UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2016

OR

☐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 000-09439

INTERNATIONAL BANCSHARES CORPORATION

(Exact name of registrant as specified in its charter)

Texas	74-2157138
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

1200 San Bernardo Avenue, Laredo, Texas 78042-1359

(Address of principal executive offices)

(Zip Code)

(956) 722-7611

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

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 ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☒	Accelerated filer ☐
Non-accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No ☒

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

Class	Shares Issued and Outstanding
Common Stock, $1.00 par value	65,948,190 shares outstanding at August 2, 2016

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition (Unaudited)

(Dollars in Thousands)

	June 30,		December 31,
	2016		2015
Assets
Cash and cash equivalents	$	245,351	$	273,053
Investment securities:
Held to maturity (Market value of $2,400 on June 30, 2016 and $2,400 on December 31, 2015)		2,400		2,400
Available for sale (Amortized cost of $4,169,804 on June 30, 2016 and $4,196,034 on December 31, 2015)		4,233,319		4,199,372
Total investment securities		4,235,719		4,201,772
Loans		5,951,597		5,950,914
Less allowance for probable loan losses		(62,033)		(66,988)
Net loans		5,889,564		5,883,926
Bank premises and equipment, net		511,485		516,716
Accrued interest receivable		31,347		31,572
Other investments		470,243		468,791
Identified intangible assets, net		89		153
Goodwill		282,532		282,532
Other assets		110,310		114,354
Total assets	$	11,776,640	$	11,772,869

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition, continued (Unaudited)

(Dollars in Thousands)

	June 30,		December 31,
	2016		2015
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Demand—non-interest bearing	$	3,099,467	$	3,149,618
Savings and interest bearing demand		3,049,405		3,020,222
Time		2,275,990		2,366,413
Total deposits		8,424,862		8,536,253
Securities sold under repurchase agreements		794,939		827,772
Other borrowed funds		552,125		505,750
Junior subordinated deferrable interest debentures		161,416		161,416
Other liabilities		102,674		76,175
Total liabilities		10,036,016		10,107,366
Shareholders’ equity:
Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 95,881,118 shares on June 30, 2016 and 95,866,218 shares on December 31, 2015		95,881		95,866
Surplus		168,687		167,980
Retained earnings		1,727,148		1,683,600
Accumulated other comprehensive income (including $(3,689) on June 30, 2016 and $(4,026) on December 31, 2015 of comprehensive loss related to other-than-temporary impairment for non-credit related issues)		40,977		2,167
		2,032,693		1,949,613
Less cost of shares in treasury, 29,934,516 shares on June 30, 2016 and 29,585,646 on December 31, 2015		(292,069)		(284,110)
Total shareholders’ equity		1,740,624		1,665,503
Total liabilities and shareholders’ equity	$	11,776,640	$	11,772,869

See accompanying notes to consolidated financial statements.

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(Dollars in Thousands, except per share data)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2016		2015		2016		2015
Interest income:
Loans, including fees	$	74,606	$	72,927	$	148,857	$	145,370
Investment securities:
Taxable		20,596		23,257		40,716		47,140
Tax-exempt		2,627		2,749		5,274		5,522
Other interest income		67		42		106		78
Total interest income		97,896		98,975		194,953		198,110
Interest expense:
Savings deposits		1,199		901		2,160		1,778
Time deposits		2,394		2,833		4,968		5,707
Securities sold under repurchase agreements		5,552		6,062		11,111		12,056
Other borrowings		757		369		1,384		844
Junior subordinated deferrable interest debentures		1,122		1,045		2,218		2,069
Total interest expense		11,024		11,210		21,841		22,454
Net interest income		86,872		87,765		173,112		175,656
Provision for probable loan losses		7,097		7,767		16,231		10,144
Net interest income after provision for probable loan losses		79,775		79,998		156,881		165,512
Non-interest income:
Service charges on deposit accounts		17,854		19,850		35,964		39,042
Other service charges, commissions and fees
Banking		10,957		13,075		21,334		23,528
Non-banking		1,694		1,856		2,991		2,966
Investment securities transactions, net		(227)		(427)		(360)		(428)
Other investments, net		2,766		3,462		10,617		7,717
Other income		3,567		2,328		6,996		4,153
Total non-interest income	$	36,611	$	40,144	$	77,542	$	76,978

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income, continued (Unaudited)

