EXHIBIT 13

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, 2008. 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 31,2008

2007

2006

2005

2004(Dollars in Thousands, Except Per Share Data)STATEMENT OF CONDITIONAssets

$
12,439,341

$
11,167,161

$
10,911,454

$
10,391,853

$
9,921,505Net loans


5,799,372


5,474,902


4,970,273


4,547,896


4,807,623Deposits


6,858,784


7,157,606


6,989,918


6,656,426


6,571,104Other borrowed funds


2,522,986


1,456,936


2,095,576


1,870,075


1,670,199Junior subordinated deferrable interest debentures


201,048


200,929


210,908


236,391


235,395Shareholders' equity


1,257,297


935,905


842,056


792,867


753,090INCOME STATEMENTInterest income

$
564,603

$
643,573

$
609,073

$
508,705

$
352,378Interest expense


231,731


333,340


319,588


206,830


108,602Net interest income


332,872


310,233


289,485


301,875


243,776Provision (credit) for probable loan losses


19,813


(1,762
)

3,849


960


5,196Non-interest income


189,809


165,363


176,971


167,222


134,816Non-interest expense


300,811


300,282


288,677


255,988


196,484Income before income taxes


202,057


177,076


173,930


212,149


176,912Minority interest in consolidated subsidiary


415





40





Income taxes


69,530


55,764


56,889


71,370


57,880Net income

$
132,112

$
121,312

$
117,001

$
140,779

$
119,032Per common share (Note 1):Basic

$
1.93

$
1.76

$
1.68

$
2.01

$
1.74Diluted

$
1.92

$
1.75

$
1.67

$
1.98

$
1.71


---

Note 1:
Per share information has been re-stated giving retroactive effect to stock dividends distributed.

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, 2008.
The following discussion should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2008, and the Selected Financial Data and
Consolidated Financial Statements included elsewhere herein.

Special Cautionary Notice Regarding Forward Looking Information

Certain matters discussed in this report, excluding historical information, include forward-looking statements, within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by these sections.
Although the Company believes such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached. The words "estimate," "expect,"
"intend," "believe" and "project," as well as other words or expressions of a similar meaning are intended to identify forward-looking statements. Readers are
cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report. Such statements are based on current expectations, are inherently uncertain, are
subject to risks and should be viewed with caution. Actual results and experience may differ materially from the forward-looking statements as a result of many factors.

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



2

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

Recent Developments

In response to the financial crisis affecting the banking system and financial markets and going concern threats to
investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the "EESA") was signed into law. Pursuant to the EESA, the U.S. Treasury
was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the
purpose of stabilizing and providing liquidity to the U.S. financial markets.

On
October 14, 2008, the Secretary of the Department of the Treasury announced that the Department of the Treasury will purchase equity stakes in a wide variety of banks and
thrifts. Under the program, known as the Troubled Asset Relief Program Capital Purchase Program (the "TARP Capital Purchase Program"), from the $700 billion authorized by the EESA, the Treasury
made $250 billion of capital available to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the Treasury received, from
participating financial institutions, warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions were required to
adopt the Treasury's standards for executive

3

---



compensation
and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program.

On
December 23, 3008, as part of the TARP Capital Purchase Program, the Company entered into a Letter Agreement incorporating an attached Securities Purchase Agreement Standard
Terms (collectively the "Securities Purchase Agreement") with the Treasury. The closing of the transactions contemplated in the Securities Purchase Agreement occurred on December 23, 2008.

Under
the Securities Purchase Agreement, the Company agreed to sell 216,000 shares of the Company's fixed-rate cumulative perpetual preferred stock, Series A, par
value $.01 per share (the "Senior Preferred Stock"), having a liquidation preference of $1,000 per share, for a total price of $216,000,000. The Senior Preferred Stock will pay dividends at the rate
of 5% per year for the first five years and 9% per year thereafter. The Senior Preferred Stock has no maturity date and ranks senior to the Company's common stock with respect to the payment of
dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Senior Preferred Stock generally is non-voting except for class voting
rights on matters that would adversely affect the rights of the holders of the Senior Preferred Stock.

Pursuant
to the Securities Purchase Agreement, the Company may redeem the Senior Preferred Stock in whole or in part at par after three years from the date of the investment. Prior to
such date, the Company may redeem the Senior Preferred Stock in whole or in part, at par if (i) the Company has raised aggregate gross proceeds in one or more Qualified Equity Offerings (as
defined in the Securities Purchase Agreement) in excess of $54 million and (ii) the aggregate redemption is subject to the consent of the Federal Reserve Bank of Dallas, which is the
Company's primary Federal banking regulator.

In
conjunction with the purchase of the Senior Preferred Stock, the Treasury received a warrant (the "Warrant") to purchase 1,326,238 shares of the Company's common stock (the "Warrant
Shares") at $24.43 per share, which would represent an aggregate common stock investment in the Company on exercise of the warrant in full equal to 15% of the Senior Preferred Stock investment. The
term of the Warrant is ten years. The per share exercise price and the number of shares issuable upon exercise of the Warrant is subject to adjustment pursuant to customary anti-dilutive
provisions in certain events, such as stock splits, certain distributions of securities or other assets to holders of the Company's common stock, and upon certain issuances of the Company's common
stock at or below specified prices relative to the initial per share exercise price of the Warrant. The Warrant is immediately exercisable. The number of shares issuable upon exercise of the Warrant
is also subject to reduction in certain limited events that involve the Company conducting Qualified Equity Offerings on or prior to December 31, 2009. Both the Senior Preferred Stock and
Warrant will be accounted for as components of Tier 1 capital.

The
Company's intention is to utilize the extra capital provided by the TARP funds to support its efforts to prudently and transparently provide lending and liquidity.

On
November 21, 2008, the Board of Directors for the Federal Deposit Insurance Corporation ("FDIC") adopted a final rule relating to the Temporary Liquidity Guarantee Program
("TLG Program"). The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by the Secretary of the Department of Treasury (after consultation
with the President), as an initiative to counter the system-wide crisis in the nation's financial sector. Under the TLG Program, the FDIC will (i) guarantee through the earlier of
maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009 (the "Debt
Guaranty Program") and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal ("NOW") accounts
paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts ("IOLTA") held at participating FDIC-insured institutions through December 31, 2009 (the "Transaction
Account Guaranty Program"). Coverage under the TLG Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis
points to 100 basis points per annum,

4

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depending
on the initial maturity of the debt. The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000. On December 5,
2008, the Company elected to opt out of the Debt Guaranty Program, but the Company will participate in the Transaction Account Guaranty Program.

Overview

The Company, which is headquartered in Laredo, Texas, with 265 facilities and more than 420 ATMs, provides banking
services for commercial, consumer and international customers of South, Central and Southeast Texas and the State of Oklahoma. The Company is one of the largest independent commercial bank holding
companies headquartered in Texas. The Company, through its bank subsidiaries, is in the business of gathering funds from various sources and investing those funds in order to earn a return. The
Company either directly or through a bank subsidiary owns two insurance agencies, a broker/dealer and a majority interest in an investment banking unit that owns a broker/dealer. The Company's primary
earnings come from the spread between the interest earned on interest-bearing assets and the interest paid on interest-bearing liabilities. In addition, the Company generates income from fees on
products offered to commercial, consumer and international customers.

A
primary goal of the Company is to grow net interest income and non-interest income while adequately managing credit risk, interest rate risk and expenses. Effective
management of capital is a critical objective of the Company. A key measure of the performance of a banking institution is the return on average common equity ("ROE"). The Company's ROE for the year
ended December 31, 2008 was 13.34% as compared to 13.73% for the year ended December 31, 2007.

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

Expense
control is an essential element in the Company's long-term profitability. As a result, the Company monitors the efficiency ratio, which is a measure of
non-interest expense to net interest income plus non-interest income closely. The efficiency ratio during 2007 was negatively affected by an impairment charge of
$13.1 million, after tax, arising from a charge on certain investment securities. This impairment charge negatively affected the efficiency ratio but does not necessarily reflect a
long-term negative trend. Additionally, the Company's efficiency ratio has been negatively impacted over the last few years because of the Company's aggressive branch expansion which has
added a total of 61 branches during 2007 and 2008. During rapid expansion periods, the Company's efficiency ratio will suffer but the long-term benefits of the expansion should be realized
in future periods and the benefits should positively impact the efficiency ratio in future periods. The Company monitors this ratio over time to assess the Company's efficiency relative to its peers
taking into account the Company's branch expansion. The Company uses this measure as one factor in determining if the Company is accomplishing its long-term goals of providing superior
returns to the Company's shareholders.

5

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Results of Operations

Summary

Consolidated Statements of Condition Information

December 31,
2008

December 31,
2007

Percent
Increase
(Decrease)(Dollars in Thousands)Assets

$
12,439,341

$
11,167,161


11.4
%Net loans


5,799,372


5,474,902


5.9Deposits


6,858,784


7,157,606


(4.2
)Other borrowed funds


2,522,986


1,456,936


73.2Junior subordinated deferrable interest debentures


201,048


200,929


.1Shareholders' equity


1,257,297


935,905


34.3


Consolidated Statements of Income Information

Year Ended
December 31,
2008

Year Ended
December 31,
2007

Percent
Increase
(Decrease)
2008 vs. 2007

Year Ended
December 31,
2006

Percent
Increase
(Decrease)
2007 vs. 2006(Dollars in Thousands)Interest income

$
564,603

$
643,573


(12.3
)%
$
609,073


5.7
%Interest expense


231,731


333,340


(30.5
)

319,588


4.3Net interest income


332,872


310,233


7.3


289,485


7.2Provision (credit) for probable loan losses


19,813


(1,762
)

(1,224.5
)

3,849


(145.8
)Non-interest income


189,809


165,363


14.8


176,971


(6.6
)Non-interest expense


300,811


300,282


.2


288,677


4.0Net income


132,112


121,312


8.9


117,001


3.7Per common share:Basic

$
1.93

$
1.76


9.7
%
$
1.68


4.8
%Diluted


1.92


1.75


9.7


1.67


4.8


Net Income

Net income for the year ended December 31, 2008 increased by 8.9% compared to the same period in 2007. Net income for the year
ended December 31, 2008 was negatively impacted by increases in the provision for probable loan losses charged to expense. The increase was due to the financial crisis in the United States,
which has negatively impacted the Company's loan portfolio. Net income for the year ended December 31, 2007 was positively affected by the credit for probable loan losses recorded in 2007. Net
income for the year ended December 31, 2007 was negatively impacted by an impairment charge of $13.1 million, after tax, on certain investments. A significant portion of the impairment
charge was the result of the Company's strategic sale of certain investment securities in the second quarter of 2007 with the proceeds from the sales used to reduce Federal Home Loan Bank ("FHLB")
borrowings. Net income for the same period was positively affected by the sale of the securities, which generated gains of $1.5 million, after tax. The investments sold were certain hybrid
mortgage-backed securities with a coupon re-set date that exceeded 30 months and a weighted average yield to coupon re-set that was approximately 100 basis points
less than the FHLB certificate of indebtedness short-term rate. The sale of the securities facilitated a re-positioning of the balance sheet to a more neutral position in terms
of interest rate risk and also improved operating ratios.

6

---



Net
income for the year ended December 31, 2007 increased by 3.7% compared to the same period in 2006. Net income for the year ended December 31, 2006 was negatively
impacted by a $8.9 million, net of tax, charge to operations as a result of the loss of a tax lawsuit with the Internal Revenue Service that was litigated during the third quarter of 2005 in
the Federal District Court in San Antonio, Texas and that relates to certain leasing transactions previously discussed in Note 17 of the Notes to Consolidated Financial Statements. Because of
the trial court judgment issued on March 31, 2006, and the loss of the case at the appellate level, and the similarity between the litigated lawsuit and the other tax case that is pending, the
Company took the $8.9 million charge, net of tax. Additionally, net income for the three years ended December 31, 2008, 2007 and 2006 was negatively impacted due to an inverted yield
curve and increasing competition for deposits and loans. Net income for the year ended December 31, 2006 was also affected by the Company's strategic decisions to reduce certain loan and
deposit categories acquired from Local Financial Corporation ("LFIN").

Net Interest Income

Net interest income is the spread between income on interest-earning assets, such as loans and securities, and the interest expense on
liabilities used to fund those assets, such as deposits, repurchase agreements and funds borrowed. Net interest income is the Company's largest source of revenue. Net interest income is affected by
both changes in the level of interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities.

For the years ended December 31,2008
Average
Rate/Cost

2007
Average
Rate/Cost

2006
Average
Rate/CostAssetsInterest earning assets:Loan, net of unearned discounts:Domestic


6.60
%

8.58
%

8.42
%Foreign


6.03


7.43


7.16Investment securities:Taxable


4.59


4.69


4.58Tax-exempt


4.87


4.89


4.88Federal funds sold


1.75


4.96


4.79Other


4.99


5.81


6.82Total interest-earning assets


5.70
%

6.82
%

6.51
%LiabilitiesInterest bearing liabilities:Savings and interest bearing demand deposits


1.17
%

2.31
%

1.91
%Time deposits:Domestic


3.25


4.32


3.81Foreign


3.11


4.28


3.77Securities sold under repurchase agreements


3.51


4.46


4.50Other borrowings


2.44


5.15


5.07Junior subordinated deferrable interest debentures


7.03


8.06


9.72Total interest bearing liabilities


2.67
%

4.01
%

3.84
%


For
the three years ended December 31, 2008, as short term interest rates have fluctuated, the Company has monitored and adjusted interest rates on loans and deposits accordingly.
The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net income and net interest margin. The yield on average interest-earning assets decreased
16.4% from 6.82% in 2007 to

7

---



5.70%
in 2008, and the rates paid on average interest-bearing liabilities decreased 33.4% from 4.01% in 2007 to 2.67% in 2008. The yield on average interest-earning assets increased 4.8% from 6.51% in
2006 to 6.82% in 2007, and the rates paid on average interest-bearing liabilities increased 4.4% from 3.84% in 2006 to 4.01% in 2007. The majority of the Company's taxable investment securities are
invested in
mortgage backed securities and during rapid increases or reduction in interest rates, the yield on these securities do not re-price as quickly as the loans.

The
following table analyzes the changes in net interest income during 2008 and 2007 and the relative effect of changes in interest rates and volumes for each major classification of
interest-earning assets and interest-bearing liabilities. Non-accrual loans have been included in assets for the purpose of this analysis, which reduces the resulting yields:

2008 compared to 2007
Net increase (decrease) due to

2007 compared to 2006
Net increase (decrease) due toVolume(1)

Rate(1)

Total

Volume(1)

Rate(1)

Total(Dollars in Thousands)

(Dollars in Thousands)Interest earned on:Loans, net of unearned discounts:Domestic

$
37,681

$
(106,085
)
$
(68,404
)
$
34,772

$
7,927

$
42,699Foreign


(463
)

(3,979
)

(4,442
)

55


790


845Investment securities:Taxable


3,026


(4,469
)

(1,443
)

(14,817
)

4,714


(10,103
)Tax-exempt


(740
)

(16
)

(756
)

(320
)

13


(307
)Federal funds sold


(80
)

(1,705
)

(1,785
)

(977
)

93


(884
)Other


(2,075
)

(65
)

(2,140
)

2,482


(232
)

2,250Total interest income

$
37,349

$
(116,319
)
$
(78,970
)
$
21,195

$
13,305

$
34,500Interest incurred on:Savings and interest bearing demand deposits

$
(972
)
$
(26,155
)
$
(27,127
)
$
3,921

$
9,413

$
13,334Time deposits:Domestic


(100
)

(18,206
)

(18,306
)

(605
)

8,601


7,996Foreign


907


(19,142
)

(18,235
)

3,605


8,342


11,947Securities sold under repurchase agreements


20,226


(13,663
)

6,563


14,067


(367
)

13,700Other borrowings


(3,465
)

(37,876
)

(41,341
)

(29,285
)

1,240


(28,045
)Junior subordinated deferrable interest debentures


(973
)

(2,068
)

(3,041
)

(1,860
)

(3,530
)

(5,390
)Other


(122
)




(122
)

210





210Total interest expense

$
15,501

$
(117,110
)
$
(101,609
)
$
(9,947
)
$
23,699

$
13,752Net interest income

$
21,848

$
791

$
22,639

$
31,142

$
(10,394
)
$
20,748


---

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

As
part of the strategy to manage interest rate risk, the Company strives to manage both assets and liabilities so that interest sensitivities match. One method of calculating interest
rate sensitivity is through gap analysis. A gap is the difference between the amount of interest rate sensitive assets and interest rate sensitive liabilities that re-price or mature in a
given time period. Positive gaps occur when interest rate sensitive assets exceed interest rate sensitive liabilities, and negative gaps occur when interest rate sensitive liabilities exceed interest
rate sensitive assets. A positive gap position in a period of rising interest rates

8

---



should
have a positive effect on net interest income as assets will re-price faster than liabilities. Conversely, net interest income should contract somewhat in a period of falling
interest rates. Management can quickly change the Company's interest rate position at any given point in time as market conditions dictate. Additionally, interest rate changes do not affect all
categories of assets and liabilities equally or at the same time. Analytical techniques employed by the Company to supplement gap analysis include simulation analysis to quantify interest rate risk
exposure. The gap analysis prepared by management is reviewed by the Investment Committee of the Company twice a year. The Investment Committee is comprised of certain senior managers of the various
Company bank subsidiaries along with consultants. Management currently believes that the Company is properly positioned for interest rate changes; however, if 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, 2008, based on these simulations, a rate shift of 200 basis points in interest rates up will vary net interest income by 5.17%, while a rate shift of 100 basis
points down will not vary net interest income by more than .18% of projected 2009 net interest income. The basis point shift in interest rates is a hypothetical rate scenario used to calibrate risk,
and does not necessarily represent management's current view of future market developments. The Company believes that it is properly positioned for a potential interest rate increase or decrease.

