128 |                      | 49,334,313 |                 
|                   |                                  |                        |         |                      |            |                 
|December 31, 2002: |                                  |                        |         |                      |            |                 
|Basic EPS          |                                  |                        |         |                      |            |                 
|                   | Net income                       |                        | $       | 100,631              |            | 49,944,476      
|                   | Potential dilutive common shares |                        |         |                     |            | 1,141,895       
|                   |                                  |                        |         |                      |            |                 
|Diluted EPS        |                                  | $                      | 100,631 |                      | 51,086,371 |                 
|                   |                                  |                        |         |                      |            |                 

(13) Employees' Profit Sharing Plan

The Company has a deferred profit sharing plan for full-time employees with a minimum of one year of continuous employment. The Company's annual
contribution to the plan is based on a percentage, as determined by the Board of Directors, of income before income taxes, as defined, for the year. Allocation of the contribution among officers and
employees' accounts is based on length of service and amount of salary earned. Profit sharing costs of $3,823,000, $2,897,000 and $2,662,000 were charged to income for the years ended
December 31, 2004, 2003, and 2002, respectively.

60

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(14) International Operations

The Company provides international banking services for its customers through its bank subsidiaries. Neither the Company nor its bank subsidiaries have facilities
located outside the United States. International operations are distinguished from domestic operations based upon the domicile of the customer.

Because
the resources employed by the Company are common to both international and domestic operations, it is not practical to determine net income generated exclusively from
international activities.

A
summary of assets attributable to international operations at December 31, 2004 and 2003 are as follows:

2004

2003(Dollars in Thousands)Loans:Commercial

$
179,068

$
161,707Others


60,554


61,090239,622


222,797Less allowance for possible loan losses


(2,327
)

(1,058
)Net loans

$
237,295

$
221,739Accrued interest receivable

$
1,370

$
1,243


At
December 31, 2004, the Company had $95,657,000 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 was $11,077,000, $11,626,000 and $14,128,000 for the years ended December 31, 2004, 2003 and 2002, respectively.

(15) Income Taxes

The Company files a consolidated U.S. Federal 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:

|         |         | 2004                |        | 2003   |        | 2002  |       
|-------- | ------- | ------------------- | ------ | ------ | ------ | ----- | ------
|
|Current  |         |                     |        |        |        |       |       
|         | U.S.    |                     | $      | 45,969 |        | $     | 54,199
|         | State   |                     |        | 523    |        |       |      
|         | Foreign |                     |        | 35     |        |       | 74    
|         |         |                     |        |        |        |       |       
|         |         | Total current taxes |        |        | 46,527 |       |       
|Deferred |         |                     | 11,353 |        |        | 6,153 |       
|         |         |                     |        |        |        |       |       
|         |         | Total income taxes  |        | $      | 57,880 |       | $     
|         |         |                     |        |        |        |       |       

61

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Total
income tax expense differs from the amount computed by applying the U.S. Federal income tax rate of 35% for 2004, 2003 and 2002 to income before income taxes. The reasons for the
differences for the years ended December 31 are as follows:

|                                |                                        | 2004               |        | 2003   |        | 2002   |       
|------------------------------- | -------------------------------------- | ------------------ | ------ | ------ | ------ | ------ | ------
|
|                                |                                        |                    |        |        |        |        |       
|Computed expected tax expense   |                                        | $                  | 61,919 |        | $      | 63,894 |       
|Change in taxes resulting from: |                                        |                    |        |        |        |        |       
|                                | Tax-exempt interest income             |                    |        | (1,847 | )      |        | (1,762
|                                | Leasing activities                     |                    |        |       |        |        | (461  
|                                | Employee benefits                      |                    |        | (2,523 | )      |        | (2,113
|                                | State tax, net of federal income taxes |                    |        | 340    |        |        |      
|                                | Other                                  |                    |        | (9     | )      |        | 868   
|                                |                                        |                    |        |        |        |        |       
|                                |                                        | Actual tax expense |        | $      | 57,880 |        | $     
|                                |                                        |                    |        |        |        |        |       

The
tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2004 and 2003 are reflected
below:

|                          |                                                                             | 2004                       |   | 2003    |        
|------------------------- | --------------------------------------------------------------------------- | -------------------------- | - | ------- | -------
|
|Deferred tax assets:      |                                                                             |                            |   |         |        
|                          | Loans receivable, principally due to the allowance for possible loan losses |                            | $ | 29,481  |        
|                          | Other real estate owned                                                     |                            |   | 513     |        
|                          | Goodwill                                                                    |                            |   | 3,181   |        
|                          | Accrued expenses                                                            |                            |   | 2,295   |        
|                          | State net operating loss carryforwards                                      |                            |   | 3,416   |        
|                          | Valuation allowance                                                         |                            |   | (801    | )      
|                          | Other                                                                       |                            |   | 3,367   |        
|                          |                                                                             |                            |   |         |        
|                          | Total deferred tax assets                                                   |                            |   | 41,452  |        
|                          |                                                                             |                            |   |         |        
|Deferred tax liabilities: |                                                                             |                            |   |         |        
|                          | Net unrealized gains on available for sale investment securities            |                            |   | (8,082  | )      
|                          | Lease financing receivable                                                  |                            |   | (20,991 | )      
|                          | Bank premises and equipment, principally due to differences in depreciation |                            |   | (16,632 | )      
|                          | FHLB stock                                                                  |                            |   | (6,503  | )      
|                          | Identified intangible assets                                                |                            |   | (18,052 | )      
|                          | Other                                                                       |                            |   | (2,317  | )      
|                          |                                                                             |                            |   |         |        
|                          | Total deferred tax liabilities                                              |                            |   | (72,577 | )      
|                          |                                                                             |                            |   |         |        
|                          |                                                                             | Net deferred tax liability |   | $       | (31,125
|                          |                                                                             |                            |   |         |        

