UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005 COMMISSION FILE NUMBER
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended March 31, 2006
Commission file number 1-15081
UNIONBANCAL CORPORATION (ExactUnionBanCal Corporation
(Exact name of registrant as specified in its charter)
DELAWARE 94-1234979 (State of Incorporation) (I.R.S. Employer Identification No.)
Delaware
94-1234979
(State of Incorporation)
(I.R.S. Employer Identification No.)
400
CALIFORNIA STREET SAN FRANCISCO, CALIFORNIACalifornia Street
San Francisco, California 94104-1302(Address(Address and zip code of principal executive offices)
Registrant'sRegistrant’s telephone number: (415) 765-2969
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
[X] No[ ]þ No oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
(as definedor a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the ExchangeAct). Yes [X] No [ ]Act.Large accelerated filer þAccelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
[ ]o No[X]þNumber of shares of Common Stock outstanding at
October 31, 2005: 144,585,174UNIONBANCAL CORPORATION AND SUBSIDIARIESApril 28, 2006: 143,864,056UnionBanCal Corporation and Subsidiaries
TABLE OF CONTENTS
PAGE NUMBER ------
Page
Number5
6
7
Condensed Consolidated Statements of Changes in Stockholders’ Equity
8
9
10
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
30
30
31
32
33
35
36
37
37
38
39
40
40
43
44
44
46
47
48
55
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK56
56
57
57
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
57
58
59
59
60
2
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements, which include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly from our forecasts and expectations. For a discussion of risk factors relating to the Company’s business, please refer to Item 1A “Risk Factors” of Part I of our Annual Report on Form 10-K for the year ended December 31, 2005 which is incorporated by reference herein and Item 1A “Risk Factors” of Part II of this Quarterly Report on Form 10-Q.
This document includes forward-looking information, which is subject to the “safe harbor” created by section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended. We may make forward-looking statements in our SEC filings, press releases, news articles, conference calls with analysts and stockholders and when we are speaking on behalf of UnionBanCal Corporation. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include the words “believe,” “expect,” “target,” “anticipate,” “intend,” “plan,” “seek,” “estimate,” “potential,” “project,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” or “may.” These forward-looking statements are intended to provide investors with additional information with which they may assess our future potential. All of these forward-looking statements are based on assumptions about an uncertain future and are based on information available to us at the date of these statements. We do not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made.
In this document, for example, we make forward-looking statements, which discuss our expectations about:
· Our business strategies, the growth of our business and our competitive position
· Our assessment of significant factors and developments that have affected and may affect our results
· Pending legal and regulatory actions, and future legislative and regulatory developments
· Increased regulatory controls and processes regarding Bank Secrecy Act and anti-money laundering matters, and their costs and impact on our business
· The costs and effects of litigation, investigations, regulatory actions, or similar matters, or adverse facts and developments related thereto
· Our ability to meet regulatory requirements
· Credit quality and provision for credit losses, including the need to provide for credit losses due to anticipated loan growth
· The unallocated portion of our allowances for credit losses
· Net interest income and effects on net interest income, including expense from derivative hedges
· The impact of increases in interest rates and growth in our commercial loan portfolio on our net interest margin
· Loan growth rates, including residential mortgage loans
· Disintermediation of noninterest bearing deposits to interest bearing deposits or other investment alternatives
· Deposit renewals
3
· Our ability and intent to hold various assets
· The formation of financial subsidiaries
· Our sensitivity to and management of market risk, including changes in interest rates, and the economic outlook of any particular region of the U.S.
· The composition and market sensitivity of our securities portfolios, our hedging strategies and the asset sensitivity of our balance sheet
· Potential dividend restrictions
· Taxes, including the possible effect of the level of earnings at The Bank of Tokyo-Mitsubishi UFJ, Ltd. on our California State tax obligations
· Off-balance sheet arrangements
· Critical accounting policies and estimates and the impact of recent accounting pronouncements
· Our insurance coverage
· Estimated pension and health costs and the investment objectives and asset allocation strategy of our pension plan and health plan
· Decisions to downsize, sell or close units or otherwise reorganize or change our business mix
· Our strategies and expectations regarding capital levels, returning excess capital to stockholders and strategic or other acquisitions
· The relationship between our business and that of The Bank of Tokyo-Mitsubishi UFJ, Ltd.
· The impact of strategic investments on our business and benefits of marketing alliances
· The impact of the sale of our international correspondent banking business and the timing and transition of the business and customers
There are numerous risks and uncertainties that could and will cause actual results to differ materially from those discussed in our forward-looking statements. Many of these factors are beyond our ability to control or predict and could have a material adverse effect on our stock price, financial condition, and results of operations or prospects. Such risks and uncertainties include, but are not limited to those listed in Item 1A “Risk Factors” of Part II of this Quarterly Report on Form 10-Q and in Item 1A “Risk Factors” of Part I of our Annual Report on Form 10-K for the year ended December 31, 2005.
Readers of this document should not rely unduly on forward-looking information and should consider all uncertainties and risks disclosed throughout this document and in our other reports to the SEC, including, but not limited to, those discussed below. Any factor described in this report could by itself, or together with one or more other factors, adversely affect our business, future prospects, results of operations or financial condition. There are also other factors that we have not described in this report and our other reports that could cause our results to differ from our expectations.
4
PART I. FINANCIAL INFORMATION
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated FinancialHighlights......................................... 2Highlights(1)
(Unaudited)
As of and for the
Three Months Ended
March 31,
March 31,
Percent
(Dollars in thousands, except per share data)
2005
2006
Change
Results of operations:
Net interest income(2)
$
436,717
$
466,341
6.78
%
Reversal of allowance for loan losses
(12,119
)
(7,000
)
(42.24
)
Noninterest income
205,625
217,910
5.97
Noninterest expense
392,952
414,544
5.49
Income before income taxes(2)
261,509
276,707
5.81
Taxable-equivalent adjustment
1,055
1,248
18.29
Income tax expense
80,703
94,004
16.48
Income from continuing operations
179,751
181,455
0.95
Income (loss) from discontinued operations, net of taxes
2,226
(8,510
)
nm
Net income
$
181,977
$
172,945
(4.96
)
Per common share:
Basic earnings:
From continuing operations
$
1.22
$
1.26
3.28
%
Net income
1.24
1.20
(3.23
)
Diluted earnings:
From continuing operations
1.20
1.24
3.33
Net income
1.21
1.18
(2.48
)
Dividends(3)
0.36
0.41
13.89
Book value (end of period)
28.41
31.94
12.43
Common shares outstanding (end of period)(4)
144,575,615
143,402,332
(0.81
)
Weighted average common shares outstanding—basic(4)
146,997,649
143,878,106
(2.12
)
Weighted average common shares outstanding—diluted(4)
149,915,503
146,026,188
(2.59
)
Balance sheet (end of period):
Total assets(5)
$
49,432,871
$
48,800,945
(1.28
)%
Total loans
29,778,461
33,528,868
12.59
Nonperforming assets
101,226
42,392
(58.12
)
Total deposits
40,414,979
39,155,904
(3.12
)
Stockholders’ equity
4,107,223
4,579,878
11.51
Balance sheet (period average):
Total assets
$
46,313,053
$
48,016,643
3.68
%
Total loans
29,714,206
34,052,067
14.60
Earning assets
41,667,831
43,084,349
3.40
Total deposits
38,199,718
38,856,033
1.72
Stockholders’ equity
4,208,650
4,538,679
7.84
Financial ratios(6):
Return on average assets(7):
From continuing operations
1.57
%
1.53
%
Net income
1.59
1.46
Return on average stockholders’ equity(7):
From continuing operations
17.32
16.21
Net income
17.54
15.45
Efficiency ratio(8)
60.64
62.10
Net interest margin(2)
4.22
4.36
Dividend payout ratio
29.51
32.54
Tangible equity ratio
7.36
8.46
Tier 1 risk-based capital ratio(5)
9.06
9.09
Total risk-based capital ratio(5)
11.41
10.94
Leverage ratio(5)
7.79
8.80
Allowances for credit losses to total loans(9)
1.63
1.26
Allowances for credit losses to nonaccrual loans(9)
506.96
1,003.48
Net loans charged off (recovered) to average total loans(7)
(0.19
)
0.06
Nonperforming assets to total loans and foreclosed assets
0.34
0.13
Nonperforming assets to total assets(5)
0.20
0.09
(1)In September 2005, Union Bank of California, N.A. committed to a plan for disposal of its international correspondent banking business. All periods presented have been restated to reflect discontinued operations.
(2)Taxable-equivalent basis.
(3)Dividends per share reflect dividends declared on UnionBanCal Corporation’s common stock outstanding as of the declaration date.
(4)Common shares outstanding reflect common shares issued less treasury shares.
(5)End of period total assets and assets used to calculate all regulatory capital ratios include those of discontinued operations.
(6)Average balances used to calculate our financial ratios are based on continuing operations data only, unless otherwise indicated.
(7)Annualized.
(8)The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income) and the (reversal of) provision for losses on off-balance sheet commitments, as a percentage of net interest income (taxable-equivalent basis) and noninterest income and is calculated for continuing operations only.
(9)The allowances for credit losses ratios include the allowances for loan losses and losses on off-balance sheet commitments. These ratios relate to continuing operations only.
nm = not meaningful
5
Item 1. Financial
Statements:StatementsUnionBanCal Corporation and Subsidiaries
Condensed Consolidated Statements ofIncome............................. 4 Condensed Consolidated Balance Sheets................................... 5 Condensed Consolidated StatementsIncome(1)
(Unaudited)
For the Three Months
Ended March 31,
(Dollars in thousands, except per share data)
2005
2006
Interest Income
Loans
$
404,630
$
512,323
Securities
100,769
96,867
Interest bearing deposits in banks
733
736
Federal funds sold and securities purchased under resale agreements
2,373
3,845
Trading account assets
842
1,431
Total interest income
509,347
615,202
Interest Expense
Deposits
55,828
115,309
Federal funds purchased and securities sold under repurchase agreements
4,998
8,802
Commercial paper
4,560
12,448
Medium and long-term debt
6,532
10,397
Trust notes
238
238
Other borrowed funds
1,529
2,915
Total interest expense
73,685
150,109
Net Interest Income
435,662
465,093
Reversal of allowance for loan losses
(12,119
)
(7,000
)
Net interest income after reversal of allowance for loan losses
447,781
472,093
Noninterest Income
Service charges on deposit accounts
79,267
81,635
Trust and investment management fees
41,963
50,115
Insurance commissions
22,017
19,518
Merchant banking fees
6,266
8,229
Foreign exchange gains, net
8,170
7,818
Brokerage commissions and fees
8,972
7,795
Card processing fees, net
5,607
6,697
Securities gains (losses), net
344
(214
)
Other
33,019
36,317
Total noninterest income
205,625
217,910
Noninterest Expense
Salaries and employee benefits
231,758
252,495
Net occupancy
32,362
32,837
Outside services
21,247
28,609
Equipment
17,403
17,922
Software
13,975
16,344
Professional services
11,741
14,547
Communications
10,380
10,552
Foreclosed asset expense (income)
406
(7,367
)
(Reversal of) provision for losses on off-balance sheet commitments
3,000
(3,000
)
Other
50,680
51,605
Total noninterest expense
392,952
414,544
Income from continuing operations before income taxes
260,454
275,459
Income tax expense
80,703
94,004
Income from Continuing Operations
179,751
181,455
Income (loss) from discontinued operations before income taxes
3,639
(13,603
)
Income tax expense (benefit)
1,413
(5,093
)
Income (Loss) from Discontinued Operations
2,226
(8,510
)
Net Income
$
181,977
$
172,945
Income from continuing operations per common share—basic
$
1.22
$
1.26
Net Income per common share—basic
$
1.24
$
1.20
Income from continuing operations per common share—diluted
$
1.20
$
1.24
Net income per common share—diluted
$
1.21
$
1.18
Weighted average common shares outstanding—basic
146,998
143,878
Weighted average common shares outstanding—diluted
149,916
146,026
(1)In September 2005, Union Bank of
Changes in Stockholders' Equity.... 6 Condensed Consolidated StatementsCalifornia, N.A. committed to a plan for disposal ofCash Flows......................... 7 Notesits international correspondent banking business. All periods presented have been restated toCondensed Consolidated Financial Statements.................... 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations: Introduction............................................................ 27 Executive Overview...................................................... 27 Discontinued Operations................................................. 28 Critical Accounting Policies............................................ 29 Financial Performance................................................... 30 Net Interest Income..................................................... 34 Noninterest Income...................................................... 37 Noninterest Expense..................................................... 37 Income Tax Expense...................................................... 38 Loans................................................................... 38 Cross-Border Outstandings............................................... 40 Reversal of Allowance for Credit Losses................................. 40 Allowance for Credit Losses............................................. 40 Nonperforming Assets.................................................... 44 Loans 90 Days or More Past Due and Still Accruing....................... 45 Quantitative and Qualitative Disclosures About Market Risk.............. 45 Liquidity Risk.......................................................... 48 Regulatory Capital...................................................... 48 Business Segments....................................................... 49 Regulatory Matters...................................................... 57 Factors That May Affect Future Results.................................. 58 Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 64 Item 4. Controls and Procedures........................................... 64 PART II OTHER INFORMATION Item 1. Legal Proceedings................................................. 65 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 65 Item 6. Exhibits.......................................................... 65 Signatures................................................................ 66
PART I. FINANCIAL INFORMATION UNIONBANCAL CORPORATION AND SUBSIDIARIES CONSOLIDATED FINANCIAL HIGHLIGHTS (UNAUDITED) AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, PERCENT (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2005 CHANGE - --------------------------------------------- ------------- ------------- ------RESULTS OF OPERATIONS: Net interest income(1).......................................................... $407,590 $465,193 14.13% Reversal of allowance for loan losses........................................... (10,939) (15,000) 37.12 Noninterest income.............................................................. 197,120 212,188 7.64 Noninterest expense(2).......................................................... 359,576 396,696 10.32 ----------- ----------- Income before income taxes(1)................................................... 256,073 295,685 15.47 Taxable-equivalent adjustment................................................... 1,012 1,051 3.85 Income tax expense.............................................................. 98,121 93,388 (4.82) ----------- ----------- Income from continuing operations............................................... 156,940 201,246 28.23 Income (loss) from discontinued operations, net of taxes........................ 6,498 (15,961) nm ----------- ----------- Net income...................................................................... $163,438 $185,285 13.37% =========== =========== PER COMMON SHARE: Basic earnings: From continuing operations.................................................... $1.06 $1.39 31.13% Net income.................................................................... 1.11 1.28 15.32 Diluted earnings: From continuing operations.................................................... 1.04 1.36 30.77 Net income.................................................................... 1.09 1.26 15.60 Dividends(3).................................................................... 0.36 0.41 13.89 Book value (end of period)...................................................... 28.04 30.07 7.24 Common shares outstanding (end of period)(4).................................... 147,163,392 144,584,972 (1.75) Weighted average common shares outstanding--basic(4)............................ 147,554,853 144,459,465 (2.10) Weighted average common shares outstanding--diluted(4).......................... 150,379,127 147,613,377 (1.84) BALANCE SHEET (END OF PERIOD): Total assets(8)................................................................. $46,990,605 $51,298,842 9.17% Total loans..................................................................... 26,902,191 32,004,747 18.97 Nonaccrual loans................................................................ 178,840 34,980 (80.44) Nonperforming assets............................................................ 189,447 37,507 (80.20) Total deposits.................................................................. 37,203,790 41,648,355 11.95 Medium and long-term debt....................................................... 820,460 806,353 (1.72) Junior subordinated debt........................................................ 15,904 15,451 (2.85) Stockholders' equity............................................................ 4,126,159 4,346,956 5.35 BALANCE SHEET (PERIOD AVERAGE): Total assets.................................................................... $43,472,704 $48,212,029 10.90% Total loans..................................................................... 26,301,914 32,177,816 22.34 Earning assets.................................................................. 39,402,003 43,371,177 10.07 Total deposits.................................................................. 35,937,713 40,293,528 12.12 Stockholders' equity............................................................ 4,067,953 4,275,122 5.09 FINANCIAL RATIOS: Return on average assets:(5) From continuing operations.................................................... 1.44% 1.66% Net income.................................................................... 1.50 1.52 Return on average stockholders' equity:(5) From continuing operations.................................................... 15.35 18.68 Net income.................................................................... 15.98 17.19 Efficiency ratio(6)............................................................. 59.46 59.07 Net interest margin(1).......................................................... 4.13 4.27 Dividend payout ratio........................................................... 33.96 29.50 Tangible equity ratio........................................................... 8.03 7.57 Tier 1 risk-based capital ratio(8).............................................. 9.99 8.88 Total risk-based capital ratio(8)............................................... 12.52 10.86 Leverage ratio(8)............................................................... 8.27 7.96 Allowance for credit losses to total loans(7)................................... 1.79 1.39 Allowance for credit losses to nonaccrual loans(7).............................. 269.31 1,272.29 Net loans charged off (recovered) to average total loans(5)..................... 0.11 0.20 Nonperforming assets to total loans and foreclosed assets....................... 0.70 0.12 Nonperforming assets to total assets(8)......................................... 0.40 0.07 - ---------------(1) Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent. (2) At September 30, 2004 and 2005, there were no expenses related to the allowance for losses on off-balance sheet commitments. (3) Dividends per share reflect dividends declared on UnionBanCal Corporation's common stock outstanding as of the declaration date. (4) Common shares outstanding reflect common shares issued less treasury shares. (5) Annualized. (6) The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income) and the provision for losses on off-balance sheet commitments, as a percentage of net interest income (taxable-equivalent basis) and noninterest income. (7) The allowance for credit losses ratios include the allowance for losses on off-balance sheet commitments. (8) End of period total assets used in calculating these ratios include those of discontinued operations.2