Allowance for Probable Loan Loss

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

December 31,2008

2007

2006

2005

2004(Dollars in Thousands)Loans accounted for on a non-accrual basis

$
163,700

$
32,900

$
13,490

$
17,129

$
16,998Accruing loans contractually past due ninety days or more as to interest or principal payments


6,208


21,330


9,201


5,478


7,833Loans accounted for as "troubled debt restructuring"

















The
allowance for probable loan losses increased 19.0% to $73,461,000 at December 31, 2008 from $61,726,000 at December 31, 2007. The provision (credit) for probable loan
losses charged to expense increased $21,575,000 to $19,813,000 for the year ended December 31, 2008 from $(1,762,000) for the same period in 2007. The Company's provision for probable loan
losses increased for the year ended December 31, 2008 in part because of the economic turmoil in the United States resulting in a slowdown in the general economic activity in the areas the
Company serves. The Company has continued to re-evaluate certain areas of concentrations within the Company's allowance for probable loan losses to reflect the appropriate amount needed in
the allowance. The decrease in the allowance for probable loan losses for the year ended December 31, 2007, can be attributed to the charge off of loans acquired as part of the LFIN
acquisition. The Company did experience good results from the loan portfolio during 2007; provided however, the subsequent subprime crisis occurred and other unforeseen events in the United States
economy rapidly deteriorated causing the provision for probable loan losses to increase rapidly. The allowance for probable loan losses was 1.25% of total loans, net of unearned income at
December 31, 2008 and 1.11% at December 31, 2007.

9

---



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 31,2008

2007

2006

2005

2004(Dollars in Thousands)Loans accounted for on a non-accrual basis

$
530

$
722

$
4,298

$
12,946

$
13,741Accruing loans contractually past due ninety days or more as to interest or principal payments


66


510


199


608


104


The
gross income that would have been recorded during 2008 and 2007 on non-accrual and restructured loans in accordance with their original contract terms was $6,148,000 and
$922,000 on domestic loans and $94,000 and $1,023,000 on foreign loans, respectively. The amount of interest income on such loans that was recognized in 2008 and 2007 was $193,000 and $1,716,000 on
domestic loans and $0 and $310,000 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 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 $1,914,733,000 and
$2,066,859,000 at December 31, 2008 and 2007, respectively. See Note 19 to the Consolidated Financial Statements.

10

---



The
following table summarizes loan balances at the end of each year and average loans outstanding during the year; changes in the allowance for probable loan losses arising from loans
charged-off and recoveries on loans previously charged-off by loan category; and additions to the allowance which have been charged to expense:

2008

2007

2006

2005

2004(Dollars in Thousands)Loans, net of unearned discounts, outstanding at December 31

$
5,872,833

$
5,536,628

$
5,034,810

$
4,625,692

$
4,888,974Average loans outstanding during the year (Note 1)

$
5,683,130

$
5,215,435

$
4,796,489

$
4,830,881

$
3,982,580Balance of allowance at January 1

$
61,726

$
64,537

$
77,796

$
81,351

$
46,396Provision (credit) charged to expense


19,813


(1,762
)

3,849


960


5,196Loans charged off:Domestic:Commercial, financial and agricultural


(5,754
)

(3,606
)

(7,302
)

(2,703
)

(5,732
)Real estatemortgage


(1,400
)

(800
)

(554
)

(806
)

(1,179
)Real estateconstruction


(202
)

(202
)

(99
)

(41
)

(295
)Consumer


(1,770
)

(1,741
)

(2,056
)

(2,948
)

(2,034
)Foreign


(8
)

(102
)

(8,377
)

(73
)

(273
)Total loans charged off:


(9,134
)

(6,451
)

(18,388
)

(6,571
)

(9,513
)Recoveries credited to allowance:Domestic:Commercial, financial and agricultural


576


810


625


1,436


4,841Real estatemortgage


94


58


130


69


93Real estateconstruction


21


89


53


24


17Consumer


361


306


448


511


451Foreign


4


3,085


24


16


5Total recoveries


1,056


4,348


1,280


2,056


5,407Net loans charged off


(8,078
)

(2,103
)

(17,108
)

(4,515
)

(4,106
)Allowance acquired in purchase transactions





1,054








33,865Balance of allowance at December 31

$
73,461

$
61,726

$
64,537

$
77,796

$
81,351Ratio of net loans charged-off during the year to average loans outstanding during the year (Note 1)


.14
%

.04
%

.36
%

.09
%

.10
%Ratio of allowance to loans, net of unearned discounts, outstanding at December 31


1.25
%

1.11
%

1.28
%

1.68
%

1.66
%


---

(Note 1)
The average balances for purposes of the above table are calculated on the basis of daily balances for 2008, 2007 and 2006 and month-end balances for the years ended 2005
and 2004.

11

---



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

At December 31,2008

2007

2006

2005

2004Allowance

Percent
of total

Allowance

Percent
of total

Allowance

Percent
of total

Allowance

Percent
of total

Allowance

Percent
of total(Dollars in Thousands)Commercial, Financial and Agricultural

$
33,737


43.8
%
$
28,117


43.9
%
$
28,158


46.5
%
$
34,283


51.4
%
$
46,061


55.5
%Real estateMortgage


11,639


15.1


9,256


14.4


9,461


15.6


12,228


18.3


16,325


19.6Real estateConstruction


25,058


32.6


21,277


33.2


16,914


27.9


13,007


19.5


12,741


15.3Consumer


2,223


2.9


2,212


3.4


2,392


3.9


3,154


4.7


3,897


4.7Foreign


804


5.6


864


5.1


7,612


6.1


15,124


6.1


2,327


4.9$
73,461


100.0
%
$
61,726


100.0
%
$
64,537


100.0
%
$
77,796


100.0
%
$
81,351


100.0
%


The allowance for probable 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 probable loan losses.

The
bank subsidiaries charge off that portion of any loan which management considers to represent a loss as well as that portion of any other loan which is classified as a "loss" by bank
examiners. Commercial, financial and agricultural or real estate loans are generally considered by management to represent a loss, in whole or part, (i) when an exposure beyond any collateral
coverage is apparent, (ii) when no further collection of the portion of the loan so exposed is anticipated based on actual results, (iii) when the credit enhancements, if any, are not
adequate, and (iv) when the borrower's financial condition would indicate so. Generally, unsecured consumer loans are charged off when 90 days past due.

The
reserve allocated to all categories of loans increased approximately $11.7 million from 2007 to 2008. The increase in the reserve occurred as the result of the deterioration of
economic conditions in 2008. The reserve allocated to Commercial and Real Estate - Construction loans increased from 2007 to 2008 primarily due to increases in impaired loans in which a specified
valuation allowance was determined in accordance with SFAS No. 114. Please refer to Note 5 - Allowance for Probable Loan Losses in the accompanying Notes to the consolidated Financial Statements.

While
management of the Company considers that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers
carefully, there is no precise method of predicting loan losses. The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged off as a loss is an
exercise of judgment. Similarly, the determination of the adequacy of the allowance for probable loan losses can be made only on a subjective basis. It is the judgment of the Company's management that
the allowance for probable loan losses at December 31, 2008 was adequate to absorb probable losses from loans in the portfolio at that date. See Critical Accounting Policies on page 25.

12

---



Non-Interest Income

Year Ended
December 31,
2008

Year Ended
December 31,
2007

Percent
Increase
(Decrease)
2008 vs. 2007

Year Ended
December 31,
2006

Percent
Increase
(Decrease)
2007 vs. 2006(Dollars in Thousands)Service charges on deposit accounts

$
98,466

$
89,186


10.4
%
$
84,770


5.2
%Other service charges, commissions and feesBanking


40,543


34,897


16.2


29,523


18.2Non-banking


7,592


18,675


(59.3
)

21,605


(13.6
)Investment securities transactions, net


6,427


(15,938
)

(140.3
)

(930
)

1,613.8Other investments, net


15,183


19,821


(23.4
)

20,035


(1.1
)Other income


21,598


18,722


15.4


21,968


(14.8
)Total non-interest income

$
189,809

$
165,363


14.8
%
$
176,971


(6.6
)%


During
2008, the Company sold certain equity securities resulting in a gain of $6.2 million, before taxes. The loss in the investment securities transactions for the year ended
December 31, 2007 can be attributed to a $17.0 million impairment charge recorded in connection with certain investment securities identified for sale in the first quarter 2007 and the
sale of certain equity investments. The impairment charge in 2007 was the result of the Company's strategic sale of certain investment securities with the proceeds from the sales used to reduce
Federal Home Loan Bank ("FHLB") borrowings. The investments identified were certain hybrid mortgage backed securities with a coupon re-set date that exceeded 30 months and a
weighted average yield to coupon re-set that was approximately 100 basis points less than the FHLB certificate of indebtedness short-term rate. The sale of the securities
facilitated a re-positioning of the balance sheet to a more neutral position in terms of interest rate risk and was done to improve the Company's operating ratios. As a result of this
decision, the Company marked the securities to market. The increase in banking service charges, commissions and fees for the year ended December 31, 2008 can be attributed to increased
surcharge and interchange income from customers using the IBC debit card and automated teller machines (ATM). The increase in service charges on deposit accounts can be attributed partially to the
Company's sales programs and the additional accounts created as a result of those programs.

13

---



Non-Interest Expense

Year Ended
December 31,
2008

Year Ended
December 31,
2007

Percent
Increase
(Decrease)
2008 vs. 2007

Year Ended
December 31,
2006

Percent
Increase
(Decrease)
2007 vs. 2006(Dollars in Thousands)Employee compensation and benefits

$
129,084

$
130,385


(1.0
)%
$
124,359


4.8
%Occupancy


38,315


33,583


14.1


27,886


20.4Depreciation of bank premises and equipment


36,700


32,069


14.4


28,251


13.5Professional fees


11,078


10,613


4.4


11,050


(4.0
)Stationery and supplies


6,129


6,414


(4.4
)

6,490


(1.2
)Amortization of identified intangible assets


5,195


5,188


0.1


4,866


6.6Advertising


13,189


11,973


10.2


12,052


(0.7
)Other


61,121


70,057


(12.8
)

73,723


(5.0
)Total non-interest expense

$
300,811

$
300,282


0.2
%
$
288,677


4.0
%


Non-interest
expense was affected by the aggressive de novo branching activity that has added 23 new branches in 2008, 38 branches in 2007, including two acquired in the
Southwest First Community acquisition, and 32 branches in 2006. The aggressive de novo branching adds additional expenses in employee compensation, occupancy and depreciation prior to the additional
revenue that is generated from the branch to offset the additional expenses. The Company deems expense control as an essential element in the Company's profitability bearing in mind the effects of
aggressive de novo branching. Expense control is achieved through maintaining optimum staffing levels, an effective budgeting process, and internal consolidation of bank functions.

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 probable 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.

14

---





Financial Condition

Investment Securities

The following table sets forth the carrying value of investment securities as of December 31, 2008, 2007 and 2006:

December 31,2008

2007

2006(Dollars in Thousands)U.S. Treasury SecuritiesAvailable for sale

$
1,319

$
1,308

$
1,268Mortgage-backed securitiesAvailable for sale


4,974,317


4,066,829


4,376,284Obligations of states and political subdivisionsAvailable for sale


82,214


84,633


95,897Equity securitiesAvailable for sale


14,030


13,500


14,629Other securitiesHeld to maturity


2,300


2,300


2,375Available for sale





1,618


Total

$
5,074,180

$
4,170,188

$
4,490,453


The
following tables set forth the contractual maturities of investment securities, based on amortized cost, at December 31, 2008 and the average yields of such
securities, except for the totals, which reflect the weighted average yields. Actual maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with
or without prepayment penalties.

Available for Sale
MaturingWithin one year

After one but within five years

After five but within ten years

After ten yearsAdjusted

Adjusted

Adjusted

AdjustedCost

Yield

Cost

Yield

Cost

Yield

Cost

Yield(Dollars in Thousands)U.S. Treasury and obligations of U.S. Government agencies

$
1,319


1.97
%
$




%
$




%
$




%Mortgage-backed securities


10,488


4.94


74,416


4.79


288,801


5.04


4,573,645


4.82Obligations of states and political subdivisions














8,474


4.72


72,734


4.82Equity securities


325

















13,500


4.25Other securities























Total

$
12,132


4.49
%
$
74,416


4.79
%
$
297,275


5.03
%
$
4,659,879


4.82
%Held to Maturity
MaturingWithin one year

After one but within five years

After five but within ten years

After ten yearsAdjusted

Adjusted

Adjusted

AdjustedCost

Yield

Cost

Yield

Cost

Yield

Cost

Yield(Dollars in Thousands)Other securities

$
350


5.32
%
$
1,950


2.98
%
$





$



Total

$
350


5.32
%
$
1,950


2.98
%
$





$






15

---



Mortgage-backed securities are securities primarily issued by the Federal Home Loan Mortgage Corporation ("Freddie Mac"), Federal National
Mortgage Association ("Fannie Mae"), and the Government National Mortgage Association ("Ginnie Mae"). Investments in mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S.
Government. Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, but carry an implied AAA rating with limited credit risk,
particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008.

Loans

The amounts of loans outstanding, by classification, at December 31, 2008, 2007, 2006, 2005 and 2004 are shown in the following
table:

December 31,2008

2007

2006

2005

2004(Dollars in Thousands)Commercial, financial and agricultural

$
2,574,247

$
2,426,064

$
2,337,573

$
2,376,276

$
2,710,270Real estatemortgage


888,095


798,708


785,401


847,512


960,599Real estateconstruction


1,911,954


1,835,950


1,404,186


901,518


749,689Consumer


169,589


190,899


198,580


218,607


229,302Foreign


328,948


285,008


309,144


281,947


239,622Total loans


5,872,833


5,536,629


5,034,884


4,625,860


4,889,482Unearned discount





(1
)

(74
)

(168
)

(508
)Loans, net of unearned discount

$
5,872,833

$
5,536,628

$
5,034,810

$
4,625,692

$
4,888,974


The
following table shows the amounts of loans (excluding real estate mortgages and consumer loans) outstanding as of December 31, 2008, which based on remaining scheduled
repayments of principal are due in the years indicated. Also, the amounts due after one year are classified according to the sensitivity to changes in interest rates:

MaturingWithin
one year

After one but
within five years

After
five years

Total(Dollars in Thousands)Commercial, financial and agricultural

$
760,911

$
1,642,972

$
170,364

$
2,574,247Real estateconstruction


1,394,919


498,448


18,587


1,911,954Foreign


214,830


107,806


6,312


328,948Total

$
2,370,660

$
2,249,226

$
195,263

$
4,815,149




Interest sensitivityFixed Rate

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

$
195,166

$
2,054,060Due after five years


46,160


149,103Total

$
241,326

$
2,203,163


16

---



International Operations

On December 31, 2008, the Company had $328,948,000 (2.6% 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 probable loan losses
as of December 31, 2008 is presented below.

Amount of Loans

Related
Allowance for
Probable Losses(Dollars in Thousands)Secured by certificates of deposit in United States banks

$
197,844

$
99Secured by United States real estate


34,885


95Secured by other United States collateral (securities, gold, silver, etc.)


25,784


233Direct unsecured Mexican sovereign debt (principally former FICORCA debt)


2,379


Other (principally Mexico real estate)


68,056


177$
328,948

$
604


The
transactions for the year ended December 31, 2008, in that portion of the allowance for probable loan losses related to foreign debt were as follows:

(Dollars in Thousands)Balance at December 31, 2007

$
864Charge-offs


(9
)Recoveries


3Net recoveries


(6
)Credit to expense


(254
)Balance at December 31, 2008

$
604


17

---



Deposits

2008
Average Balance

2007
Average Balance(Dollars in Thousands)Deposits:Demandnon-interest bearingDomestic

$
1,324,178

$
1,291,513Foreign


130,879


126,238Total demand non-interest bearing


1,455,057


1,417,751Savings and interest bearing demandDomestic


1,924,622


1,964,411Foreign


361,378


363,667Total savings and interest bearing demand


2,286,000


2,328,078Time certificates of deposit$100,000 or more:Domestic


874,040


827,830Foreign


1,249,290


1,228,124Less than $100,000:Domestic


828,510


877,041Foreign


395,706


395,667Total time, certificates of deposit


3,347,546


3,328,662Total deposits

$
7,088,603

$
7,074,491




2008

2007

2006(Dollars in Thousands)Interest expense:Savings and interest bearing demandDomestic

$
23,197

$
46,878

$
36,606Foreign


3,454


6,900


3,838Total savings and interest bearing demand


26,651


53,778


40,444Time, certificates of deposit$100,000 or moreDomestic


28,990


37,133


32,851Foreign


41,383


54,494


44,143Less than $100,000Domestic


26,297


36,460


33,225Foreign


9,809


14,933


12,858Total time, certificates of deposit


106,479


143,020


123,077Total interest expense on deposits

$
133,130

$
196,798

$
163,521


18

---



Scheduled
maturities of time deposits in amounts of $100,000 or more at December 31, 2008, were as follows:

Due within 3 months or less

$
876,867Due after 3 months and within 6 months


1,101,492Due after 6 months and within 12 months


138,744Due after 12 months


19,689$
2,136,792


The
Company offers a variety of deposit accounts having a wide range of interest rates and terms. The Company relies primarily on its high quality customer service, sales programs,
customer referrals and
advertising to attract and retain these deposits. Deposits provide the primary source of funding for the Company's lending and investment activities, and the interest paid for deposits must be managed
carefully to control the level of interest expense. Deposits at December 31, 2008 were $6,858,784,000 decrease of 4.2% from $7,157,606,000 at December 31, 2007. The decrease in deposits
from 2007 to 2008 is primarily the result of current market conditions which have created enormous pressure to pay rates above what would be typically customary in the current rate environment as well
as the lack of secondary funding markets that institutions rely upon for funding their lending and investment activities. As a result of these pressures, many institutions have paid excessively for
certain deposits thereby forcing the Company to not compete to retain certain deposits.