(Dollars in Thousands, except per share data)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2016		2015		2016		2015
Non-interest expense:
Employee compensation and benefits	$	31,155	$	29,650	$	61,938	$	61,402
Occupancy		5,906		6,681		12,072		12,860
Depreciation of bank premises and equipment		6,208		6,332		12,388		12,558
Professional fees		3,446		4,020		6,739		7,267
Deposit insurance assessments		1,508		1,440		3,001		2,930
Net expense, other real estate owned		1,377		928		2,255		2,396
Amortization of identified intangible assets		32		161		64		280
Advertising		2,319		2,023		4,424		4,030
Software and software maintenance		3,723		2,563		7,034		5,129
Impairment charges (Total other-than-temporary impairment charges, $(300) net of $(367), $(54), net of $(278), $(332) net of $(523) and $(176), net of $(627), included in other comprehensive income)		67		224		191		451
Other		16,243		14,249		29,796		26,591
Total non-interest expense		71,984		68,271		139,902		135,894
Income before income taxes		44,402		51,871		94,521		106,596
Provision for income taxes		14,714		17,996		31,849		36,859
Net income	$	29,688	$	33,875	$	62,672	$	69,737
Basic earnings per common share:
Weighted average number of shares outstanding		65,944,220		66,424,723		65,979,167		66,420,511
Net income	$	0.45	$	0.51	$	0.95	$	1.05
Fully diluted earnings per common share:
Weighted average number of shares outstanding		66,159,105		66,684,136		66,138,593		66,619,788
Net income	$	0.45	$	0.51	$	0.95	$	1.05

See accompanying notes to consolidated financial statements

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in Thousands)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2016		2015		2016		2015
Net income	$	29,688	$	33,875	$	62,672	$	69,737
Other comprehensive income, net of tax:
Net unrealized holding gains (losses) on securities available for sale arising during period (net of tax effects of $5,451, $(13,610), $20,705, and $(1,854))		10,124		(25,275)		38,452		(3,443)
Reclassification adjustment for losses on securities available for sale included in net income (net of tax effects of $79, $149, $126, and $150)		148		278		234		278
Reclassification adjustment for impairment charges on available for sale securities included in net income (net of tax effects of $23, $78, $67, and $158)		44		146		124		293
		10,316		(24,851)		38,810		(2,872)
Comprehensive income	$	40,004	$	9,024	$	101,482	$	66,865

See accompanying notes to consolidated financial statements.

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

	Six Months Ended
	June 30,
	2016		2015
Operating activities:
Net income	$	62,672	$	69,737
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for probable loan losses		16,231		10,144
Specific reserve, other real estate owned		570		118
Depreciation of bank premises and equipment		12,388		12,558
Gain on sale of bank premises and equipment		(40)		(143)
Gain on sale of other real estate owned		(55)		(205)
Accretion of investment securities discounts		(259)		(886)
Amortization of investment securities premiums		12,311		14,074
Investment securities transactions, net		360		428
Impairment charges on available for sale securities		191		451
Amortization of identified intangible assets		64		280
Stock based compensation expense		554		583
Earnings from affiliates and other investments		(5,555)		(6,527)
Deferred tax expense		386		118
Decrease in accrued interest receivable		225		119
Increase in other assets		(1,894)		(972)
Net increase in other liabilities		5,006		511
Net cash provided by operating activities		103,155		100,388
Investing activities:
Proceeds from maturities of securities		—		1,075
Proceeds from sales and calls of available for sale securities		195,538		30,282
Purchases of available for sale securities		(582,117)		(241,570)
Principal collected on mortgage backed securities		407,011		432,542
Net increase in loans		(23,852)		(115,735)
Purchases of other investments		(1,509)		(12,491)
Distributions from other investments		3,942		10,332
Purchases of bank premises and equipment		(7,160)		(11,983)
Proceeds from sales of bank premises and equipment		43		10,922
Proceeds from sales of other real estate owned		2,010		891
Net cash (used in) provided by investing activities	$	(6,094)	$	104,265

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows, continued (Unaudited)

(Dollars in Thousands)

	Six Months Ended
	June 30,
	2016		2015
Financing activities:
Net (decrease) increase in non-interest bearing demand deposits	$	(50,151)	$	74,961
Net increase (decrease) in savings and interest bearing demand deposits		29,183		(10,341)
Net decrease in time deposits		(90,423)		(39,411)
Net (decrease) increase in securities sold under repurchase agreements		(32,833)		48,861
Net increase (decrease) in other borrowed funds		46,375		(253,619)
Purchase of treasury stock		(7,959)		(1,245)
Proceeds from stock transactions		168		645
Payments of cash dividends - common		(19,123)		(19,258)
Net cash used in financing activities		(124,763)		(199,407)
(Decrease ) increase in cash and cash equivalents		(27,702)		5,246
Cash and cash equivalents at beginning of year		273,053		255,146
Cash and cash equivalents at end of year	$	245,351	$	260,392
Supplemental cash flow information:
Interest paid	$	23,207	$	22,606
Income taxes paid		26,175		37,840
Non-cash investing and financing activities:
Purchases of available-for-sale securities not yet settled		6,804		2,279
Net transfers from loans to other real estate owned		1,983		6,084

See accompanying notes to consolidated financial statements.