PART I. FINANCIAL INFORMATION UNIONBANCAL CORPORATION AND SUBSIDIARIES CONSOLIDATED FINANCIAL HIGHLIGHTS (UNAUDITED) AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, PERCENT (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2005 CHANGE - --------------------------------------------- ------------- ------------- ------RESULTS OF OPERATIONS: Net interest income(1).......................................................... $1,198,862 $1,361,638 13.58% Reversal of allowance for loan losses........................................... (29,038) (40,683) 40.10 Noninterest income.............................................................. 700,434 621,367 (11.29) Noninterest expense(2).......................................................... 1,084,751 1,178,048 8.60 ----------- ----------- Income before income taxes(1)................................................... 843,583 845,640 0.24 Taxable-equivalent adjustment................................................... 2,617 3,124 19.37 Income tax expense.............................................................. 308,989 274,041 (11.31) ----------- ----------- Income from continuing operations............................................... 531,977 568,475 6.86 Income (loss) from discontinued operations, net of taxes........................ 20,045 (14,031) nm ----------- ----------- Net income...................................................................... $552,022 $554,444 0.44% =========== =========== PER COMMON SHARE: Basic earnings: From continuing operations.................................................... $3.61 $3.91 8.31% Net income.................................................................... 3.74 3.82 2.14 Diluted earnings: From continuing operations.................................................... 3.55 3.84 8.17 Net income.................................................................... 3.68 3.74 1.63 Dividends(3).................................................................... 1.03 1.18 14.56 Book value (end of period)...................................................... 28.04 30.07 7.24 Common shares outstanding (end of period)(4).................................... 147,163,392 144,584,972 (1.75) Weighted average common shares outstanding--basic(4)............................ 147,547,527 145,325,640 (1.51) Weighted average common shares outstanding--diluted(4).......................... 150,026,647 148,062,139 (1.31) BALANCE SHEET (END OF PERIOD): Total assets(8)................................................................. $46,990,605 $51,298,842 9.17% Total loans..................................................................... 26,902,191 32,004,747 18.97 Nonaccrual loans................................................................ 178,840 34,980 (80.44) Nonperforming assets............................................................ 189,447 37,507 (80.20) Total deposits.................................................................. 37,203,790 41,648,355 11.95 Medium and long-term debt....................................................... 820,460 806,353 (1.72) Junior subordinated debt........................................................ 15,904 15,451 (2.85) Stockholders' equity............................................................ 4,126,159 4,346,956 5.35 BALANCE SHEET (PERIOD AVERAGE): Total assets.................................................................... $42,325,380 $47,342,684 11.85% Total loans..................................................................... 25,328,476 30,843,202 21.77 Earning assets.................................................................. 38,352,522 42,575,954 11.01 Total deposits.................................................................. 35,395,054 39,304,760 11.05 Stockholders' equity............................................................ 3,984,194 4,209,884 5.66 FINANCIAL RATIOS: Return on average assets:(5) From continuing operations.................................................... 1.68% 1.61% Net income.................................................................... 1.74 1.57 Return on average stockholders' equity:(5) From continuing operations.................................................... 17.84 18.05 Net income.................................................................... 18.51 17.61 Efficiency ratio(6)............................................................. 57.09 59.74 Net interest margin(1).......................................................... 4.17 4.27 Dividend payout ratio........................................................... 28.53 30.18 Tangible equity ratio........................................................... 8.03 7.57 Tier 1 risk-based capital ratio(8).............................................. 9.99 8.88 Total risk-based capital ratio(8)............................................... 12.52 10.86 Leverage ratio(8)............................................................... 8.27 7.96 Allowance for credit losses to total loans(7)................................... 1.79 1.39 Allowance for credit losses to nonaccrual loans(7).............................. 269.31 1,272.29 Net loans charged off (recovered) to average total loans(5)..................... 0.15 (0.02) Nonperforming assets to total loans and foreclosed assets....................... 0.70 0.12 Nonperforming assets to total assets(8)......................................... 0.40 0.07 - ---------------(1) Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent. (2) Included in noninterest expense at September 30, 2005 was a $1 million reversal of the allowance for losses on off-balance sheet commitments. (3) Dividends per share reflect dividends declared on UnionBanCal Corporation's common stock outstanding as of the declaration date. (4) Common shares outstanding reflects common shares issued less treasury shares. (5) Annualized. (6) The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income) and the provision for losses on off-balance sheet commitments, as a percentage of net interest income (taxable-equivalent basis) and noninterest income. (7) The allowance for credit losses ratios include the allowance for losses on off-balance sheet commitments. (8) End of period total assets used in calculating these ratios include those of discontinued operations.3ITEM 1. FINANCIAL STATEMENTSreflect the discontinued operations.
UnionBanCal Corporation and Subsidiaries Condensed Consolidated Statements of Income(1)(Unaudited) FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2005 2004 2005 - --------------------------------------------- ---- ---- ---- ----INTEREST INCOME Loans....................................................................... $341,532 $461,381 $991,081 $1,304,324 Securities.................................................................. 106,172 97,569 320,077 300,868 Interest bearing deposits in banks.......................................... 1,656 303 1,946 1,432 Federal funds sold and securities purchased under resale agreements......... 1,616 6,777 6,503 14,406 Trading account assets...................................................... 1,140 1,062 2,558 2,902 -------- -------- --------- ---------- Total interest income..................................................... 452,116 567,092 1,322,165 1,623,932 -------- -------- --------- ---------- INTEREST EXPENSE Domestic deposits........................................................... 34,725 78,983 100,193 197,801 Foreign deposits............................................................ 370 3,813 951 8,247 Federal funds purchased and securities sold under repurchase agreements..... 3,013 294 3,540 9,330 Commercial paper............................................................ 1,697 9,394 3,883 21,761 Medium and long-term debt................................................... 4,369 8,520 11,201 22,511 Trust notes................................................................. 242 239 2,553 715 Other borrowed funds........................................................ 1,122 1,707 3,599 5,053 -------- -------- --------- ---------- Total interest expense.................................................... 45,538 102,950 125,920 265,418 -------- -------- --------- ---------- NET INTEREST INCOME........................................................... 406,578 464,142 1,196,245 1,358,514 Reversal of allowance for loan losses(2).................................... (10,939) (15,000) (29,038) (40,683) -------- -------- --------- ---------- Net interest income after reversal of allowance for loan losses........... 417,517 479,142 1,225,283 1,399,197 -------- -------- --------- ---------- NONINTEREST INCOME Service charges on deposit accounts......................................... 85,667 84,822 252,974 243,835 Trust and investment management fees........................................ 39,089 43,500 111,699 127,053 Insurance commissions....................................................... 17,463 17,819 57,850 59,176 Merchant banking fees....................................................... 11,682 11,257 26,863 35,637 Foreign exchange gains, net................................................. 8,268 8,849 24,209 25,570 Brokerage commissions and fees.............................................. 8,527 5,290 24,847 22,867 Card processing fees, net................................................... 4,653 6,597 28,901 18,668 Securities gains (losses), net.............................................. (6) (320) 1,612 (13,289) Other....................................................................... 21,777 34,374 171,479 101,850 -------- -------- --------- ---------- Total noninterest income.................................................. 197,120 212,188 700,434 621,367 -------- -------- --------- ---------- NONINTEREST EXPENSE Salaries and employee benefits.............................................. 209,554 236,124 632,463 701,858 Net occupancy............................................................... 32,029 34,336 93,517 100,251 Outside services............................................................ 19,572 28,533 52,130 76,248 Equipment................................................................... 15,949 15,832 49,370 50,176 Software.................................................................... 12,790 14,374 37,309 43,072 Professional services....................................................... 11,976 11,240 33,410 36,131 Communications.............................................................. 10,234 10,808 31,728 30,950 Foreclosed asset expense (income)........................................... (10) (3,435) 526 (5,606) Reversal of allowance for losses on off-balance sheet commitments(2)........ -- -- -- (1,000) Other....................................................................... 47,482 48,884 154,298 145,968 -------- -------- --------- ---------- Total noninterest expense................................................. 359,576 396,696 1,084,751 1,178,048 -------- -------- --------- ---------- Income from continuing operations before income taxes....................... 255,061 294,634 840,966 842,516 Income tax expense.......................................................... 98,121 93,388 308,989 274,041 -------- -------- --------- ---------- INCOME FROM CONTINUING OPERATIONS............................................. 156,940 201,246 531,977 568,475 -------- -------- --------- ---------- Income (loss) from discontinued operations before income taxes.............. 10,592 (25,612) 32,673 (22,385) Income tax expense (benefit)................................................ 4,094 (9,651) 12,628 (8,354) -------- -------- --------- ---------- INCOME (LOSS) FROM DISCONTINUED OPERATIONS.................................... 6,498 (15,961) 20,045 (14,031) -------- -------- --------- ---------- NET INCOME.................................................................... $163,438 $185,285 $552,022 $554,444 ======== ======== ========= ========== INCOME FROM CONTINUING OPERATIONS PER COMMON SHARE--BASIC..................... $1.06 $1.39 $3.61 $3.91 NET INCOME PER COMMON SHARE--BASIC............................................ $1.11 $1.28 $3.74 $3.82 ======== ======== ========= ========== INCOME FROM CONTINUING OPERATIONS PER COMMON SHARE--DILUTED................... $1.04 $1.36 $3.55 $3.84 NET INCOME PER COMMON SHARE--DILUTED.......................................... $1.09 $1.26 $3.68 $3.74 ======== ======== ========= ========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--BASIC............................. 147,555 144,459 147,548 145,326 ======== ======== ========= ========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--DILUTED........................... 150,379 147,613 150,027 148,062 ======== ======== ========= ========== - ---------------(1) In September 2005, Union Bank of California, N.A. committed to a plan for disposal of its international correspondent banking business. All periods presented have been restated to reflect the discontinued operations. (2) Beginning in the quarter ended March 31, 2005, the net change in the allowance for losses on off-balance sheet commitments was recognized separately from the change in the allowance for loan losses. Prior periods have not been restated.See accompanying notes to condensed consolidated financial statements.
4
UNIONBANCAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (UNAUDITED) SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, (DOLLARS IN THOUSANDS) 2004 2004 2005 - ---------------------- ---- ---- ----ASSETS Cash and due from banks........................................................... $ 2,036,226 $ 1,977,033 $ 2,163,149 Interest bearing deposits in banks................................................ 348,471 277,482 471,340 Federal funds sold and securities purchased under resale agreements............... 1,045,275 944,950 1,454,193 ----------- ----------- ----------- Total cash and cash equivalents............................................... 3,429,972 3,199,465 4,088,682 Trading account assets............................................................ 288,601 235,840 371,551 Securities available for sale: Securities pledged as collateral................................................ 124,896 144,240 158,878 Held in portfolio............................................................... 11,863,216 10,994,981 9,647,093 Loans (net of allowance for loan losses: September 30, 2004, $481,642; December 31, 2004, $399,156; September 30, 2005, $363,671)(1)................................ 26,420,549 28,710,259 31,641,076 Due from customers on acceptances................................................. 16,295 23,841 47,167 Premises and equipment, net....................................................... 497,899 526,543 509,922 Intangible assets................................................................. 60,977 61,737 46,781 Goodwill.......................................................................... 320,835 450,961 452,617 Other assets...................................................................... 1,768,710 1,731,354 2,318,507 Assets of discontinued operations to be disposed or sold(2)....................... 2,198,655 2,018,800 2,016,568 ----------- ----------- ----------- Total assets.................................................................. $46,990,605 $48,098,021 $51,298,842 =========== =========== =========== LIABILITIES Domestic deposits: Noninterest bearing............................................................. $18,903,588 $19,100,128 $20,541,706 Interest bearing................................................................ 17,838,599 19,402,379 20,475,166 Foreign deposits: Interest bearing................................................................ 461,603 216,999 631,483 ----------- ----------- ----------- Total deposits................................................................ 37,203,790 38,719,506 41,648,355 Federal funds purchased and securities sold under repurchase agreements........... 648,864 587,249 357,725 Commercial paper.................................................................. 615,816 824,887 859,515 Other borrowed funds.............................................................. 150,503 172,549 114,324 Acceptances outstanding........................................................... 16,295 23,841 47,167 Other liabilities(1).............................................................. 1,173,988 1,112,743 1,616,174 Medium and long-term debt......................................................... 820,460 816,113 806,353 Junior subordinated debt payable to subsidiary grantor trust...................... 15,904 15,790 15,451 Liabilities of discontinued operations to be extinguished or assumed(2)........... 2,218,826 1,533,099 1,486,822 ----------- ----------- ----------- Total liabilities............................................................. 42,864,446 43,805,777 46,951,886 ----------- ----------- ----------- Commitments and contingencies--See Note 10 STOCKHOLDERS' EQUITY Preferred stock: Authorized 5,000,000 shares, no shares issued or outstanding as of September 30, 2004, December 31, 2004, and September 30, 2005............................... -- -- -- Common stock, par value $1 per share at September 30, 2004, December 31, 2004 and September 30, 2005: Authorized 300,000,000 shares, issued 149,529,292 shares as of September 30, 2004, 152,191,818 shares as of December 31, 2004, and 153,960,915 shares as of September 30, 2005 149,529 152,192 153,961 Additional paid-in capital........................................................ 728,791 881,928 967,242 Treasury stock--2,365,900 shares as of September 30, 2004, 3,831,900 shares as of December 31, 2004 and 9,375,943 shares as of September 30, 2005................. (131,464) (223,361) (552,786) Retained earnings................................................................. 3,400,117 3,526,312 3,901,625 Accumulated other comprehensive loss.............................................. (20,814) (44,827) (123,086) ----------- ----------- ----------- Total stockholders' equity.................................................... 4,126,159 4,292,244 4,346,956 ----------- ----------- ----------- Total liabilities and stockholders' equity.................................... $46,990,605 $48,098,021 $51,298,842 =========== =========== =========== - ---------------(1) On December 31, 2004, UnionBanCal Corporation transferred the allowance related to losses on off-balance sheet commitments of $83 million from the allowance for loan losses to other liabilities. At September 30, 2005, the allowance related to losses on off-balance sheet commitments was $82 million. Periods prior to December 31, 2004 have not been restated. (2) In September 2005, Union Bank of California, N.A. committed to a plan for disposal of its international correspondent banking business. All prior periods presented have been restated to reflect the discontinued operations.6
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Balance Sheets(1)
(Unaudited)
(Unaudited)
March 31,
December 31,
March 31,
(Dollars in thousands)
2005
2005
2006
Assets
Cash and due from banks
$
1,870,367
$
2,402,212
$
2,035,544
Interest bearing deposits in banks
73,667
771,164
170,187
Federal funds sold and securities purchased under resale agreements
1,695,835
796,500
513,777
Total cash and cash equivalents
3,639,869
3,969,876
2,719,508
Trading account assets
234,791
312,655
329,703
Securities available for sale:
Securities pledged as collateral
251,657
96,994
88,152
Held in portfolio
10,975,242
8,072,286
8,394,318
Loans (net of allowance for loan losses: March 31, 2005, $401,275; December 31, 2005, $351,532; March 31, 2006, $339,443)
29,377,186
32,744,063
33,189,425
Due from customers on acceptances
21,158
19,252
20,541
Premises and equipment, net
520,286
536,074
511,095
Intangible assets
56,751
42,616
39,186
Goodwill
450,125
454,015
453,489
Other assets
1,929,837
2,113,577
2,814,603
Assets of discontinued operations to be disposed or sold(1)
1,975,969
1,054,594
240,925
Total assets
$
49,432,871
$
49,416,002
$
48,800,945
Liabilities
Noninterest bearing
$
20,421,830
$
19,489,377
$
18,118,506
Interest bearing
19,993,149
20,592,862
21,037,398
Total deposits
40,414,979
40,082,239
39,155,904
Federal funds purchased and securities sold under repurchase agreements
400,570
651,529
292,758
Commercial paper
1,042,795
680,027
1,420,276
Other borrowed funds
126,662
134,485
66,472
Acceptances outstanding
21,158
19,252
20,541
Other liabilities
1,128,383
1,466,478
2,259,464
Medium and long-term debt
803,233
801,095
788,763
Junior subordinated debt payable to subsidiary grantor trust
15,677
15,338
15,225
Liabilities of discontinued operations to be extinguished or assumed(1)
1,372,191
1,005,859
201,664
Total liabilities
45,325,648
44,856,302
44,221,067
Commitments and contingencies—See Note 9
Stockholders’ Equity
Preferred stock:
Authorized 5,000,000 shares; no shares issued or outstanding as of March 31, 2005, December 31, 2005, and March 31, 2006
—
—
—
Common stock, par value $1 per share at March 31, 2005, December 31, 2005 and March 31, 2006:
Authorized 300,000,000 shares; issued 152,530,458 shares as of March 31, 2005, 154,469,215 shares as of December 31, 2005, and 154,832,175 shares as of March 31, 2006
152,530
154,469
154,832
Additional paid-in capital
896,855
994,956
1,018,943
Treasury stock—7,954,843 shares as of March 31, 2005, 10,262,143
shares as of December 31, 2005 and 11,429,843 shares as of March 31, 2006
(463,527
)
(612,732
)
(692,783
)
Retained earnings
3,656,187
4,141,400
4,258,533
Accumulated other comprehensive loss
(134,822
)
(118,393
)
(159,647
)
Total stockholders’ equity
4,107,223
4,559,700
4,579,878
Total liabilities and stockholders’ equity
$
49,432,871
$
49,416,002
$
48,800,945
(1)In September 2005, Union Bank of California, N.A. committed to a plan for disposal of its international correspondent banking business. All prior periods presented have been restated to reflect the discontinued operations.