The
net deferred tax liability of $31,125,000 and $22,532,000 at December 31, 2004 and 2003, respectively, is included in other liabilities in the consolidated statements of
condition.

62

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As
part of the Local Financial Corporation acquisition, the Company assumed $2,206,381 in net deferred tax assets.

The
valuation allowance included in the Company's deferred tax assets at December 31, 2004, represent state net operating loss carryforwards for which it is more likely than not
that realization of the tax benefits related to the losses will occur. The state operating losses were acquired as part of various deferred tax items in the LFIN acquisition.

(16) Other Investments

Included in other investments is the Company's investment in Aircraft Finance Trust ("AFT"), a special purpose business trust formed to acquire and lease
aircraft. The Company accounts for its investment in AFT under the equity method of accounting. AFT utilizes derivative instruments to manage the interest rate on bonds that it has issued. The
derivatives qualify as cash flow hedges and are reported at fair value. The Company records its proportionate share of the fair value of the derivatives as an increase or decrease in the investment in
AFT and accumulated other comprehensive income, net of tax.

The
Company's proportionate share of earnings or losses of AFT were losses of $0 and $948,000 for the years ended December 31, 2004 and 2003, respectively. Because of the losses
from operations that AFT has reported as a result of the events of September 11 and the resulting impact on the airline industry, the Company evaluated its investment, which resulted in the
Company recording an impairment charge of $6,081,000 in 2002.

At
December 31, 2004 and 2003, the Company's investment in AFT, excluding its proportionate share of the fair value of the AFT derivatives was $0. The Company's investment
including the proportionate share of the fair value of the AFT derivatives at December 31, 2004 and 2003, was $0.

(17) Stock Options

On April 3, 1996, the Board of Directors adopted the 1996 International Bancshares Corporation Stock Option Plan (the "1996 Plan"). The 1996 Plan replaced
the 1987 International Bancshares Corporation Key Contributor Stock Option Plan (the "1987 Plan"). On April 5, 2001, the Board of Directors amended the 1996 plan and added 300,000 shares to the
plan. Under the 1987 Plan and the 1996 Plan both qualified incentive stock options ("ISOs") and nonqualified stock options ("NQSOs") may be granted. Options granted may be exercisable for a period of
up to 10 years from the date of grant, excluding ISOs granted to 10% shareholders, which may be exercisable for a period of up to only five years.

The
Company granted nonqualified stock options exercisable for a total of 139,160 shares, adjusted for stock dividends, of Common Stock to certain employees of the GulfStar Group. The
grants were not made under either the 1987 Plan or the 1996 Plan. The options are exercisable for a period of seven years and vest in equal increments over a period of five years. All options granted
to the GulfStar Group employees had an option price of not less than the fair market value of the Common Stock on or about the date of grant.

63

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The
following schedule summarizes the pertinent information (adjusted for stock distributions) with regard to the Company's stock options.

Option price
per share

Options
outstandingBalance at December 31, 2001






2,210,195Terminated

$6.44

-
17.43

(26,932
)Granted






Exercised

5.15

-
17.43

(221,052
)Balance at December 31, 2002






1,962,211Terminated

$8.04

-
21.79

(13,444
)Granted

23.04

-
36.32

122,890Exercised

6.44

-
21.79

(316,719
)Balance at December 31, 2003






1,754,938Terminated

$9.90

-
27.40

(26,192
)Granted

32.00

-
41.80

22,562Exercised

9.90

-
27.40

(313,403
)Balance at December 31, 2004






1,437,905


At
December 31, 2004, 2003, and 2002, 1,141,590, 944,096, and 760,121 options were exercisable, respectively, and as of December 31, 2004, 388,157 shares were available for
future grants under the 1996 Plan, as amended. All options granted under the1987 Plan and the 1996 Plan had an option price of not less than the fair market value of the Company's common stock at the
date of grant and a vesting period of five years.

