FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2002

OR

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             

Commission file number  0-9439

INTERNATIONAL BANCSHARES CORPORATION

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý         No  o

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

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition (Unaudited)

(Dollars in Thousands, except per share data)

2

See accompanying notes to interim condensed consolidated financial statements.

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(Dollars in Thousands, except per share data)

See accompanying notes to interim condensed consolidated financial statements.

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in Thousands)

See accompanying notes to interim condensed consolidated financial statements.

5

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

See accompanying notes to interim condensed consolidated financial statements.

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

Note 1 - Basis of Presentation

The accounting and reporting policies of International Bancshares Corporation (“Corporation”) and Subsidiaries (the Corporation and Subsidiaries collectively referred to herein as the “Company”) conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry.  The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, International Bank of Commerce, Laredo (“IBC”), Commerce Bank, International Bank of Commerce, Zapata, International Bank of Commerce, Brownsville and the Corporation’s wholly-owned non-bank subsidiaries, IBC Subsidiary Corporation, IBC Life Insurance Company, IBC Trading Company, IBC Capital Corporation, International Bancshares Capital Trust I, International Bancshares Capital Trust II, International Bancshares Capital Trust III, International Bancshares Capital Trust IV, as well as the GulfStar Group in which the Company owns a controlling interest.  All significant intercompany balances and transactions have been eliminated in consolidation.  The consolidated financial statements are unaudited, but include all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented.  All such adjustments were of a normal and recurring nature, except for the change in accounting principle disclosed in Note 6.  It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto in the Company’s latest Annual Report on Form 10K.  The consolidated statement of condition at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  Certain reclassifications have been made to make prior periods comparable.

Management of the Company believes that it does not have separate reportable operating segments under the provisions of SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information.”  The Company’s non-banking operations do not meet the threshold for reporting as separate segments.

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

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

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

The Company adopted the remaining provisions of SFAS No. 142 as of January 1, 2002.  See Note 6 to the consolidated financial statements for the effects of the adoption of SFAS No. 142.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets.

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While SFAS No. 144 supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,” it retains many of the fundamental provisions of SFAS No. 121, establishes a single accounting model for long-lived assets to be disposed of by sale, and resolves certain implementation issues not previously addressed by SFAS No. 121.  SFAS No. 144 also supercedes the accounting and reporting provisions of Financial Accounting Standards Board Opinion No. 30, “Reporting the Results of Operations - Reporting the Effects of a Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, for the disposal of a segment of a business.  However, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends the reporting to a component of an entity, rather than a segment of a business, that either has been disposed of or is classified as held for sale.  SFAS No. 144 is effective for fiscal years beginning after December 15, 2001.  The Company adopted SFAS No. 144 on January 1, 2002.  The adoption of SFAS No. 144 did not have an impact on the Company’s consolidated financial statements.

Note 2 - Investment Securities

The Company classifies debt and equity securities into one of three categories:  held-to maturity, available-for-sale, or trading.  Such classifications are reassessed for appropriate classification at each reporting date.  Securities classified as “held-to-maturity” are carried at amortized cost for financial statement reporting, while securities classified as “available-for-sale” and “trading” are carried at their fair value.  Unrealized holding gains and losses are included in net income for those securities classified as “trading”, while unrealized holding gains and losses related to those securities classified as “available-for-sale” are excluded from net income and reported net of tax as other comprehensive income and accumulated other comprehensive income until realized.

A summary of the investment securities held for investment and securities available for sale as reflected on the books of the Company is as follows:

Note 3 - Allowance for Possible Loan Losses

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

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The Company classifies as impaired 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 include 1) all non-accrual loans, 2) 90 day past due loans unless they are well secured (the collateral value is sufficient to cover principal and accrued interest) and are in the process of collection, and 3) other loans which management believes are impaired.  Substantially all of the Company’s impaired loans are measured based on 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.  Amounts received on non-accruals are applied, for financial accounting purposes, first to principal and then to interest after all principal has been collected.  Impaired loans at June 30, 2002 were $4,029,000.  The income associated with these loans is not significant.

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

The subsidiary banks 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.  Collateral based loans are generally considered 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 carefully monitor credit extended to such borrowers, there is no precise method of predicting loan losses.  The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged-off as a loss, is an exercise of judgment.  Similarly, the determination of the adequacy of the allowance for possible loan losses can be made only on a subjective basis.  It is the judgment of the Company’s management that the allowance for possible loan losses at June 30, 2002, was adequate to absorb possible losses from loans in the portfolio at that date.