See accompanying notes to condensed consolidated financial statements.
5
UNIONBANCAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) ACCUMULATED ADDITIONAL OTHER TOTAL NUMBER COMMON PAID-IN TREASURY RETAINED COMPREHENSIVE STOCKHOLDERS' (IN THOUSANDS, EXCEPT SHARES) OF SHARES STOCK CAPITAL STOCK EARNINGS INCOME (LOSS) EQUITY - ----------------------------- --------- ----- ------- ----- -------- ------------- ------BALANCE DECEMBER 31, 2003................. 146,000,156 $146,000 $555,156 $ (12,846) $2,999,884 $ 52,242 $3,740,436 -------- -------- --------- ---------- --------- ---------- Comprehensive income Net income--For the nine months ended September 30, 2004.................... 552,022 552,022 Other comprehensive income, net of tax: Net change in unrealized gains on cash flow hedges......................... (30,285) (30,285) Net change in unrealized losses on securities available for sale....... (43,404) (43,404) Foreign currency translation adjustment 633 633 ---------- Total comprehensive income................ 478,966 Dividend reinvestment plan................ 308 17 17 Deferred compensation--restricted stock awards.................................. 185 185 Stock options exercised................... 1,520,109 1,520 61,223 62,743 Stock issued in acquisitions.............. 2,008,719 2,009 112,569 114,578 Common stock repurchased(1)............... (174) (118,618) (118,792) Dividends declared on common stock, $1.03 per share(2)............................ (151,974) (151,974) -------- -------- --------- ---------- --------- ---------- Net change................................ 3,529 173,635 (118,618) 400,233 (73,056) 385,723 ----------- -------- -------- --------- ---------- --------- ---------- BALANCE SEPTEMBER 30, 2004................ 149,529,292 $149,529 $728,791 $(131,464) $3,400,117 $ (20,814) $4,126,159 =========== ======== ======== ========= ========== ========= ========== BALANCE DECEMBER 31, 2004................. 152,191,818 $152,192 $881,928 $(223,361) $3,526,312 $ (44,827) $4,292,244 -------- -------- --------- ---------- --------- ---------- Comprehensive income Net income--For the nine months ended September 30, 2005.................... 554,444 554,444 Other comprehensive income, net of tax: Net change in unrealized losses on cash flow hedges.................... (29,476) (29,476) Net change in unrealized losses on securities available for sale....... (48,846) (48,846) Foreign currency translation adjustment 79 79 Minimum pension liability adjustment.. (16) (16) ---------- Total comprehensive income................ 476,185 Dividend reinvestment plan................ -- Deferred compensation--restricted stock awards.................................. 215,363 215 12,956 (8,461) 4,710 Stock options exercised................... 1,553,734 1,554 72,358 73,912 Common stock repurchased(1)............... (329,425) (329,425) Dividends declared on common stock, $1.18 per share(2)............................ (170,670) (170,670) -------- -------- --------- ---------- --------- ---------- Net change................................ 1,769 85,314 (329,425) 375,313 (78,259) 54,712 ----------- -------- -------- --------- ---------- --------- ---------- BALANCE SEPTEMBER 30, 2005................ 153,960,915 $153,961 $967,242 $(552,786) $3,901,625 $(123,086) $4,346,956 =========== ======== ======== ========= ========== ========= ========== - ---------------(1) Common stock repurchased includes commission costs. (2) Dividends are based on UnionBanCal Corporation's shares outstanding as of the declaration date.7
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(Unaudited)
Accumulated
Total
Additional
other
stock-
Number
Common
paid-in
Treasury
Retained
comprehensive
holders’
(In thousands, except shares)
of shares
stock
capital
stock
earnings
income (loss)
equity
BALANCE DECEMBER 31, 2004
152,191,818
$
152,192
$
881,928
$
(223,361
)
$
3,526,312
$
(44,827
)
$
4,292,244
Comprehensive income
Net income—For the three months ended March 31, 2005
181,977
181,977
Other comprehensive income, net of tax:
Net change in unrealized losses on cash flow hedges
(23,894
)
(23,894
)
Net change in unrealized losses on securities available for sale
(66,382
)
(66,382
)
Foreign currency translation
adjustment
297
297
Minimum pension liability adjustment
(16
)
(16
)
Total comprehensive income
91,982
Deferred compensation—restricted stock awards
100
100
Stock options exercised
338,640
338
14,927
15,265
Common stock repurchased(1)
(240,166
)
(240,166
)
Dividends declared on common stock, $0.36 per share(2)
(52,202
)
(52,202
)
Net change
338
14,927
(240,166
)
129,875
(89,995
)
(185,021
)
BALANCE MARCH 31, 2005
152,530,458
$
152,530
$
896,855
$
(463,527
)
$
3,656,187
$
(134,822
)
$
4,107,223
BALANCE DECEMBER 31, 2005
154,469,215
$
154,469
$
994,956
$
(612,732
)
$
4,141,400
$
(118,393
)
$
4,559,700
Comprehensive income
Net income—For the three months ended March 31, 2006
172,945
172,945
Other comprehensive income, net of tax:
Net change in unrealized losses on cash flow hedges
(11,907
)
(11,907
)
Net change in unrealized losses on securities available for sale
(29,331
)
(29,331
)
Foreign currency translation
adjustment
(16
)
(16
)
Total comprehensive income
131,691
Deferred compensation—restricted stock awards
2,925
3
204
3,105
3,312
Compensation expense—stock options
6,214
6,214
Stock options exercised
360,035
360
17,569
17,929
Common stock repurchased(1)
(80,051
)
(80,051
)
Dividends declared on common stock, $0.41 per share(2)
(58,917
)
(58,917
)
Net change
363
23,987
(80,051
)
117,133
(41,254
)
20,178
BALANCE MARCH 31, 2006
154,832,175
$
154,832
$
1,018,943
$
(692,783
)
$
4,258,533
$
(159,647
)
$
4,579,878
(1)Common stock repurchased includes commission costs.
(2)Dividends are based on UnionBanCal Corporation’s shares outstanding as of the declaration date.
See accompanying notes to condensed consolidated financial statements.
6
UNIONBANCAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE NINE MONTHS ENDED SEPTEMBER 30, (DOLLARS IN THOUSANDS) 2004 2005 - ---------------------- ---- ----CASH FLOWS FROM OPERATING ACTIVITIES: Net income........................................................................................ $ 552,022 $ 554,444 Income (loss) from discontinued operations, net of taxes........................................ 20,045 (14,031) ---------- ---------- Income from continuing operations, net of taxes................................................. 531,977 568,475 Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities: Reversal of allowance for loan losses........................................................... (29,038) (40,683) Reversal of allowance for losses on off-balance sheet commitments............................... -- (1,000) Depreciation, amortization and accretion........................................................ 99,361 97,815 Provision for deferred income taxes............................................................. 29,411 71,328 Losses (gains) on securities available for sale................................................. (1,612) 13,289 Net increase in prepaid expenses................................................................ (96,002) (191,791) Net (increase) decrease in fees and other charges receivable.................................... 4,069 (130,382) Net increase (decrease) in accrued expenses..................................................... 22,905 4,709 Net increase (decrease) in unearned and deferred income......................................... (2,557) 134,111 Net increase (decrease) in other liabilities.................................................... 204,546 289,340 Net (increase) decrease in other assets, net of acquisitions.................................... 182,905 (276,735) Net (increase) decrease in trading account assets............................................... (36,580) (135,711) Loans originated for resale..................................................................... (661,342) (90,238) Net proceeds from sale of loans originated for resale........................................... 518,739 200,637 Other, net...................................................................................... 15,281 (16,484) Discontinued operations, net.................................................................... (62,352) 1,349 ---------- ---------- Total adjustments............................................................................... 187,734 (70,446) ---------- ---------- Net cash provided by (used in) operating activities............................................... 719,711 498,029 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale.............................................. 13,479 506,070 Proceeds from matured and called securities available for sale.................................... 3,170,560 1,753,484 Purchases of securities available for sale, net of acquisitions................................... (4,380,888) (1,036,810) Net (increase) decrease in loans, net of acquisitions............................................. (1,996,067) (2,984,426) Net cash provided by (paid in) acquisitions....................................................... 28,086 -- Other, net........................................................................................ (55,962) (47,776) Discontinued operations, net...................................................................... (155,348) 9,794 ---------- ---------- Net cash provided by (used in) investing activities............................................. (3,376,140) (1,799,664) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in deposits, net of acquisitions.......................................... 2,512,609 2,928,849 Net increase (decrease) in federal funds purchased and securities sold under repurchase agreements 367,896 (229,524) Net increase (decrease) in commercial paper and other borrowed funds.............................. 11,961 (23,597) Repayment of junior subordinated debt............................................................. (360,825) -- Common stock repurchased.......................................................................... (118,792) (329,425) Payments of cash dividends........................................................................ (144,146) (164,946) Other, net........................................................................................ 63,578 78,701 Discontinued operations, net...................................................................... 553,962 (69,219) ---------- ---------- Net cash provided by (used in) financing activities............................................. 2,886,243 2,190,839 ---------- ---------- Net increase (decrease) in cash and cash equivalents from continuing operations..................... 229,814 889,204 Cash and cash equivalents of continuing operations at beginning of period........................... 3,200,158 3,199,465 Effect of exchange rate changes on cash and cash equivalents........................................ -- 13 ---------- ---------- Cash and cash equivalents at end of period.......................................................... $3,429,972 $4,088,682 ========== ========== CASH PAID DURING THE PERIOD FOR: Interest.......................................................................................... $ 122,236 $ 226,584 Income taxes...................................................................................... 230,094 158,089 SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisitions: Fair value of assets acquired................................................................... $ 991,887 $ -- Purchase price: Cash.......................................................................................... (33,772) -- Stock issued.................................................................................. (114,578) -- ---------- ---------- Liabilities assumed............................................................................. $ 843,537 $ -- ========== ========== Loans transferred to foreclosed assets (OREO)..................................................... $ 6,723 $ --8
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Three Months
Ended March 31,
(Dollars in thousands)
2005
2006
Cash Flows from Operating Activities:
Net income
$
181,977
$
172,945
Income (loss) from discontinued operations, net of taxes
2,226
(8,510
)
Income from continuing operations, net of taxes
179,751
181,455
Adjustments to reconcile net income to net cash provided by operating activities:
Reversal of allowance for loan losses
(12,119
)
(7,000
)
(Reversal of) provision for losses on off-balance sheet commitments
3,000
(3,000
)
Depreciation, amortization and accretion
40,885
35,336
Stock-based compensation—stock options
—
6,214
Stock-based compensation—restricted stock
100
3,312
Provision for deferred income taxes
37,605
50,398
(Gains) losses on sales of securities available for sale, net
(344
)
214
Net decrease in accrued expenses
(41,164
)
(58,878
)
Net increase (decrease) in unearned and deferred income
20,714
(2,100
)
Net (increase) decrease in trading account assets
1,049
(17,047
)
Net increase in prepaid expenses
(135,518
)
(87,878
)
Net (increase) decrease in fees and other charges receivable
73,848
(9,318
)
Net increase in other liabilities
14,107
816,916
Net increase in other assets
(155,264
)
(622,930
)
Loans originated for resale
(35,640
)
(58,529
)
Net proceeds from loans originated for resale
114,823
96,558
Excess tax benefit—stock options exercised
—
(3,900
)
Other, net
(10,694
)
1,708
Discontinued operations, net
32,315
126,736
Total adjustments
(52,297
)
266,812
Net cash provided by operating activities
127,454
448,267
Cash Flows from Investing Activities:
Proceeds from sales of securities available for sale
24,958
4,041
Proceeds from matured and called securities available for sale
347,619
389,888
Purchases of securities available for sale
(575,295
)
(758,213
)
Net (purchases) sales of premises and equipment
(15,472
)
2,923
Net increase in loans
(723,287
)
(478,230
)
Other, net
(42
)
708
Discontinued operations, net
11,487
622,138
Net cash used in investing activities
(930,032
)
(216,745
)
Cash Flows from Financing Activities:
Net increase (decrease) in deposits
1,695,473
(926,336
)
Net decrease in federal funds purchased and securities sold under repurchase agreements
(186,679
)
(358,771
)
Net increase in commercial paper and other borrowed funds
172,021
672,236
Common stock repurchased
(240,166
)
(80,051
)
Payments of cash dividends
(53,548
)
(59,103
)
Stock options exercised
15,265
17,929
Other, net
297
(16
)
Discontinued operations, net
(160,043
)
(747,910
)
Net cash provided by (used in) financing activities
1,242,620
(1,482,022
)
Net increase (decrease) in cash and cash equivalents
440,042
(1,250,500
)
Cash and cash equivalents at beginning of period
3,199,854
3,969,876
Effect of exchange rate changes on cash and cash equivalents
(27
)
132
Cash and cash equivalents at end of period
$
3,639,869
$
2,719,508
Cash Paid During the Period For:
Interest
$
54,715
$
143,090
Income taxes
41,325
111,783
See accompanying notes to condensed consolidated financial statements.
7UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1--BASIS OF PRESENTATION AND NATURE OF OPERATIONS9
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)Note 1—Basis of Presentation and Nature of Operations
The unaudited condensed consolidated financial statements of UnionBanCal Corporation and subsidiaries (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Rules and Regulations of the Securities and Exchange Commission (SEC). However, they do not include all of the disclosures necessary for annual financial statements in conformity with US GAAP. The results of operations for the period ended
September 30, 2005March 31, 2006 are not necessarily indicative of the operating results anticipated for the full year. Accordingly, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in theCompany'sCompany’s Annual Report on Form 10-K for the year ended December 31,2004.2005. The preparation of financial statements in conformity with US GAAP also requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.UnionBanCal Corporation is a commercial bank holding company and has, as its major subsidiary, a banking subsidiary, Union Bank of California, N.A. (the Bank). The Company provides a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, primarily in California, Oregon, and Washington, but also nationally. Upon completion of the exit from the international correspondent banking business (see Note 3
"Discontinued Operations"“Discontinued Operations” of thisquarterly reportQuarterly Report on Form 10-Q), the Bank will continue to provide trade finance and other international financial services (but not international correspondent banking) to customers.Under a previously announced stock repurchase
plans,plan that provided for repurchases up to $200 million, the Company was authorized to repurchase$162$22 million of theCompany'sCompany’s common stock as ofSeptember 30, 2005.March 31, 2006. The Company repurchased$210 million, $40 million and $89$80 million of common stock in2004,the first quarter of2005 and the second quarter of 2005, respectively, as part of these repurchase plans (excluding commission costs). There were no repurchases of common stock2006, compared to $40 million in thethirdfirst quarter of 2005. Under a separate stock repurchase agreement, the Company repurchased $200 million of its common stock inFebruarythe first quarter 2005, from its majority owner, The Bank ofTokyo-Mitsubishi,Tokyo-Mitsubishi UFJ, Ltd.(BTM)(BTMU), with no comparable repurchases in the first quarter 2006. BTMU, which is a wholly-owned subsidiary of Mitsubishi UFJ Financial Group, Inc.At September 30, 2005, BTM, owned approximately6163 percent of theCompany'sCompany’s outstanding commonstock.stock at March 31, 2006.Certain amounts for prior periods have been reclassified to conform to current financial statement presentation.