The
following table summarizes information about stock options outstanding at December 31, 2004:

|                |  | Options Outstanding |  | Options Exercisable
|--------------- |  | ------------------- |  | -------------------
|
|$  6.38 - 12.58 |  | 381,989             |  | .5 years           
|12.58 - 13.04   |  | 47,880              |  | 1.1 years          
|12.06 - 14.10   |  | 332,988             |  | 3.3 years          
|12.70 - 13.46   |  | 162,126             |  | 4.1 years          
|15.57 - 18.69   |  | 376,841             |  | 5.9 years          
|23.04 - 36.32   |  | 115,518             |  | 6.6 years          
|32.00 - 41.80   |  | 20,563              |  | 7.7 years          
|                |  |                     |  |                    
|$  6.38 - 41.80 |  | 1,437,905           |  |                    
|                |  |                     |  |                    

64

---



The
fair values of options at date of grant were estimated using the Black-Scholes option pricing model with the following weighted-average assumptions:

2004

2003Expected Life (Years)

5

5Dividend yield

2.50
%
2.50
%Interest rate

3.59
%
2.96
%Volatility

25.29
%
30.86
%


The
Company has a formal stock repurchase program and as part of the program, the Company occasionally repurchases shares of Common Stock related to the exercise of stock options through
the surrender of other shares of Common Stock of the Company owned by the option holders.

(18) Commitments, Contingent Liabilities and Other Tax Matters

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

The
Company leases portions of its banking premises and equipment under operating leases. Total rental expense for the years ended December 31, 2004, 2003 and 2002 and
non-cancellable lease commitments at December 31, 2004 were not significant.

Cash
of approximately $50,411,000 and $35,865,000 at December 31, 2004 and 2003, respectively, was maintained to satisfy regulatory reserve requirements.

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

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

In
order to curtail the accrual of additional interest related to the disputed tax benefits and because interest rates were unfavorable, on March 7, 2003, the Company submitted to
the IRS a total of $13,640,797, which constitutes the interest that would have accrued based on the adjustments proposed in the FPAAs related to both of the lease-financing transactions. If it is
determined that the amount of

65

---



interest
due, if any, related to the lease-financing transactions is less than the $13,640,797, the remaining amount of the prepaid interest will be refunded to the Company, plus interest thereon.

No
reliable prediction can be made at this time as to the likely outcome of the lawsuits; however, if the lawsuits are decided adversely to the partnerships, all or a portion of the
$12 million in tax benefits previously recognized by the Company in connection with the Partnerships' lease-financing transactions would be in question and penalties and interest could be
assessed by the IRS. The Company has accrued approximately $12 million at December 31, 2004 in connection with the lawsuits. Management intends to continue to evaluate the merits of each
matter and make appropriate revisions to the accrued amount as deemed necessary.

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

(19) Transactions with Related Parties

In the ordinary course of business, the subsidiaries of the Company make loans to directors and executive officers of the Corporation, including their affiliates,
families and companies in which they are principal owners. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and do not involve more than normal risk of collectibility or present other unfavorable features. The aggregate amounts receivable
from such related parties amounted to approximately $56,211,000 and $48,431,000 at December 31, 2004 and 2003, respectively.

(20) 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, 2004, the following financial amounts of instruments, whose contract amounts represent credit risks, were outstanding:

Commitments to extend credit

$
1,283,806,000Credit card lines


27,135,000Standby letters of credit


91,171,000Commercial letters of credit


4,486,000


66

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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, 2004, the maximum potential amount of
future payments is $91,171,000. At December 31, 2004, the fair value of these guarantees is not significant.

The
Company enters into commercial letters of credit on behalf of its customers which authorize a third party to draw drafts on the Company up to a stipulated amount and with specific
terms and conditions. A commercial letter of credit is a conditional commitment on the part of the Company to provide payment on drafts drawn in accordance with the terms of the commercial letter of
credit.

The
bank subsidiaries' exposure to credit loss in the event of nonperformance by the other party to the above financial instruments is represented by the contractual amounts of the
instruments. The bank subsidiaries use the same credit policies in making commitments and conditional obligations as they do for on-statement of condition instruments. The bank
subsidiaries control the credit risk of these transactions through credit approvals, limits and monitoring procedures. Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates normally less than one year or other termination clauses and may require the
payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The bank
subsidiaries evaluate each customer's credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the subsidiary banks upon extension
of credit, is based on management's credit evaluation of the customer. Collateral held varies, but may include residential and commercial real estate, bank certificates of deposit, accounts receivable
and inventory.

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.

(21) Dividend Restrictions and Capital Requirements

Bank regulatory agencies limit the amount of dividends, which the bank subsidiaries can pay the Corporation, through IBC Subsidiary Corporation, without obtaining
prior approval from such agencies. At December 31, 2004, the subsidiary banks could pay dividends of up to $61,000,000 to the Company without prior regulatory approval and without adversely
affecting their "well capitalized" status. In addition to legal requirements, regulatory authorities also consider the adequacy of the bank subsidiaries' total capital in relation to their deposits
and other factors. These capital adequacy considerations also limit amounts available for payment of dividends. The Company historically has not allowed any subsidiary bank to pay dividends in such a
manner as to impair its capital adequacy.

The
Company and the bank subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements.
Under capital adequacy

67

---



guidelines
and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and
certain off-statement of condition items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.