Note 4 - Other Investments

The Company’s investment in Aircraft Finance Trust (“AFT”) is accounted for under the equity method of accounting.  The Company records its share of earnings or losses from the most recent available financial statements of AFT, which are on a 90 day lag. For the fourth quarter of 2001, AFT recorded an impairment charge of $28.4 million and net operating losses of $424,000.  Accordingly, the Company reduced the carrying amount of the investment by $5.8 million, its share of such charge and loss, in the first quarter of 2002.  For the first quarter of 2002, AFT reported an operating loss of $1,425,000 which resulted in a reduction of the Company’s investment by $285,000, its share of the loss, in the second quarter of 2002.  Because of the events of September 11 and the impact on the airline industry including continued declines in air travel and continued reduced demand for commercial aircraft, the Company concluded as of June 30, 2002 that an impairment charge was appropriate and as a result the Company recorded an other than temporary decline in its investment in AFT of $3.7 million, $2.4 million net of tax, in the second quarter.  AFT utilizes derivative instruments to manage the interest rate on bonds that it has issued.  The derivatives qualify as cash flow hedges and are reported at fair value.  The Company records its proportionate share of the fair value of the derivatives as an increase or decrease in the investment in AFT and accumulated other comprehensive income, net of tax, which is illustrated below.

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A summary of the investment in AFT follows:

Note 5 - Common Stock and Cash Dividends

All per share data presented has been restated to reflect the stock splits effected through stock dividends which became effective May 17, 2001 and May 20, 2002 and were paid on June 15, 2001 and June 14, 2002, respectively.  Such stock dividends resulted in the issuance of 6,627,539 and 8,331,124 shares of Common Stock in 2001 and 2002, respectively.  A cash dividend of $.40 per share was paid to holders of record of Common Stock on April 15, 2002.

The Company expanded its formal stock repurchase program on January 28, 2002 and June 6, 2002.  Under the expanded stock repurchase program, the Company is authorized to repurchase up to $105,000,000 of its common stock through December 2002.  Stock repurchases may be made from time to time, on the open market or through private transactions.  Shares repurchased in this program will be held in treasury for reissue for various corporate purposes, including employee stock option plans.  As of August 9, 2002, a total of 2,354,588 shares had been repurchased under this program at a cost of $96,127,000, which shares are now reflected as 3,291,870 shares of treasury stock as adjusted for stock dividends.  Stock repurchases are reviewed quarterly at the Company’s Board of Directors meetings and the Board of Directors has stated that the aggregate investment in treasury stock should not exceed $125,973,000.  In the past, the Board of Directors has increased previous caps on treasury stock once they were met, but there are no assurances that an increase of the $125,973,000 cap will occur in the future.  As of August 9, 2002, the Company has approximately $117,100,000 invested in treasury shares, adjusted for stock dividends, which amount has been accumulated since the inception of the Company.

Note 6 - Adoption of SFAS 142

The Company fully adopted the remaining provisions of SFAS No. 142 as of January 1, 2002 and discontinued amortizing goodwill relating to business combinations consummated before July 1, 2001.  As of the date of the adoption, the Company had unamortized goodwill in the amount of $69,638,000 and unamortized identifiable intangible assets in the amount of $21,979,000.  The Company evaluated its existing intangible assets and goodwill that were acquired in prior purchase business combinations and determined that no reclassifications were necessary in order to conform with the new classification criteria in SFAS No. 141 for recognition apart from goodwill.  The Company has reassessed the useful lives and residual values of all intangible assets acquired in purchase business combinations and determined that no amortization adjustments were necessary and no intangible assets had indefinite lives.

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The Company has completed its transitional assessment of whether there is an indication that goodwill is impaired.  The Company has concluded that it is probable that the goodwill related to its investment services reporting unit is impaired.  The Company estimates that the amount of the impairment to be $5,130,000, net of tax.  The fair value of the investment services reporting unit was estimated using a combination of capitalized cash flows, discounted cash flows and multiples based on publicly traded company’s market capitalization to sales.  The final determination of the impairment is contingent on the Company completing its assessment of the fair value of the investment services reporting unit and assigning the fair value to the assets and liabilities to the reporting unit.  Adjustments, if any, to the estimate will be reported in the period that the fair value assessment is completed.