STOCK-BASED COMPENSATION As allowed underStock-Based Compensation
On January 1, 2006, the
provisions ofCompany adopted Statement of Financial AccountingStandardsStandard (SFAS) No. 123R, “Share-Based Payment,” a revision of SFAS No. 123,"Accounting“Accounting for Stock-Based Compensation,"” and elected to use the modified prospective application method to transition to the new accounting standard. SFAS No. 123R requires that compensation costs related to share-based payment transactions be recognized in the financial statements. Measurement of the cost of employee service is based on the grant-date fair value of the equity or liability instrument issued. SFAS 123R also prescribes that estimated forfeitures of shares are to be included in the calculation of compensation expense.10
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)Note 1—Basis of Presentation and Nature of Operations (Continued)
Under the modified prospective transition method, compensation cost is recognized as
amended,of January 1, 2006 for the portion of outstanding stock option awards for which the requisite service has not yet been rendered. The cost will be recognized over the period during which the employees are required to provide service. The after-tax impact of the adoption of SFAS 123R on income from continuing operations was a reduction of $3.8 million. The corresponding impact to both basic and diluted earnings per share was a reduction of $0.03 per share. Cash flows from operating activities increased as a result of this non-cash adjustment to net income in the amount of $6.2 million.For the period ended March 31, 2005, as allowed under SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company
has chosen to continue to recognizerecognized compensation expense using the intrinsic value-based method of valuing stock options prescribed in Accounting Principles Board Opinion (APB) No. 25,"Accounting“Accounting for Stock Issued toEmployees"Employees” and related Interpretations. Under the intrinsic value-based method, compensation costiswas measured as the amount by which the quoted market price of theCompany'sCompany’s stock at the date of grant exceeds the stock option exercise price.8UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1--BASIS OF PRESENTATION AND NATURE OF OPERATIONS (CONTINUED)For the quarter ended March 31, 2005, options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of the grant and, therefore, were not included in compensation expense.At
September 30, 2005,March 31, 2006, the Company had two stock-based employee compensation plans. For further discussion concerning theCompany'sCompany’s stock-based employee compensation plans see Note15 of the Notes11 to these Condensed Consolidated Financial Statementsincluded inand Note 16 of the Company’s Annual Report on Form 10-K for the year ended December 31,2004. The value of the restricted stock awards issued under the plans has been reflected in compensation expense.2005. Options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date ofgrantgrant. The value of the restricted stock awards issued under the plans andtherefore, werethe value of that portion of outstanding option awards for which the requisite service has notincluded inyet been rendered is being amortized over the remaining service period as compensationexpense as allowed by current US GAAP.expense.The following table illustrates the effect on net income, which includes discontinued operations, and corresponding earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee
compensation.compensation for the three months ended March 31, 2005. For the purpose of this disclosure, the Company has recognized compensation expense for graded vesting on a straight-line basis andwithout regarddid not include an estimate for forfeitures.
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, (DOLLARS IN THOUSANDS) 2004 2005 2004 2005 - ---------------------- ---- ---- ---- ----AS REPORTED NET INCOME........................................................... $163,438 $185,285 $552,022 $554,444 Add: stock-based employee compensation expense included in reported net income, net of income taxes............................................................ 34 1,274 114 2,908 Deduct: total stock-based employee compensation expense, net of income taxes..... 6,744 6,086 20,039 18,445 -------- -------- -------- -------- Pro forma net income, after stock-based employee compensation expense............ $156,728 $180,473 $532,097 $538,907 ======== ======== ======== ======== NET INCOME PER COMMON SHARE--BASIC As reported.................................................................. $1.11 $1.28 $3.74 $3.82 Pro forma.................................................................... $1.06 $1.25 $3.61 $3.71 NET INCOME PER COMMON SHARE--DILUTED As reported.................................................................. $1.09 $1.26 $3.68 $3.74 Pro forma.................................................................... $1.04 $1.23 $3.55 $3.66Compensation cost associated with the Company's unvested restricted stock issued under the management stock plan is measured based on the market price of the stock at the grant date
For the Three
Months Ended
(Dollars in thousands)
March 31, 2005
As reported net income
$
181,977
Add: stock-based employee compensation expense included in reported net income, net of income taxes
62
Deduct: total stock-based employee compensation expense, net of income taxes
5,606
Pro forma net income, after stock-based employee compensation expense
$
176,433
Net income per common share—basic
As reported
$
1.24
Pro forma
$
1.20
Net income per common share—diluted
As reported
$
1.21
Pro forma
$
1.18
11
UnionBanCal Corporation and
is expensed over the vesting period. Compensation costSubsidiariesNotes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)Note 2—Recently Issued and Proposed Accounting Pronouncements
Accounting for
unvested stock option awards is based upon the fair value method. NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS ACCOUNTING FOR EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITSShare-Based PaymentsIn December
2003,2004, the Financial Accounting Standards Board (FASB), issued SFAS No.132R, a revision of SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88, and 106." The Statement expands the disclosure requirements of SFAS No. 132 to include information describing types of plan assets, investment strategy, measurement date(s)123 (revised 2004),plan obligations, cash flows, and components of net periodic benefit costs of defined pension plans 9UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED) and other defined benefit postretirement plans. The Statement was effective for financial statements with fiscal years ending after December 15, 2003, with additional disclosure of expected benefits to be paid in each of the next five years and in the aggregate for the five years thereafter required for fiscal years ending after June 15, 2004. The disclosures required under SFAS No. 132R are contained in Note 11 of these condensed consolidated financial statements. ACCOUNTING FOR SHARE-BASED PAYMENTS In December 2004, the FASB issued SFAS No. 123R, "Share--Based Payment", a revision of SFAS No. 123.“Share-Based Payment.” This Statement requires that compensation costs related to share-based payment transactions be recognized in the financial statements. Measurement of the cost of employee service will be based on the grant-date fair value of the equity or liability instruments issued. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. Additionally, liability awards will be remeasured each reporting period. Statement 123R replaces SFAS No. 123,"Accounting“Accounting for Stock-BasedCompensation"Compensation” andsupersedessupercedes APB Opinion No. 25,"Accounting“Accounting for Stock Issued to Employees."” This Statement is effective for annual periods beginning after June 15, 2005 and requires adoption using a modified prospective application or a modified retrospective application.The Statement is effective for interim periods beginning after June 15, 2005.However, on April 14, 2005, the SEC issued rule 2005-57, whichallowsallowed companies to delay implementation of the Statement to the beginning of the next fiscal year. The Companyhas not yet concludedadopted Statement 123R on January 1, 2006 under the modified prospective method, which resulted in an increase in noninterest expense ofadoption allowed byapproximately $6.2 million in theStatement and is currently evaluating the impact of this accounting guidance on its financial condition and results of operations.quarter ended March 31, 2006. Disclosure required under SFAS No.123123R is shown in Note 1 and Note 11 of these condensed consolidated financial statements.EXCHANGES OF NONMONETARY ASSETSExchanges of Nonmonetary Assets
In December 2004, the FASB issued SFAS No. 153,
"Exchanges“Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29."” This Statement amends the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and more broadly provides for exceptions regarding exchanges of nonmonetary assets that do not have commercial substance. This Statement specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of the Statement are effective for nonmonetary asset exchanges occurring in fiscalperiodperiods beginning after June 15, 2005.TheAt adoption,of this Statement did not have a materialthere was no impact on theCompany'sCompany’s financial position or results of operations.ACCOUNTING CHANGES AND ERROR CORRECTIONSAccounting Changes and Error Corrections
In May 2005, the FASB issued SFAS No. 154,
"Accounting“Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3."” The Statement requires that a voluntary change in accounting principle be applied retrospectively to all priorperiodperiods financial statements presented, unless impracticable to do so. It also provides that a change in method of depreciation or amortization for long-lived nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle, with the change applied prospectively and that correction of errors in previously issued financial statements should be termed a"restatement."“restatement.” The Statement is effective January 1, 2006. At adoption, there was no impact on the Company’s financial position or results of operations.Accounting for Certain Hybrid Financial Instruments
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140.” The Statement allows financial instruments that have embedded derivatives to be accounted for as a whole, (eliminating the need to bifurcate the derivative from its host) if the holder elects to irrevocably account for the whole instrument
12
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)Note 2—Recently Issued and Proposed Accounting Pronouncements (Continued)
on a fair value basis. The Statement is effective for
fiscal years 10UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED) beginningall financial instruments acquired or issued after December15, 2005.31, 2006. Management believes that adopting this Statement will not have a material impact on theCompany'sCompany’s financial position or results of operations.CONSOLIDATION OF VARIABLE INTEREST ENTITIESAccounting for Servicing of Financial Assets
In
January 2003,March 2006, the FASB issuedInterpretationSFAS No.46 (FIN 46), "Consolidation156, “Accounting for Servicing ofVariable Interest Entities." FIN 46 provides guidance on how to identify a variable interest entity (VIE),Financial Assets—an amendment of FASB Statement No. 140.” The Statement requires that all separately recognized servicing assets andwhen the assets,servicing liabilitiesnoncontrolling interests and results of operations of a VIE need tobeincluded in a company's consolidated financial statements. A VIE exists when either the total equity investmentinitially measured atrisk is not sufficient to permit thefair value, if practicable. It allows an entity tofinance its activities by itself,choose one of two subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities: the amortization method or theequity investors lack a controlling financial interestfair value method. Under the amortization method, servicing assets and liabilities are amortized in proportion to and over the period of estimated net servicing income orthey have voting rights thatservicing loss. Under the fair value method, servicing assets and liabilities arenot proportionate to their economic interest. A company that holds variable interestsrecorded at fair value each reporting period with any changes reported inan entity will need to consolidate that entity if the company's interest in the VIEcurrent period earnings. The Statement issuch that the company will absorb a majority of the VIE's expected losses and/or receive a majority of the VIE's expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. In December 2003, the FASB issued FIN 46R, a revision of FIN 46. FIN 46R clarifies that only the holder of a variable interest can ever be a VIE's primary beneficiary. FIN 46R delays theeffectivedate of FIN 46for allentities created subsequent to January 31, 2003 and non-SPEs (special-purpose entities) created prior to February 1, 2003 to reporting periods ending after March 15, 2004. Entities created prior to February 1, 2004 and defined as SPEs must apply either the provisions of FIN 46 or early adopt the provisions of FIN 46R by the first reporting period ending after December 15, 2003. The adoption of FIN 46Rservicing assets on January 1,2004 did2007. Management believes that adopting this Statement will not have a material impact on theCompany'sCompany’s financial position or results of operations.ACCOUNTING FOR CERTAIN LOANS ACQUIRED INAccounting for Conditional Asset Retirement Obligations
In March 2005, the FASB issued Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143.” FIN 47 generally applies to long-lived assets and requires a liability to be recognized for a conditional asset retirement obligation if the fair value of that liability can be reasonably estimated. A
TRANSFER In December 2003, under clearanceconditional asset retirement obligation is defined as a legal obligation to perform an activity associated with an asset retirement in which the timing and/or method of settlement are conditional on a future event that may or may not occur or be within the control of theFASB,company. A liability should be recognized when incurred (based on its fair value at that date), which generally would be upon theAccounting Standards Executive Committee (AcSEC)acquisition or construction of theAICPA issued Statementrelated asset. Upon recognition, the offset to the liability would be capitalized as part ofPosition (SOP) 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer." This SOP establishes accounting standards for discounts on purchased loans whenthediscountcost of the asset and depreciated over the estimated useful life of that asset. The Interpretation isattributable to credit quality.effective no later than December 31, 2005. TheSOP requires that the loan discount, rather than contractual amounts, establishes the investor's estimate of undiscounted expected future principal and interest cash flows as a benchmark for yield and impairment measurements. The SOP prohibits the carryover or creation of a valuation allowanceCompany adopted FIN 47 in theinitial accounting for these loans. This SOP is effective for loans acquired in years beginning after December 15, 2004. At adoption, there was no impactfourth quarter 2005 without material effect onthe Company'sits financial position or results of operations.DETERMINING WHETHER A GENERAL PARTNER CONTROLS A LIMITED PARTNERSHIPDetermining Whether a General Partner Controls a Limited Partnership
In June 2005, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 04-5,
"Determining“Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights."” The EITF reached a consensus that the general partners in a limited partnership are presumed to control that limited partnership regardless of the extent of the generalpartners'partners’ ownership interest in the limited partnership. The presumption of control by the general partner can be overcome if the limited partners have either (a) the substantive ability to dissolve the limited partnership or remove the general partners without cause or (b) substantive participating11UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)rights. The guidance is effective for all limited partnerships created or modified after June 29, 2005 and for all existing limited partnerships beginning January 1, 2006.Management believes that adopting this guidance will not have a materialAt adoption, there was no impact on theCompany'sCompany’s financial position or results of operations.NOTE 3--DISCONTINUED OPERATIONS13
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)Note 2—Recently Issued and Proposed Accounting Pronouncements (Continued)
Accounting for Defined Benefit Pension and Other Postretirement Plans—Exposure Draft
In March 2006, the FASB issued an Exposure Draft, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R).” This proposed Statement would require a company that sponsors a defined benefit pension plan or other postretirement benefit plan to fully recognize, as an asset or liability, the amount by which the defined-benefit-postretirement obligation is over- or under-funded. The amount would be measured as the difference between the fair value of plan assets and the projected benefit obligation. The proposed Statement would result in the immediate recognition of unrecognized prior service costs and credits and unrecognized net actuarial gains or losses as components of other comprehensive income with any unrecognized transition obligation or asset recorded as an adjustment to beginning retained earnings. The final statement is expected to be issued during the third quarter 2006, to be effective as of December 31, 2006. Based on guidance in the current exposure draft, the Company’s stockholders’ equity at December 31, 2005 would have been reduced by approximately six percent, if adopted.
Note 3—Discontinued Operations
During the third quarter 2005, the Bank signed a definitive agreement to sell its international correspondent banking operations (previously reported as the International Banking Group for segment reporting) to Wachovia Bank, N.A. effective October 6, 2005.