Return on Equity and Assets

Certain key ratios for the Company for the years ended December 31, 2008, 2007 and 2006 follows (Note 1):

Years ended December 31,2008

2007

2006Percentage of net income to:Average shareholders' equity


13.34
%

13.73
%

14.02
%Average total assets


1.17


1.12


1.10Percentage of average shareholders' equity to average total assets


8.81


8.19


7.82Percentage of cash dividends per share to net income per share


34.27


38.45


37.64


---

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

19

---





Liquidity and Capital Resources

Liquidity

The maintenance of adequate liquidity provides the Company's bank subsidiaries with the ability to meet potential depositor
withdrawals, provide for customer credit needs, maintain adequate statutory reserve levels and take full advantage of high-yield investment opportunities as they arise. Liquidity is
afforded by access to financial markets and by holding appropriate amounts of liquid assets. The Company's bank subsidiaries derive their liquidity largely from deposits of individuals and business
entities. Deposits from persons and entities domiciled in Mexico comprise a stable portion of the deposit base of the Company's bank subsidiaries. Historically, the Mexico based deposits of the
Company's bank subsidiaries have been a stable source of funding. Such deposits comprised approximately 30%, of the Company's bank subsidiaries' total deposits at each of the years ended
December 31, 2008, 2007 and 2006. Other important funding sources for the Company's bank subsidiaries have been borrowings from the Federal Home Loan Bank ("FHLB"), securities sold under
repurchase agreements and large certificates of deposit, requiring management to closely monitor its asset/liability mix in terms of both rate sensitivity and maturity distribution. Primary liquidity
of the Company and its subsidiaries has been maintained by means of
increased investment in shorter-term securities, certificates of deposit and repurchase agreements. As in the past, the Company will continue to monitor the volatility and cost of funds in
an attempt to match maturities of rate-sensitive assets and liabilities, and respond accordingly to anticipate fluctuations in interest rates over reasonable periods of time.

Asset/Liability Management

The Company's fund management policy has as its primary focus the measurement and management of the banks' earnings at risk in the face
of rising or falling interest rate forecasts. The earliest and most simplistic concept of earnings at risk measurement is the gap report, which is used to generate a rough estimate of the
vulnerability of net interest income to changes in market rates as implied by the relative re-pricings of assets and liabilities. The gap report calculates the difference between the
amounts of assets and liabilities re-pricing across a series of intervals in time, with emphasis typically placed on the one-year period. This difference, or gap, is usually
expressed as a percentage of total assets.

If
an excess of liabilities over assets matures or re-prices within the one-year period, the statement of condition is said to be negatively gapped. This
condition is sometimes interpreted to suggest that an institution is liability-sensitive, indicating that earnings would suffer from rising rates and benefit from falling rates. If a surplus of assets
over liabilities occurs in the one-year time frame, the statement of condition is said to be positively gapped, suggesting a condition of asset sensitivity in which earnings would benefit
from rising rates and suffer from falling rates.

The
gap report thus consists of an inventory of dollar amounts of assets and liabilities that have the potential to mature or re-price within a particular period. The flaw in
drawing conclusions about interest rate risk from the gap report is that it takes no account of the probability that potential maturities or re-pricings of
interest-rate-sensitive accounts will occur, or at what relative magnitudes. Because simplicity, rather than utility, is the only virtue of gap analysis, financial institutions
increasingly have either abandoned gap analysis or accorded it a distinctly secondary role in managing their interest-rate risk exposure.

20

---



The
net interest rate sensitivity at December 31, 2008, is illustrated in the following table. This information reflects the balances of assets and liabilities whose rates are
subject to change. As indicated in the table on the following page, the Company is liability-sensitive during the early time periods and is asset-sensitive in the longer periods. The table shows the
sensitivity of the statement of condition at one point in time and is not necessarily indicative of the position at future dates.

INTEREST RATE SENSITIVITY(Dollars in Thousands)

Rate/MaturityDecember 31, 2008

3 Months
or Less

Over 3 Months
to 1 Year

Over 1 Year
to 5 Years

Over
5 Years

Total(Dollars in Thousands)Rate sensitive assetsFederal funds sold

$


$


$


$


$
Time deposits with banks


396











396Investment securities


722,295


1,958,219


2,393,136


530


5,074,180Loans, net of non-accruals


4,316,136


309,689


466,840


688,314


5,780,979Total earning assets

$
5,038,827

$
2,267,908

$
2,859,976

$
688,844

$
10,855,555Cumulative earning assets

$
5,038,827

$
7,306,735

$
10,166,711

$
10,855,555Rate sensitive liabilitiesTime deposits

$
1,429,899

$
1,577,527

$
309,485

$
601

$
3,317,512Other interest bearing deposits


2,081,602











2,081,602Securities sold under repurchase agreements


331,183


104,866


5,082


1,000,000


1,441,131Other borrowed funds


2,522,986











2,522,986Junior subordinated deferrable interest debentures


61,858





128,868


10,322


201,048Total interest bearing liabilities

$
6,427,528

$
1,682,393

$
443,435

$
1,010,923

$
9,564,279Cumulative sensitive liabilities

$
6,427,528

$
8,109,921

$
8,553,356

$
9,564,279Repricing gap

$
(1,388,701
)
$
585,515

$
2,416,541

$
(322,079
)
$
1,291,276Cumulative repricing gap


(1,388,701
)

(803,186
)

1,613,355


1,291,276Ratio of interest-sensitive assets to liabilities


.784


1.348


6.450


.681


1.135Ratio of cumulative, interest-sensitive assets to liabilities


.784


.901


1.189


1.135


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

21

---



focuses
on the relative sensitivities of these balance sheet items and projects their behavior over an extended period of time in a motion picture rather than snapshot fashion. Finally, income
simulation analysis permits management to assess the probable effects on balance sheet items not only of changes in market interest rates, but also of proposed strategies for responding to such
changes. The Company and many other institutions rely primarily upon income simulation analysis in measuring and managing exposure to interest rate risk.

At
December 31, 2008, based on these simulations, a rate shift of 200 basis points in interest rates up will vary projected 2009 net interest income by 5.17%, while a rate shift
of 100 basis points down will not vary net interest income by more than .18% of projected 2009 net interest income. The basis point shift in interest rates is a hypothetical rate scenario used to
calibrate risk, and does not necessarily represent management's current view of future market developments. The Company believes that it is properly positioned for a potential interest rate increase
or decrease.

All
the measurements of risk described above are made based upon the Company's business mix and interest rate exposures at the particular point in time. The exposure changes continuously
as a result of the Company's ongoing business and its risk management initiatives. While management believes these measures provide a meaningful representation of the Company's interest rate
sensitivity, they do not necessarily take into account all business developments that have an effect on net income, such as changes in credit quality or the size and composition of the statement of
condition.

Principal
sources of liquidity and funding for the Company are dividends from subsidiaries and borrowed funds, with such funds being used to finance the Company's cash flow requirements.
The Company closely monitors the dividend restrictions and availability from the bank subsidiaries as disclosed in Note 20 to the Consolidated Financial Statements. At December 31, 2008,
the aggregate amount legally available to be distributed to the Company from bank subsidiaries as dividends was approximately $237,000,000, assuming that each bank subsidiary continues to be
classified as "well capitalized" under the applicable regulations. The restricted capital (capital and surplus) of the bank subsidiaries was approximately $981,876,000 as of December 31, 2008.
The undivided profits of the bank subsidiaries were approximately $627,902,000 as of December 31, 2008. Additionally, as a result of the Company's participation in the TARP Capital Purchase
Program, the Company is restricted in the payment of dividends and may not without the Treasury Department's consent, declare or pay any dividend on the Company Common Stock other than a regular
semi-annual cash dividend of not more than $.33 per share, as adjusted for any stock dividend or stock split. The restriction ceases to exist only on the earlier to occur of
December 23, 2011 or the date on which the Company has redeemed all of the Series A Preferred Stock issued as part of the Capital Purchase Program or the date on which the Treasury has
transferred all of the Preferred Stock to third parties affiliated with the Treasury.

At
December 31, 2008, the Company has outstanding $2,522,986,000 in other borrowed funds and $201,048,000 in junior subordinated deferrable interest debentures. In addition to
borrowed funds and dividends, the Company has a number of other available alternatives to finance the growth of its existing banks as well as future growth and expansion.

Capital

The Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders. At December 31,
2008, shareholders' equity was $1,257,297,000 compared to $935,905,000 at December 31, 2007, an increase of $321,392,000, or 34.3%. Shareholders' equity increased primarily due to the issuance
of $216,000,000 of Series A Preferred Shares to the Treasury as part of the Company's participation in the TARP Capital Purchase Program and the retention of earnings offset by the payment of
cash dividends to shareholders. The accumulated other comprehensive income is not included in the calculation of regulatory capital ratios.

22

---



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 9.97% at December 31, 2008 and 7.76% at December 31, 2007. The large increase in the Company's leverage ratio is primarily due to the Company's participation in the
Treasury's CPP program. The core deposit intangibles and goodwill of $309,917,000 as of December 31, 2008, 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
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 15.30% and 11.98% and risk weighted total capital ratios of 16.35% and 12.99% as of December 31, 2008 and 2007,
respectively, which are well above the minimum regulatory requirements and exceed the well capitalized ratios (see Note 20 to Notes to Consolidated Financial Statements).

During
the past few years the Company has expanded its banking facilities. Among the activities and commitments the Company funded during 2008 and 2007 were certain capital expenditures
relating to the modernization and improvement of several existing bank facilities and the expansion of the bank branch network.

Junior Subordinated Deferrable Interest Debentures

The Company has formed twelve statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust
preferred securities. As part of the Local Financial Corporation ("LFIN") acquisition, the Company acquired three additional statutory business trusts previously formed by LFIN for the purpose of
issuing trust preferred securities. The twelve 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. As of December 31, 2008, the Debentures issued by four of the trusts formed by the Company and the Debentures issued by all three of the trusts formed by LFIN
have been redeemed by the Company. As of December 31, 2008, the principal amount of debentures outstanding totaled $201,048,000. As a result of participation in the TARP Capital Purchase
Program, the Company may not without the consent of the Treasury Department redeem any of the Debentures until the earlier to occur of December 23, 2011, or the date on which the Company has
redeemed all of the Series A Preferred Stock issued under the Capital Purchase Program or the date on which the Treasury has transferred all of the Series A Preferred Stock to third
parties not affiliated with the Treasury.

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

23

---



Debentures
for up to ten consecutive semi-annual periods on Trust I and for up to twenty consecutive quarterly periods on Trusts VI, VII, VIII, IX, X, XI and XII. If interest payments on
any of the Debentures are deferred, distributions on both the Capital and Common Securities related to that Debenture would also be deferred. The redemption prior to maturity of any of the Debentures
may require the prior approval of the Federal Reserve and/or other regulatory bodies.

For
financial reporting purposes, the Trusts are treated as investments of the Company and not consolidated in the consolidated financial statements. Although the Capital Securities
issued by each of the Trusts are not included as a component of shareholders' equity on the consolidated statement of condition, the Capital Securities are treated as capital for regulatory purposes.
Specifically, under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital on an aggregate
basis. Any amount that exceeds the 25% threshold would qualify as Tier 2 capital. As of December 31, 2008, the total $201,048,000, of the Capital Securities outstanding qualified as
Tier 1 capital.

In
March 2005, the Federal Reserve Board issued a final rule that allowed the inclusion of trust preferred securities in Tier 1 capital, but placed stricter quantitative limits.
Under the final rule, after a transition period ending March 31, 2009, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of
Tier 1 capital, 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. The Company believes that substantially all of the current trust preferred securities will be included in Tier 1 capital after the
five-year transition period ending March 31, 2009.

The
following table illustrates key information about each of the Debentures and their interest rates at December 31, 2008:

Junior Subordinated Deferrable
Interest Debentures

Repricing
Frequency

Interest
Rate

Interest
Rate
Index

Maturity
Date

Optional
Redemption
Date(in thousands)Trust I

$
10,322

Fixed


10.18
%
Fixed

June 2031

June 2011Trust VI

$
25,774

Quarterly


5.60
%
LIBOR + 3.45

November 2032

May 2009Trust VII

$
10,310

Quarterly


6.44
%
LIBOR + 3.25

April 2033

April 2009Trust VIII

$
25,774

Quarterly


7.87
%
LIBOR + 3.05

October 2033

April 2009Trust IX

$
41,238

Fixed


7.10
%
Fixed

October 2036

October 2011Trust X

$
34,021

Fixed


6.66
%
Fixed

February 2037

February 2012Trust XI

$
32,990

Fixed


6.82
%
Fixed

July 2037

July 2012Trust XII

$
20,619

Fixed


6.85
%
Fixed

September 2037

September 2012$
201,048


---

24

---





Contractual Obligations and Commercial Commitments

The following table presents contractual cash obligations of the Company (other than deposit liabilities) as of December 31,
2008:

Payments due by PeriodContractual Cash Obligations

Total

Less than
One Year

One to
Three Years

Three to
Five Years

After
Five Years(Dollars in Thousands)Securities sold under repurchase agreements

$
1,441,131

$
436,049

$
4,482

$
600

$
1,000,000Federal Home Loan Bank borrowings

$
2,522,986


2,522,986








Junior subordinated deferrable interest debentures

$
201,048











201,048Operating leases

$
37,151


9,541


15,154


6,352


6,104Total Contractual Cash Obligations

$
4,202,316

$
2,968,576

$
19,636

$
6,952

$
1,207,152


The
following table presents contractual commercial commitments of the Company (other than deposit liabilities) as of December 31, 2008:

Amount of Commitment Expiration Per PeriodCommercial Commitments

Total

Less than
One Year

One to
Three Years

Three to
Five Years

After
Five Years(Dollars in Thousands)Financial and Performance Standby Letters of Credit

$
137,708

$
121,780

$
15,826

$
102

$
Commercial Letters of Credit

$
18,468


18,468








Credit Card Lines

$
45,157


45,157








Other Commercial Commitments

$
1,713,400


1,028,667


499,515


139,378


45,840Total Commercial Commitments

$
1,914,733

$
1,214,072

$
515,341

$
139,480

$
45,840


Due
to the nature of the Company's commercial commitments, including unfunded loan commitments and lines of credit, the amounts presented above do not necessarily reflect the amounts the
Company anticipates funding in the periods presented above.

Critical Accounting Policies

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

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

25

---



factors
both internal and external to the Company. See also discussion regarding the allowance for probable loan losses and provision for probable loan losses included in the results of operations and
"Provision and Allowance for Probable Loan Losses" included in Notes 1 and 5 of the Notes to Consolidated Financial Statements.

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

The
Company's internal classified report is segregated into the following categories: (i) "Special Review Credits," (ii) "Watch ListPass Credits," or
(iii) "Watch ListSubstandard Credits." The loans placed in the "Special Review Credits" category reflect the Company's opinion that
the loans reflect potential weakness which require monitoring on a more frequent basis. The "Special Review Credits" are reviewed and discussed on a regular basis with the credit department and the
lending staff to determine if a change in category is warranted. The loans placed in the "Watch ListPass Credits" category reflect the Company's opinion that the credit contains
weaknesses which represent a greater degree of risk, which warrant "extra attention." The "Watch ListPass Credits" are reviewed and discussed on a regular basis with the credit department
and the lending staff to determine if a change in category is warranted. The loans placed in the "Watch ListSubstandard Credits" classification are considered to be potentially
inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These credit obligations, even if apparently protected by collateral value,
have shown defined weaknesses related to adverse financial, managerial, economic, market or political conditions which may jeopardize repayment of principal and interest. Furthermore, there is the
possibility that some future loss could be sustained by the bank if such weaknesses are not corrected; provided however, management may evaluate these credits 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, but management does not necessarily
believe there is a loss present in this classified credit category. The specific reserve allocated under SFAS No. 114, is based on (1) the present value of expected future cash flows
discounted at the loan's effective interest rate; (2) the loan's observable market price; or (3) the fair value of the collateral if the loan is collateral dependent. Substantially all
of the Company's loans evaluated under SFAS No. 114 are measured using the fair value of collateral method. In limited cases, the Company may use other methods to determine the specific reserve
of a loan under SFAS No. 114 if such loan is not collateral dependent.

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

26

---



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,
allowance established on quantitative historical percentages, allowance based on qualitative data, 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.

Recent Accounting Standards Issued

See Note 1Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial
Statements for details of recently issued and recently adopted accounting standards and their impact on the Company's consolidated financial statements.

Preferred Stock, Common Stock and Dividends

The Company had issued and outstanding 68,603,091 shares of $1.00 par value Common Stock held by approximately 2,523 holders of record
at February 20, 2009. The book value of the Common Stock at December 31, 2008 was $16.25 per share compared with $14.54 per share at December 31, 2007. The Company has issued and
outstanding 216,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $0.01 per share, having a liquidation preference of $1,000 per share, as of
February 25, 2009. The book value of the Series A Preferred at December 31, 2008 was $1,000 per share.

The
Common Stock is traded on the NASDAQ National Market under the symbol "IBOC." The following table sets forth the approximate high and low bid prices in the Company's Common Stock
during 2008 and 2007, as quoted on the NASDAQ National Market for each of the quarters in the two year period ended December 31, 2008. 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 $10.50 per
share at February 20, 2009.

High

Low2008:

First quarter

$
24.61

$
18.25Second quarter


26.05


21.36Third quarter


35.80


19.28Fourth quarter


27.40


19.08High

Low2007:

First quarter

$
29.05

$
25.85Second quarter


27.69


23.03Third quarter


26.18


19.45Fourth quarter


23.65


19.64


The
Company paid cash dividends to the shareholders in 2008 of $.33 per share on April 18 and October 15, 2008, to all holders of record on March 31, 2008 and
September 30, 2008, respectively, or $45,253,000 in the aggregate during 2008. In 2007, the Company paid cash dividends of $.32 (adjusted for the effect of the May 21, 2007 stock
dividend) and $.35 on May 1 November 1, 2007, respectively, or $44,765,000 in the aggregate during 2007.

Additionally,
as a result of the Company's participation in the TARP Capital Purchase Program, the Company is restricted in the payment of dividends and may not without the Treasury
Department's consent, declare or pay any dividend on the Company Common Stock other than a regular semi-annual cash dividend of not more than $.33 per share, as adjusted for any stock
dividend or stock split. The restriction ceases to exist only on the earlier to occur of December 23, 2011 or the date on which the Company has redeemed all of the Series A Preferred
Stock issued as part of the Capital Purchase Program

27

---



or
the date on which the Treasury has transferred all of the Preferred Stock to third parties not affiliated with the Treasury.