The goodwill impairment is reported as a cumulative effect of change in accounting principle.  In accordance with Statement of Financial Accounting Standards No. 3 “Reporting Accounting Changes in Interim Financial Statements” (SFAS 3), the impairment charge is included in net income for the six months ended June 30, 2002 and the three months ended March 31, 2002.  The effect of the $5,130,000 cumulative effect of a change in accounting principle on the first quarter of 2002 is as follows:

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The following table reconciles the Company’s reported net income and earnings per share amounts to the adjusted amounts adding back previous amounts of goodwill amortization:

Changes in the carrying amount of goodwill are as follows for the six month period ended June 30, 2002:

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Information on the Company’s identifiable intangibles follows:

Amortization expense of identified intangibles for the six months ended June 30, 2002 was $863,000.  Estimated amortization expense for each of five succeeding fiscal years is as follows:

Note 7 - Commitments and Contingent Liabilities

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

The Company’s lead bank subsidiary has invested in partnerships which have entered into several lease financing transactions.  The lease financing transactions in two of the partnerships have been examined by the Internal Revenue Service (“IRS”).  In both partnerships, the lead bank subsidiary is the owner of a ninety-nine percent (99%) limited partnership interest.  The IRS has issued a Notice of Proposed Adjustments to Affected Items of a Partnership to one of the partnerships for the lease financing transactions.  The partnership has submitted a Protest contesting the adjustments.  The IRS has issued a Notice of Final Partnership Administrative Adjustment (“FPAA”) to the other partnership and on September 25, 2001 the Company filed a lawsuit contesting the FPAA.  Prior to filing the lawsuit the Company was required to deposit the estimated tax due of approximately $4,083,000 with the IRS pursuant to the Internal Revenue Code.

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No reliable prediction can be made at this time as to the likely outcome of the lawsuit or the IRS proceedings regarding the other partnership.  However, if the lawsuit and the IRS proceedings are decided adversely to the partnerships, all or a portion of the $12 million in tax benefits previously recognized by the Company in connection with the partnerships’ lease financing transactions would be in question.  Management has estimated the Company’s exposure in connection with these transactions and has reserved an appropriate amount based on the estimated exposure at June 30, 2002.  Management intends to continue to evaluate the merits of each matter and make appropriate revisions to the reserve amount as deemed necessary.

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

Special Cautionary Notice Regarding Forward Looking Information

Certain matters discussed in this report, excluding historical information, include forward-looking statements.  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,” and “project,” as well as other words or expressions of a similar meaning are intended to identify forward-looking statements.  Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report.  Such statements are based on current expectations, are inherently uncertain, are subject to risks and should be viewed with caution.  Actual results and experience may differ materially from the forward-looking statements as a result of many factors.

Factors that could cause actual results to differ materially from any results that are projected, forecasted, estimated or budgeted by the Company in forward-looking statements include, among others the following possibilities:  (I) changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations, (II) changes in the capital markets utilized by the Company and its subsidiaries, including changes in the interest rate environment that may reduce margins, (III) changes in state and/or federal laws and regulations to which the Company and its subsidiaries, as well as their customers, competitors and potential competitors, are subject, including, without limitation, banking, tax, securities, insurance and employment laws and regulations, (IV) the loss of senior management or operating personnel, (V) increased competition from both within and without the banking industry, (VI) changes in local, national and international economic business conditions which adversely affect the Company’s customers and their ability to transact profitable business with the Company, including the ability of its borrowers to repay their loans according to their terms or a change in the value of the related collateral, (VII) the timing, impact and other uncertainties of the Company’s potential future acquisitions including the Company’s ability to identify suitable potential future acquisition candidates, the success or failure in the integration of their operations, and the Company’s ability to maintain its current branch network and to enter new markets successfully and capitalize on growth opportunities, (VIII) changes in the Company’s ability to pay dividends on its Common Stock, (IX) the effects of the litigation and proceedings pending with the Internal Revenue Service regarding the Company’s lease financing transactions, and (X) changes in economic and business conditions which would adversely affect the value of the Company’s investment in the Aircraft Finance Trust (“AFT”).  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.