Effective third quarter 2005, theThe Company
is accountinghas accounted for this transaction as a discontinued operation andhasrestatedall ofits prior period financial statements. Theprincipal legal closingassets of the discontinued operations were reclassified as “held for sale” and accounted for at the lower of cost or fair value less the costs to sell. In determining the timing for recognizing the transactiontook place on October 6, 2005, withas a discontinued operation, the Bankreceiving $245 million inconcluded that the operations and cashfrom Wachovia Bank, N.A. The Bank may also earn a contingent payment not to exceed $45 million, based on the results of conversionflows of theinternational correspondent banking customer base to Wachovia Bank, N.A. Any such contingent payment woulddisposal group will beearned and receivedeliminated at the end of the transition period in the second quarter of2006. At the principal closing, no loans or other assets were acquired by Wachovia Bank, N.A., and no liabilities were assumed. The Bank continues to operate this international business, and will continue to do so over a transition period of several months, during which it is expected that a majority of the Bank's international correspondent banking customers will transfer to Wachovia Bank, N.A. In conjunction with the customer conversion process during the fourth quarter of 20052006 and thefirst quarter of 2006, it is expected that certain loans and other assets of the businessBank willbe acquired by Wachovia Bank, N.A. and certain related liabilities may be assumed. Wachovia Bank, N.A. will paynot have any significant continuing involvement incash to the Bank an amount equal to the net book value of assets acquired less any liabilities assumed. The Bank expects to complete its exit fromthe international correspondent bankingbusiness by the second quarter 2006. As customers are transferredbusiness.Interest expense was allocated to
Wachovia Bank, N.A.discontinued operations based on average net assets. The amount of interest expense allocated to discontinued operations during thecomingthree monthsthe Bank's international correspondent banking revenue will decline. International correspondent banking expenses will also decline, but not necessarilyended March 31, 2005 and 2006 was $2.5 million and $0.6 million, respectively.The severance reserve balances at
the same rate as revenue. 12UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 3--DISCONTINUED OPERATIONS (CONTINUED)December 31, 2005 and March 31, 2006 were $21.7 million and $16.2 million, respectively. The decrease of $5.5 million from December 31, 2005 primarily related to cash payments to employees.14
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)Note 3—Discontinued Operations (Continued)
At
September 30,March 31, 2005the Bank recordedand 2006, all assets related to the discontinued operations were recorded at the lower of cost or fairvalue.value, less costs of disposal. The assets and liabilities identified as discontinued operations were comprised of the following:
(DOLLARS IN THOUSANDS) DECEMBER 31, 2004 SEPTEMBER 30, 2005 - ---------------------- ----------------- -------------------ASSETS Cash and due from banks................................................................ $ 134,152 $ 77,738 Interest bearing deposits in banks..................................................... 214,423 245,371 Loans.................................................................................. 1,599,542 1,589,905 Due from customers on acceptances...................................................... 32,074 48,038 Premises and equipment................................................................. 3,888 3,030 Other assets........................................................................... 34,721 52,486 ---------- ---------- Assets of discontinued operations to be disposed or sold............................... $2,018,800 $2,016,568 ========== ========== LIABILITIES Noninterest bearing deposits........................................................... $ 541,467 $ 508,705 Interest bearing deposits.............................................................. 914,863 878,406 Other liabilities...................................................................... 76,769 99,711 ---------- ---------- Liabilities of discontinued operations to be extinguished or assumed................... $1,533,099 $1,486,822 ========== ==========
(Dollars in thousands)
March 31,
2005
March 31,
2006
Assets
Cash and due from banks
$
92,136
$
108,284
Interest bearing deposits in banks
224,029
18,489
Loans
1,584,124
101,134
Due from customers on acceptances
34,714
3,542
Premises and equipment
3,634
3
Other assets
37,332
9,473
Assets of discontinued operations to be disposed or sold
$
1,975,969
$
240,925
Liabilities
Noninterest bearing deposits
$
530,237
$
124,321
Interest bearing deposits
766,049
36,440
Other liabilities
75,905
40,904
Liabilities of discontinued operations to be extinguished or assumed
$
1,372,191
$
201,664
The components of income from discontinued operations for the three
and ninemonths endedSeptember 30, 2004March 31, 2005 and2005,2006, respectively are:
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- ------------------- (DOLLARS IN THOUSANDS) 2004 2005 2004 2005 - ---------------------- ---- ---- ---- ----Net interest income............................................................ $ 5,512 $ 5,400 $16,124 $15,683 Provision for loan losses...................................................... 938 -- 4,038 6,683 Noninterest income............................................................. 18,833 21,233 57,733 56,165 Noninterest expense............................................................ 12,815 52,245 37,146 87,550 ------- -------- ------- ------- Income (loss) from discontinued operations before income taxes................. 10,592 (25,612) 32,673 (22,385) Income tax expense (benefit)................................................... 4,094 (9,651) 12,628 (8,354) ------- -------- ------- -------- Income (loss) from discontinued operations..................................... $ 6,498 $(15,961) $20,045 $(14,031) ======= ======== ======= ========
For the three months
ended March 31,
(Dollars in thousands)
2005
2006
Net interest income
$
5,137
$
1,725
Provision for loan losses
4,119
—
Noninterest income
17,136
5,811
Noninterest expense
14,515
21,139
Income (loss) from discontinued operations before income taxes
3,639
(13,603
)
Income tax expense (benefit)
1,413
(5,093
)
Income (loss) from discontinued operations
$
2,226
$
(8,510
)
Included in noninterest expense for the three
and ninemonths endedSeptember 30,March 31, 2005was approximately $25 million of severance expenseandan impairment of approximately $1 million was recorded relating to the write-off of software in development. In addition,2006 were compliance related expensesthe majorityofwhich relates to outside consultants, were approximately $14$2.6 million and$25$4.8 million,for the three and nine months ended September 30, 2005,respectively.For the three and nine months ended September 30, 2004, these compliance related expenses were $0.5 million and $0.5 million, respectively. 13UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 4--EARNINGS PER SHARENote 4—Earnings Per Share
Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS incorporates the dilutive effect of common stock equivalents outstanding on an average basis during the period. Stock options are a common stock
15
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)Note 4—Earnings Per Share (Continued)
equivalent. The following table presents a reconciliation of basic and diluted EPS for the three
and ninemonths endedSeptember 30, 2004March 31, 2005 and2005.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, -------------------------------- ------------------------------- 2004 2005 2004 2005 ---- ---- ---- ---- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) BASIC DILUTED BASIC DILUTED BASIC DILUTED BASIC DILUTED - --------------------------------------------- ----- ------- ----- ------- ----- ------- ----- -------Income from continuing operations............ $156,940 $156,940 $201,246 $201,246 $531,977 $531,977 $568,475 $568,475 Income (loss) from discontinued operations... 6,498 6,498 (15,961) (15,961) 20,045 20,045 (14,031) (14,031) -------- -------- -------- -------- -------- -------- -------- -------- Net income................................... $163,438 $163,438 $185,285 $185,285 $552,022 $552,022 $554,444 $554,444 ======== ======== ======== ======== ======== ======== ======== ======== Weighted average common shares outstanding... 147,555 147,555 144,459 144,459 147,548 147,548 145,326 145,326 Additional shares due to: Assumed conversion of dilutive stock options -- 2,824 -- 3,154 -- 2,479 -- 2,736 -------- -------- -------- -------- -------- -------- -------- -------- Adjusted weighted average common shares outstanding................................ 147,555 150,379 144,459 147,613 147,548 150,027 145,326 148,062 ======== ======== ======== ======== ======== ======== ======== ======== Income from continuing operations per share.. $1.06 $1.04 $1.39 $1.36 $3.61 $3.55 $3.91 $3.84 Income (loss) from discontinued operations per share...................................... 0.05 0.05 (0.11) (0.10) 0.13 0.13 (0.09) (0.10) -------- -------- -------- -------- -------- -------- -------- -------- Net income per share......................... $1.11 $1.09 $1.28 $1.26 $3.74 $3.68 $3.82 $3.74 ======== ======== ======== ======== ======== ======== ======== ========14UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 5--ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)2006.
Three Months Ended March 31,
2005
2006
(Amounts in thousands, except per share data)
Basic
Diluted
Basic
Diluted
Income from continuing operations
$
179,751
$
179,751
$
181,455
$
181,455
Income (loss) from discontinued operations
2,226
2,226
(8,510
)
(8,510
)
Net Income
$
181,977
$
181,977
$
172,945
$
172,945
Weighted average common shares outstanding
146,998
146,998
143,878
143,878
Additional shares due to:
Assumed conversion of dilutive stock options
—
2,918
—
2,148
Adjusted weighted average common shares outstanding
146,998
149,916
143,878
146,026
Income from continuing operations per share
$
1.22
$
1.20
$
1.26
$
1.24
Income (loss) from discontinued operations per share
0.02
0.01
(0.06
)
(0.06
)
Net income per share
$
1.24
$
1.21
$
1.20
$
1.18
16
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 5—Accumulated Other Comprehensive Income (Loss)
The following table presents the change in each of the components of other comprehensive income (loss) and the related tax effect of the change allocated to each component.
BEFORE TAX TAX NET OF (DOLLARS IN THOUSANDS) AMOUNT EFFECT TAX - ---------------------- ------ ------ ---FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004: Cash flow hedge activities: Unrealized net gains on hedges arising during the period................................ $ 12,680 $(4,850) $ 7,830 Reclassification adjustment for net gains on hedges included in net income.............. (61,725) 23,610 (38,115) --------- ------- -------- Net change in unrealized gains on hedges.................................................. (49,045) 18,760 (30,285) --------- ------- -------- Securities available for sale: Unrealized holding losses arising during the period on securities available for sale.... (68,679) 26,270 (42,409) Reclassification adjustment for net gains on securities available for sale included in net income............................................................................ (1,612) 617 (995) --------- ------- -------- Net change in unrealized losses on securities available for sale.......................... (70,291) 26,887 (43,404) --------- ------- -------- Foreign currency translation adjustment................................................... 1,025 (392) 633 --------- ------- -------- Net change in accumulated other comprehensive income (loss)............................... $(118,311) $45,255 $(73,056) ========= ======= ======== FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005: Cash flow hedge activities: Unrealized net losses on hedges arising during the period............................... $ (31,082) $11,889 $(19,193) Reclassification adjustment for net gains on hedges included in net income.............. (16,652) 6,369 (10,283) --------- ------- -------- Net change in unrealized losses on hedges................................................. (47,734) 18,258 (29,476) --------- ------- -------- Securities available for sale: Unrealized holding losses arising during the period on securities available for sale.... (92,392) 35,340 (57,052) Reclassification adjustment for net losses on securities available for sale included in net income............................................................................ 13,289 (5,083) 8,206 --------- ------- -------- Net change in unrealized losses on securities available for sale.......................... (79,103) 30,257 (48,846) --------- ------- -------- Foreign currency translation adjustment................................................... 128 (49) 79 --------- ------- -------- Minimum pension liability adjustment...................................................... (26) 10 (16) --------- ------- -------- Net change in accumulated other comprehensive income (loss)............................... $(126,735) $48,476 $(78,259) ========= ======= ========15UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 5--ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (CONTINUED)
Before
Tax
Tax
Net of
(Dollars in thousands)
Amount
Effect
Tax
For the Three Months Ended March 31, 2005:
Cash flow hedge activities:
Unrealized net losses on hedges arising during the period
$
(32,277
)
$
12,346
$
(19,931
)
Reclassification adjustment for net gains on hedges included in net income
(6,418
)
2,455
(3,963
)
Net change in unrealized losses on hedges
(38,695
)
14,801
(23,894
)
Securities available for sale:
Unrealized holding losses arising during the period on securities available for sale
(107,158
)
40,988
(66,170
)
Reclassification adjustment for net gains on securities available for sale included in net income
(344
)
132
(212
)
Net change in unrealized losses on securities available for sale
(107,502
)
41,120
(66,382
)
Foreign currency translation adjustment
481
(184
)
297
Minimum pension liability adjustment
(26
)
10
(16
)
Net change in accumulated other comprehensive income (loss)
$
(145,742
)
$
55,747
$
(89,995
)
For the Three Months Ended March 31, 2006:
Cash flow hedge activities:
Unrealized net losses on hedges arising during the period
$
(25,004
)
$
9,564
$
(15,440
)
Reclassification adjustment for net losses on hedges included in net income
5,722
(2,189
)
3,533
Net change in unrealized losses on hedges
(19,282
)
7,375
(11,907
)
Securities available for sale:
Unrealized holding losses arising during the period on securities available for sale
(47,713
)
18,250
(29,463
)
Reclassification adjustment for net losses on securities available for sale included in net income
214
(82
)
132
Net change in unrealized losses on securities available for sale
(47,499
)
18,168
(29,331
)
Foreign currency translation adjustment
(26
)
10
(16
)
Net change in accumulated other comprehensive income (loss)
$
(66,807
)
$
25,553
$
(41,254
)
17
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 5—Accumulated Other Comprehensive Income (Loss) (Continued)
The following table presents accumulated other comprehensive income (loss) balances.
NET NET UNREALIZED UNREALIZED GAINS GAINS (LOSSES) (LOSSES) FOREIGN MINIMUM ACCUMULATED ON CASH ON SECURITES CURRENCY PENSION OTHER FLOW AVAILABLE TRANSLATION LIABILITY COMPREHENSIVE (DOLLARS IN THOUSANDS) HEDGES FOR SALE ADJUSTMENT ADJUSTMENT INCOME (LOSS) - ---------------------- ------ -------- ---------- ---------- -------------BALANCE, DECEMBER 31, 2003............................ $ 43,786 $ 22,535 $(10,293) $(3,786) $ 52,242 Change during the period.............................. (30,285) (43,404) 633 -- (73,056) -------- -------- -------- ------- --------- BALANCE, SEPTEMBER 30, 2004........................... $ 13,501 $(20,869) $ (9,660) $(3,786) $ (20,814) ======== ======== ======== ======= ========= BALANCE, DECEMBER 31, 2004............................ $1,429 $(31,696) $ (7,870) $(6,690) $ (44,827) Change during the period.............................. (29,476) (48,846) 79 (16) (78,259) -------- -------- -------- ------- --------- BALANCE, SEPTEMBER 30, 2005........................... $(28,047) $(80,542) $ (7,791) $(6,706) $(123,086) ======== ======== ======== ======= =========NOTE 6--BUSINESS COMBINATIONS The following describes the Company's most recent acquisitions: On January 16, 2004, the Company completed its acquisition of Business Bank of California, a commercial bank headquartered in San Bernardino, California, with $704 million in assets
Net
Net
��
Unrealized
Unrealized
Gains (Losses)
Gains (Losses)
Foreign
Minimum
Accumulated
on Cash
on Securites
Currency
Pension
Other
Flow
Available
Translation
Liability
Comprehensive
(Dollars in thousands)
Hedges
For Sale
Adjustment
Adjustment
Income (Loss)
Balance, December 31, 2004
$
1,429
$
(31,696
)
$
(7,870
)
$
(6,690
)
$
(44,827
)
Change during the period
(23,894
)
(66,382
)
297
(16
)
(89,995
)
Balance, March 31, 2005
$
(22,465
)
$
(98,078
)
$
(7,573
)
$
(6,706
)
$
(134,822
)
Balance, December 31, 2005
$
(34,308
)
$
(74,099
)
$
264
$
(10,250
)
$
(118,393
)
Change during the period
(11,907
)
(29,331
)
(16
)
—
(41,254
)
Balance, March 31, 2006
$
(46,215
)
$
(103,430
)
$
248
$
(10,250
)
$
(159,647
)
Note 6—Goodwill and
fifteen full-service branches in the Southern California Inland Empire and the San Francisco Bay Area. The core deposit intangibles are being amortized on an accelerated basis over an estimated life of 6 years. On August 1, 2004, the Company completed its acquisition of the business portfolio of CNA Trust Company (CNAT). The Company acquired total assets and assumed total liabilities of $173 million, each. CNAT, based in Costa Mesa, California, was a subsidiary of Chicago-based CNA Financial Corporation. The identifiable intangibles are being amortized on an accelerated basis over an estimated life of 7 years. On October 28, 2004, the Company completed its acquisition of Jackson Federal Bank, a savings bank headquartered in Brea, California. The Company acquired approximately $1.4 billion in total assets and fourteen branches. The core deposit intangibles are being amortized on an accelerated basis over an estimated life of 7 years. NOTE 7--GOODWILL AND INTANGIBLE ASSETSIntangible AssetsThe table below reflects the
Company'sCompany’s identifiable intangible assets and accumulated amortization atSeptember 30, 2004March 31, 2005 and2005.
SEPTEMBER 30, 2004 SEPTEMBER 30, 2005 ------------------ ------------------ GROSS GROSS CARRYING ACCUMULATED NET CARRYING CARRYING ACCUMULATED NET CARRYING DOLLARS IN THOUSANDS AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT - -------------------- ------ ------------ ------ ------ ------------ ------Core Deposit Intangibles.................... $62,888 $(25,680) $37,208 $ 67,237 $(41,198) $26,039 Rights-to-Expiration........................ 35,808 (12,039) 23,769 35,808 (16,530) 19,278 Other....................................... -- -- -- 2,100 (636) 1,464 ------- -------- ------- -------- -------- ------- Total..................................... $98,696 $(37,719) $60,977 $105,145 $(58,364) $46,781 ======= ======== ======= ======== ======== =======16UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 7--GOODWILL AND INTANGIBLE ASSETS (CONTINUED)2006.
March 31, 2005
March 31, 2006
Dollars in thousands
Gross
Carrying
Amount
Accumulated
Amortization
Net
Carrying
Amount
Gross
Carrying
Amount
Accumulated
Amortization
Net
Carrying
Amount
Core Deposit Intangibles
$
67,237
$
(33,651
)
$
33,586
$
67,237
$
(47,368
)
$
19,869
Rights-to-Expiration
35,808
(14,360
)
21,448
36,608
(18,532
)
18,076
Other
2,100
(383
)
1,717
2,100
(859
)
1,241
Total
$
105,145
$
(48,394
)
$
56,751
$
105,945
$
(66,759
)
$
39,186
Total amortization expense for the
three-monthsthree months endedSeptember 30, 2004March 31, 2005 and2005 were $5.12006 was $5.0 million and$5.0$3.4 million, respectively.For the nine-months ended September 30, 2004
Core Deposit
Intangibles
Rights-to-
Expiration
Other
Total Identifiable
Intangible Assets
Estimated amortization expense for the years ending:
Remaining 2006
$
7,176
$
2,788
$
291
$
10,255
2007
5,471
3,166
299
8,936
2008
3,245
2,675
231
6,151
2009
1,764
2,242
178
4,184
2010
807
1,859
137
2,803
2011
443
1,519
105
2,067
thereafter
963
3,827
—
4,790
Total amortization expense after March 31, 2006
$
19,869
$
18,076
$
1,241
$
39,186
18
UnionBanCal Corporation and
2005, the expense was $13.8 millionSubsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 6—Goodwill and
$15.0 million, respectively.Intangible Assets (Continued)
TOTAL IDENTIFIABLE CORE DEPOSIT RIGHTS-TO- INTANGIBLE INTANGIBLES EXPIRATION OTHER ASSETS ----------- ---------- ----- ------Estimated amortization expense for the years ending: Remaining 2005.............................................................. $ 3,775 $ 1,056 $ 124 $ 4,955 2006........................................................................ 9,571 3,672 389 13,632 2007........................................................................ 5,471 3,113 299 8,883 2008........................................................................ 3,245 2,622 231 6,098 2009........................................................................ 1,764 2,188 178 4,130 2010........................................................................ 807 1,805 138 2,749 thereafter.................................................................. 1,406 4,822 105 6,334 ------- ------- ------ ------- Total amortization expense after September 30, 2005......................... $26,039 $19,278 $1,464 $46,781 ======= ======= ====== =======The changes in the carrying amount of goodwill during the
ninethree months endedSeptember 30, 2004March 31, 2005 and20052006 are shown below.An error in the recognition of deferred taxes related to one of the bank acquisitions is included in the table. This error had no impact on net income.