In
addition, the Company has issued common stock dividends during the last five-year period as follows:

Date

Stock
DividendMay 3, 2004


25
%May 2, 2005


25
%May 2006


0
%May 21, 2007


10
%May 2008


0
%


The
Company's principal source of funds to pay cash dividends on its Common Stock and Series A Preferred Stock is cash dividends from its bank subsidiaries. For a discussion of
the limitations, please see Note 20 of Notes to Consolidated Financial Statements.

Stock Repurchase Program

The Company terminated its formal stock repurchase program on December 19, 2008. The Company terminated its formal stock
repurchase program as a condition to participation in the TARP Capital Purchase Program. Under the Capital Purchase Program, the Company may not repurchase any shares of Common Stock until the earlier
to occur of December 23, 2011, or the date on which the Company has redeemed all of the Series A Preferred Stock issued under the Capital Purchase Program or the date on which the
Treasury has transferred all of the Series A Preferred Stock to third parties not affiliated with the Treasury, unless the repurchase of Common Stock is in connection with the administration of
any employee benefit plan in the ordinary course of business and consistent with past practices. Prior to the termination, the program had been expanded periodically, as needed. Under the expanded
stock repurchase program that prior to termination, the Company was authorized to repurchase up to $225,000,000 of its common stock through December 2008. Stock repurchases were made from time to
time, on the open market or through private transactions. Shares repurchased in the program were held in treasury for reissue for various corporate purposes, including employee stock option plans. As
of December 31, 2008, a total of 6,204,332 shares had been repurchased under the program at a cost of $213,090,000. As of December 31, 2008, the Company has approximately $234,063,000
invested in treasury shares, which amount has been accumulated since the inception of the Company.

During
2008, share repurchases were 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, 2008.

Total Number
of Shares
Purchased

Average Price
Paid Per Share

Total Number of Shares Purchased as Part of a Publicly-Announced Program

Approximate
Dollar Value of
Shares Available
for Repurchase(2)October 1 - October 31, 2008


1,387


24.51




$
11,995,000November 1 - November 30, 2008











11,995,000December 1 - December 31, 2008


4,106


20.70





5,493

$
21.66





---

28

---



Equity Compensation Plan Information

The following table sets forth information as of December 31, 2008, with respect to the Company's equity compensation plans:

Plan Category

(A)
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights

(B)
Weighted average
exercise price of
outstanding options,
warrants and rights

(C)
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding securities
reflected in column A)Equity Compensation plans approved by security holders


833,597

$
21.43


368,197Total


833,597

$
21.43


368,197


29

---



Stock Performance

GRAPHIC

Total Return To Shareholders
(Includes reinvestment of dividends)

INDEXED RETURNSDecember 31,Base Period
2003Company / Index

2004

2005

2006

2007

2008International Bancshares Corporation


100


106.52


101.45


109.34


83.72


89.64S&P 500 Index


100


110.88


116.33


134.70


142.10


89.53S&P 500 Banks


100


114.42


112.75


130.90


91.91


48.26


30

---





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Shareholders
International Bancshares Corporation:

We
have audited the accompanying consolidated statements of income, comprehensive income, shareholders' equity, and cash flows of International Bancshares Corporation and subsidiaries
(the "Company") for the year ended December 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.

We
conducted our audit 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 audit provides a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of International Bancshares
Corporation and subsidiaries for the year ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

As
discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards
No. 123(R),Share-based Payment, to account for stock-based compensation.

/s/
KPMG, LLP

San
Antonio, Texas
February 28, 2007

31

---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Shareholders
International Bancshares Corporation:

We
have audited the accompanying consolidated statements of condition of International Bancshares Corporation and subsidiaries (the "Company") as of December 31, 2008 and 2007,
and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the years then ended. 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, 2008 and 2007, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting
principles.

As
discussed in Note 1 to the Financial Statements, effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards. No. 157, "Fair Value
Measurements."

We
also have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), International Bancshares Corporation and subsidiaries' internal
control over financial reporting as of December 31, 2008, based on criteria established inInternal ControlIntegrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 24, 2009 expressed an unqualified opinion on the effectiveness of International
Bancshares Corporation and subsidiaries' internal control over financial reporting.

/s/
McGladrey & Pullen, LLP

Dallas,
Texas
February 24, 2009

32

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Condition        December 31, 2008 and 2007        (Dollars in
Thousands, Except Per Share Amounts)

2008

2007AssetsCash and due from banks

$
298,720

$
329,052Federal funds sold





17,000Total cash and cash equivalents


298,720


346,052Time deposits with banks


396


4,852Investment securities:Held to maturity (Market value of $2,300 on December 31, 2008 and $2,300 on December 31, 2007)


2,300


2,300Available for sale (Amortized cost of $5,043,703 on December 31, 2008 and $4,167,624 on December 31, 2007)


5,071,880


4,167,888Total investment securities


5,074,180


4,170,188Loans


5,872,833


5,536,628Less allowance for probable loan losses


(73,461
)

(61,726
)Net loans


5,799,372


5,474,902Bank premises and equipment, net


466,371


435,654Accrued interest receivable


48,712


54,301Other investments


388,071


323,885Identified intangible assets, net


27,385


31,507Goodwill, net


282,532


283,198Other assets


53,602


42,622Total assets

$
12,439,341

$
11,167,161


33

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition (Continued)

December 31, 2008 and 2007

(Dollars in Thousands, Except Per Share Amounts)

2008

2007Liabilities and Shareholders' EquityLiabilities:Deposits:Demandnon-interest bearing

$
1,459,670

$
1,512,627Savings and interest bearing demand


2,081,602


2,292,589Time


3,317,512


3,352,390Total deposits


6,858,784


7,157,606Securities sold under repurchase agreements


1,441,131


1,328,983Other borrowed funds


2,522,986


1,456,936Junior subordinated deferrable interest debentures


201,048


200,929Other liabilities


158,095


86,802Total liabilities


11,182,044


10,231,256Commitments, Contingent Liabilities and Other Tax Matters (Note 17)Shareholders' equity:Series A Cumulative perpetual preferred shares, $.01 par value, $1,000 per share liquidation value. Authorized 25,000,000 shares; issued 216,000 shares on
December 31, 2008, net of discount of $12,442


203,558


Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 95,499,339 shares on December 31, 2008 and 95,440,983 shares on
December 31, 2007


95,499


95,441Surplus


158,110


144,140Retained earnings


1,016,004


929,145Accumulated other comprehensive income


18,189


1651,491,360


1,168,891Less cost of shares in treasury, 26,898,219 shares on December 31, 2008 and 26,848,880 shares on December 31, 2007


(234,063
)

(232,986
)Total shareholders' equity


1,257,297


935,905Total liabilities and shareholders' equity

$
12,439,341

$
11,167,161


See
accompanying notes to consolidated financial statements.

34

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Income        Years ended December 31, 2008, 2007 and 2006    
   (Dollars in Thousands, Except Per Share Amounts)

2008

2007

2006Interest income:Loans, including fees

$
370,718

$
443,564

$
400,020Federal funds sold


927


2,712


3,596Investment securities:Taxable


188,928


190,371


200,474Tax-exempt


3,514


4,270


4,577Other interest income


516


2,656


406Total interest income


564,603


643,573


609,073Interest expense:Savings and interest bearing demand deposits


26,651


53,778


40,444Time deposits


106,479


143,020


123,077Securities sold under repurchase agreements


50,400


43,837


30,137Other borrowings


33,976


75,317


103,362Junior subordinated deferrable interest debentures


14,137


17,178


22,568Other interest expense


88


210


Total interest expense


231,731


333,340


319,588Net interest income


332,872


310,233


289,485Provision (credit) for probable loan losses


19,813


(1,762
)

3,849Net interest income after provision (credit) for probable loan losses


313,059


311,995


285,636Non-interest income:Service charges on deposit accounts


98,466


89,186


84,770Other service charges, commissions and feesBanking


40,543


34,897


29,523Non-banking


7,592


18,675


21,605Investment securities transactions, net


6,427


(15,938
)

(930
)Other investments, net


15,183


19,821


20,035Other income


21,598


18,722


21,968Total non-interest income


189,809


165,363


176,971


35

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Continued)

Years ended December 31, 2008, 2007 and 2006

(Dollars in Thousands, Except Per Share Amounts)

2008

2007

2006Non-interest expense:Employee compensation and benefits

$
129,084

$
130,385

$
124,359Occupancy


38,315


33,583


27,886Depreciation of bank premises and equipment


36,700


32,069


28,251Professional fees


11,078


10,613


11,050Stationery and supplies


6,129


6,414


6,490Amortization of identified intangible assets


5,195


5,188


4,866Advertising


13,189


11,973


12,052Other


61,121


70,057


73,723Total non-interest expense


300,811


300,282


288,677Income before income taxes


202,057


177,076


173,930Minority interest in consolidated subsidiaries


415





40Provision for income taxes


69,530


55,764


56,889Net income

$
132,112

$
121,312

$
117,001Basic earnings per common share:Weighted average number of shares outstanding


68,576,654


69,036,274


69,446,874Net income

$
1.93

$
1.76

$
1.68Fully diluted earnings per common share:Weighted average number of shares outstanding


68,714,390


69,370,111


70,154,577Net income

$
1.92

$
1.75

$
1.67


See
accompanying notes to consolidated financial statements.

36

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Comprehensive Income        Years ended December 31, 2008, 2007, and 2006
      (Dollars in Thousands)

2008

2007

2006Net income

$
132,112

$
121,312

$
117,001Other comprehensive income, net of tax:Net unrealized gains on securities available for sale arising during the year (tax effects of $7,456, $27,416, and $1,175)


13,846


50,915


2,182Reclassification adjustment for gains (losses) on securities available for sale included in net income (tax effects of $2,249, $(5,578), and
$(326))


4,178


(10,360
)

(604
)Comprehensive income

$
150,136

$
161,867

$
118,579


See
accompanying notes to consolidated financial statements.

37

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Shareholders' Equity        Years ended December 31, 2008, 2007 and 2006
     (in Thousands)

Number
of Shares

Preferred
Stock

Common
Stock

Surplus

Retained
Earnings

Other
Comprehensive
Income
(Loss)

Treasury
Stock

TotalBalance at December 31, 2005


86,059

$


$
86,059

$
135,619

$
788,416

$
(41,968
)
$
(175,259
)
$
792,867Net Income














117,001








117,001Dividends:Cash ($.70 per share)














(44,166
)







(44,166
)Purchase of treasury stock (981,977 shares)




















(28,017
)

(28,017
)Exercise of stock options


165





165


1,754











1,919Stock compensation expense recognized in earnings











874











874Other comprehensive income, net of tax:Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustment

















1,578





1,578Balance at December 31, 2006


86,224





86,224


138,247


861,251


(40,390
)

(203,276
)

842,056Net Income














121,312








121,312Dividends:Shares issued


8,653





8,653





(8,653
)







Cash ($.68 per share)














(44,765
)







(44,765
)Purchase of treasury (1,196,688 shares)




















(29,710
)

(29,710
)Exercise of stock options


564





564


5,122











5,686Stock compensation expense recognized in earnings











771











771Other comprehensive income, net of tax:Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustment

















40,555





40,555Balance at December 31, 2007


95,441





95,441


144,140


929,145


165


(232,986
)

935,905Net Income














132,112








132,112Dividends:Cash ($.66 per share)














(45,253
)







(45,253
)Issuance of preferred stock





203,558





12,442











216,000Purchase of treasury stock (48,339 shares)




















(1,077
)

(1,077
)Exercise of stock options


58





58


836











894Stock compensation expense recognized in earnings











692











692Other comprehensive income, net of tax:Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustment

















18,024





18,024Balance at December 31, 2008


95,499

$
203,558

$
95,499

$
158,110

$
1,016,004

$
18,189

$
(234,063
)
$
1,257,297


See accompanying notes to consolidated financial statements.

38

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Consolidated Statements of Cash Flows        Years ended December 31, 2008, 2007 and 2006        (Dollars in Thousands)

2008

2007

2006Operating activities:Net income:

$
132,112

$
121,312

$
117,001Adjustments to reconcile net income to net cash provided by operating activities:Provision (credit) for probable loan losses


19,813


(1,762
)

3,849Amortization of loan premiums


134


191


1,190Accretion of discounts on time deposits with banks


1


(60
)

Accretion of time deposit discounts


(36
)

(19
)

Decrease in loans held for sale


1,411


18,630


3,834Depreciation of bank premises and equipment


36,700


32,069


28,251Loss (gain) on sale of bank premises and equipment


282


(3,434
)

2,096Depreciation and amortization of leased assets


880


2,167


2,169Accretion of investment securities discounts


(1,405
)

(546
)

(416
)Amortization of investment securities premiums


6,017


4,528


4,097Investment securities transactions, net


(6,427
)

15,938


930Accretion of junior subordinated debenture discounts


119


332


548Amortization of identified intangible assets


5,195


5,188


4,866Stock based compensation expense


692


771


874Earnings from affiliates and other investments


(11,324
)

(12,298
)

(12,204
)Deferred tax benefit


(4,683
)

(4,626
)

(15,686
)Decrease (increase) in accrued interest receivable


5,589


3,505


(8,641
)(Increase) decrease in other assets


(10,677
)

(1,976
)

9,424(Decrease) increase in other liabilities


(18,878
)

3,482


13,560Net cash provided by operating activities


155,515


183,392


155,742Investing activities:Proceeds from maturities of securities


18,124


25,903


7,720Proceeds from sales of available for sale securities


8,376


841,084


60,447Purchases of available for sale securities


(2,002,446
)

(1,522,833
)

(1,159,306
)Principal collected on mortgage backed securities


1,186,450


1,036,364


864,611Proceeds from matured time deposits with banks


4,457


42,155


Net increase in loans


(345,829
)

(489,084
)

(431,250
)Purchases of other investments


(60,567
)

(56,460
)

(15,294
)Distributions from other investments


7,385


93,411


16,832Purchases of bank premises and equipment


(68,537
)

(80,614
)

(85,363
)Proceeds from sales of bank premises and equipment


838


7,973


16,679Adjustment to goodwill related tax contingencies





5,885


Purchase of identified intangible asset (Note 2)


(1,074
)




Cash paid in purchase transaction





(23,470
)

Cash acquired in purchase transaction





30,772


Net cash used in investing activities


(1,252,823
)

(88,914
)

(724,924
)


39

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Continued)

Years ended December 31, 2008, 2007 and 2006

(Dollars in Thousands)

2008

2007

2006Financing activities:Net (decrease) increase in non-interest bearing demand deposits

$
(52,957
)
$
29,813

$
114,096Net (decrease) increase in savings and interest bearing demand deposits


(210,987
)

31,517


48,217Net (decrease) increase in time deposits


(34,842
)

(11,624
)

171,179Net increase (decrease) in securities sold under repurchase agreements


112,148


622,648


(54,427
)Other borrowed funds, net


1,066,050


(638,887
)

225,501Principal payments of long-term debt





(63,920
)

(101,290
)Proceeds from issuance of long-term debt





53,609


75,259Purchase of treasury stock


(1,077
)

(29,710
)

(28,017
)Proceeds from stock transactions


216,894


5,686


1,919Payments of cash dividends


(45,253
)

(44,738
)

(44,166
)Payments of cash dividends in lieu of fractional shares





(27
)

Net cash provided by (used in) financing activities


1,049,976


(45,633
)

408,271(Decrease) increase in cash and cash equivalents


(47,332
)

48,845


(160, 911
)Cash and cash equivalents at beginning of year


346,052


297,207


458,118Cash and cash equivalents at end of year

$
298,720

$
346,052

$
297,207Supplemental cash flow information:Interest paid

$
245,509

$
333,907

$
312,018Income taxes paid


69,646


62,145


67,421Purchases of available-for-sale securities not yet settled


84,768





Adjustment to goodwill arising from acquisition





7,960


7,016


See
accompanying notes to consolidated financial statements.

40

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Notes to Consolidated Financial Statements

(1) Summary of Significant Accounting Policies

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

Consolidation and Basis of Presentation

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

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

The
Company owns two insurance-related subsidiaries, IBC Life Insurance Company and IBC Insurance Agency, Inc., a wholly owned subsidiary of IBC, the bank subsidiary. Neither of
the insurance-related subsidiaries conducts underwriting activities. The IBC Life Insurance Company is in the business of reinsuring credit life and credit accident and health insurance. The business
is assumed from an unaffiliated insurer and the only business written is generated by the bank subsidiaries of the Company. The risk assumed on each of the policies is not significant to the
consolidated financial statements.

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

Per Share Data

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

41

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

Fair ValueFinancial Instruments

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157 ("SFAS
No. 157"), "Fair Value Measurements" for financial assets and financial liabilities. In accordance with Financial Accounting Standards Board Staff Position No. 157-2, ("FSP
No. 157-2"), "Effective date of FASB Statement No. 157," the Company will delay application of SFAS No. 157 for non-financial assets and
non-financial liabilities until January 1, 2009, except for those that are recognized or
disclosed at fair value on a recurring basis. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands
disclosures about fair value measurements. SFAS No. 157 applies to all financial instruments that are being measured and reported on a fair value basis. SFAS No. 157 defines fair value
as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 also establishes
a fair value hierarchy that prioritizes the inputs used in valuation methodologies into the following three levels:



A
description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy is
set forth below.

The
following table represents assets and liabilities reported on the consolidated balance sheets at their fair value as of December 31, 2008 by level within the SFAS
No. 157 fair value measurement hierarchy:

Fair Value Measurements at Reporting Date UsingAssets/Liabilities
Measured at
Fair Value
December 31,
2008

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

Significant
Other
Observable
Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)(Dollars in Thousands)Measured on a recurring basis:Assets:Investment securities available-for-sale

$
5,071,880

$
530

$
5,071,350

$
Measured on a non-recurring basis:Assets:Impaired Loans


116,482








116,482


42

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

Investment
securities available-for-sale are classified within Level 2 of the valuation hierarchy, with the exception of certain equity investments that
are classified within Level 1. The Company obtains fair value measurements for investment securities from an independent pricing service. The fair value measurements consider observable data
that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the
bond's terms and conditions, among other things.