Quantitative
measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table on the following page) of
Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets. Management believes, as of December 31, 2004, that the Company and each of the bank
subsidiaries met all capital adequacy requirements to which it is subject.

As
of December 31, 2004, 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.

68

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The
Company's and the bank subsidiaries' actual capital amounts and ratios for 2004 are presented in the following table:

|                                          |                                             | Actual |   | For Capital Adequacy
Purposes |  | To Be Well Capitalized
Under Prompt Corrective
Action Provisions |  
|----------------------------------------- | ------------------------------------------- | ------ | - | ----------------------------- |  | ---------------------------------------------------------------- | -
|
|
|
|As of December 31, 2004:                  |                                             |        |   |                               |  |                                                                  |  
|Total Capital (to Risk Weighted Assets):  |                                             |        |   |                               |  |                                                                  |  
|                                          | Consolidated                                |        | $ | 714,612                       |  | 11.99                                                            | %
|                                          | International Bank of Commerce, Laredo      |        |   | 534,464                       |  | 10.16                                                            |  
|                                          | International Bank of Commerce, Brownsville |        |   | 65,994                        |  | 18.89                                                            |  
|                                          | International Bank of Commerce, Zapata      |        |   | 29,474                        |  | 21.84                                                            |  
|                                          | Commerce Bank                               |        |   | 35,241                        |  | 19.54                                                            |  
|Tier 1 Capital (to Risk Weighted Assets): |                                             |        |   |                               |  |                                                                  |  
|                                          | Consolidated                                |        | $ | 639,875                       |  | 10.74                                                            | %
|                                          | International Bank of Commerce, Laredo      |        |   | 468,510                       |  | 8.91                                                             |  
|                                          | International Bank of Commerce, Brownsville |        |   | 62,911                        |  | 18.00                                                            |  
|                                          | International Bank of Commerce, Zapata      |        |   | 28,543                        |  | 21.15                                                            |  
|                                          | Commerce Bank                               |        |   | 32,970                        |  | 18.28                                                            |  
|Tier 1 Capital (to Average Assets):       |                                             |        |   |                               |  |                                                                  |  
|                                          | Consolidated                                |        | $ | 639,875                       |  | 6.91                                                             | %
|                                          | International Bank of Commerce, Laredo      |        |   | 468,510                       |  | 5.86                                                             |  
|                                          | International Bank of Commerce, Brownsville |        |   | 62,911                        |  | 8.41                                                             |  
|                                          | International Bank of Commerce, Zapata      |        |   | 28,543                        |  | 9.96                                                             |  
|                                          | Commerce Bank                               |        |   | 32,970                        |  | 8.40                                                             |  

69

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The Company's and the bank subsidiaries' actual capital amounts and ratios for 2003 are also presented in the following table:

|                                          |                                             | Actual |   | For Capital Adequacy
Purposes |  | To Be Well Capitalized
Under Prompt Corrective
Action Provisions |  
|----------------------------------------- | ------------------------------------------- | ------ | - | ----------------------------- |  | ---------------------------------------------------------------- | -
|
|
|
|As of December 31, 2003:                  |                                             |        |   |                               |  |                                                                  |  
|Total Capital (to Risk Weighted Assets):  |                                             |        |   |                               |  |                                                                  |  
|                                          | Consolidated                                |        | $ | 708,940                       |  | 19.33                                                            | %
|                                          | International Bank of Commerce, Laredo      |        |   | 540,856                       |  | 17.70                                                            |  
|                                          | International Bank of Commerce, Brownsville |        |   | 66,515                        |  | 21.31                                                            |  
|                                          | International Bank of Commerce, Zapata      |        |   | 33,387                        |  | 28.06                                                            |  
|                                          | Commerce Bank                               |        |   | 37,003                        |  | 22.18                                                            |  
|Tier 1 Capital (to Risk Weighted Assets): |                                             |        |   |                               |  |                                                                  |  
|                                          | Consolidated                                |        | $ | 634,525                       |  | 17.30                                                            | %
|                                          | International Bank of Commerce, Laredo      |        |   | 502,536                       |  | 16.44                                                            |  
|                                          | International Bank of Commerce, Brownsville |        |   | 63,442                        |  | 20.33                                                            |  
|                                          | International Bank of Commerce, Zapata      |        |   | 32,503                        |  | 27.32                                                            |  
|                                          | Commerce Bank                               |        |   | 34,895                        |  | 20.92                                                            |  
|Tier 1 Capital (to Average Assets):       |                                             |        |   |                               |  |                                                                  |  
|                                          | Consolidated                                |        | $ | 634,525                       |  | 8.75                                                             | %
|                                          | International Bank of Commerce, Laredo      |        |   | 502,536                       |  | 8.63                                                             |  
|                                          | International Bank of Commerce, Brownsville |        |   | 63,442                        |  | 8.36                                                             |  
|                                          | International Bank of Commerce, Zapata      |        |   | 32,503                        |  | 11.24                                                            |  
|                                          | Commerce Bank                               |        |   | 34,895                        |  | 9.21                                                             |  

(22) Fair Value of Financial Instruments

The fair value estimates, methods, and assumptions for the Company's financial instruments at December 31, 2004 and 2003 are outlined below.