(DOLLARS IN THOUSANDS) 2004 2005 - ---------------------- ---- ----Balance, January 1,.................................................................................. $226,556 $450,961 Acquired during the nine months ended September 30,.................................................. 94,279 -- Contingent period adjustments...................................................................... -- (415) Correction of an error............................................................................. -- 2,071 -------- -------- Balance, September 30,............................................................................... $320,835 $452,617 ======== ========NOTE 8--BUSINESS SEGMENTS
(Dollars in thousands)
2005
2006
Balance, January 1,
$
450,961
$
454,015
Acquired during the three months ended March 31,
—
—
Contingent period adjustments
(1,274
)
—
Adjustment for contingent consideration
438
(526
)
Balance, March 31,
$
450,125
$
453,489
Note 7—Business Segments
In April 2005, the Company announced several organizational changes that affected its business segments. The Global Markets Group
has beenwas eliminated and the activities of this grouphave beenwere transferred. Corporate Treasury, which is responsible forAsset- LiabilityAsset-Liability Management (ALM) wholesale funding and theinvestment portfolioALM securities and derivatives hedging portfolios of the Company, is now included in"Other."“Other.” The trading of securities and foreign exchange contracts, as well as the responsibilities for customer accommodated derivative contracts, are now included in the"Global“Global MarketsDivision"Division” of the Community Banking and Investment Services Group. In addition, the discontinued operations resulting from thesaledisposal of most of theCompany'sCompany’s International Banking Group are also reflected in"Other."“Other.” The Company is now organized around the target markets it serves and operates in two principal areas:o· The Community Banking and Investment Services Group offers a range of banking services, primarily to individuals and small businesses, delivered generally through a tri-state (California, Washington and Oregon) network of branches and ATMs. These services include mortgages, home equity lines of credit, consumer and commercial loans, deposit services and cash management as
17UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 8--BUSINESS SEGMENTS (CONTINUED)well as fiduciary, private banking, investment and asset management services for individuals and institutions, and risk management and insurance products for businesses and individuals. AtSeptember 30, 2004March 31, 2005 and2005,2006, this Group had$307.0$312.0 million and$314.8$315.7 million, respectively, of goodwill assigned to its businesses.o· The Commercial Financial Services Group provides credit, depository and cash management services to large corporate and
middle- marketmiddle-market companies and numerous specialty niches. Services include commercial and project loans, real estate financing, asset-based financing, trade finance and letters of credit, lease financing, customized cash management services and selected capital markets products. AtSeptember 30, 2004,March 31, 2005 and 2006, this Group had$13.8$138.1 million and $137.8 million, respectively, of goodwill assigned to itsbusinesses compared to $137.8 million of goodwill assigned to its businesses at September 30, 2005.businesses.The information, set forth in the
tablestable on the following page, reflects selected income statement and balance sheet items by business segment. The information presented does not necessarily represent the businessunits'units’ financial condition and results of operations were they independent entities. Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to US GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies. Included in thetablestable within total assets are the amounts of goodwill for each business segment as ofSeptember 30, 2004March 31, 2005 and2005.2006.19
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 7—Business Segments (Continued)
The information in
these tablesthe table is derived from the internal management reporting system used by management to measure the performance of the business segments and the Company overall. The management reporting system assigns balance sheet and income statement items to each business segment based on internal management accounting policies. Net interest income is determined by theCompany'sCompany’s internal funds transfer pricing system, which assigns a cost of funds or a credit for funds to assets or liabilities based on their type, maturity or repricing characteristics. Noninterest income and expense directly attributable to a business segment are assigned to thatbusiness.business segment. Certain indirect costs, such as operations and technology expense, are allocated to the segments based on studies of billable unit costs for product or data processing. Other indirect costs, such as corporate overhead, are allocated to the business segments based on a predetermined percentage of usage. Under theCompany'sCompany’s risk-adjusted return on capital (RAROC) methodology, credit expense is charged to business segments based upon expected losses arising from credit risk. In addition, the attribution of economic capital is related to unexpected losses arising from credit, market and operational risks."Other"“Other” is comprised of our discontinued operations, certain parent company non-bank subsidiaries, the elimination of the fully taxable-equivalent basis amount, the transfer pricing center, the amount of the provision for loan losses over/(under) the RAROC expected loss for the period, the earnings associated with the unallocated equity capital and
allowanceallowances for credit losses, and the residual costs of support groups. In addition,"Other"“Other” includes the Pacific Rim Corporate Group, which offers financial products to Japanese-owned subsidiaries located in the U.S.and, Corporate Treasury, whichmanages the Company'sis responsible for ALM, wholesale funding,needs, securities portfolio, interest rateandliquidity risk.the ALM Investment and derivatives hedging portfolios, and the results of our discontinued operations. Except as discussed above, none of the items in"Other"“Other” are significant to theCompany'sCompany’s business.18UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 8--BUSINESS SEGMENTS (CONTINUED)In the first quarter 2006, the Company changed its reporting to reflect a “market view” perspective in measuring the business segments. The market view is a measurement of customer markets aggregated to show all revenues generated and expenses incurred from all products and services sold to those customers regardless of where product areas organizationally report. Therefore, revenues and expenses are included in both the business segment that provides the service and the business segment that manages the customer relationship. The duplicative results from this internal management accounting view are reflected in “Reconciling Items.”
20
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 7—Business Segments (Continued)
The business
units'unit results for the prior periods have beenrestatedadjusted to reflect changes in the transfer pricing methodology, the organizational changes that have occurred, discontinued operations andour discontinued operations.
COMMUNITY BANKING AND INVESTMENT SERVICES COMMERCIAL FINANCIAL GROUP SERVICES GROUP ----------------------- -------------------- AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, -------------------------------------------------- 2004 2005 2004 2005 ---- ---- ---- ----RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS): Net interest income....................................................... $197,024 $235,907 $176,381 $227,476 Noninterest income (expense).............................................. 127,907 138,885 63,020 67,994 -------- -------- -------- -------- Total revenue............................................................. 324,931 374,792 239,401 295,470 Noninterest expense....................................................... 242,406 246,936 104,361 122,404 Credit expense (income)................................................... 8,450 8,783 24,738 20,458 -------- -------- -------- -------- Income from continuing operations before income taxes..................... 74,075 119,073 110,302 152,608 Income tax expense........................................................ 28,334 45,545 35,233 51,493 -------- -------- -------- -------- Income from continuing operations......................................... 45,741 73,528 75,069 101,115 Income (loss) from discontinued operations, net of income taxes........... -- -- -- -- -------- -------- -------- -------- Net income................................................................ $ 45,741 $ 73,528 $ 75,069 $101,115 ======== ======== ======== ======== TOTAL ASSETS, END OF PERIOD (DOLLARS IN MILLIONS):........................ $ 14,867 $ 17,611 $ 15,751 $ 19,728 ======== ======== ======== ========UNIONBANCAL OTHER CORPORATION ----------------------- -------------------- AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, -------------------------------------------------- 2004 2005 2004 2005 ---- ---- ---- ----RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS): Net interest income......................................................... $33,173 $ 759 $406,578 $464,142 Noninterest income (expense)................................................ 6,193 5,309 197,120 212,188 ------- ------- -------- -------- Total revenue............................................................... 39,366 6,068 603,698 676,330 Noninterest expense......................................................... 12,809 27,356 359,576 396,696 Credit expense (income)..................................................... (44,127) (44,241) (10,939) (15,000) ------- ------- -------- -------- Income from continuing operations before income taxes....................... 70,684 22,953 255,061 294,634 Income tax expense.......................................................... 34,554 (3,650) 98,121 93,388 ------- ------- -------- -------- Income from continuing operations........................................... 36,130 26,603 156,940 201,246 Income (loss) from discontinued operations, net of income taxes............. 6,498 (15,961) 6,498 (15,961) ------- ------- -------- -------- Net income.................................................................. $42,628 $10,642 $163,438 $185,285 ======= ======= ======== ======== TOTAL ASSETS, END OF PERIOD (DOLLARS IN MILLIONS):.......................... $16,373 $13,960 $ 46,991 $ 51,299 ======= ======= ======== ========19UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 8--BUSINESS SEGMENTS (CONTINUED)
COMMUNITY BANKING AND INVESTMENT SERVICES COMMERCIAL FINANCIAL GROUP SERVICES GROUP ----------------------- -------------------- AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------------------- 2004 2005 2004 2005 ---- ---- ---- ----RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS): Net interest income..................................................... $553,095 $ 692,546 $495,870 $646,283 Noninterest income (expense)............................................ 379,818 410,391 202,629 206,445 -------- ---------- -------- -------- Total revenue........................................................... 932,913 1,102,937 698,499 852,728 Noninterest expense..................................................... 695,739 763,189 311,470 346,525 Credit expense (income)................................................. 24,134 25,423 82,443 65,500 -------- ---------- -------- -------- Income from continuing operations before income taxes................... 213,040 314,325 304,586 440,703 Income tax expense...................................................... 81,488 120,229 97,187 147,343 -------- ---------- -------- -------- Income from continuing operations....................................... 131,552 194,096 207,399 293,360 Income (loss) from discontinued operations, net of income taxes......... -- -- -- -- -------- ---------- -------- -------- Net income.............................................................. $131,552 $ 194,096 $207,399 $293,360 ======== ========== ======== ======== TOTAL ASSETS, END OF PERIOD (DOLLARS IN MILLIONS):...................... $ 14,867 $ 17,611 $ 15,751 $ 19,728 ======== ========== ======== ========UNIONBANCAL OTHER CORPORATION ----------------------- -------------------- AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------------------- 2004 2005 2004 2005 ---- ---- ---- ----RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS): Net interest income....................................................... $147,280 $ 19,685 $1,196,245 $1,358,514 Noninterest income (expense).............................................. 117,987 4,531 700,434 621,367 -------- -------- ---------- ---------- Total revenue............................................................. 265,267 24,216 1,896,679 1,979,881 Noninterest expense....................................................... 77,542 68,334 1,084,751 1,178,048 Credit expense (income)................................................... (135,615) (131,606) (29,038) (40,683) -------- -------- ---------- ---------- Income from continuing operations before income taxes..................... 323,340 87,488 840,966 842,516 Income tax expense........................................................ 130,314 6,469 308,989 274,041 -------- -------- ---------- ---------- Income from continuing operations......................................... 193,026 81,019 531,977 568,475 Income (loss) from discontinued operations, net of income taxes........... 20,045 (14,031) 20,045 (14,031) -------- -------- ---------- ---------- Net income................................................................ $213,071 $ 66,988 $ 552,022 $ 554,444 ======== ======== ========== ========== TOTAL ASSETS, END OF PERIOD (DOLLARS IN MILLIONS):........................ $ 16,373 $ 13,960 $ 46,991 $ 51,299 ======== ======== ========== ==========NOTE 9--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGINGthe market view contribution.
Community Banking
and Investment
Services Group
Commercial Financial
Services Group
As of and for the
As of and for the
Three Months Ended
March 31,
Three Months Ended
March 31,
2005
2006
2005
2006
Results of operations—Market View (dollars in thousands):
Net interest income (expense)
$
222,860
$
242,829
$
203,576
$
224,687
Noninterest income (expense)
149,747
162,311
65,110
65,936
Total revenue
372,607
405,140
268,686
290,623
Noninterest expense (income)
269,271
279,312
108,203
122,513
Credit expense (income)
8,933
8,931
23,511
22,563
Income from continuing operations before income taxes
94,403
116,897
136,972
145,547
Income tax expense
35,415
43,949
45,594
47,899
Income from continuing operations
58,988
72,948
91,378
97,648
Income (loss) from discontinued operations, net of income taxes
—
—
—
—
Net income
$
58,988
$
72,948
$
91,378
$
97,648
Total assets, end of period—Market View (dollars in millions):
$
16,398
$
18,694
$
18,041
$
20,836
Other
Reconciling Items
UnionBanCal
Corporation
As of and for the
As of and for the
As of and for the
Three Months Ended
March 31,
Three Months Ended
March 31,
Three months Ended
March 31,
2005
2006
2005
2006
2005
2006
Results of operations—Market View (dollars in thousands):
Net interest income (expense)
$
9,816
$
(1,916
)
$
(590
)
$
(507
)
$
435,662
$
465,093
Noninterest income (expense)
6,498
7,508
(15,730
)
(17,845
)
205,625
217,910
Total revenue
16,314
5,592
(16,320
)
(18,352
)
641,287
683,003
Noninterest expense (income)
21,225
20,232
(5,747
)
(7,513
)
392,952
414,544
Credit expense (income)
(44,414
)
(38,451
)
(149
)
(43
)
(12,119
)
(7,000
)
Income from continuing operations before income taxes
39,503
23,811
(10,424
)
(10,796
)
260,454
275,459
Income tax expense
3,681
6,285
(3,987
)
(4,129
)
80,703
94,004
Income from continuing operations
35,822
17,526
(6,437
)
(6,667
)
179,751
181,455
Income (loss) from discontinued operations, net of income taxes
2,226
(8,510
)
—
—
2,226
(8,510
)
Net income
$
38,048
$
9,016
$
(6,437
)
$
(6,667
)
$
181,977
$
172,945
Total assets, end of period—Market View (dollars in millions):
$
15,057
$
9,323
$
(63
)
$
(52
)
$
49,433
$
48,801
21
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 8—Derivative Instruments and Other Financial Instruments Used For Hedging
Derivative positions are integral components of the
Company'sCompany’s designated ALM activities. The Company uses interest rate derivatives to manage the sensitivity of theCompany'sCompany’s net interest income to changes in interest rates. These instruments are used to manage interest rate risk relating to specified20UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 9--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING (CONTINUED)groups of assets and liabilities, primarily LIBOR-based commercial loans, certificates of deposit, medium-term notes and subordinated debt.CASH FLOW HEDGES HEDGING STRATEGIES FOR VARIABLE RATE LOANS AND CERTIFICATES OF DEPOSITThe following describes the significant hedging strategies of the Company.Cash Flow Hedges
Hedging Strategies for Variable Rate Loans and Certificates of Deposit
The Company engages in several types of cash flow hedging strategies for which the hedged transactions are forecasted future loan
and depositinterestreceipt andpayments, and the hedged risk is the variability in thosereceipts/payments due to changes in the designated benchmark rate,e.g.,i.e. U.S. dollar LIBOR. In these strategies, the hedging instruments are matched with groups of variable rate loansor depositssuch that the tenor of the variable rateloans/depositsloans and that of the hedging instrument arealigned.identical. Cash flow hedging strategies include the utilization of purchased floor, cap and corridor options and interest rate swaps. AtSeptember 30, 2005,March 31, 2006, the weighted average remaining life of the currently active (excluding any forward positions) cash flow hedges was approximately1.51.6 years.The Company uses purchased interest rate floors to hedge the variable cash flows associated with 1-month
to 6-monthLIBOR or 3-month LIBOR indexed loans. Payments received under the floor contract offset the decline in loan interest income caused by the relevant LIBOR index falling below thefloor'sfloor’s strike rate.The Company uses interest rate floor corridors to hedge the variable cash flows associated with 1-month
to 6-monthLIBOR or 3-month LIBOR indexed loans. Net payments to be received under the floor corridor contracts offset the decline in loan interest income caused by the relevant LIBOR index falling below thecorridor'scorridor’s upper strike rate, but only to the extent the index falls to the lower strike rate. The corridor will not provide protection from declines in the relevant LIBOR index to the extent it falls below thecorridor'scorridor’s lower strike rate.The Company uses interest rate collars to hedge the variable cash flows associated with 1-month
to 6-monthLIBOR or 3-month LIBOR indexed loans. Net payments to be received under the collar contract offset the decline in loan interest income caused by the relevant LIBOR index falling below thecollar'scollar’s floor strike rate while net payments to be paid will reduce the increase in loan interest income caused by the LIBOR index rising above thecollar'scollar’s cap strike rate.The Company uses interest rate swaps to hedge the variable cash flows associated with 1-month
to 6-monthLIBOR or 3-month LIBOR indexed loans. Payments to be received (or paid) under the swap contract will offset the fluctuations in loan interest income caused by changes in the relevant LIBOR index. As such, these instruments hedge all fluctuations in theloans'loans’ interest income caused by changes in the relevant LIBOR index.The Company uses purchased interest rate caps to hedge the variable interest cash flows associated with the forecasted issuance and rollover of short-term, fixed rate
certificates of deposit (CDs)time deposits (TDs). In these hedging relationships, the Company hedges the LIBOR component of theCDTD rates, which is1-month to 6-month3-month LIBOR, based on theCDs'TDs’ original term to maturity, which reflects their repricing frequency. Net payments to be received22
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 8—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)
under the cap contract offset the increase in interest expense caused by the relevant LIBOR index rising above the
cap'scap’s strike rate.The Company uses interest rate cap corridors to hedge the variable cash flows associated with the forecasted issuance and rollover of short-term, fixed rate,
CDs.TDs. In these hedging relationships, the21UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 9--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING (CONTINUED)Company hedges the LIBOR component of theCDTD rates, either 1-month LIBOR, 3-month LIBOR, or 6-month LIBOR, based on the original term to maturity of theCDs,TDs, which reflects their repricing frequency. Net payments to be received under the cap corridor contract offset the increase in deposit interest expense caused by the relevant LIBOR index rising above thecorridor'scorridor’s lower strike rate, but only to the extent the index rises to the upper strike rate. The corridor will not provide protection from increases in the relevant LIBOR index to the extent it rises above thecorridor'scorridor’s upper strike rate.Hedging transactions are structured at inception so that the notional amounts of the hedge are matched with an equal principal amount of loans or
CDs,TDs, the index and repricing frequencies of the hedge matches those of the loans orCDs,TDs, and the period in which the designated hedged cash flows occurs is equal to the term of the hedge. As such, most of the ineffectiveness in the hedging relationship results from the mismatch between the timing of reset dates on the hedge versus those of the loans orCDs.TDs. In thethirdfirst quarter of2005,2006, the Company recognized a net loss of less than $0.1 million due to ineffectiveness, which is recognized in other noninterest expense, compared to a netgainloss of $0.1 million in thethirdfirst quarter of2004. FAIR VALUE HEDGES HEDGING STRATEGY FOR "MARKETPATH" CERTIFICATES OF DEPOSIT The Company engages in a hedging strategy in which interest bearing CDs issued to customers, which are tied to the changes in the Standard and Poor's 500 index, are exchanged2005.Fair Value Hedges
Hedging Strategy for
a fixed rate of interest. The Company accounts for the embedded derivative in the CDs at fair value. A total return swap that encompasses the value of a series of options that had individually hedged each CD is valued at fair value and any ineffectiveness resulting from the hedge and the hedged item are recognized in noninterest expense. HEDGING STRATEGY FOR UNIONBANCAL CORPORATION--JUNIOR SUBORDINATED DEBT PAYABLE TO SUBSIDIARY GRANTOR TRUST (TRUST NOTES) On February 19, 2004, the Company terminated its fair value hedge and called its Trust Notes. Prior to this date, the Company engaged in an interest rate hedging strategy in which an interest rate swap was associated with a specific interest bearing liability, UnionBanCal Corporation's TrustMedium-Term Notesin order to convert the liability from a fixed rate to a floating rate instrument. This strategy mitigated the changes in fair value of the hedged liability caused by changes in the designated benchmark interest rate, U.S. dollar LIBOR. At the termination date, the Company recognized a net gain of $1.6 million related to hedge ineffectiveness. HEDGING STRATEGY FOR MEDIUM-TERM NOTESThe Company engages in an interest rate hedging strategy in which an interest rate swap is associated with a specified interest bearing liability, UnionBanCal
Corporation'sCorporation’s five-year, medium-term debt issuance, in order to convert the liability from a fixed rate to a floating rate instrument. This strategy mitigates the changes in fair value of the hedged liability caused by changes in the designated benchmark interest rate, U.S. dollar LIBOR.22UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 9--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING (CONTINUED)The fair value hedging transaction for the medium-term notes was structured at inception to mirror all of the provisions of the medium-term notes, which allows the Company to assume that no ineffectiveness exists.