As
of December 31, 2008, the Company's Financial instruments measured at fair value on a non-recurring basis are limited to impaired loans. Impaired loans are classified within
Level 3 of the valuation hierarchy. The fair value of impaired loans is derived in accordance with Statement of Financial Accounting Standards No. 114 ("SFAS No. 114"),
"Accounting by Creditors for Impairment of a Loan." The fair value of impaired loans is based on the fair value of the collateral, as determined through an external appraisal process, discounted based
on internal criteria. Impaired loans are primarily comprised of collateral-dependent commercial loans.

Certain
financial assets and financial liabilities are measured at fair value on a nonrecurring basis. The instruments are not measured at fair value on an ongoing basis but are subject
to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

Investment Securities

The Company classifies debt and equity securities into one of these categories: held-to-maturity,
available-for-sale, or trading. Such classifications are reassessed for appropriate classification at each reporting date. Securities that are intended and expected to be held
until maturity are classified as "held-to-maturity" and are carried at amortized cost for financial statement reporting. Securities that are not positively expected to be held
until maturity, but are intended to be held for an indefinite period of time are classified as "available-for-sale" or "trading" and are carried at their fair value. Unrealized
holding gains and losses are included in net income for those securities classified as "trading", while unrealized holding gains and losses related to those securities classified as
"available-for-sale" are excluded from net income and reported net of tax as other comprehensive income and in shareholders' equity as accumulated other comprehensive income
until realized. The Company did not maintain any trading securities during the three year period ended December 31, 2008.

Mortgage-backed
securities held at December 31, 2008 and 2007 represent participating interests in pools of long-term first mortgage loans originated and serviced by
the issuers of the securities. Mortgage-backed securities are either issued or guaranteed by the U.S. Government or its agencies including the Federal Home Loan Mortgage Corporation ("Freddie Mac"),
the Federal National Mortgage Association ("Fannie Mae"), the Government National Mortgage Association ("Ginnie Mae") or other non-government entities. Investments in mortgage-backed
securities issued by Ginnie Mae are fully guaranteed by the U. S. Government. Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S.
Government, but carry an implied AAA rating with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September
2008. Market interest rate fluctuations can affect the prepayment speed of principal and the yield on the security.

Premiums
and discounts are amortized using the level yield or "interest method" over the terms of the securities. Declines in the fair value of held-to-maturity
and available-for sale-securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining

43

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

whether
other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less
than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a
period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific
identification method.

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 Probable Loan Losses

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

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

Loans

Loans are reported at the principal balance outstanding, net of unearned discounts. Interest income on loans is reported on an accrual
basis. Loan fees and costs associated with originating the loans are amortized over the life of the loan using the interest method. The Company originates mortgage loans that may subsequently be sold
to an unaffiliated third party. The loans are not securitized and if sold, are sold without recourse. Loans held for sale are carried at cost and the principal amount outstanding is not significant to
the consolidated financial statements.

Non-Accrual Loans

The non-accrual loan policy of the Company's bank subsidiaries is to discontinue the accrual of interest on loans when
management determines that it is probable that future interest accruals will be un-collectible. As it relates to consumer loans, management charges off those loans when the loan is
contractually 90 days past due. Under special circumstances, a consumer or non-consumer loan may be more than 90 days delinquent as to interest or principal and not be placed
on non-accrual status. This situation generally results when a bank subsidiary has a borrower who is experiencing financial difficulties, but not to the extent that requires a
restructuring of indebtedness. The majority of this category is composed of loans that are considered to be adequately secured and/or for which there has been a recent

44

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

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. As it relates to
non-consumer loans that are not 90 days past due, management will evaluate each of these loans to determine if placing the loan on non-accrual status is warranted.
Interest income on non-accrual loans is recognized only to the extent payments are received or when, in management's opinion, the debtor's financial condition warrants reestablishment of
interest accruals.

Other Real Estate Owned

Other real estate owned is comprised of real estate acquired by foreclosure and deeds in lieu of foreclosure. 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 probable 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. Other real
estate owned totaled $27,733,000 and $2,363,000 at December 31, 2008 and 2007, respectively. Other real estate owned is included in other assets.

Bank Premises and Equipment

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

Other Investments

Other investments include equity investments in non-financial companies, bank owned life insurance, as well as equity
securities with no readily determinable fair market value. Equity investments are accounted for using the equity method of accounting. Equity securities with no readily determinable fair value are
accounted for using the cost method.

Income Taxes

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

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

45

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

Stock Options

Through December 31, 2005, the Company accounted for stock-based employee compensation plans based on the intrinsic value method
provided in Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," ("APB No. 25"), and related interpretations. Because the exercise price of the
Company's employee stock options equals the market price of the underlying stock on the measurement date, which is generally the date of grant, no compensation expense was recognized on options
granted. Compensation expense for stock awards is based on the market price of the stock on the measurement date, which is generally the date of grant, and is recognized ratably over the service
period of the award.

Statement
of Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation," as amended by Statement of Financial Accounting Standards
No. 148 ("SFAS No. 148"), "Accounting for Stock-Based CompensationTransition and Disclosure, an amendment of FASB Statement No. 123," requires pro forma disclosures
of net income and earnings per share for companies not adopting its fair value accounting method for stock-based employee compensation. The pro forma disclosures presented in Note 16 in the
accompanying Notes to Consolidated Financial Statements included elsewhere in this report use the fair value method of SFAS No. 123 to measure compensation expense for stock-based employee
compensation plans. The fair value of stock options granted was estimated as the measurement date, which is generally the date of grant, using the Black-Sholes-Merton option-pricing model. This model
was developed for use in estimating the fair value of publicly traded options that have no vesting restrictions and are fully transferable. Additionally, the model requires the input of highly
subjective assumptions. Because the Company's employee stock options have characteristics significantly different from those of publicly traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's opinion, the Black-Scholes-Merton option-pricing model does not necessarily provide a reliable single measure of the fair
value of the Company's stock options.

In
December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 123R ("SFAS No. 123R"), "Share-Based Payment
(Revised 2004)." Among other things, SFAS No. 123R eliminates the ability to account for stock-based compensation using APB No. 25 and requires that such transactions be recognized as
compensation cost in the income statement based on their fair values on the date of the grant. SFAS No. 123R was adopted by the Company on January 1, 2006.

Net Income Per Share

Basic Earnings Per Share ("EPS") is calculated by dividing net income by the weighted average number of common shares outstanding. The
computation of diluted EPS assumes the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. The dilutive effect of stock options is considered in
earnings per share calculations, if dilutive, using the treasury stock method.

Goodwill and Identified Intangible Assets

Goodwill represents the excess of costs over fair value of assets of businesses acquired. Goodwill is tested for impairment at least
annually or on an interim basis if an event triggering impairment may have

46

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

occurred.
As of December 31, 2008, after completing goodwill testing, the Company has determined that no goodwill impairment exists.

Identified
intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is
capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. The Company's identified intangible assets relate to core deposits and contract
rights. As of December 31, 2008, the Company has determined that no impairment of identified intangibles exists. Identified intangible assets with definite useful lives are amortized on an accelerated
basis over their estimated life. See Note 7Goodwill and Other Intangible Assets.

Impairment of Long-Lived Assets

Long-lived assets, such as property, plant and equipment, and purchased intangibles subject to amortization, are reviewed
for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison
of the carrying value of the asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying value of an asset exceeds its estimated future cash flows, an
impairment charge is recognized by the amount by which the carrying value of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the statement of
condition and reported at the lower of the carrying value or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale
would be presented separately in the appropriate asset and liability sections of the statement of condition.

Consolidated Statements of Cash Flows

For purposes of the consolidated statements of cash flows, the Company considers all short-term investments with a maturity
at date of purchase of three months or less to be cash equivalents. Also, the Company reports transactions related to deposits and loans to customers on a net basis.

Accounting for Transfers and Servicing of Financial Assets

The Company accounts for transfers and servicing of financial assets and extinguishments of liabilities based on the application of a
financial-components approach that focuses on control. After a transfer of financial assets, the Company recognizes the financial and servicing assets it controls and liabilities it has incurred,
derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. The Company has retained mortgage servicing rights in connection with the sale of
mortgage loans. Because the Company may not initially identify loans as originated for resale, all loans are initially treated as held for investment. The value of the mortgage servicing rights are
reviewed periodically for impairment and are amortized in proportion to, and over the period of estimated net servicing income or net servicing losses. The value of the mortgage servicing rights is
not significant to the consolidated statements of condition.

Segments of an Enterprise and Related Information

The Company operates as one segment. The operating information used by the Company's chief executive officer for purposes of assessing
performance and making operating decisions about the Company is the consolidated financial statements presented in this report. The Company has four active

47

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

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.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale.

Advertising

Advertising costs are expensed as incurred.

Reclassifications

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

New Accounting Standards

In February 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 155, ("SFAS
No. 155"), "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140." SFAS No. 155 amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 155 permits fair value measurements for any hybrid financial
instrument that contains an embedded derivative and that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS
No. 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain
an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the
prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial interest. SFAS No. 155
is effective for all financial instruments acquired, issued, or subject to a re-measurement event occurring after the beginning of an entity's first fiscal year that begins after September 15,
2006. The adoption of this new standard at January 1, 2007 did not have an impact on the Company's financial statements.

In
March 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 156, ("SFAS No. 156"), "Accounting for Servicing of Financial Assets
-an amendment of FASB Statement No. 140." SFAS No. 156 amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB
Statement No. 125," by requiring, in certain situations, an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering
into a servicing contract. All separately recognized servicing assets and servicing liabilities are required to be initially measured at fair value. Subsequent measurement methods include the
amortization method, whereby servicing assets or servicing liabilities are amortized in proportion to an over the period of estimated net servicing income or net

48

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

servicing
loss or the fair value method, whereby servicing assets or servicing liabilities are measured at fair value at each reporting date and changes in fair value are reported in earnings in the
period in which they occur. If the amortization method is used, an entity must assess servicing assets or servicing liabilities for impairment or increased obligation based on the fair value at each
reporting date. SFAS No. 156 is effective as of the beginning of an entity's first fiscal year that begins after September 15, 2006. The adoption of this new standard at January 1, 2007
did not have a significant impact on the Company's consolidated financial statements.

In
September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157 ("SFAS No. 157"), "Fair Value Measurements." SFAS
No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The Company
adopted SFAS No. 157 on January 1, 2008. The impact of the adoption of the new accounting standard was not significant.

In
February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159 ("SFAS No. 159"), "The Fair Value Option for Financial
Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115." SFAS No. 159 permits entities to choose to measure eligible items at fair value at certain
specified review dates. Changes in unrealized gains/losses for items elected to be measured using the fair value option are reported in earnings at each subsequent reporting date. The fair value
option (i) may be applied instrument by instrument, with certain exceptions, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire
instruments and not to portions of instruments. The Company adopted SFAS No. 159 on January 1, 2008. The adoption of the new accounting standard did not have an impact on the Company's
Financial statements.

In
December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141R ("SFAS No. 141R"), "Business Combinations (Revised
2007)." SFAS No. 141R, replaces SFAS No. 141, "Business Combinations," and applies to all transactions and other events in which one entity obtains control over one or more other
entities. SFAS No. 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities, and any non-controlling interest in the
acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the
amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under SFAS No. 141, whereby the
cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value. SFAS No. 141R requires the acquiring entity to expense
acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under SFAS No. 141. Under SFAS
No. 141R, the requirements of SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," would have to be met in order to accrue for a restructuring plan in
purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which
case, nothing should be recognized in purchase accounting and, instead, that contingency would be subject to the probable and estimateable criteria of SFAS No. 5, "Accounting for
Contingencies." SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008. An entity may not adopt this standard early. It is unknown what the impact of the adoption of this new standard will have on the Company's financial statements.

49

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(1) Summary of Significant Accounting Policies (Continued)

In
December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160 ("SFAS No. 160"), "Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB Statement No. 51." SFAS No. 160 amends Accounting Research Bulleting (ARB) No. 51. "Consolidated Financial Statements," to
establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 clarifies that a
non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of
equity in the consolidated financial statements. Among other
requirements, SFAS No. 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It
also requires disclosure, on the face of the consolidated financial statements, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest.
SFAS No. 160 is effective for fiscal year, and interim periods within those fiscal years, beginning on or after December 15, 2008, or January 1, 2009 for entities with a calendar
year end. An entity may not adopt this standard early. The Company does not anticipate a significant impact to the financial statements upon the adoption of this new standard.

In
March 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 161 ("SFAS No. 161"), "Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133." SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133 to provide greater
transparency about how and why and entity uses derivative instruments, how derivative instruments and related hedge items are accounted for under SFAS No. 133 and its related interpretations
and how derivative instruments and related hedged items affect an entity's financial position, results of operations and cash flows. SFAS No. 161 requires qualitative disclosures about
objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about
credit-risk-related contingent features in derivative agreements. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15,
2008. The Company does not anticipate a significant impact to the financial statements upon the adoption of this new standard.

In
May 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 162 ("SFAS No. 162"), "The Hierarchy of Generally Accepted
Accounting Principles." SFAS No. 162 identifies the sources of accounting principles and framework for selecting the principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. The hierarchy guidance provided by SFAS No. 162 did not have a
significant impact on the Company's financial statements.

(2) Acquisitions

On December 4, 2008, the Company completed its acquisition of certain rights to InsCorp, Inc. insurance contracts for $1,074,000. InsCorp, Inc. is a multiline independently
owned insurance agency, which insures oil operators, merchants and industrial businesses.

On
March 16, 2007, the Company completed its acquisition of Southwest First Community, Inc. ("SWFC"), a bank holding company with approximately $133 million in
assets that owned State Bank & Trust in Beeville, Texas and Commercial State Bank in Sinton, Texas. The transaction was pursuant to the Agreement and Plan of Merger dated
December 1, 2006 (the "Merger Agreement"). The Company paid consideration totaling $23.5 million in cash.

50

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Investment Securities

The amortized cost and estimated fair value by type of investment security at December 31, 2008 are as follows:

Held to MaturityAmortized
cost

Gross
unrealized
gains

Gross
unrealized
losses

Estimated
fair value

Carrying
value(Dollars in Thousands)Other securities

$
2,300

$


$


$
2,300

$
2,300Total investment securities

$
2,300

$


$


$
2,300

$
2,300Available for SaleAmortized
cost

Gross
unrealized
gains

Gross
unrealized
losses

Estimated
fair value

Carrying
value(1)(Dollars in Thousands)U.S. Treasury securities

$
1,319

$


$


$
1,319

$
1,319Mortgage-backed securities


4,947,351


59,915


(32,949
)

4,974,317


4,974,317Obligations of states and political subdivisions


81,208


1,346


(340
)

82,214


82,214Equity securities


13,825


205





14,030


14,030Total investment securities

$
5,043,703

$
61,466

$
(33,289
)
$
5,071,880

$
5,071,880


---

The
amortized cost and estimated fair value of investment securities at December 31, 2008, 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 SaleAmortized
Cost

Estimated
fair value

Amortized
Cost

Estimated
fair value(Dollars in Thousands)Due in one year or less

$
350

$
350

$
1,319

$
1,319Due after one year through five years


1,950


1,950





Due after five years through ten years








8,474


8,560Due after ten years








72,734


73,654Mortgage-backed securities








4,947,351


4,974,317Equity securities








13,825


14,030Total investment securities

$
2,300

$
2,300

$
5,043,703

$
5,071,880


51

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Investment Securities (Continued)

The
amortized cost and estimated fair value by type of investment security at December 31, 2007 are as follows:

Held to MaturityAmortized
cost

Gross
unrealized
gains

Gross
unrealized
losses

Estimated
fair value

Carrying
value(Dollars in Thousands)Other securities

$
2,300

$


$


$
2,300

$
2,300Total investment securities

$
2,300

$


$


$
2,300

$
2,300Available for SaleAmortized
cost

Gross
unrealized
gains

Gross
unrealized
losses

Estimated
fair value

Carrying
value(1)(Dollars in Thousands)U.S. Treasury securities

$
1,308

$


$


$
1,308

$
1,308Mortgage-backed securities


4,068,568


7,095


(8,835
)

4,066,828


4,066,828Obligations of states and political subdivisions


82,937


1,721


(25
)

84,633


84,633Other securities


985


12





997


997Equity securities


13,826


296





14,122


14,122Total investment securities

$
4,167,624

$
9,124

$
(8,860
)
$
4,167,888

$
4,167,888


---

Mortgage-backed
securities are securities issued by the Freddie Mac, Fannie Mae, Ginnie Mae or non-government entities. Investments in mortgage-backed securities issued by
Ginnie
Mae are fully guaranteed by the U.S. Government. Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, but carry an implied
AAA rating with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008.

The
amortized cost and fair value of available for sale investment securities pledged to qualify for fiduciary powers, to secure public monies as required by law, repurchase agreements
and short-term fixed borrowings was $4,255,447,000 and $4,297,440,000, respectively, at December 31, 2008.

Proceeds
from the sale of securities available-for-sale were $8,376,000, $841,084,000 and $60,477,000 during 2008, 2007 and 2006, respectively, which amounts
included $0, $838,561,000 and $61,377,000 of mortgage-backed securities. In 2007, the Company sold approximately $833,160,000 of mortgage-backed securities that were in a loss position. The securities
identified for sale had unique attributes that distinguished them from the rest of the portfolio and caused them to not meet the interest rate risk profile of the Company at the time. The first sale
occurred in the first quarter. The securities sold were certain hybrid mortgage-backed securities with a coupon re-set date that exceeded 30 months and a weighted average yield to
coupon re-set that was approximately 100 basis points less than the FHLB certificate of

52

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Investment Securities (Continued)

indebtedness
short-term rate. The second sale occurred in the third quarter. The securities sold were certain hybrid mortgage-backed securities with a coupon re-set date that
was 15 - 30 months and a weighted average yield coupon re-set that was approximately 60 basis points below the FHLB short-term advance rate. In
both quarters, the proceeds from the sales of the securities were used to pay down FHLB borrowings. The sales of the securities facilitated a re-positioning of the balance sheet to a more
neutral position in terms of interest rate risk and are expected to improve operating ratios in the short term. In 2006, the Company sold approximately $61,377,000 of mortgage-backed securities that
were in a loss position in order to re-position a portion of the balance sheet of one of its subsidiary banks in response to unexpected changes in the economic landscape of the subsidiary
bank. Gross gains of $6,427,000, $2,431,000 and $412,000 and gross losses of $0, $18,369,000 and $1,342,000 were realized on the sales in 2008, 2007 and 2006, respectively.