For these short-term instruments, the carrying amount is a reasonable estimate of fair value.



As the contract interest rates are comparable to current market rates, the carrying amount approximates fair market value.

70

---





For investment securities, which include U. S. Treasury securities, obligations of other U. S. government agencies, obligations of states and political
subdivisions and mortgage pass through and related securities, fair values are based on quoted market prices or dealer quotes. Fair values are based on the value of one unit without regard to any
premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications, or estimated transaction costs. See disclosures of fair value of investment
securities in Note 3.



Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, real estate and
consumer loans as outlined by regulatory reporting guidelines. Each category is segmented into fixed and variable interest rate terms and by performing and non-performing categories.

For
variable rate performing loans, the carrying amount approximates the fair value. For fixed rate performing loans, except residential mortgage loans, the fair value is calculated by
discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. For performing residential
mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources or the primary origination
market. At December 31, 2004 and 2003, the carrying amount of fixed rate performing loans was $1,681,916,000 and $765,458,000 respectively, and the estimated fair value was $1,679,719,000 and
$775,280,000, respectively.

Fair
value for significant non-performing loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate
commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market and specific
borrower information. As of December 31, 2004 and 2003, the net carrying amount of non-performing loans was a reasonable estimate of the fair value.



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, 2004 and 2003. 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, 2004 and 2003, the carrying amount of time deposits was $3,188,003,000 and $2,225,611,000, respectively, and the estimated
fair value was $3,197,198,000 and $2,211,589,000, respectively.



Due to the contractual terms of these financial instruments, the carrying amounts approximated fair value at December 31, 2004 and 2003.

71

---





Due to the contractual terms of these financial instruments, the carrying amounts approximated fair value at December 31, 2004.



Commitments to extend credit and fund letters of credit are principally at current interest rates and therefore the carrying amount approximates fair value.



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.

72

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(23) International Bancshares Corporation (Parent Company Only) Financial Information

Statements of Condition  (Parent Company Only)    December 31, 2004 and 2003  (Dollars in Thousands)

|                                     |                                                    | 2004 |                                            | 2003    |  
|------------------------------------ | -------------------------------------------------- | ---- | ------------------------------------------ | ------- | -
|ASSETS                               |                                                    |      |                                            |         |  
|Cash                                 |                                                    | $    | 387                                        |         | $
|Repurchase Agreements                |                                                    |      | 4,400                                      |         |  
|Other investments                    |                                                    |      | 25,425                                     |         |  
|Notes receivable                     |                                                    |      | 5,775                                      |         |  
|Premises & fixed assets              |                                                    |      | 6,057                                      |         |  
|Investment in subsidiaries           |                                                    |      | 946,665                                    |         |  
|Other assets                         |                                                    |      | 3,088                                      |         |  
|                                     |                                                    |      |                                            |         |  
|                                     |                                                    |      | Total assets                               |         | $
|                                     |                                                    |      |                                            |         |  
|LIABILITIES AND SHAREHOLDERS' EQUITY |                                                    |      |                                            |         |  
|Liabilities:                         |                                                    |      |                                            |         |  
|                                     | Junior subordinated deferrable interest debentures |      | $                                          | 235,395 |  
|                                     | Due to IBC Trading                                 |      |                                            | 21      |  
|                                     | Other liabilities                                  |      |                                            | 3,291   |  
|                                     |                                                    |      |                                            |         |  
|                                     |                                                    |      | Total liabilities                          |         |  
|                                     |                                                    |      |                                            |         |  
|Shareholders' equity:                |                                                    |      |                                            |         |  
|                                     | Common shares                                      |      |                                            | 68,431  |  
|                                     | Surplus                                            |      |                                            | 130,597 |  
|                                     | Retained earnings                                  |      |                                            | 705,642 |  
|                                     | Accumulated other comprehensive income             |      |                                            | 15,010  |  
|                                     |                                                    |      |                                            |         |  
|                                     |                                                    |      | 919,680                                    |         |  
|Less cost of shares in treasury      |                                                    |      | (166,590                                   | )       |  
|                                     |                                                    |      |                                            |         |  
|                                     |                                                    |      | Total shareholders' equity                 |         |  
|                                     |                                                    |      |                                            |         |  
|                                     |                                                    |      | Total liabilities and shareholders' equity |         | $
|                                     |                                                    |      |                                            |         |  

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(24) International Bancshares Corporation (Parent Company Only) Financial Information