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INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

Note 1 — Basis of Presentation

The accounting and reporting policies of International Bancshares Corporation (the “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 Trading Company, Premier Tierra Holdings, Inc., IBC Charitable and Community Development Corporation, and IBC Capital Corporation.  All significant inter-company 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.  These financial statements should be read in conjunction with the financial statements and the notes thereto in the Company’s latest Annual Report on Form 10-K.  The consolidated statement of condition at December 31, 2015 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. Operating results for the three and six months ended June 30, 2016 are not necessarily indicative of the results for the year ending December 31, 2016 or any future period.

The Company operates as one segment.  The operating information used by the Company’s chief executive officer for purposes of assessing performance and making operating decisions about the Company is the consolidated statements presented in this report.  The Company has four active operating subsidiaries, namely, the bank subsidiaries, 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 Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), FASB ASC 280, “Segment Reporting,” in determining its reportable segments and related disclosures.

The Company has evaluated all events or transactions that occurred through the date the Company issued these financial statements. During this period, the Company did not have any material recognizable or non-recognizable subsequent events.

In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update No. 2016-13, to ASC 326, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”   The update requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio.  In addition, the update amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.  The update will be effective on for interim and fiscal years ending after December 31, 2019.  The Company is currently evaluating the potential impact of the update on the Company’s consolidated financial statements.

Note 2 — Fair Value Measurements

ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”), defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  ASC 820 applies to all financial instruments that are being measured and reported on a fair value basis.  ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly

8

transaction between market participants at the measurement date; it also establishes a fair value hierarchy that prioritizes the inputs used in valuation methodologies into the following three levels:

· Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities.

· Level 2 Inputs - Observable inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

· Level 3 Inputs - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or other valuation techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

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

The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of June 30, 2016 by level within the fair value measurement hierarchy:

			Fair Value Measurements at
			Reporting Date Using
			(in Thousands)
			Quoted
			Prices in
			Active		Significant
	Assets/Liabilities		Markets for		Other		Significant
	Measured at		Identical		Observable		Unobservable
	Fair Value		Assets		Inputs		Inputs
	June 30, 2016		(Level 1)		(Level 2)		(Level 3)
Measured on a recurring basis:
Assets:
Available for sale securities
Residential mortgage-backed securities	$	3,925,794	$	—	$	3,906,421	$	19,373
States and political subdivisions		278,596		—		278,596		—
Other		28,929		28,929		—		—
	$	4,233,319	$	28,929	$	4,185,017	$	19,373

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The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of December 31, 2015 by level within the fair value measurement hierarchy:

			Fair Value Measurements at
			Reporting Date Using
			(in Thousands)
			Quoted
			Prices in
			Active		Significant
	Assets/Liabilities		Markets for		Other		Significant
	Measured at		Identical		Observable		Unobservable
	Fair Value		Assets		Inputs		Inputs
	December 31, 2015		(Level 1)		(Level 2)		(Level 3)
Measured on a recurring basis:
Assets:
Available for sale securities
Residential mortgage - backed securities	$	3,893,211	$	—	$	3,871,982	$	21,229
States and political subdivisions		277,704		—		277,704		—
Other		28,457		28,457		—		—
	$	4,199,372	$	28,457	$	4,149,686	$	21,229

Investment securities available-for-sale are classified within Level 2 and Level 3 of the valuation hierarchy, with the exception of certain equity investments that are classified within Level 1.  For investments classified as Level 2 in the fair value hierarchy, the Company obtains fair value measurements for investment securities from an independent pricing service.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.  Investment securities classified as Level 3 are non-agency mortgage-backed securities.  The non-agency mortgage-backed securities held by the Company are traded in inactive markets and markets that have experienced significant decreases in volume and level of activity, as evidenced by few recent transactions, a significant decline or absence of new issuances, price quotations that are not based on comparable securities transactions and wide bid-ask spreads among other factors.  As a result of the inability to use quoted market prices to determine fair value for these securities, the Company determined that fair value, as determined by level 3 inputs in the fair value hierarchy, is more appropriate for financial reporting and more consistent with the expected performance of the investments.  For the investments classified within level 3 of the fair value hierarchy, the Company used a discounted cash flow model to determine fair value.  Inputs in the model included both historical performance and expected future performance based on information currently available.