Gross
unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been
in a continuous unrealized loss position, at December 31, 2008 were as follows:

Less than 12 months

12 months or more

TotalFair Value

Unrealized
Losses

Fair Value

Unrealized
Losses

Fair Value

Unrealized
Losses(Dollars in Thousands)Available for sale:Mortgage-backed securities

$
893,067

$
(32,335
)
$
96,734

$
(614
)
$
989,801

$
(32,949
)Obligations of states and political subdivisions


8,262


(274
)

1,299


(66
)

9,561


(340
)$
901,329

$
(32,609
)
$
98,033

$
(680
)
$
999,362

$
(33,289
)


Gross
unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been
in a continuous loss position, at December 31, 2007 were as follows:

Less than 12 months

12 months or more

TotalFair Value

Unrealized
Losses

Fair Value

Unrealized
Losses

Fair Value

Unrealized
Losses(Dollars in Thousands)Available for sale:Mortgage-backed securities

$
678,596

$
(1,551
)
$
1,273,719

$
(7,284
)
$
1,952,315

$
(8,835
)Obligations of states and political subdivisions


2,520


(25
)







2,520


(25
)$
681,116

$
(1,576
)
$
1,273,719

$
(7,284
)
$
1,954,835

$
(8,860
)


The
unrealized losses on investments in mortgage-backed securities are primarily caused by changes in market interest rates. Mortgage-backed securities are primarily securities issued by
the Freddie Mac, Fannie Mae and Ginnie Mae. The contractual cash obligations of the securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. The contractual cash obligations of the
securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government; however, the securities

53

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(3) Investment Securities (Continued)

carry
an implied AAA rating with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008. The
decrease in fair value on mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae is due to market interest rates. The Company has the ability and intent to hold these investments
until a market price recovery or maturity of the securities; therefore, it is the conclusion of the Company that the investments in mortgage-backed securities issued by Freddie Mac, Fannie Mae and
Ginnie Mae are not considered other-than-temporarily impaired. In addition, the Company has a minor investment in non-agency mortgage-backed securities that have strong credit backgrounds and include
additional credit enhancements to protect the Company from losses arising from high foreclosure rates. These securities have additional market volatility beyond economically induced interest rate
events. The Company has received principal and interest payments in line with expected cash flows at the time of purchase. The Company has the ability and intent to hold the non-agency mortgage-backed
securities until a market price recovery or maturity and has continued to receive cash as expected; therefore, it is the conclusion of the Company that the investments in non-agency mortgage-backed
securities are not other-than-temporarily impaired.

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

(4) Loans

A summary of net loans, by loan type at December 31, 2008 and 2007 is as follows:

December 31,2008

2007(Dollars in thousands)Commercial, financial and agricultural

$
2,574,247

$
2,426,064Real estatemortgage


888,095


798,708Real estateconstruction


1,911,954


1,835,950Consumer


169,589


190,899Foreign


328,948


285,008Total loans


5,872,833


5,536,629Unearned discount





(1
)Loans, net of unearned discount

$
5,872,833

$
5,536,628


54

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(5) Allowance for Probable Loan Losses

A summary of the transactions in the allowance for probable loan losses for the years ended December 31, 2008, 2007 and 2006 is as follows:

2008

2007

2006(Dollars in Thousands)Balance at January 1,

$
61,726

$
64,537

$
77,796Losses charged to allowance


(9,134
)

(6,451
)

(18,388
)Recoveries credited to allowance


1,056


4,348


1,280Net losses charged to allowance


(8,078
)

(2,103
)

(17,108
)Provision (credit) charged to operations


19,813


(1,762
)

3,849Acquired in purchase transactions





1,054


Balance at December 31,

$
73,461

$
61,726

$
64,537


Loans
accounted for on a non-accrual basis at December 31, 2008, 2007 and 2006 amounted to $164,230,000, $33,622,000 and $17,788,000, respectively. The effect of such
non-accrual loans reduced interest income by $6,242,000, $1,378,000 and $1,868,000 for the years ended December 31, 2008, 2007 and 2006, respectively. Amounts received on
non-accruals are applied, for financial accounting purposes, first to principal and then to interest after all principal has been collected. Accruing loans contractually past due
90 days or more as to principal or interest payments at December 31, 2008, 2007 and 2006 amounted to $6,274,000, $21,840,000 and $9,400,000, respectively.

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:

2008

2007

2006(Dollars in Thousands)Balance of impaired loans where there is a related allowance for loan loss

$
137,153

$
39,618

$
22,909Balance of impaired loans where there is no related allowance for loan loss


27,786





Total impaired loans

$
164,939

$
39,618

$
22,909Allowance allocated to impaired loans

$
20,671

$
4,903

$
7,171


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 $93,654,000, $22,590,000, and $25,684,000 for the years ended December 31, 2008, 2007 and 2006, respectively. Interest income recorded on impaired loans was $236,000,
$1,989,000 and $404,000 for the years ended December 31, 2008, 2007 and 2006. The increase in the balance of impaired loans can be

55

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(5) Allowance for Probable Loan Losses (Continued)

partially
attributed to certain loans that filed for bankruptcy protection and a loan relationship that deteriorated during 2008. A substantial amount of the impaired loans have adequate collateral
and credit enhancements to not require a related allowance for loan loss. The increase in the impaired loans from 2006 to 2007 is the result of certain loans being placed in this category, and does
not necessarily reflect the environment of the current sub-prime crisis. The Company has no direct exposure to sub-prime loans, in its loan portfolio, but the
sub-prime crisis has affected the credit markets on a national level, and as a result, the Company has experienced an increasing amount of impaired loans; however, management's decision to
place loans in this category does not necessarily mean that the Company will experience significant losses from these loans.

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 probable loan losses can be made only on a subjective basis. It is the
judgment of the Company's management that the allowance for probable loan losses at December 31, 2008 was adequate to absorb probable losses from loans in the portfolio at that date.

(6) Bank Premises and Equipment

A summary of bank premises and equipment, by asset classification, at December 31, 2008 and 2007 were as follows:

Estimated
useful lives

2008

2007(Dollars in Thousands)Bank buildings and improvements

5 - 40 years

$
351,766

$
323,382Furniture, equipment and vehicles

1 - 20 years


252,290


229,495Land




109,214


97,713Real estate held for future expansion:Land, building, furniture, fixture and equipment

7 - 27 years


766


817Less: accumulated depreciation




(247,665
)

(215,753
)Bank premises and equipment, net



$
466,371

$
435,654


(7) Goodwill and Other Intangible Assets

The majority of the Company's identified intangibles are in the form of amortizable core deposit premium. In 2008, the Company purchased $1,074,000 in identified intangibles in the
acquisition of the InsCorp, Inc. insurance agency, which will be amortized over a 7 year period. In 2007, the Company

56

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(7) Goodwill and Other Intangible Assets (Continued)

acquired
$2,337,000 in identified intangibles in the form of core deposit premium in the SWFC acquisition, which will be amortized over a ten year period. Information on the Company's identified
intangible assets follows:

Carrying
Amount

Accumulated
Amortization

Net(Dollars in Thousands)December 31, 2008:Core deposit premium

$
58,675

$
32,364

$
26,311Identified intangible (contract rights)


1,074





1,074Total identified intangibles

$
59,749

$
32,364

$
27,385December 31, 2007:Core deposit premium

$
58,675

$
27,168

$
31,507


Amortization
expense of intangible assets for the years ended December 31, 2008, 2007 and 2006, was $5,195,000, $5,188,000 and $4,866,000, respectively. Estimated amortization
expense for each of the five succeeding fiscal years, and thereafter, is as follows:

Total(in thousands)Fiscal year ending:2009

$
5,2862010


5,2402011


5,2022012


4,4962013


4,477Thereafter


2,684Total

$
27,385


Changes
in the carrying amount of goodwill for the years ended December 31, 2008 and 2007 were as illustrated in the table below.

2008

2007(Dollars in Thousands)Balance at January 1,

$
283,198

$
282,246Adjustment to goodwill related to prior acquisition (Note 17)





(7,960
)Decrease in goodwill due to sale of partnership interest


(841
)

Goodwill from purchase transaction (Note 2)


175


8,912Balance as of December 31,

$
282,532

$
283,198


57

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Deposits

Deposits as of December 31, 2008 and 2007 and related interest expense for the years ended December 31, 2008, 2007 and 2006 were as follows:

2008

2007(Dollars in Thousands)Deposits:Demandnon-interest bearingDomestic

$
1,325,272

$
1,371,711Foreign


134,398


140,916Total demand non-interest bearing


1,459,670


1,512,627Savings and interest bearing demandDomestic


1,750,317


1,932,415Foreign


331,285


360,174Total savings and interest bearing demand


2,081,602


2,292,589Time, certificates of deposit$100,000 or moreDomestic


945,348


841,832Foreign


1,191,444


1,262,119Less than $100,000Domestic


793,953


851,438Foreign


386,767


397,001Total time, certificates of deposit


3,317,512


3,352,390Total deposits

$
6,858,784

$
7,157,606




2008

2007

2006(Dollars in Thousands)Interest expense:Savings and interest bearing demandDomestic

$
23,197

$
46,878

$
36,606Foreign


3,454


6,900


3,838Total savings and interest bearing demand


26,651


53,778


40,444Time, certificates of deposit$100,000 or moreDomestic


28,990


37,133


32,851Foreign


41,383


54,494


44,143Less than $100,000Domestic


26,297


36,460


33,225Foreign


9,809


14,933


12,858Total time, certificates of deposit


106,479


143,020


123,077Total interest expense on deposits

$
133,130

$
196,798

$
163,521


58

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(8) Deposits (Continued)

Scheduled
maturities of time deposits as of December 31, 2008 were as follows:

Total(in thousands)2009

$
3,011,1642010


204,5342011


57,6482012


39,7162013


3,851Thereafter


599Total

$
3,317,512


Scheduled
maturities of time deposits in amounts of $100,000 or more at December 31, 2008, were as follows:

Due within 3 months or less

$
876,867Due after 3 months and within 6 months


1,101,492Due after 6 months and within 12 months


138,744Due after 12 months


19,689$
2,136,792


(9) Securities Sold Under Repurchase Agreements

The Company's bank subsidiaries have entered into repurchase agreements with an investment banking firm and individual customers of the bank subsidiaries. The purchasers have agreed to
resell to the bank subsidiaries identical securities upon the maturities of the agreements. Securities sold under repurchase agreements were mortgage-backed book entry securities and averaged
$1,436,224,000 and $982,747,000 during 2008 and 2007, respectively, and the maximum amount outstanding at any month end during 2008 and 2007 was $1,556,734,000 and $1,334,147,000, respectively.

59

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(9) Securities Sold Under Repurchase Agreements (Continued)

Further
information related to repurchase agreements at December 31, 2008 and 2007 is set forth in the following table:

Collateral Securities

Repurchase BorrowingBook Value of
Securities Sold

Fair Value of
Securities Sold

Balance of
Liability

Weighted Average
Interest Rate(Dollars in Thousands)December 31, 2008 term:Overnight agreements

$
344,161

$
348,784

$
250,268


1.30
%1 to 29 days


66,002


66,341


26,942


2.4030 to 90 days


105,195


105,917


53,972


2.42Over 90 days


1,341,304


1,350,612


1,109,949


3.65Total

$
1,856,662

$
1,871,654

$
1,441,131


3.17
%December 31, 2007 term:Overnight agreements

$
286,367

$
286,709

$
234,060


3.67
%1 to 29 days


50,684


50,933


24,227


4.6630 to 90 days


118,456


118,672


48,416


4.66Over 90 days


1,207,423


1,208,842


1,022,280


4.25Total

$
1,662,930

$
1,665,156

$
1,328,983


4.17
%


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.

60

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(10) Other Borrowed Funds (Continued)

Further
information regarding the Company's other borrowed funds at December 31, 2008 and 2007 is set forth in the following table:

December 31,2008

2007(Dollars in Thousands)Federal Home Loan Bank advancesshort-termBalance at year end

$
2,522,986

$
1,456,870Rate on balance outstanding at year end


1.07
%

4.38
%Average daily balance

$
1,395,220

$
1,462,435Average rate


2.44
%

5.15
%Maximum amount outstanding at any month end

$
2,522,986

$
2,157,148Federal Home Loan Bank advanceslong-termBalance at year end

$


$
66Rate on balance outstanding at year end





5.15
%Average daily balance

$


$
69Average rate





5.15
%Maximum amount outstanding at any month end

$


$
71


(11) Junior Subordinated Deferrable Interest Debentures

The Company has formed twelve statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. As part of the Local Financial
Corporation ("LFIN") acquisition, the Company acquired three additional statutory business trusts previously formed by LFIN for the purpose of issuing trust preferred securities. The twelve 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. As of December 31, 2008, the Debentures issued by four of the trusts
formed by the Company and the Debentures issued by all three of the trusts formed by LFIN have been redeemed by the Company. As of December 31, 2008, the principal amount of debentures
outstanding totaled $201,048,000. As a result of participation in the TARP Capital Purchase Program, the Company may not, without the consent of the Treasury Department, redeem any of the Debentures
until the earlier to occur of December 23, 2011, or the date on which the Company has redeemed all of the Series A Preferred Stock issued under the Capital Purchase Program or the date
on which the Treasury has transferred all of the Series A Preferred Stock to third parties not affiliated with the Treasury.

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 Trust I and for up to twenty consecutive quarterly periods on Trusts VI, VII, VIII, IX, X, XI and XII. If interest payments on any of
the Debentures

61

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Junior Subordinated Deferrable Interest Debentures (Continued)

are
deferred, distributions on both the Capital and Common Securities related to that Debenture would also be deferred. The redemption prior to maturity of any of the Debentures may require the prior
approval of the Federal Reserve and/or other regulatory bodies.

For
financial reporting purposes, the Trusts are treated as investments of the Company and not consolidated in the consolidated financial statements. Although the Capital Securities
issued by each of the Trusts are not included as a component of shareholders' equity on the consolidated statement of condition, the Capital Securities are treated as capital for regulatory purposes.
Specifically, under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital on an aggregate
basis. Any amount that exceeds the 25% threshold would qualify as Tier 2 capital. As of December 31, 2008, the total $201,048,000, of the Capital Securities outstanding qualified as
Tier 1 capital.

In
March 2005, the Federal Reserve Board issued a final rule that allowed the inclusion of trust preferred securities in Tier 1 capital, but placed stricter quantitative limits.
Under the final rule, after a transition period ending March 31, 2009, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of
Tier 1 capital, 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. The Company believes that substantially all of the current trust preferred securities will be included in Tier 1 capital after the
five-year transition period ending March 31, 2009.

On
November 7, 2007, the Company, as successor issuer, redeemed all of its Floating Rate Junior Subordinated Debt Securities ("the Debt Securities") issued to Local Financial
Capital Trust III ("LFIN Trust III") at a redemption price equal to approximately $10,547,000, which includes accrued interest to, but not including, the redemption date. The proceeds
from the redemption were used to simultaneously redeem an equal amount of LFIN Trust III Floating Rate Capital Securities and Floating Rate Common Securities issued by LFIN Trust III.

On
July 30, 2007, the Company, as successor issuer, redeemed all of its Floating Rate Junior Subordinated Debt Securities (the "Debt Securities"), issued to Local Financial
Capital Trust II ("LFIN
Trust II") at a redemption price equal to approximately $10,764,000, which includes accrued interest to, but not including, the redemption date. The proceeds from the redemption of the Debt
Securities were used to simultaneously redeem an equal amount of LFIN Trust II Floating Rate Capital Securities and Floating Rate Common Securities issued by LFIN Trust II.

On
July 7, 2007, the Company redeemed all of its Floating Rate Junior Subordinated Debt Securities (the "Debt Securities"), issued to International Bancshares Capital
Trust V ("Trust V") at a redemption price equal to approximately $21,088,000, which includes accrued interest to, but not including, the redemption date. The proceeds from the redemption
were used to simultaneously redeem an equal amount of Trust V Floating Rate Capital Securities and Floating Rate Common Securities issued by Trust V.

On
June 11, 2007, the Company formed International Bancshares Corporation Trust XII ("Trust XII"), for the purpose of issuing trust preferred securities. On
June 26, 2007, Trust XII issued $20,000,000 of Capital Securities. The Capital Securities accrue interest for the first five years at a fixed rate of 6.851% and subsequently at a
floating rate of 1.45% over the three month LIBOR, and interest is payable quarterly beginning September 1, 2007. The Trust XII Capital Securities will mature on

62

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(11) Junior Subordinated Deferrable Interest Debentures (Continued)

September 1,
2037; however, the Capital Securities may be redeemed at specified prepayment prices (a) in whole or in part on any interest payment date on or after September 1,
2012, or (b) in whole or in part within 90 days upon the occurrence of certain legal, regulatory, or tax events.

On
April 22, 2007, the Company redeemed all of its Floating Rate Junior Subordinated Debt Securities (the "Debt Securities"), issued to International Bancshares Capital
Trust IV ("Trust IV") at a redemption price equal to approximately $23,723,000, which includes accrued interest to, but not including, the redemption date. The proceeds from the
redemption were used to simultaneously redeem an equal amount of Trust IV Floating Rate Capital Securities and Floating Rate Common Securities issued by Trust IV.

On
April 13, 2007, the Company formed International Bancshares Corporation Trust XI ("Trust XI"), for the purpose of issuing trust preferred securities. On
April 19, 2007, Trust XI issued $32,000,000 of Capital Securities. The Capital Securities accrue interest for the first five years at a fixed rate of 6.82% and subsequently at a floating
rate of 1.62% over the three month LIBOR, and interest is payable quarterly beginning July 1, 2007. The Trust XI Capital Securities will mature on July 1, 2037, however, the
Capital Securities may be redeemed at specified prepayment prices (a) in whole or in part on any interest payment date on or after July 1, 2012, or (b) in whole or in part within
90 days upon the occurrence of certain legal, regulatory, or tax events.