Statements of Income  (Parent Company Only)    Years ended December 31, 2004, 2003 and 2002  (Dollars in Thousands)

|                                                   |                                      | 2004                                                                                      |        | 2003   |         | 2002    |      
|-------------------------------------------------- | ------------------------------------ | ----------------------------------------------------------------------------------------- | ------ | ------ | ------- | ------- | -----
|Income:                                            |                                      |                                                                                           |        |        |         |         |      
|                                                   | Dividends from subsidiaries          |                                                                                           | $      | 62,950 |         | $       | 8,000
|                                                   | Interest income on notes receivable  |                                                                                           |        | 682    |         |         | 1,330
|                                                   | Interest income on other investments |                                                                                           |        | 1,437  |         |         | 876  
|                                                   | Other interest income                |                                                                                           |        | 511    |         |         |     
|                                                   | Gain on sale of other securities     |                                                                                           |        | 151    |         |         | 100  
|                                                   | Gain on sale of assets               |                                                                                           |        | 1,659  |         |         |     
|                                                   | Other                                |                                                                                           |        | 5,683  |         |         | 2,522
|                                                   |                                      |                                                                                           |        |        |         |         |      
|                                                   |                                      | Total income                                                                              |        |        | 73,073  |         |      
|Expenses:                                          |                                      |                                                                                           |        |        |         |         |      
|                                                   | Interest expense (Debentures)        |                                                                                           |        | 13,152 |         |         | 9,125
|                                                   | Interest expense (Senior Notes)      |                                                                                           |        | 383    |         |         |     
|                                                   | Other                                |                                                                                           |        | 1,271  |         |         | 554  
|                                                   |                                      |                                                                                           |        |        |         |         |      
|                                                   |                                      | Total expenses                                                                            |        |        | 14,806  |         |      
|                                                   |                                      |                                                                                           |        |        |         |         |      
|                                                   |                                      | Income before federal income taxes and equity in undistributed net income of subsidiaries |        |        | 58,267  |         |      
|Income tax benefit                                 |                                      |                                                                                           | (1,559 | )      |         | (1,394  | )    
|                                                   |                                      |                                                                                           |        |        |         |         |      
|                                                   |                                      | Income before equity in undistributed net income of subsidiaries                          |        |        | 59,826  |         |      
|                                                   |                                      |                                                                                           |        |        |         |         |      
|Equity in undistributed net income of subsidiaries |                                      |                                                                                           | 59,206 |        |         | 117,585 |      
|                                                   |                                      |                                                                                           |        |        |         |         |      
|                                                   |                                      | Net income                                                                                |        | $      | 119,032 |         | $    
|                                                   |                                      |                                                                                           |        |        |         |         |      

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(25) International Bancshares Corporation (Parent Company Only) Financial Information

Statements of Cash Flows  (Parent Company Only)    Years ended December 31, 2004, 2003 and 2002  (Dollars in Thousands)

|                                                                                  |                             | 2004                                                            |       | 2003    |         | 2002  |        
|--------------------------------------------------------------------------------- | --------------------------- | --------------------------------------------------------------- | ----- | ------- | ------- | ----- | -------
|Operating activities:                                                             |                             |                                                                 |       |         |         |       |        
|                                                                                  | Net income                  |                                                                 | $     | 119,032 |         | $     | 122,128
|Adjustments to reconcile net income to net cash provided by operating activities: |                             |                                                                 |       |         |         |       |        
|                                                                                  |                             | Gain on sale of other investments                               |       |         | (151    | )     |        
|                                                                                  |                             | Gain on sale of assets                                          |       |         | (1,659  | )     |        
|                                                                                  |                             | Accretion of junior subordinated interest deferrable debentures |       |         | 1,026   |       |        
|                                                                                  |                             | Depreciation of bank premises and equipment                     |       |         | 15      |       |        
|                                                                                  |                             | Increase in other liabilities                                   |       |         | 904     |       |        
|                                                                                  |                             | Equity in undistributed net income of subsidiaries              |       |         | (59,206 | )     |        
|                                                                                  |                             |                                                                 |       |         |         |       |        
|                                                                                  |                             | Net cash provided by operating activities                       |       |         | 59,961  |       |        
|                                                                                  |                             |                                                                 |       |         |         |       |        
|Investing activities:                                                             |                             |                                                                 |       |         |         |       |        
|                                                                                  |                             | Contributions to subsidiaries                                   |       |         | (9,581  | )     |        
|                                                                                  |                             | Proceeds (repurchase) of repurchase agreement with banks        |       |         | 300     |       |        
|                                                                                  |                             | Purchase of available for sale other securities                 |       |         | (5,068  | )     |        
|                                                                                  |                             | Proceeds of sales of available for sale securities              |       |         | 5,010   |       |        
|                                                                                  |                             | Principal collected on mortgage-backed securities               |       |         |        |       |        
|                                                                                  |                             | Proceeds from sales of bank premises and equipment              |       |         | 2,598   |       |        
|                                                                                  |                             | Net decrease in notes receivable                                |       |         | 5,750   |       |        
|                                                                                  |                             | (Decrease) increase in other assets                             |       |         | (2,982  | )     |        
|                                                                                  |                             |                                                                 |       |         |         |       |        
|                                                                                  |                             | Net cash used in investing activities                           |       |         | (3,973  | )     |        
|                                                                                  |                             |                                                                 |       |         |         |       |        
|Financing activities:                                                             |                             |                                                                 |       |         |         |       |        
|                                                                                  |                             | Proceeds from issuance of subordinated debentures               |       |         |        |       |        
|                                                                                  |                             | Principal payments on senior notes                              |       |         | (21,295 | )     |        
|                                                                                  |                             | Proceeds from stock transactions                                |       |         | 5,265   |       |        
|                                                                                  |                             | Payments of cash dividends                                      |       |         | (39,729 | )     |        
|                                                                                  |                             | Payments of cash dividends in lieu of fractional shares         |       |         | (38     | )     |        
|                                                                                  |                             | Purchase of treasury stock                                      |       |         | (974    | )     |        
|                                                                                  |                             |                                                                 |       |         |         |       |        
|                                                                                  |                             | Net cash used in financing activities                           |       |         | (56,771 | )     |        
|                                                                                  |                             |                                                                 |       |         |         |       |        
|                                                                                  | (Decrease) increase in cash |                                                                 |       | (783    | )       |       | (3,613 
|Cash at beginning of year                                                         |                             |                                                                 | 1,170 |         |         | 4,783 |        
|                                                                                  |                             |                                                                 |       |         |         |       |        
|Cash at end of year                                                               |                             | $                                                               | 387   |         | $       | 1,170 |        
|                                                                                  |                             |                                                                 |       |         |         |       |        