Results of Operations

Overview

On August 6, 2002, the Company reported net income for the three months ended June 30, 2002 of $19.6 million.  The net income included a $5.1 million, after tax charge as a result of the transitional implementation of SFAS 142.  As required by SFAS 3, the impairment charge, a cumulative effect change in accounting principle, should have been included in the net income of the first quarter of 2002, as illustrated in Note 6 of the Notes to Consolidated Financial Statements.  Therefore, the net income

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for the three months ended June 30, 2002, as revised, was $24.7 million or .77 per share - basic (.75 per share - diluted).  In accordance with SFAS 3, the previously reported net income for the three months ended March 31, 2002 of $22.4 million is restated to $17.3 million or $.66 per share - basic (.65 per share - diluted) to reflect the $5.1 million, after tax cumulative effect of a change in accounting principle.  The above has no effect on the previously reported net income or per share amounts for the six months ended June 30, 2002.

The second quarter earnings of $24.7 million represents a 24% increase over the corresponding period of 2001, including a $2.4 million impairment charge, net of tax, recorded in the second quarter 2002 recognized by the Company on its investment in the Aircraft Finance Trust (“AFT”).  Net income for the six months ended June 30, 2002 was $41.9 million or $1.30 per share - basic ($1.27 per share - diluted) as compared to $41.5 million or $1.25 per share - basic ($1.23 per share - diluted) for the six months ended June 30, 2001.

Management continues to believe its investment in AFT has been impaired by the events of September 11 and the impact on the airline industry including declines in air travel and continued reduced demand for commercial aircraft.  AFT may suffer further significant impairment charges as a result of continuing weakness in the airline industry, which would result in the Company recognizing further reductions in the carrying amount of the Company’s AFT investment.  Further reductions, if any, in the Company’s investment in AFT will be limited to the value of the investment.

Total assets at June 30, 2002, were $6,651,033,000 which represents a 4% increase from total assets of $6,381,401,000 at December 31, 2001.  Deposits at June 30, 2002 were $4,302,993,000 which represents a decrease of .7% from the $4,332,834,000 reported at December 31, 2001.  Total loans at June 30, 2002 of $2,692,874,000 increased 1.5% from the $2,654,208,000 reported at December 31, 2001.  The increase in assets from December 31, 2001 can be attributed to cash flow from operations and proceeds from other borrowed funds and long term debt, which were invested in available for sale investment securities and loans.  Long term debt of $68,000,000 in the form of trust preferred securities were issued in 2001. Additional trust preferred securities in the amount of $22,000,000 and $20,000,000 were issued in April 2002 and July 2002, respectively. The aggregate amount of Federal Home Loan Bank certificates of indebtedness and trust preferred securities increased to $1,316,100,000 at June 30, 2002 from the $777,296,000 at December 31, 2001.  Trust preferred securities, certificates of indebtedness and deposits are used to fund the earning asset base of the Company.

On March 13, 2002, Albertson’s, Inc. announced its intention to exit substantially all of the Company’s markets.  The Company began its relationship with Albertson’s in 1995. 38 Albertson’s supermarkets and the related in-store branches of the Company located in Houston, San Antonio, Brownsville, Corpus Christi, Laredo, Endinburg, San Juan, Pharr, Mission, Weslaco and Harlingen have already been closed or will be closed in the near future.  On June 7, 2002, H-E-B agreed to purchase certain former Albertson’s locations in San Antonio and the Rio Grande Valley.  The Company subsequently agreed with H-E-B to open in 5 of the Company’s previous in-store locations and the Company also agreed to open an in-store branch in another former Albertson’s store that was not occupied by the Company.  On May 10, 2002, Kroger Co. agreed to purchase certain former Albertson’s locations in Houston.  The Company subsequently agreed with Kroger to open in 3 of the Company’s previous in-store locations.  As of June 30, 2002, the Company has concluded that 4 in-store locations will not be re-opened and has written off $357,000 of its investment in the related in-store branches.  The Company is continuing to determine  if a continued presence within the remaining former Albertson’s stores is feasible.  The Company will continue to maintain 3 Albertson’s in-store branches in the Kerrville, New Braunfels and Victoria markets that were not closed by Albertson’s.  Additionally, the Company plans to aggressively expand its branch banking operations to service its in-store branch deposit base and existing and future deposit base.  As a result of the new branch arrangements in Houston and San Antonio and the Company’s extensive branch network, the Company does not expect a significant loss of its deposit base or a significant impact from the branch closings on its consolidated financial condition or results of operations.