HEDGING STRATEGY FOR SUBORDINATED DEBTHedging Strategy for Subordinated Debt
The Company engages in an interest rate hedging strategy in which an interest rate swap is associated with a specified interest bearing liability, UnionBanCal
Corporation'sCorporation’s ten-year, subordinated debt issuance, in order to convert the liability from a fixed rate to a floating rate instrument. This strategy mitigates the changes in fair value of the hedged liability caused by changes in the designated benchmark interest rate, U.S. dollar LIBOR.The fair value hedging transaction for the subordinated debt was structured at inception to mirror all of the provisions of the subordinated debt, which allows the Company to assume that no ineffectiveness exists.
OTHER23
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 8—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)
Other
The Company uses To-Be-Announced (TBA) contracts to fix the price and yield of anticipated purchases or sales of mortgage-backed securities that will be delivered at an agreed upon date. This strategy hedges the risk of variability in the cash flows to be paid or received upon settlement of the TBA contract.
NOTE 10--GUARANTEESEconomic Hedging Strategy for “MarketPath” Certificates of Deposit
The Company engages in an economic hedging strategy in which interest bearing CDs issued to customers, which are tied to the changes in the Standard and Poor’s 500 index, are exchanged for a fixed rate of interest. The Company accounts for the embedded derivative in the CDs at fair value. A total return swap that encompasses the value of a series of options that had individually hedged each CD is valued at fair value. The changes in the fair value of the embedded derivative and the hedge instrument are recognized as interest expense.
Note 9—Commitments and Contingencies
Standby and commercial letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party, while commercial letters of credit are issued specifically to facilitate foreign or domestic trade transactions. The majority of these types of commitments have terms of one year or less.
Collateral may be obtained based on management's credit assessment of the customer.As ofSeptember 30, 2005,March 31, 2006, theCompany'sCompany’s maximum exposure to loss for standby and commercial letters of credit was$3.4$3.6 billion and$115.8$93.1 million, respectively. AtSeptember 30, 2005,March 31, 2006, the carrying value of theCompany'sCompany’s standby and commercial letters of credit totaled$8.0$7.7 million. Exposure to loss related to these commitments is covered by the allowance for off-balance sheet commitments. Both of these amounts are included in other liabilities on the condensed consolidated balance sheet. In addition, the Company's maximum exposure to loss for standby and commercial letters of credit related to discontinued operations was$48.4$30.1 million and$85.0$4.7 million, respectively. The corresponding carrying value of these standby and commercial letters of credit totaled$0.2$0.1 million.The credit risk involved in issuing loan commitments and standby and commercial letters of credit is essentially the same as that involved in extending loans to customers and is represented by the contractual amount of these instruments. Collateral may be obtained based on management’s credit assessment of the customer.
Principal investments include direct investments in private and public companies and indirect investments in private equity funds. The Company issues commitments to provide equity and mezzanine capital financing to private and public companies through either direct investments in specific companies or through investment funds and partnerships. The timing of future cash requirements to fund such commitments is generally dependent on the investment cycle. This cycle, the period over which privately-held companies are funded by private equity investors and ultimately sold, merged, or taken
23UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 10--GUARANTEES (CONTINUED)public through an initial offering, can vary based on overall market conditions as well as the nature and type of industry in which the companies operate. AtSeptember 30, 2005,March 31, 2006, the Company had commitments to fund principal investments of$119.6$116.1 million.24
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 9—Commitments and Contingencies (Continued)
The Company has contingent consideration agreements that guarantee additional payments to acquired insurance
agencies'agencies’ stockholders based on theagencies'agencies’ future performance in excess of established revenue and/or earnings before interest, taxes, depreciation and amortization (EBITDA) thresholds. If the insuranceagencies'agencies’ future performance exceeds these thresholds during a three-year period, the Company will be liable to make payments tothoseformer stockholders. As ofSeptember 30, 2005,March 31, 2006, the Company had a maximum exposure of$5.4$4.4 million for these agreements, the last of which expire in December 2006.The Company is fund manager for limited liability corporations issuing low-income housing credit (LIHC) investments. LIHC investments provide tax benefits to investors in the form of tax deductions from operating losses and tax credits. To facilitate the sale of these LIHC investments, the Company guarantees the timely completion of projects and delivery of tax benefits throughout the investment term. Guarantees may include a minimum rate of return, the availability of tax credits, and operating deficit thresholds over
a ten-yearan eleven-year weighted average period. Additionally, the Company receives project completion and tax credit guarantees from the limited liability corporations issuing the LIHC investments that reduce theCompany'sCompany’s ultimate exposure to loss. As ofSeptember 30, 2005,March 31, 2006, theCompany'sCompany’s maximum exposure to loss under these guaranteeswasis limited to a return of investor capital and minimum investment yield, or$158.5$158.6 million. The Company maintains a reserve of$6.5$6.1 million for these guarantees.The Company has guarantees that obligate it to perform if its affiliates are unable to discharge their obligations. These obligations include
guaranteeguarantees of commercial paper obligations and leveraged lease transactions.GuaranteesThe guarantee issued by the Bank for anaffiliate'saffiliate’s commercial paper programareis done in order to facilitate their sale. As ofSeptember 30, 2005,March 31, 2006, the Bank had a maximum exposure to loss under the commercial paperguarantees, which haveprogram guarantee of $1.5 billion. The Bank’s guarantee has an average term of less thanone year, of $884.1million. The Bank's guaranteenine months and is fully collateralized by a pledged deposit.UnionBanCal CorporationThe Company guarantees itssubsidiaries'subsidiaries’ leveraged lease transactionswhich havewith terms ranging from15fifteen to30thirty years. Following the original funding ofthethese leveraged lease transactions,UnionBanCal Corporationthe Company has no material obligation to be satisfied. As ofSeptember 30, 2005, UnionBanCal CorporationMarch 31, 2006, the Company had nomaterialexposure to lossunderfor theseguarantees.agreements.The Company conducts securities lending transactions for institutional customers as a fully disclosed agent. At times, securities lending indemnifications are issued to guarantee that a security lending customer will be made whole in the event the borrower does not return the security subject to the lending agreement and collateral held is insufficient to cover the market value of the security. All lending transactions are collateralized, primarily by cash. The amount of securities lent with indemnifications was
$2.0$2.4 billion atSeptember 30, 2005.March 31, 2006. The market value of the associated collateral was$2.0$2.4 billion atSeptember 30, 2005.March 31, 2006.The Company occasionally enters into financial guarantee contracts where a premium is received from another financial institution counterparty to guarantee a portion of the credit risk on interest rate swap contracts entered into between the financial institution and its customer. The Company becomes liable to pay the financial institution only if the financial institution is unable to collect amounts owed to
24UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 10--GUARANTEES (CONTINUED)them by their customer. As ofSeptember 30, 2005,March 31, 2006, the maximum exposure to loss under these contracts totaled$11.9$0.7 million.TheAt March 31, 2006, the Companymaintainsmaintained a reserve of $0.1 million for losses related to these guarantees.NOTE 11--PENSION AND OTHER POSTRETIREMENT BENEFITS25
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 9—Commitments and Contingencies (Continued)
For further discussion of the Company's commitments, contingencies and guarantees, see Note 24 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Note 10—Pension and Other Postretirement Benefits
The following tables summarize the components of net periodic benefit cost for the three
and ninemonths endedSeptember 30, 2004March 31, 2005 and2005.
PENSION BENEFITS OTHER BENEFITS ---------------- -------------- FOR THE THREE MONTHS FOR THE THREE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- ------------------- (DOLLARS IN THOUSANDS) 2004 2005 2004 2005 - ---------------------- ---- ---- ---- ----COMPONENTS OF NET PERIODIC BENEFIT COST Service cost...................................................................... $ 9,415 $11,383 $ 849 $1,551 Interest cost..................................................................... 13,059 14,587 1,399 2,115 Expected return on plan assets.................................................... (20,782) (23,966) (2,292) (2,626) Amortization of prior service cost................................................ 266 267 (24) (24) Amortization of transition amount................................................. -- -- 637 508 Recognized net actuarial loss..................................................... 3,609 6,656 (539) 699 ------- ------- ------ ------ Total net periodic benefit cost................................................. $ 5,567 $ 8,927 $ 30 $2,223 ======= ======= ====== ======PENSION BENEFITS OTHER BENEFITS ---------------- -------------- FOR THE NINE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------- ------------------- (DOLLARS IN THOUSANDS) 2004 2005 2004 2005 - ---------------------- ---- ---- ---- ----COMPONENTS OF NET PERIODIC BENEFIT COST Service cost........................................................................ $28,244 $34,148 $4,232 $4,653 Interest cost....................................................................... 39,179 43,763 7,079 6,345 Expected return on plan assets...................................................... (62,347) (71,899) (6,759) (7,801) Amortization of prior service cost.................................................. 800 800 (72) (72) Amortization of transition amount................................................... -- -- 1,912 1,526 Recognized net actuarial loss....................................................... 10,826 19,968 2,997 2,096 ------- ------- ------ ------ Total net periodic benefit cost................................................... $16,702 $26,780 $9,389 $6,747 ======= ======= ====== ======In 2004, the2006.
Pension Benefits
Other Benefits
For the Three Months
Ended March 31,
For the Three Months
Ended March 31,
(Dollars in thousands)
2005
2006
2005
2006
Components of net periodic benefit cost
Service cost
$
11,392
$
13,625
$
1,549
$
1,785
Interest cost
14,320
16,049
2,228
2,240
Expected return on plan assets
(23,905
)
(28,356
)
(2,599
)
(2,843
)
Amortization of prior service cost
267
267
(24
)
508
Amortization of transition amount
—
—
509
(23
)
Recognized net actuarial loss
6,101
7,563
968
1,065
Total net periodic benefit cost
$
8,175
$
9,148
$
2,631
$
2,732
The Company
recorded a $6.1 million reduction in employee benefit expense associated with the remeasurement of postretirement benefits as a result of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("the Act"). The reduction is attributable to a federal subsidy provided by the Act to employers that sponsor retiree health care plans with drug benefits that are equivalent to those offered under Medicare Part D. The effect of the subsidy on the measurement of net periodic postretirement benefit cost has been recognized since the effective date of the Act, July 1, 2004. As a result, the Company recorded a reduction in the accumulated postretirement benefit obligation of $30.8 million relating to benefits attributable to past service in the third quarter of 2004. 25UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 11--PENSION AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) At December 31, 2004, the Company expected to makemade cash contributions of$125$100 million to the Pension Planand $17in the first quarter of 2006. During 2006, the Company plans to make $19 million in contributions to the Health Plan forpension andpostretirementbenefits, respectively, in 2005.benefits.Note 11—Management Stock Plans
The Company
madehas two management stock plans. The Year 2000 UnionBanCal Corporation Management Stock Plan, as amended (the 2000 Stock Plan), and the$125UnionBanCal Corporation Management Stock Plan, restated effective June 1, 1997 (the 1997 Stock Plan), have 20.0 millionpension contribution in January 2005andcontinues6.6 million shares, respectively, of the Company’s common stock authorized tomake the postretirement benefit contributions on a monthly basis. In July 2005,be awarded to key employees, outside directors and consultants of the Companymade an additional $57 million pension contribution. NOTE 12--SUBSEQUENT EVENTS On October 6, 2005, the Bank received $245 million in cash from Wachovia Bank, N.A.at theprincipal legal closingdiscretion of thesaleExecutive Compensation and Benefits Committee of theBank's international correspondent banking business. A gainBoard ofapproximately $147 million, netDirectors (the Committee). Employees on rotational assignment from BTMU are not eligible for stock awards.The Committee determines the term of
direct expenses and income tax expense willeach stock option grant, up to a maximum of ten years from the date of grant. The exercise price of the options issued under the Stock Plans may not berecognizedless than the fair market value on the date the option is granted. Starting in thefourth quarter 2005. The Bank may earn a contingent payment not to exceed $45 million of cash during the secondfirst quarter of 2006, the value of options is amortized to compensation expense over the vesting period during which the employees are required to provide service. Unvested restricted stock issued under the Stock Plans is shown as a reduction to retained earnings at the time of the grant. The value of the restricted shares at the date of grant is amortized to compensation expense over its vesting period with a corresponding credit adjustment to retained earnings. All cancelled or forfeited options and restricted stock become available for future grants.Under the 2000 Stock Plan, the Company granted options to various key employees, including policy-making officers, and to non-employee directors for selected years. Under both Stock Plans, options granted
26
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 11—Management Stock Plans (Continued)
to employees vest pro-rata on each anniversary of the grant date and become fully exercisable three years from the grant date, provided that the employee has completed the specified continuous service requirement. The options vest earlier if the employee dies, is permanently disabled, or retires under certain grant, age, and service conditions or terminates employment under certain conditions. Options granted to non-employee directors are fully vested on the grant date and exercisable 331¤3 percent on each anniversary under the 1997 Stock Plan, and are fully vested and exercisable on the grant date under the 2000 Stock Plan.