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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, 2004, 2003, and 2002:

|                                     |                                                                         | 2004       |                                      | 2003                |           | 2002      |       
|------------------------------------ | ----------------------------------------------------------------------- | ---------- | ------------------------------------ | ------------------- | --------- | --------- | ------
|
|
|Assets                               |                                                                         |            |                                      |                     |           |           |       
|Interest earning assets:             |                                                                         |            |                                      |                     |           |           |       
|                                     | Loan, net of unearned discounts:                                        |            |                                      |                     |           |           |       
|                                     |                                                                         | Domestic   |                                      | $                   | 3,757,015 |           | $     
|                                     |                                                                         | Foreign    |                                      |                     | 225,565   |           |       
|                                     | Investment securities:                                                  |            |                                      |                     |           |           |       
|                                     |                                                                         | Taxable    |                                      |                     | 2,996,046 |           |       
|                                     |                                                                         | Tax-exempt |                                      |                     | 111,671   |           |       
|                                     | Time deposits with banks                                                |            |                                      | 5,459               |           |           | 92    
|                                     | Federal funds sold                                                      |            |                                      | 129,731             |           |           | 1,577 
|                                     | Other                                                                   |            |                                      | 6,153               |           |           | 467   
|                                     |                                                                         |            |                                      |                     |           |           |       
|                                     |                                                                         |            | Total interest-earning assets        |                     |           | 7,231,640 |       
|Non-interest earning assets:         |                                                                         |            |                                      |                     |           |           |       
|                                     | Cash and due from banks                                                 |            |                                      | 162,278             |           |           |       
|                                     | Bank premises and equipment, net                                        |            |                                      | 260,671             |           |           |       
|                                     | Other assets                                                            |            |                                      | 552,880             |           |           |       
|                                     | Less allowance for possible loan losses                                 |            |                                      | (69,324             | )         |           |       
|                                     |                                                                         |            |                                      |                     |           |           |       
|                                     |                                                                         |            | Total                                |                     | $         | 8,138,145 |       
|                                     |                                                                         |            |                                      |                     |           |           |       
|Liabilities and Shareholders' Equity |                                                                         |            |                                      |                     |           |           |       
|Interest bearing liabilities:        |                                                                         |            |                                      |                     |           |           |       
|                                     | Savings and interest bearing demand deposits                            |            | $                                    | 1,832,714           |           | $         | 13,797
|                                     | Time deposits:                                                          |            |                                      |                     |           |           |       
|                                     |                                                                         | Domestic   |                                      |                     | 1,590,229 |           |       
|                                     |                                                                         | Foreign    |                                      |                     | 1,178,775 |           |       
|                                     | Securities sold under repurchase agreements and federal funds purchased |            |                                      | 545,572             |           |           | 19,865
|                                     | Other borrowings                                                        |            |                                      | 1,083,222           |           |           | 16,746
|                                     | Junior subordinated interest deferrable debentures                      |            |                                      | 206,272             |           |           | 13,152
|                                     | Senior notes                                                            |            |                                      | 3,340               |           |           | 383   
|                                     |                                                                         |            |                                      |                     |           |           |       
|                                     |                                                                         |            | Total interest bearing liabilities   |                     |           | 6,440,124 |       
|Non-interest bearing liabilities:    |                                                                         |            |                                      |                     |           |           |       
|                                     | Demand Deposits                                                         |            |                                      | 988,659             |           |           |       
|                                     | Other liabilities                                                       |            |                                      | 54,261              |           |           |       
|Shareholders' equity                 |                                                                         |            | 655,101                              |                     |           |           |       
|                                     |                                                                         |            |                                      |                     |           |           |       
|                                     |                                                                         |            | Total                                |                     | $         | 8,138,145 |       
|                                     |                                                                         |            |                                      |                     |           |           |       
|                                     |                                                                         |            |                                      | Net interest income |           |           |       
|                                     |                                                                         |            |                                      |                     |           |           |       
|                                     |                                                                         |            | Net yield on interest earning assets |                     |           |           |       
|                                     |                                                                         |            |                                      |                     |           |           |       

(Note 1) The average balances for purposes of the above table are calculated on the basis of month-end balances.