The
following table illustrates key information about each of the Debentures and their interest rates at December 31, 2008:

Junior
Subordinated
Deferrable
Interest Debentures

Repricing
Frequency

Interest
Rate

Interest
Rate
Index(1)

Maturity
Date

Optional
Redemption
Date(in thousands)Trust I

$
10,322

Fixed


10.18
%
Fixed

June 2031

June 2011Trust VI

$
25,774

Quarterly


5.60
%
LIBOR + 3.45

November 2032

May 2009Trust VII

$
10,310

Quarterly


6.44
%
LIBOR + 3.25

April 2033

April 2009Trust VIII

$
25,774

Quarterly


7.87
%
LIBOR + 3.05

October 2033

April 2009Trust IX

$
41,238

Fixed


7.10
%
Fixed

October 2036

October 2011Trust X

$
34,021

Fixed


6.66
%
Fixed

February 2037

February 2012Trust XI

$
32,990

Fixed


6.82
%
Fixed

July 2037

July 2012Trust XII

$
20,619

Fixed


6.85
%
Fixed

September 2037

September 2012$
201,048


---

63

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(12) Earnings per Share ("EPS")

Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding. The computation of diluted EPS assumes the issuance of common shares for all
dilutive potential common shares outstanding during the reporting period. The calculation of the basic EPS and the diluted EPS for the years ended December 31, 2008, 2007, and 2006 is set forth
in the following table:

Net Income
(Numerator)

Shares
(Denominator)

Per Share
Amount(Dollars in Thousands, Except Per Share Amounts)December 31, 2008:Basic EPSNet income

$
132,112


68,576,587

$
1.93Potential dilutive common shares





137,736Diluted EPS

$
132,112


68,714,323

$
1.92December 31, 2007:Basic EPSNet income

$
121,312


69,036,274

$
1.76Potential dilutive common shares





333,837Diluted EPS

$
121,312


69,370,111

$
1.75December 31, 2006:Basic EPSNet income

$
117,001


69,446,874

$
1.68Potential dilutive common shares





707,703Diluted EPS

$
117,001


70,154,577

$
1.67


(13) Employees' Profit Sharing Plan

The Company has a deferred profit sharing plan for full-time employees with a minimum of one year of continuous employment. The Company's annual contribution to the plan is
based on a percentage, as determined by the Board of Directors, of income before income taxes, as defined, for the year. Allocation of the contribution among officers and employees' accounts is based
on length of service and amount of salary earned. Profit sharing costs of $4,683,000, $4,628,000 and $4,685,000 were charged to income for the years ended December 31, 2008, 2007, and 2006,
respectively.

(14) International Operations

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

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

64

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(14) International Operations (Continued)

A
summary of assets attributable to international operations at December 31, 2008 and 2007 are as follows:

2008

2007(Dollars in Thousands)Loans:Commercial

$
270,298

$
223,507Others


58,650


61,501328,948


285,008Less allowance for probable loan losses


(604
)

(864
)Net loans

$
328,344

$
284,144Accrued interest receivable

$
1,896

$
2,464


At
December 31, 2008, the Company had $156,176,000 in outstanding standby and commercial letters of credit to facilitate trade activities. The letters of credit are issued
primarily in conjunction with credit facilities, which are available to various Mexican banks doing business with the Company.

Revenues
directly attributable to international operations were $17,084,000, $21,525,000 and $20,344,000 for the years ended December 31, 2008, 2007 and 2006, respectively.

(15) Income Taxes

The Company files a consolidated U.S. Federal and State income tax return. The current and deferred portions of net income tax expense included in the consolidated statements of
income are presented below for the years ended December 31:

2008

2007

2006(Dollars in Thousands)CurrentU.S.

$
71,280

$
60,462

$
70,701State


2,882


(127
)

1,838Foreign


51


55


36Total current taxes


74,213


60,390


72,575DeferredU.S.


(6,030
)

582


(15,442
)State


1,347


(5,208
)

(244
)Total deferred taxes


(4,683
)

(4,626
)

(15,686
)Total income taxes

$
69,530

$
55,764

$
56,889


65

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(15) Income Taxes (Continued)

Total
income tax expense differs from the amount computed by applying the U.S. Federal income tax rate of 35% for 2008, 2007 and 2006 to income before income taxes. The reasons for the
differences for the years ended December 31 are as follows:

2008

2007

2006(Dollars in Thousands)Computed expected tax expense

$
70,720

$
61,977

$
60,876Change in taxes resulting from:Tax-exempt interest income


(1,552
)

(1,625
)

(1,681
)State tax, net of federal income taxes and tax credit


2,834


(2,272
)

1,037Other investment income


(3,321
)

(3,079
)

(3,724
)Other


849


763


381Actual tax expense

$
69,530

$
55,764

$
56,889


The
tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007 are reflected
below:

2008

2007(Dollars in Thousands)Deferred tax assets:Loans receivable, principally due to the allowance for probable loan losses

$
27,237

$
24,788Other real estate owned


42


5Goodwill


3,132


3,132Accrued expenses


200


200State net operating loss carryforwards


5,069


6,620Other


6,710


6,079Total deferred tax assets


42,390


40,824Deferred tax liabilities:Lease financing receivable


(4,503
)

(7,376
)Bank premises and equipment, principally due to differences on depreciation


(21,514
)

(18,277
)Net unrealized gains on available for sale investment securities


(9,988
)

(99
)FHLB stock


(1,398
)

(6,305
)Identified intangible assets


(20,202
)

(19,993
)Other


(8,021
)

(6,803
)Total deferred tax liabilities


(65,626
)

(58,853
)Net deferred tax liability

$
(23,236
)
$
(18,029
)


The
net deferred tax liability of $23,236,000 at December 31, 2008 is included in other liabilities in the consolidated statements of condition. The net deferred tax liability of
$18,029,000 at December 31, 2007 is included in other liabilities in the consolidated statements of condition.

66

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(15) Income Taxes (Continued)

State
net operating loss carryforwards expire beginning in June 2013 and ending in December 2024.

(16) Stock Options

On April 1, 2005, the Board of Directors adopted the 2005 International Bancshares Corporation Stock Option Plan (the "2005 Plan"). Effective May 19, 2008, the 2005 Plan
was amended to increase the number of shares available for stock option grants under the 2005 Plan by 300,000 shares. The 2005 Plan replaced the 1996 International Bancshares Corporation Key
Contributor Stock Option Plan (the "1996 Plan"). Under the 2005 Plan, both qualified incentive stock options ("ISOs") and
non-qualified stock options ("NQSOs") may be granted. Options granted may be exercisable for a period of up to 10 years from the date of grant, excluding ISOs granted to 10%
shareholders, which may be exercisable for a period of up to only five years. As of December 31, 2008, 368,197 shares were available for future grants under the 2005 Plan.

On
January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123R ("SFAS No. 123R"),"Share-Based Payment, (Revised
2004)." SFAS No. 123R sets accounting requirements for "share-based" compensation to employees and non-employee directors, including employee stock purchase plans, and requires
companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation.

The
Company chose the modified-prospective transition alternative in adopting SFAS No. 123R. Under the modified-prospective transition method, compensation cost is recognized in
financial statements issued subsequent to the date of adoption for all stock-based payments granted, modified or settled after the date of adoption, as well as for any unvested awards that were
granted prior to the date of adoption.

The
fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option valuation model that uses the assumptions noted in the following table. Expected
volatility is based on the historical volatility of the price of the Company's stock. The Company uses historical data to estimate the expected dividend yield and employee termination rates within the
valuation model. The expected term of options is derived from historical exercise behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S.
Treasury yield curve in effect at the time of grant.

2008

2007Expected Life (Years)


6.13


6.13Dividend yield


2.75
%

2.27
%Interest rate


1.44
%

4.63
%Volatility


31.08
%

20.15
%


67

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(16) Stock Options (Continued)

A
summary of option activity under the stock option plans for the twelve months ended December 31, 2008 is as follows:

Number
of options

Weighted average
exercise price

Weighted average
remaining contractual term
(years)

Aggregate
intrinsic
value ($)Options outstanding at December 31, 2007


924,483

$
21.00Plus: Options granted


8,000


21.54Less:Options exercised


58,356


13.26Options expired





Options forfeited


40,530


23.54Options outstanding at December 31, 2008


833,597

$
21.43


3.67

$
2,364,000Options fully vested and exercisable at December 31, 2008


466,389

$
18.07


2.23

$
2,356,000


Stock-based
compensation expense included in the consolidated statements of income for the twelve months ended December 31, 2008 and December 31, 2007 was approximately
$692,000 and $771,000, respectively. As of December 31, 2008 there was approximately $1,113,000, of total unrecognized stock-based compensation cost related to non-vested options
granted under the Company plans that will be recognized over a weighted average period of 1.4 years.

A
summary of the status of the Company's non-vested options as of December 31, 2008, and changes during the twelve months ended December 31, 2008, is presented
below:

Non-vested Options

Options

Weighted average
grant-date
fair value ($)Non-vested options at December 31, 2007


490,203

$
6.28Granted


8,000


4.90Vested


93,821


6.65Forfeited


37,174


5.98Non-vested options at December 31, 2008


367,208

$
6.19


Other
information pertaining to option activity during the twelve month period ending December 31, 2008 and December 31, 2007 is as follows:

Twelve Months Ended
December 31,2008

2007Weighted average grant date fair value of stock options granted

$
4.90

$
5.35Total fair value of stock options vested

$
624,000

$
392,000Total intrinsic value of stock options exercised

$
591,000

$
10,542,000


68

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(17) Commitments, Contingent Liabilities and Other Tax Matters

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

The
Company leases portions of its banking premises and equipment under operating leases. Total rental expense for the years ended December 31, 2008, 2007 and 2006 were
$11,700,000, $10,100,000 and $7,800,000, respectively. Future minimum lease payments due under non-cancellable operating leases at December 31, 2008 were as follows:

Total(in thousands)Fiscal year ending:2009

$
9,5412010


8,5102011


6,6442012


3,9792013


2,373Thereafter


6,104Total

$
37,151


It
is expected that certain leases will be renewed, as these leases expire. Aggregate future minimum rentals to be received under non-cancellable sub-leases greater than one
year at December 31, 2008 were $13,300,000.

Cash
of approximately $60,405,000 and $65,931,000 at December 31, 2008 and 2007, 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 issued a 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 approximately $13.7 million, which constitutes the interest that would have accrued based on the

69

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(17) Commitments, Contingent Liabilities and Other Tax Matters (Continued)

adjustments
proposed in the FPAAs related to both of the lease-financing transactions. If it is determined that the amount of interest due, if any, related to the lease-financing transactions is less
than the approximate $13.7 million, the remaining amount of the prepaid interest would be refunded to the Company, plus interest thereon.

Beginning
August 29, 2005, IBC proceeded to litigate one of the partnership tax cases in the Federal District Court in San Antonio, Texas. The case was tried over nine days
beginning August 29, 2005. On March 31, 2006, the trial court rendered a judgment against the Company on the first FPAA. IBC timely filed its notice of appeal to the Fifth Circuit Court
of Appeals. The appeal was argued on August 8, 2007 and the Trial Court decision was affirmed on August 23, 2007. The judgment became non-appealable on November 21,
2007. The other partnership case was stayed by the same Trial Court pending the appeal. Following the resolution of the first case, the trial court reopened the second case and set it for trial on
September 2, 2008. Subsequently, the Company engaged in settlement negotiations with the Department of Justice, and agreed to settle the second case. Under the terms of the settlement, the
Company has conceded the entire amount in dispute based upon the similarity of the facts of the second case to the first case and the likelihood of an unfavorable outcome if litigated based upon the
Court rulings in the first case. On August 13, 2008, the Company filed a lawsuit in the Texas State District Court in Laredo, Texas against KPMG, LLP and a number of other third parties
asserting claims against the defendants related to the underlying transactions of the two partnership tax cases. The Company is currently pursuing settlement discussions with a number of the
defendants and reached a settlement agreement with KPMG, LLP on January 16, 2009.

The
Company, through December 31, 2005, had previously expensed approximately $12.0 million in connection with the lawsuits. Because of the above-referenced trial court
judgment against the Company on the first FPAA and the similarity between the two FPAAs, the Company additionally expensed an approximate $13.7 million in the first quarter of 2006. The
resultant approximately $25.7 million expensed is the total of the tax adjustments due and the interest due on such adjustments for both FPAAs. Management will continue to evaluate the
correspondence with the IRS on the FPAAs and make any appropriate revisions to the amounts as deemed necessary.

(18) Transactions with Related Parties

In the ordinary course of business, the subsidiaries of the Company make loans to directors and executive officers of the Corporation, including their affiliates, families and companies
in which they are principal owners. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for
comparable transactions with other persons and do not involve more than normal risk of collectibility or present other unfavorable features. The aggregate amounts receivable from such related parties
amounted to approximately $79,438,000 and $76,711,000 at December 31, 2008 and 2007, respectively.

(19) Financial Instruments with Off-Statement of Condition Risk and Concentrations of Credit Risk

In the normal course of business, the bank subsidiaries are party to financial instruments with off-statement of condition risk to meet the financing needs of their
customers. These financial instruments include commitments to their customers. These financial instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in
the consolidated statement of condition. The contract amounts of these instruments reflect the extent of involvement the bank subsidiaries have in particular

70

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(19) Financial Instruments with Off-Statement of Condition Risk and Concentrations of Credit Risk (Continued)

classes
of financial instruments. At December 31, 2008, the following financial amounts of instruments, whose contract amounts represent credit risks, were outstanding:

Commitments to extend credit

$
1,713,400,000Credit card lines


45,157,000Standby letters of credit


137,708,000Commercial letters of credit


18,468,000


The
Company enters into a standby letter of credit to guarantee performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved is represented by the contractual amounts of those instruments. Under the standby letters of credit, the Company is required to make payments to the beneficiary
of the letters of credit upon request by the beneficiary so long as all performance criteria have been met. At
December 31, 2008, the maximum potential amount of future payments is $137,708,000. At December 31, 2008, the fair value of these guarantees is not significant. Unsecured letters of
credit totaled $28,771,000 and $54,461,000 at December 31, 2008 and 2007, respectively.

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

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

The
bank subsidiaries make commercial, real estate and consumer loans to customers principally located in South, Central and Southeast Texas and the State of Oklahoma. Although the loan
portfolio is diversified, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in these areas, especially in the real estate and commercial
business sectors.

71

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(20) Capital Requirements

On December 23, 3008, as part of the Troubled Asset Relief Program Capital Purchase Program (the "TARP Capital Purchase Program") of the United States Department of the Treasury
("Treasury"), the Company entered into a Letter Agreement incorporating an attached Securities Purchase AgreementStandard Terms (collectively, the "Securities Purchase Agreement") with
the Treasury. The closing of the transactions contemplated in the Securities Purchase Agreement occurred on December 23, 2008.

Under
the Securities Purchase Agreement, the Company agreed to sell 216,000 shares of the Company's fixed-rate cumulative perpetual preferred stock, Series A, par
value $.01 per share (the "Senior Preferred Stock"), having a liquidation preference of $1,000 per share, for a total price of $216,000,000. The Senior Preferred Stock will pay dividends at the rate
of 5% per year for the first five years and 9% per year thereafter. The Senior Preferred Stock has no maturity date and ranks senior to the Company's common stock with respect to the payment of
dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Senior Preferred Stock generally is non-voting except for class voting
rights on matters that would adversely affect the rights of the holders of the Senior Preferred Stock. The Senior Preferred Stock qualifies for inclusion in Tier 1 capital for regulatory
capital purposes and the issuance of the Senior Preferred Stock increased the capital ratios of the Company.

Pursuant
to the Securities Purchase Agreement, the Company may redeem the Senior Preferred Stock in whole or in part at par after three years from the date of the investment. Prior to
such date, the Company may redeem the Senior Preferred Stock in whole or in part, at par if (i) the Company has raised aggregate gross proceeds in one or more Qualified Equity Offerings (as
defined in the Securities Purchase Agreement) in excess of $54 million and (ii) the aggregate redemption is subject to the consent of the Federal Reserve Bank of Dallas, which is the
Company's primary Federal banking regulator.

In
conjunction with the purchase of the Senior Preferred Stock, the Treasury received a warrant (the "Warrant") to purchase 1,326,238 shares of the Company's common stock (the "Warrant
Shares") at $24.43 per share, which would represent an aggregate common stock investment in the Company on exercise of the warrant in full equal to 15% of the Senior Preferred Stock investment. The
term of the Warrant is ten years. The per share exercise price and the number of shares issuable upon exercise of the Warrant is subject to adjustment pursuant to customary anti-dilutive
provisions in certain events, such as stock splits, certain distributions of securities or other assets to holders of the Company's common stock, and upon certain issuances of the Company's common
stock at or below specified prices relative to the initial per share exercise price of the Warrant. The Warrant is immediately exercisable. The number of shares issuable upon exercise of the Warrant
is also subject to reduction in certain limited events that involve the Company conducting Qualified Equity Offerings on or prior to December 31, 2009. Both the Senior Preferred Stock and
Warrant will be accounted for as components of Tier 1 capital.

Bank
regulatory agencies limit the amount of dividends, which the bank subsidiaries can pay the Corporation, through IBC Subsidiary Corporation, without obtaining prior approval from
such agencies. At December 31, 2008, the subsidiary banks could pay dividends of up to $237,000,000 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.

72

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(20) Capital Requirements (Continued)

The
Company and the bank subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's
assets, liabilities, and certain off-statement of condition items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and other factors.

Additionally,
as a result of the Company's participation in the TARP Capital Purchase Program, the Company is restricted in the payment of dividends and may not, without Treasury
Department's consent, declare or pay any dividend on the Company Common Stock other than a regular semi-annual dividend of not more than $.33 per share, as adjusted for any stock dividend
or stock split. The restriction ceases to exist only on the earlier to occur of December 23, 2011 or the date on which the Company has redeemed all of the Series A Preferred Stock issued
as part of the Capital Purchase Program or the date on which the Treasury has transferred all of the Preferred Stock to third parties not affiliated with the Treasury. Also, all accrued and unpaid
dividends on the Senior Preferred Stock would have to be fully paid before the Company paid any dividends on its Common Stock.