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Net Interest Income

As part of its strategy to manage interest rate risk, the Company strives to manage both assets and liabilities so that interest sensitivities match.  In this way both earning assets and funding sources of the Company respond to changes in a similar time frame.  Net interest income for the second quarter of 2002 increased $14,872,000 (or 33%) over the same period in 2001.  Net interest income for the six months ended June 30, 2002 increased $26,427,000  (or 29%) over the same period in 2001. The increase in net interest income is the result of the Company’s efforts to manage interest rate risk.

Interest and fees on loans for the second quarter of 2002 decreased $4,519,000 (or 9%) when compared to the same period in 2001.  Interest and fees on loans for the six months ended June 30, 2002 decreased $13,120,000 (or 12%) when compared to the same period in 2001.  Interest income on taxable and tax exempt investment securities for the second quarter of 2002 decreased $6,544,000 (or 14%) when compared to the same quarter in 2001.  Interest income on taxable and tax exempt investment securities for the six months ended June 30, 2002 decreased $18,714,000 (or 19%) when compared to the same period in 2001.  Interest income on time deposits with banks for the second quarter in 2002 decreased $56,000 (or 97%) when compared to the same quarter in 2001.  Interest income on time deposits with banks for the six months ended June 30, 2002 decreased $85,000 (or 80%) when compared to the same period in 2001.  Interest income on federal funds sold for the second quarter in 2002 decreased $95,000 (or 36%) when compared to the same quarter in 2001.  Interest income on federal funds sold for the six months ended June 30, 2002 decreased $114,000 (or 23%) when compared to the same period in 2001.  Overall, total interest income from loans, time deposits, federal funds sold, investment securities and other interest income for the second quarter in 2002 decreased $11,237,000 (or 11%) when compared to the same quarter in 2001.  Total interest income from loans, time deposits, federal funds sold, investment securities and other interest income for the six months ended June 30, 2002 decreased $32,419,000 (or 16%) when compared to the same period in 2001.  The decrease in total interest income was primarily due to the decreases in market rates that occurred throughout 2001.

Total interest expense for savings deposits, time deposits and other borrowings decreased $26,109,000 (or 48%) when compared to the same quarter in 2001 and decreased $58,846,000 (or 50%) for the six months ended June 30, 2002.  The decrease in total interest expense was primarily due to lower interest rates paid on interest bearing liabilities.

Non Interest Income

Non-interest income decreased $2,609,000 (or 12%) when compared to the same quarter in  2001 and $7,548,000 (or 18%) for the six months ended June 30, 2002 when compared to the same period in 2001.  The decrease in non-interest income was primarily due to a total of $9,772,000 in charges recognized by the Company from its investment in AFT during the first and second quarters of 2002 for its share of AFT operating losses and impairment charges.  Investment securities losses of $146,000 and $43,000 were recorded during the second quarter and first six months of 2002, respectively, compared to losses of $614,000 and $1,076,000 for the same periods in 2001. The losses in 2001 occurred due to a bond program initiated by management in 2000 to reposition a portion of the Company’s bond portfolio and take advantage of higher bond yields.

Non Interest Expense

Non-interest expense increased $5,307,000 to $38,795,000 for the second quarter of 2002 when compared to $33,488,000 for the same quarter of 2001.  Non-interest expense increased $9,966,000 to $74,280,000 for the six months ended June 30, 2002 when compared the same period of 2001.  Non-interest expense increased due to the Company’s expanded operations at the bank subsidiaries.

The efficiency ratio, a measure of non-interest expense to net interest income plus non-interest income was 49.6% for the second quarter of 2002, compared to 50.9% for the second quarter of 2001 and 49.5% for the six months ended June 30, 2002 when

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compared to 49% for the same period of 2001.

Accounting for Business Combinations, Goodwill and Other Intangible Assets

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, “Business Combination” (SFAS 141), and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS 142).  SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001.  SFAS 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001.  SFAS 142, effective January 1, 2002, prohibits the amortization of goodwill and intangible assets with indefinite useful lives.  Intangible assets with finite useful lives will continue to be amortized over their estimated useful lives.  The Company currently has $21,116,000 of identified intangible assets.  Additionally, SFAS 142 requires that goodwill and intangible assets with indefinite lives be reviewed for impairment at least annually.