Assumptions used in the discounted cash flow model as of June 30, 2016 and December 31, 2015 were applied separately to those portions of the bond where the underlying residential mortgage loans had been performing under original contract terms for at least the prior 24 months and those where the underlying residential mortgages had not been meeting the original contractual obligation for the same period.  Unobservable inputs included in the model are estimates on future principal prepayment rates and default and loss severity rates.  For that portion of the bond where the underlying residential mortgage had been meeting the original contract terms for at least 24 months, the Company used the following estimates in the model: (i) a voluntary prepayment rate of 7%, (ii) a 1% default rate, (iii) a loss severity rate of 25%, and (iv) a discount rate of 13%.  The assumptions used in the model for the rest of the bond included the following estimates:  (i) a voluntary prepayment rate of 2%, (ii) a default rate of 4.5%, (iii) a loss severity rate that started at 60% for the first year (2012)  then declines by 5% for the following five years (2013, 2014, 2015, 2016 and 2017) and remains at 25% thereafter (2018 and beyond), and (iv) a discount rate of 13%.  The estimates used in the model to determine fair value are based on observable historical data of the underlying collateral.  The model anticipates that the housing market will gradually improve and that the underlying collateral will eventually all perform in accordance with the original contract terms on the bond.  Should the number of loans in the underlying collateral that default and go into foreclosure or the severity of the losses in the underlying collateral significantly change, the results of the model would be impacted.  The Company will continue to evaluate the actual historical performance of the underlying collateral and will modify the assumptions used in the model as necessary.

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The following table presents a reconciliation of activity for such mortgage-backed securities on a net basis (Dollars in Thousands):

Balance at December 31, 2015	$	21,229
Principal paydowns		(2,188)
Total unrealized gains (losses) included in:
Other comprehensive income		523
Impairment realized in earnings		(191)
Balance at June 30, 2016	$	19,373

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).

The following table represents financial instruments measured at fair value on a non-recurring basis as of and for the period ended June 30, 2016 by level within the fair value measurement hierarchy:

			Fair Value Measurements at Reporting
			Date Using
			(in thousands)
			Quoted
	Assets/Liabilities		Prices in
	Measured at		Active		Significant
	Fair Value		Markets for		Other		Significant		Net Provision
	Year ended		Identical		Observable		Unobservable		(Credit)
	June 30,		Assets		Inputs		Inputs		During
	2016		(Level 1)		(Level 2)		(Level 3)		Period
Measured on a non-recurring basis:
Assets:
Impaired loans	$	34,468	$	—	$	—	$	34,468	$	17,057
Other real estate owned		4,338		—		—		4,338		570

The following table represents financial instruments measured at fair value on a non-recurring basis as of and for the period ended December 31, 2015 by level within the fair value measurement hierarchy:

			Fair Value Measurements at Reporting
			Date Using
			(in thousands)
			Quoted
	Assets/Liabilities		Prices in
	Measured at		Active		Significant
	Fair Value		Markets		Other		Significant		Net (Credit)
	Year ended		for Identical		Observable		Unobservable		Provision
	December 31,		Assets		Inputs		Inputs		During
	2015		(Level 1)		(Level 2)		(Level 3)		Period
Measured on a non-recurring basis:
Assets:
Impaired loans	$	18,033	$	—	$	—	$	18,033	$	(8,589)
Other real estate owned		12,705		—		—		12,705		1,023

The Company’s assets measured at fair value on a non-recurring basis are limited to impaired loans and other real estate owned.  Impaired loans are classified within Level 3 of the valuation hierarchy.  The fair value of impaired loans is derived in accordance with FASB ASC 310, “Receivables”.  Impaired loans are primarily comprised of collateral-dependent commercial loans.   Understanding that as the primary sources of loan repayments decline, the secondary repayment source takes on greater significance and correctly evaluating the fair value of that secondary source, the collateral, becomes even more important.  Re-measurement of the impaired loan to fair value is done through a specific valuation allowance included in the allowance for probable loan losses.  The fair value of impaired loans is

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