A
company that participates in the TARP Capital Purchase Program must adopt certain standards for executive compensation under the Emergency Economic Stabilization Act of 2008 (EESA) and
the American Recovery and Reinvestment Act of 2009 (the "ARRA") which was signed into law on February 17, 2009. While the U.S. Treasury must promulgate regulations to implement the
executive compensation restrictions and standards set forth in the ARRA, the new law significantly expands the executive compensation restrictions previously imposed by the EESA. Such restrictions
apply to any entity that has received or will receive funds under the TARP Capital Purchase Program, and shall generally continue to apply for as long as any obligation arising from securities issued
under TARP, including preferred stock issued under the Capital Purchase Program, remain outstanding. These ARRA restrictions shall not apply to any TARP Capital Purchase Program recipient during such
time when the federal government (i) only holds any warrants to purchase common stock of such recipient or (ii) holds no preferred stock or warrants to purchase common stock of such
recipient. As a result of the Company's participation in the TARP Capital Purchase Program, the restrictions and standards set forth in the ARRA shall be applicable to the Company, subject to
regulations promulgated by the U.S. Treasury. Pursuant to the provisions of the ARRA, the Company shall be permitted to repay the $216 million it received under the TARP Capital Purchase
Program, subject to consultation with the Federal Reserve, without regard to certain repayment restrictions in the Securities Purchase Agreement, in accordance with regulations that have not, yet,
been promulgated by the Treasury Department.

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, 2008, that the Company and each of
the bank subsidiaries met all capital adequacy requirements to which it is subject.

As
of December 31, 2008, the most recent notification from the Federal Deposit Insurance Corporation categorized all the bank subsidiaries as well capitalized under the regulatory
framework for

73

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(20) Capital Requirements (Continued)

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.

The
Company's and the bank subsidiaries' actual capital amounts and ratios for 2008 are presented in the following table:

Actual

For Capital Adequacy Purposes

To Be Well Capitalized Under Prompt Corrective Action ProvisionsAmount

Ratio

Amount

Ratio

Amount

Ratio(greater than or equal to)

(greater than or equal to)

(greater than or equal to)

(greater than or equal to)(Dollars in Thousands)As of December 31, 2008:Total Capital (to Risk Weighted Assets):Consolidated

$
1,205,014


16.35
%
$
589,741


8.00
%

N/A


N/AInternational Bank of Commerce, Laredo


804,621


12.39


519,556


8.00

$
649,445


10.00
%International Bank of Commerce, Brownsville


89,087


18.96


37,589


8.00


46,987


10.00International Bank of Commerce, Zapata


42,120


25.51


13,207


8.00


16,509


10.00Commerce Bank


53,451


28.43


15,042


8.00


18,803


10.00Tier 1 Capital (to Risk Weighted Assets):Consolidated

$
1,128,057


15.30
%
$
294,870


4.00
%

N/A


N/AInternational Bank of Commerce, Laredo


736,263


11.34


259,778


4.00

$
389,667


6.00
%International Bank of Commerce, Brownsville


83,998


17.88


18,795


4.00


28,192


6.00International Bank of Commerce, Zapata


40,634


24.61


6,604


4.00


9,905


6.00Commerce Bank


51,427


27.35


7,521


4.00


11,282


6.00Tier 1 Capital (to Average Assets):Consolidated

$
1,128,057


9.97
%
$
452,574


4.00
%

N/A


N/AInternational Bank of Commerce, Laredo


736,263


7.54


390,531


4.00

$
488,164


5.00
%International Bank of Commerce, Brownsville


83,998


10.00


33,589


4.00


41,987


5.00International Bank of Commerce, Zapata


40,634


9.32


17,433


4.00


21,791


5.00Commerce Bank


51,427


11.83


17,387


4.00


21,734


5.00


74

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(20) Capital Requirements (Continued)

The Company's and the bank subsidiaries' actual capital amounts and ratios for 2007 are also presented in the following table:

Actual

For Capital Adequacy Purposes

To Be Well Capitalized Under Prompt Corrective Action ProvisionsAmount

Ratio

Amount

Ratio

Amount

Ratio(greater than or equal to)

(greater than or equal to)

(greater than or equal to)

(greater than or equal to)(Dollars in Thousands)As of December 31, 2007:Total Capital (to Risk Weighted Assets):Consolidated

$
889,637


12.99
%
$
547,708


8.00
%

N/A


N/AInternational Bank of Commerce, Laredo


686,411


11.36


483,532


8.00

$
604,415


10.00
%International Bank of Commerce, Brownsville


76,313


18.51


32,983


8.00


41,229


10.00International Bank of Commerce, Zapata


35,102


22.13


12,692


8.00


15,865


10.00Commerce Bank


47,109


24.56


15,346


8.00


19,182


10.00Tier 1 Capital (to Risk Weighted Assets):Consolidated

$
820,319


11.98
%
$
273,854


4.00
%

N/A


N/AInternational Bank of Commerce, Laredo


625,133


10.34


241,766


4.00

$
362,649


6.00
%International Bank of Commerce, Brownsville


71,594


17.36


16,492


4.00


24,738


6.00International Bank of Commerce, Zapata


33,845


21.33


6,346


4.00


9,519


6.00Commerce Bank


45,045


23.48


7,673


4.00


11,509


6.00Tier 1 Capital (to Average Assets):Consolidated

$
820,319


7.76
%
$
422,929


4.00
%

N/A


N/AInternational Bank of Commerce, Laredo


625,133


7.02


356,394


4.00

$
445,492


5.00
%International Bank of Commerce, Brownsville


71,594


8.79


32,581


4.00


40,726


5.00International Bank of Commerce, Zapata


33,845


8.78


15,423


4.00


19,278


5.00Commerce Bank


45,045


9.92


18,168


4.00


22,710


5.00


(21) Fair Value of Financial Instruments

The fair value estimates, methods, and assumptions for the Company's financial instruments at December 31, 2008 and 2007 are outlined below.

Cash and Due From Banks and Federal Funds Sold

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

Time Deposits with Banks

The carrying amounts of time deposits with banks approximate fair value.

Investment Securities

For investment securities, which include U. S. Treasury securities, obligations of other U. S. government agencies, obligations of
states and political subdivisions and mortgage pass through and related securities, fair values are 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

75

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(21) Fair Value of Financial Instruments (Continued)

ownership
of a financial instrument, probable tax ramifications, or estimated transaction costs. See disclosures of fair value of investment securities in Note 3.

Loans

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

For
variable rate performing loans, the carrying amount approximates the fair value. For fixed rate performing loans, except residential mortgage loans, the fair value is calculated by
discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. For performing residential
mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources or the primary origination
market. At December 31, 2008 and 2007, the carrying amount of fixed rate performing loans was $1,272,370,000 and $1,385,715,000 respectively, and the estimated fair value was $1,253,496,000 and
$1,372,652,000, respectively.

Fair
value for significant impaired loans is based on recent external appraisals, discounted based on internal criteria. 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, 2008 and 2007, the net carrying amount of impaired loans was a reasonable estimate of the fair value.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Deposits

The fair value of deposits with no stated maturity, such as non-interest bearing demand deposit accounts, savings accounts
and interest bearing demand deposit accounts, was equal to the amount payable on demand as of December 31, 2007 and 2006. 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, 2008 and 2007, the carrying amount of time deposits was $3,317,512,000 and $3,352,390,000,
respectively, and the estimated fair value was $3,343,150,000 and $3,376,754,000, respectively.

Securities Sold Under Repurchase Agreements and Other Borrowed Funds

Due to the contractual terms of these financial instruments, the carrying amounts approximated fair value at December 31, 2008
and 2007.

Junior Subordinated Deferrable Interest Debentures

The Company currently has fixed and floating junior subordinated deferrable interest debentures outstanding. Due to the contractual
terms of the floating rate junior subordinated deferrable interest debentures, the carrying amounts approximated fair value at December 31, 2008 and December 31, 2007.

76

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

(21) Fair Value of Financial Instruments (Continued)

The
fair value of the fixed junior subordinated deferrable interest debentures is based on established market spreads to the debentures. At December 31, 2008 and 2007, the carrying amount of
fixed junior subordinated deferrable interest debentures was $139,190,000 and $139,154,000, respectively, and the estimated fair value was $44,704,000 and $139,566,000, respectively.

Commitments to Extend Credit and Letters of Credit

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

Limitations

Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists
for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be
determined with precision. Changes in assumptions could significantly affect the estimates.

Fair
value estimates are based on existing on-and off-statement of condition financial instruments without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered financial instruments. Other significant
assets and liabilities that are not considered financial assets or liabilities include the bank premises and equipment and core deposit value. In addition, the tax ramifications related to the effect
of fair value estimates have not been considered in the above estimates.

77

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

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

Statements of Condition
(Parent Company Only)

December 31, 2008 and 2007
(Dollars in Thousands)

2008

2007ASSETSCash

$
160,754

$
580Repurchase Agreements





1,000Other investments


38,079


31,449Notes receivable


350


1,841Investment in subsidiaries


1,264,021


1,103,690Other assets


1,037


2,667Total assets

$
1,464,241

$
1,141,227LIABILITIES AND SHAREHOLDERS' EQUITYLiabilities:Junior subordinated deferrable interest debentures

$
201,048

$
200,929Due to IBC Trading


21


21Other liabilities


5,876


4,372Total liabilities


206,945


205,322Shareholders' equity:Preferred shares


203,558


Common shares


95,499


95,441Surplus


158,110


144,140Retained earnings


1,016,003


929,145Accumulated other comprehensive income


18,189


1651,491,359


1,168,891Less cost of shares in treasury


(234,063
)

(232,986
)Total shareholders' equity


1,257,296


935,905Total liabilities and shareholders' equity

$
1,464,241

$
1,141,227


78

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

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

Statements of Income
(Parent Company Only)

Years ended December 31, 2008, 2007 and 2006
(Dollars in Thousands)

2008

2007

2006Income:Dividends from subsidiaries

$
53,460

$
114,520

$
113,839Interest income on notes receivable


80


50


126Interest income on other investments


5,313


6,283


2,508Other interest income


486


573


1,339Other


65





7Total income


59,404


121,426


117,819Expenses:Interest expense (Debentures)


14,137


17,178


22,568Other interest expense


88





Other


1,793


4,789


3,220Total expenses


16,018


21,967


25,788Income before federal income taxes and equity in undistributed net income of subsidiaries


43,386


99,459


92,031Income tax benefit


(3,593
)

(5,281
)

(7,918
)Income before equity in undistributed net income of subsidiaries


46,979


104,740


99,949Equity in undistributed net income of subsidiaries


85,133


16,572


17,052Net income

$
132,112

$
121,312

$
117,001


79

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

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

Statements of Cash Flows
(Parent Company Only)

Years ended December 31, 2008, 2007 and 2006
(Dollars in Thousands)

2008

2007

2006Operating activities:Net income

$
132,112

$
121,312

$
117,001Adjustments to reconcile net income to net cash provided by operating activities:Accretion of junior subordinated interest deferrable debentures


119


332


548Stock compensation expense


692


771


874Increase (decrease) in other liabilities


1,443


(1,732
)

1,459Equity in undistributed net income of subsidiaries


(85,133
)

(16,572
)

(17,052
)Net cash provided by operating activities


49,233


104,111


102,830Investing activities:Contributions to subsidiaries


(57,114
)

(23,470
)

(424
)Proceeds (repurchase) of repurchase agreement with banks


1,000


5,303


(3,703
)Net decrease (increase) in notes receivable


1,491


(205
)

900Increase in other assets


(5,000
)

(6,714
)

(4,215
)Net cash used in investing activities


(59,623
)

(25,086
)

(7,442
)Financing activities:Proceeds from issuance of subordinated debentures





53,609


75,259Payments on subordinated debentures





(63,920
)

(101,290
)Proceeds from issuance of preferred shares


216,000





Proceeds from stock transactions


894


5,686


1,919Payments of cash dividends


(45,253
)

(44,738
)

(44,166
)Payments of cash dividends in lieu of fractional shares





(27
)

Purchase of treasury stock


(1,077
)

(29,710
)

(28,017
)Net cash provided by (used in) financing activities


170,564


(79,100
)

(96,295
)Increase (decrease) in cash


160,174


(75
)

(907
)Cash at beginning of year


580


655


1,562Cash at end of year

$
160,754

$
580

$
655


80

---





INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES        Condensed Quarterly Income Statements        (Dollars in Thousands, Except Per Share Amounts)        (Unaudited)

Fourth
Quarter

Third
Quarter

Second
Quarter

First
Quarter2008Interest income

$
140,817

$
138,194

$
136,931

$
148,661Interest expense


49,835


54,076


56,790


71,030Net interest income


90,982


84,118


80,141


77,631Provision for probable loan losses


7,123


7,037


4,101


1,552Non-interest income


41,675


50,823


51,017


46,294Non-interest expense


77,156


76,274


76,384


70,997Income before income taxes


48,378


51,630


50,673


51,376Minority interest in consolidated subsidiaries


98


317





Income taxes


16,577


17,433


17,624


17,896Net income

$
31,703

$
33,880

$
33,049

$
33,480Per common share:BasicNet income

$
.47

$
.49

$
.48

$
.49DilutedNet income

$
.46

$
.49

$
.48

$
.49


81

---



INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Condensed Quarterly Income Statements (Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Fourth
Quarter

Third
Quarter

Second
Quarter

First
Quarter2007Interest income

$
159,152

$
159,158

$
162,408

$
162,855Interest expense


81,064


81,350


82,847


88,079Net interest income


78,088


77,808


79,561


74,776(Credit) provision for probable loan losses


(405
)

(3,916
)

1,198


1,361Non-interest income


46,240


45,617


47,266


26,240Non-interest expense


76,433


78,352


73,429


72,068Income before income taxes


48,300


48,989


52,200


27,587Minority interest in consolidated subsidiaries








(78
)

78Income taxes


12,884


16,327


17,688


8,865Net income

$
35,416

$
32,662

$
34,590

$
18,644Per common share:BasicNet income

$
.52

$
.47

$
.50

$
.27DilutedNet income

$
.52

$
.47

$
.50

$
.26


82

---



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, 2008, 2007, and 2006:

2008

2007

2006Average
Balance

Interest

Average
Rate/Cost

Average
Balance

Interest

Average
Rate/Cost

Average
Balance

Interest

Average
Rate/Cost(Dollars in Thousands)AssetsInterest earning assets:Loan, net of unearned discounts:Domestic

$
5,360,116

$
353,635


6.60
%
$
4,920,774

$
422,039


8.58
%
$
4,507,583

$
379,340


8.42
%Foreign


283,444


17,083


6.03


289,678


21,525


7.43


288,906


20,680


7.16Investment securities:Taxable


4,120,008


188,928


4.59


4,055,546


190,371


4.69


4,379,218


200,474


4.58Tax-exempt


72,117


3,514


4.87


87,234


4,270


4.89


93,776


4,577


4.88Federal funds sold


53,019


927


1.75


54,634


2,712


4.96


75,016


3,596


4.79Other


9,874


516


5.23


22,448


2,656


5.81


5,956


406


6.82Total interest-earning assets


9,898,578


564,603


5.70
%

9,430,314


643,573


6.82
%

9,350,455


609,073


6.51
%Non-interest earning assets:Cash and due from banks


236,656








222,116








243,374Bank premises and equipment, net


445,487








405,536








369,058Other assets


728,038








750,454








764,330Less allowance for probable loan losses


(64,917
)







(65,688
)







(68,673
)Total

$
11,243,842







$
10,742,732







$
10,658,544Liabilities and Shareholders' EquityInterest bearing liabilities:Savings and interest bearing demand deposits

$
2,286,000

$
26,651


1.17
%
$
2,328,078

$
53,778


2.31
%
$
2,122,302

$
40,444


1.91
%Time deposits:Domestic


1,702,549


55,287


3.25


1,704,871


73,593


4.32


1,720,742


65,597


3.81Foreign


1,644,997


51,192


3.11


1,623,791


69,427


4.28


1,527,958


57,480


3.77Securities sold under repurchase agreements


1,436,374


50,400


3.51


982,884


43,837


4.46


670,104


30,137


4.50Other borrowings


1,395,220


33,976


2.44


1,462,504


75,317


5.15


2,040,691


103,362


5.07Junior subordinated interest deferrable debentures


201,042


14,137


7.03


213,119


17,178


8.06


232,260


22,568


9.72Senior notes





88








210











Total interest bearing liabilities


8,666,182


231,731


2.67
%

8,315,247


333,340


4.01
%

8,314,057


319,588


3.84
%Non-interest bearing liabilities:Demand Deposits


1,455,036








1,417,751








1,364,611Other liabilities


132,306








125,952








145,538Shareholders' equity


990,318








883,782








834,338Total

$
11,243,842







$
10,742,732







$
10,658,544Net interest income




$
332,872







$
310,233







$
289,485Net yield on interest earning assets








3.36
%







3.29
%







3.10
%


83

---





INTERNATIONAL BANCSHARES CORPORATION  OFFICERS AND DIRECTORS

OFFICERSDENNIS 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
MARISA V. SANTOS
Secretary
HILDA V. TORRES
Assistant Secretary

DIRECTORSDENNIS E. NIXON
President, International Bank of Commerce
IRVING GREENBLUM
International Investments/Real Estate
R. DAVID GUERRA
President
International Bank of Commerce
Branch in McAllen, TX
DANIEL B. HASTINGS, JR.
Licensed U. S. Custom Broker
President
Daniel B. Hastings, Inc.
RICHARD E. HAYNES
Attorney at Law
Real Estate Investments
IMELDA NAVARRO
Senior Executive Vice President
International Bank of Commerce
SIOMA NEIMAN
International Entrepreneur
PEGGY J. NEWMAN
Investments
LEONARDO SALINAS
Investments
ANTONIO R. SANCHEZ, JR.
Chairman of the Board
Sanchez Oil & Gas Corporation
Investments


84

---



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