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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
|---- | ---------------------------------- | -------------- | - | ------------- | --- | -------------- | ------- | -------------
|2004 |                                    |                |   |               |     |                |         |              
|     | Interest income                    |                | $ | 107,117       |     | $              | 101,787 |              
|     | Interest expense                   |                |   | 35,240        |     |                | 30,362  |              
|     |                                    |                |   |               |     |                |         |              
|     | Net interest income                |                |   | 71,877        |     |                | 71,425  |              
|     | Provision for possible loan losses |                |   | 1,717         |     |                | 2,066   |              
|     | Non-interest income                |                |   | 39,462        |     |                | 35,951  |              
|     | Non-interest expense               |                |   | 59,690        |     |                | 56,913  |              
|     |                                    |                |   |               |     |                |         |              
|     | Income before income taxes         |                |   | 49,932        |     |                | 48,397  |              
|     | Income taxes                       |                |   | 16,819        |     |                | 15,226  |              
|     |                                    |                |   |               |     |                |         |              
|     | Net income                         |                | $ | 33,113        |     | $              | 33,171  |              
|     |                                    |                |   |               |     |                |         |              
|     | Per common share:                  |                |   |               |     |                |         |              
|     |                                    | Basic          |   |               |     |                |         |              
|     |                                    | Net income     |   | $             | .65 |                | $       | .65          
|     |                                    |                |   |               |     |                |         |              
|     |                                    | Diluted        |   |               |     |                |         |              
|     |                                    | Net income     |   | $             | .64 |                | $       | .64          
|     |                                    |                |   |               |     |                |         |              

77

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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
|---- | ---------------------------------- | -------------- | - | ------------- | ---- | -------------- | ------ | -------------
|2003 |                                    |                |   |               |      |                |        |              
|     | Interest income                    |                | $ | 76,967        |      | $              | 80,510 |              
|     | Interest expense                   |                |   | 23,107        |      |                | 23,923 |              
|     |                                    |                |   |               |      |                |        |              
|     | Net interest income                |                |   | 53,860        |      |                | 56,587 |              
|     | Provision for possible loan losses |                |   | 2,101         |      |                | 2,077  |              
|     | Non-interest income                |                |   | 32,713        |      |                | 34,051 |              
|     | Non-interest expense               |                |   | 41,465        |      |                | 38,009 |              
|     |                                    |                |   |               |      |                |        |              
|     | Income before income taxes         |                |   | 43,007        |      |                | 50,552 |              
|     | Income taxes                       |                |   | 14,537        |      |                | 16,694 |              
|     |                                    |                |   |               |      |                |        |              
|     | Net income                         |                | $ | 28,470        |      | $              | 33,858 |              
|     |                                    |                |   |               |      |                |        |              
|     | Per common share:                  |                |   |               |      |                |        |              
|     |                                    | Basic          |   |               |      |                |        |              
|     |                                    | Net income     |   | $             | ..59 |                | $      | ..70         
|     |                                    |                |   |               |      |                |        |              
|     |                                    | Diluted        |   |               |      |                |        |              
|     |                                    | Net income     |   | $             | ..58 |                | $      | ..69         
|     |                                    |                |   |               |      |                |        |              

Net
income and per common share amounts for the first three quarters have been re-stated to reflect the reversal of $792,000 of amortization expense in accordance with SFAS
No. 147. (See Note 1 to the consolidated financial statements)

78

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INTERNATIONAL BANCSHARES CORPORATION        OFFICERS AND DIRECTORS

|OFFICERS                                                                                                                                                                                                                                                           |  | DIRECTORS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|DENNIS E. NIXON
Chairman of the Board and President
R. DAVID GUERRA
Vice President
EDWARD J. FARIAS
Vice President
RICHARD CAPPS
Vice President
IMELDA NAVARRO
Treasurer
WILLIAM CUELLAR
Auditor
LUISA D. BENAVIDES
Secretary
MARISA V. SANTOS
Assistant Secretary |  | DENNIS E. NIXON
President,
International Bank of Commerce
LESTER AVIGAEL
Retail Merchant
Chairman of the Board
International Bank of Commerce
IRVING GREENBLUM
Retail Merchant
R. DAVID GUERRA
President
International Bank of Commerce
Branch in McAllen, TX
DANIEL B. HASTINGS, JR.
Licensed U. S. Custom Broker
President
Daniel B. Hastings, Inc.
RICHARD E. HAYNES
Attorney at Law
Real Estate Investments
IMELDA NAVARRO
Senior Executive Vice President
International Bank of Commerce
SIOMA NEIMAN
International Entrepreneur
PEGGY J. NEWMAN
Investments
LEONARDO SALINAS
Investments
ANTONIO R. SANCHEZ, JR.
Chairman of the Board
Sanchez Oil & Gas Corporation
Investments

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