During the second quarter of 2002, the Company completed its transitional assessment of whether there is an indication that goodwill is impaired.  As a result of the assessment, the Company has concluded that the goodwill associated with its  investment services reporting unit has been impaired in the amount of $5.1 million, after tax.  The fair value of the investment services reporting unit was estimated using a combination of capitalized cash flows, discounted cash flows and multiples based on publicly traded company’s market capitalization to sales.  The impairment of the Company’s goodwill was primarily due to the economic climate and business conditions in the investment services line of business.

Financial Condition

Allowance for Possible Loan Losses

The allowance for possible loan losses increased 7% to $42,945,000 at the end of the second quarter of 2002 from $40,065,000 for the year ended December 31, 2001.  The provision for possible loan losses charged to expense decreased 9% to $4,131,000 for the six months ended June 30, 2002 from $4,555,000 for the same period in 2001.  The allowance for possible loan losses was 1.60% of total loans, net of unearned income, at June 30, 2002, compared to 1.51% at December 31, 2001.

Investment Securities

Investment securities increased 13% to $3,303,729,000 at June 30, 2002, from investment securities of $2,927,206,000 at December 31, 2001.  Time deposits with other banks at June 30, 2002 decreased 92% to $100,000 from $1,253,000 at December 31, 2001. Total federal funds sold decreased 65% to $37,500,000 at June 30, 2002 as compared to $108,100,000 at December 31, 2001.  The changes reflected during the second quarter of 2002 were primarily from the results of increased purchases of available for sale investment securities.

Foreign Operations

On June 30, 2002, the Company had $6,651,033,000 of consolidated assets of which approximately $256,947,000 or 4% were related to loans outstanding to borrowers domiciled in Mexico compared to $273,038,000 or 4% at December 31, 2001.  Of the $256,947,000, 70% is directly or indirectly secured by U.S. assets, principally certificates of deposits and real estate; 24% is secured by Mexican real estate; 4% is secured by Mexican real estate, related to maquiladora plants, guaranteed under lease obligations primarily by U.S. companies, many of which are on the Fortune 500 list of companies; 1.4% is unsecured; and .6% represents accrued interest receivable on the portfolio.

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Critical Accounting Policies

The Company considers the Allowance for Possible Loan Losses policy as a policy critical to the sound operations of the subsidiary banks.  The Company provides for loan losses each period by an amount resulting from both (a) the Company’s review of specific impaired loans, (b) an estimate by management of possible loan losses that may occur during the period and (c) the ongoing adjustment of prior estimates of possible losses occurring in prior periods.  The provision for possible loan losses increases the allowance for possible loan losses, which is netted against net loans after unearned discounts on the consolidated statement of condition.  As losses are confirmed, the loan is written down, reducing the allowance for possible loan losses.  See discussion regarding the allowance for possible loan losses and provision for possible loan losses included in the results of operations and “Allowance for Possible Loan Losses” included in Note 3 of the Notes to Consolidated Financial Statements for further information regarding the Company’s provision and allowance for possible loan losses policy.

Liquidity and Capital Resources

The maintenance of adequate liquidity provides the Company’s bank subsidiaries with the ability to meet potential depositor withdrawals, provide for customer credit needs, maintain adequate statutory reserve levels and take full advantage of high-yield investment opportunities as they arise.  Liquidity is afforded by access to financial markets and by holding appropriate amounts of liquid assets.  The bank subsidiaries of the Company derive their liquidity largely from deposits of individuals and business entities.  Deposits from persons and entities domiciled in Mexico comprise a significant and stable portion of the deposit base of the Company’s bank subsidiaries. Other important funding sources for the Company’s bank subsidiaries during 2002 and 2001 have been borrowings from FHLB, securities sold under repurchase agreements and large certificates of deposit, requiring management to closely monitor its asset/liability mix in terms of both rate sensitivity and maturity distribution.  Primary liquidity of the Company and its subsidiaries has been maintained by means of increased investment in shorter-term securities, certificates of deposit and loans.  As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities, and respond accordingly to anticipated fluctuations in interest rates over reasonable periods of time.  Principal sources of liquidity and funding for the Corporation are dividends from subsidiaries and borrowed funds, with such funds being used to finance the Company’s cash flow requirements.

The Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders.  At June 30, 2002, shareholders’ equity was $518,131,000 compared to $497,028,000 at December 31, 2001, an increase of $21,103,000 or 4%.  The increase in shareholders’ equity resulted from the retention of earnings throughout 2002, the increase in the unrealized gain on available for sale investment securities and increase in the fair value of AFT’s derivatives.

The Company had a leverage ratio of 7.80% and 6.67%, risk-weighted Tier 1 capital ratio of 14.46% and 13.83% and risk-weighted total capital ratio of 15.71% and 15.06% at June 30, 2002 and December 31, 2001, respectively.  The identified intangibles and goodwill of $82,506,000 as of June 30, 2002, recorded in connection with the acquisitions of the Company, are deducted from the sum of core capital elements when determining the capital ratios of the Company.

On June 27, 2002, the Company formed International Bancshares Capital Trust V ("Trust V"), a statutory business trust formed under the laws of the State of Delaware, for the purpose of issuing trust preferred securities.  On July 11, 2002, Trust V issued $20,000,000 of Capital Securities.  The Capital Securities accrue interest at a floating rate of 3.65% over the London Interbank Offer Rate ("LIBOR"), payable quarterly beginning October 7, 2002.  The Capital Securities will mature October 7, 2032; 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 7, 2007, or (b) in whole within 90 days upon the occurrence of any of certain legal, regulatory, or tax events.  The Capital Securities are subordinated and junior in right of payment to all present and future senior indebtedness of the Company.  The Company has fully and unconditionally guaranteed the obligation of the Trusts with respect to the Capital Securities.  The Company has the right, unless an Event of Default has occurred and is continuing, to defer payment of interest on the Capital Securities for up to 20 consecutive quarterly periods.  The redemption prior to maturity of any of the Capital Securities may require the prior approval of the Federal Reserve and/or other regulatory bodies.

After taking into account the $20,000,000 in trust securities issued on July 11, 2002, the Company has a total of $110,000,000 of trust preferred securities issued by statutory business trusts formed by the Company.

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As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities, and respond accordingly to anticipated fluctuations in interest rates by adjusting the balance between sources and uses of funds as deemed appropriate.  The net-interest rate sensitivity as of June 30, 2002 is illustrated in the table on page 23.  This information reflects the balances of assets and liabilities for which rates are subject to change.  A mix of assets and liabilities that are roughly equal in volume and repricing characteristics represents a matched interest rate sensitivity position.  Any excess of assets or liabilities results in an interest rate sensitivity gap.

The Company undertakes an interest rate sensitivity analysis to monitor the potential risk on future earnings resulting from the impact of possible future changes in interest rates on currently existing net asset or net liability positions.  However, this type of analysis is as of a point-in-time position, when in fact that position can quickly change as market conditions, customer needs, and management strategies change. Thus, interest rate changes do not affect all categories of asset and liabilities equally or at the same time.  As indicated in the table, the Company is liability sensitive during the early time periods and asset sensitive in the longer periods.  The Company’s Asset and Liability Committee semi-annually reviews the consolidated position along with simulation and duration models, and makes adjustments as needed to control the Company’s interest rate risk position.  The Company uses modeling of future events as a primary tool for monitoring interest rate risk.

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INTEREST RATE SENSITIVITY

(Dollars in Thousands)

Item 3.  Quantitative and Qualitative Disclosure about Market Risk

During the second quarter of 2002, there were no material changes in market risk exposures that affected the quantitative and qualitative disclosures regarding market risk presented in the Company’s Form 10-K for the year ended December 31, 2001.

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PART II - OTHER INFORMATION

Item 4.  Submission of Matters to a Vote of Security Holders

The Annual Meeting of Shareholders of the Company was held May 20, 2002 for the consideration of the following items which were approved by the number of votes set forth:

Item 6.  Exhibits and Reports on Form 8-K

(a)           Exhibits

The following exhibit is filed with this report:

(99) Certification of Periodic Financial Report pursuant to 18 U.S.C. Section 1350

(b)           Reports on Form 8-K

Registrant filed a current report on Form 8-K on June 6, 2002, covering Item 5 - Other Events and Item 7 - Financial Statements and Exhibits in connection with the announcement that the Registrant had expanded its stock repurchase program.

Registrant filed a current report on Form 8-K on June 10, 2002, covering Item 5 - Other Events and Item 7 - Financial Statements and Exhibits in connection with the announcement that the Registrant’s lead bank subsidiary will open branches inside selected H-E-B grocery stores.

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Registrant filed a current report on Form 8-K on August 7, 2002, covering Item 5 - Other Events and Item 7 - Financial Statements and Exhibits in connection with the announcement of Registrant’s second quarter 2002 earnings.

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SIGNATURES  Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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