Stock Options
The following is a summary of stock option transactions under the Stock Plans for the quarter ended March 31, 2006.
For the Three Months Ended
March 31, 2006
Number of
Weighted-Average
Shares
Exercise Price
Options outstanding, beginning of the period
8,696,589
$
45.26
Granted
4,500
69.18
Exercised
(360,035
)
38.97
Forfeited
(5,319
)
56.15
Options outstanding, end of the period
8,335,735
$
45.54
Options exercisable, end of the period
5,041,077
$
40.51
The following table summarizes information about stock options outstanding and stock options exercisable.
As of March 31, 2006
Number of
Shares
Weighted-
Average
Exercise Price
Weighted-
Average
Remaining
Contractual Term
Aggregate
Intrinsic Value
(in thousands)
Options outstanding
8,335,735
$
45.54
6.16
$
193,437
Options exercisable
5,041,077
40.51
5.57
142,139
27
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 11—Management Stock Plans (Continued)
The following is a summary of the Company’s unvested stock options under the Stock Plans.
For the Three Months Ended
March 31, 2006
Number of
Shares
Weighted-Average Grant
Date Fair Value
Unvested awards, beginning of the period
3,346,716
$
14.69
Granted
4,500
11.85
Vested
(51,289
)
14.69
Forfeited
(5,269
)
14.90
Unvested awards, end of the period
3,294,658
$
14.68
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the following table. Because the Black-Scholes option pricing model uses tranches based on
customer conversion results.expected terms that resulted in ranges of input assumptions, such ranges are disclosed below. Expected volatilities are based on historical data and implied volatilities from traded options on the Company’s stock, and other factors. TheBank continuesCompany uses historical data tooperateestimate option exercise and employee terminations within theinternational correspondent banking business,valuation model. The expected term of an option granted is derived from the output of the option valuation model, which is based on historical data andwill continue to do so over a transitionrepresents the period ofseveral months, duringtime that the option granted is expected to be outstanding. 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 based on the expected term.
For the Three Months Ended
March 31,
2005
2006
Weighted-average fair value—per share
$
13.38
$
11.85
Risk-free interest rates (a range for 1 to 7 year tenors)
3.41 - 4.33
%
4.27 - 4.32
%
Expected volatility
27.00
%
16.57 - 22.88
%
Expected term (in years)
4.4
3.4 - 5.4
Expected dividend yield
2.72
%
2.72
%
As of March 31, 2006, the total unrecognized compensation cost related to unvested stock option awards was $19.7 million and the weighted-average period over which
periodit is expected to be recognized is 0.8 year.For the three months ended March 31, 2006, the amount of cash received on exercise of options was $14.0 million and the corresponding tax benefit realized was $3.9 million.
Restricted Stock
In general, restricted shares are granted under the 2000 Stock Plan to key employees, and in 2005, to non-employee directors. The awards of restricted stock vest pro-rata on each anniversary of the grant date and become fully vested four years from the grant date, provided that the
majorityemployee has completed the specified continuous service requirement. They vest earlier if the employee dies, is permanently and totally disabled, retires under certain grant, age, and service conditions or terminates employment under certain conditions. The awards ofcustomersrestricted stock granted to existing non-employee directors in 2005 willtransfervest in28
UnionBanCal Corporation and Subsidiaries
Notes toWachovia Bank, N.A.Condensed Consolidated Financial Statements (Continued)(Unaudited)
Note 11—Management Stock Plans (Continued)
full in July 2006. The award granted to a newly elected director in 2005 will vest as to two-thirds of the shares in November 2006 and the remaining portion will vest in two equal installments in November 2007 and 2008, respectively. Restricted stockholders have the right to vote their restricted shares and receive dividends.
The Company did not grant any restricted stock during the first quarter of 2005. During the first quarter of 2006, the Company granted 4,100 shares of restricted stock with weighted average grant date fair values of $69.18. There were no restricted stock forfeitures in the first quarter of 2005 and 1,175 restricted stock forfeitures in the first quarter of 2006.
As of March 31, 2006, the total unrecognized compensation cost related to unvested restricted stock awards was $15.1 million and the weighted-average period over which it is expected to be recognized is 1.2 years.
At March 31, 2005 and March 31, 2006, a total of 2,945,680 shares and 5,443,873 shares, respectively, were available for future grants as either stock options or restricted stock under the 2000 Stock Plan. The remaining shares under the 1997 Stock Plan are not available for future grants.
Note 12—Subsequent Events
On
OctoberApril 26,2005,2006, theCompany'sCompany’s Board of Directors declared a quarterly cash dividend of$0.41$0.47 per share of common stock. The dividend will be paid onJanuary 6,July 7, 2006 to stockholders of record as of June 2, 2006.On April 26, 2006, the Company’s Board of Directors authorized the repurchase of an additional $500 million of the Company’s common stock. When combined with the $21 million remaining on its previous repurchase authorizations, the Company had $521 million available to repurchase at that date.
29
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This report includes forward-looking statements, which include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly from our forecasts and expectations. Please refer to Part II Item 1A “Risk Factors” of this Quarterly Report on Form 10-Q and Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December
9, 2005. 26. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THIS REPORT INCLUDES FORWARD-LOOKING STATEMENTS, WHICH INCLUDE FORECASTS OF OUR FINANCIAL RESULTS AND CONDITION, EXPECTATIONS FOR OUR OPERATIONS AND BUSINESS, AND OUR ASSUMPTIONS FOR THOSE FORECASTS AND EXPECTATIONS. DO NOT RELY UNDULY ON FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS MIGHT DIFFER SIGNIFICANTLY FROM OUR FORECASTS AND EXPECTATIONS. PLEASE REFER TO "FACTORS THAT MAY AFFECT FUTURE RESULTS" FOR A DISCUSSION OF SOME FACTORS THAT MAY CAUSE RESULTS TO DIFFER.31, 2005 for a discussion of some factors that may cause results to differYou should read the following discussion and analysis of our condensed consolidated financial condition and results of our operations for the period ended
September 30, 2005March 31, 2006 in thisquarterly reportQuarterly Report on Form 10-Q together with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31,2004 (2004 Annual Report).2005. Averages, as presented in the following tables, are substantially all based upon daily average balances.INTRODUCTIONWe are a California-based, commercial bank holding company
withand have as our major subsidiary, a banking subsidiary, Union Bank of California, N.A. (the Bank). We had consolidated assets of$51.3$48.8 billion atSeptember 30, 2005.March 31, 2006. AtSeptember 30, 2005,March 31, 2006, The Bank of Tokyo-Mitsubishi UFJ, Ltd., our majority owner, owned approximately6163 percent of our outstanding common stock.EXECUTIVE OVERVIEWWe are providing you with an overview of what we believe are the most significant factors and developments that impacted our
thirdfirst quarter20052006 results and that could impact our future results. We ask that you carefully read the rest of this document for more detailed information that will complete your understanding of trends, events and uncertainties that impact us.Our average loans grew by 15 percent in first quarter 2006 compared to the first quarter 2005 and by 2 percent over the fourth quarter 2005. This growth has been concentrated in our commercial and residential mortgage lending areas, although we expect that the growth rate in residential mortgage loans will slow if interest rates continue to rise.
Although our deposit base continues to be strong, our average noninterest bearing deposits did decline in first quarter 2006 compared to the first quarter of 2005. At 45 percent of average total deposits, our average noninterest bearing deposits continue to provide us with an advantage in our primary markets.
Overall credit quality remained strong during the first quarter 2006. Our nonperforming assets totaled $42 million at March 31, 2006 compared to $62 million at December 31, 2005 and $101 million at March 31, 2005. While such low levels of nonperforming assets are not sustainable, we believe that our responsible lending and monitoring practices will help us maintain high credit quality in our loan portfolios.
During the first quarter 2006, we reversed $10 million of our provision for credit losses ($7 million reversal related to loans and a $3 million reversal of allowance for losses on off-balance sheet commitments) compared with a reversal of $9 million in the first quarter 2005. We expect that we will need to provide for credit losses during 2006 as a result of our anticipated loan growth.
In the
thirdfirst quarter 2006, our net interest income was $466 million compared to $437 million in the first quarter 2005, as wesignedbenefited from strong loan growth and higher interest rates.Noninterest income grew 6 percent in the first quarter 2006 compared with the first quarter 2005 primarily from higher service charges on deposit accounts and trust and investment management fees.
30
In the first quarter 2006, our noninterest expense grew to $415 million compared to $393 million in the first quarter 2005. Most of this increase was related to salaries and employee benefits, of which $10 million related to our adoption of the new share-based compensation accounting rules and higher costs for restricted stock awards.
Our effective tax rate increased to 34 percent in the first quarter 2006 from 31 percent during the first quarter 2005. This increase was due to a
definitive agreementreduction in reserves in the first quarter 2005 of $10 million for estimated amounts owed tosellthe Internal Revenue Service (IRS) with respect to certain leveraged lease transactions.In the first quarter 2006, we returned a significant amount of capital to our stockholders in the form of dividends and common stock repurchases. In addition, on April 26, 2006, we announced an increase of 15 percent in our quarterly dividend effective with our next dividend payment on July 7, 2006 and a $500 million increase to the buyback program.
As previously disclosed, we sold our international correspondent banking business
to Wachovia Bank, N.A. The principal legal closing of the transaction occurred onin October6, 2005 and we received $245 million. In the fourth quarter 2005 we will record a gain of approximately $147 million after recognizing direct expenses and income taxes related to the transaction.2005. Wewillcontinue toserve our customers impacted byoperate thistransaction over thebusiness during a transition period, whichis not expected towe expect will continuebeyondwell into the second quarter 2006.TheWe expect no material impact on our future earnings per share as a result of this sale. This transaction has been accounted for as a discontinuedoperation. The following discusses highlights fromoperation; therefore, all subsequent discussion of our results is focused on continuing operationsthat have been restated to reflect the impact of our discontinued operations. Overall credit quality in the commercial lending area is stable. Our nonaccrual portfolio declined to $38 million at September 30, 2005 compared to $150 million at December 31, 2004 and $189 million at September 30, 2004. Loan payoffs and chargeoffs, loan sales, the resumption to accrual status and the absence of new inflows contributed to the decline in nonaccrual loans. We reversed $15 million of our allowance for loan losses in the third quarter 2005 compared with a reversal of $10.9 million in the third quarter 2004. A significant portion of the reversal in the third quarter 2005 ($10 million) was the result of the impact to our non-specific allowance for loan losses from our decision to exit the international correspondent banking business. Net interest income grew from $407 million for the three months ended September 30, 2004 to $464 million for the three months ended September 30, 2005. Our 14 percent growth in net interest income reflects the impact of higher interest rates and increased average earning assets and noninterest bearing deposits, offset by lower income from our derivative hedges. We believe that as interest rates gradually rise and our commercial loan portfolio continues its growth, our net interest margin will be positively impacted through the remainder of 2005. 27Noninterest income grew 7.6 percent in the third quarter 2005 compared with the third quarter 2004 primarily from higher trust and investment management fees, investment income and card processing fees. Noninterest expense grew 10.3 percent in the third quarter 2005 compared with the third quarter 2004, primarily from the investments we made in bank acquisitions, de novo branches and technology in 2004. We believe that these investments will continue to bring opportunities for growth in our business by increasing our customer base and expanding the services we provide. DISCONTINUED OPERATIONSunless otherwise stated.During the third quarter 2005, we committed to a plan to exit our international correspondent banking business and entered into a definitive agreement to sell this business to Wachovia Bank, N.A. This business
consistsconsisted of international payment and trade processing along with the related lending activities. The principal legal closing of the transaction occurred on October 6, 2005 and we received $245 million. Wewillcontinue to operate this business over a transition periodthat may extend towhich we expect will continue well into second quarter 2006.This transaction has been accounted for as a discontinued operation and all prior periods, except where specifically mentioned, have been restated to reflect this accounting treatment. All of the assets and liabilities of the discontinued operations have been separately identified on our
condensedconsolidated balance sheet and the assets are shown at the lower of cost or fair value less costs to dispose. The average net assets or liabilities of our discontinued operations are reflected in our analysis of net interest margin. For the detailed components of our assets and liabilities from discontinued operations, see Note 3"Discontinued Operations" in“Discontinued Operations” to the Condensed Consolidated Financial Statements of thisquarterly reportQuarterly Report on Form 10-Q.Included in our net income are the net results of our discontinued operations. For the three
and ninemonths endedSeptember 30, 2004March 31, 2005 and2005,2006, income from discontinued operations included the following:
FOR THE THREE FOR THE NINE MONTHS ENDED MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------- --------------- (DOLLARS IN THOUSANDS) 2004 2005 2004 2005 - ---------------------- ---- ---- ---- ----Net interest income............................................................... $5,512 $ 5,400 $16,124 $ 15,683 Provision for loan losses......................................................... 938 -- 4,038 6,683 Noninterest income................................................................ 18,833 21,233 57,733 56,165 Noninterest expense............................................................... 12,815 52,245 37,146 87,550 ------ -------- ------- -------- Income (loss) from discontinued operations before income taxes.................... 10,592 (25,612) 32,673 (22,385) Income tax expense (benefit)...................................................... 4,094 (9,651) 12,628 (8,354) ------ -------- ------- -------- Income (loss) from discontinued operations........................................ $6,498 $(15,961) $20,045 $(14,031) ====== ======== ======= ========
For the three months ended
March 31,
(Dollars in thousands)
2005
2006
Net interest income
$
5,137
$
1,725
Provision for loan losses
4,119
—
Noninterest income
17,136
5,811
Noninterest expense
14,515
21,139
Income (loss) from discontinued operations before income taxes
3,639
(13,603
)
Income tax expense (benefit)
1,413
(5,093
)
Income (loss) from discontinued operations
$
2,226
$
(8,510
)
31
For the three months ended
September 30,March 31, 2005 and March 31, 2006, net interest income included the allocation of interest expenseof approximately $4.9 millionfrom continuing operationscomparedof approximately $2.5 million and $0.6 million, respectively. Interest expense allocated tointerest income of $0.2 million for the three months ended September 30, 2004. We allocated interest expense from continuingdiscontinued operationsto theis calculated based on its average net assets and the corresponding cost ofthe discontinued operations based uponfunds rate equivalent to the average federal funds purchased rate for the period.NoninterestIncluded in noninterest expenseincluded severance andwere compliance relatedbenefitexpenses ofapproximately $25$2.6 million andapproximately $14$4.8 million forcompliance-related matters. An impairment charge of $1 million resulted fromthewrite-off of software in development. Expenses related to the termination of lease contracts are not included in these results. Upon ceasing to use the leased premises during the first sixthree monthsofended March 31, 2005 and 2006,we expect to record lease premise related expenses. We do not believe the amount of this expense will be material. In the fourth quarter 2005, we will recognize a gain of approximately $147 million, after income taxes and expenses directly related to the transaction. 28respectively. The remaining discussion of our financial results is based on results from continuing operations, unless otherwise stated.
CRITICAL ACCOUNTING POLICIESUnionBanCal
Corporation'sCorporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) and the general practices of the banking industry. The financial information contained within our statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. In many instances, we use a discount factor to determine the present value of assets and liabilities. A change in the discount factor could increase or decrease the values of those assets and liabilities and such a change would result in either a beneficial or adverse impact to our financial results. We use historical loss factors, adjusted for current conditions, to determine the inherent loss that may be present in our loan and lease portfolio. Actual losses could differ significantly from the loss factors that we use. Other significant estimates that we use are employee turnover factors for pension purposes, residual values in our leasing portfolio, fair value of our derivatives and securities, expected useful lives of our depreciable assets and assumptions regarding our effective income tax rates. We enter into derivative contracts to accommodate our customers and for our own risk management purposes. The derivative contracts are generallyforeign exchange, interest rate swapswaps andinterest rateoption contractsand energy-related derivativesindexed toaccommodate our customers in the oil and gas industry.energy commodities, interest rates or foreign currencies, although we could enter into other types of derivative contracts. We value these contracts at fair value, using either readily available, market quoted prices orfrominformation that can be extrapolated to approximate a market price.We have not historically entered into derivative contracts for our customers or for ourselves, which relate to credit, non-energy commodity or weather-related indices.We are subject to US GAAP that may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.Our most significant estimates are approved by our Chief Executive Officer
(CEO)Forum (CEO Forum), which is comprised of our most seniorexecutives. Atofficers. For each financial reporting period, a review of these estimatesare then reviewed byis presented to and discussed with the Audit Committee of our Board of Directors.Understanding our accounting policies is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly,
except for an update toboth ourpension obligations accounting policy below,Critical Accounting Policies and our significant accounting policies are discussed in detail inNote 1 in the "Notes to Consolidated Financial Statements" inour20042005 Annual Report on Form 10-K filed with theSecurities and Exchange Commission (SEC). In addition to information provided in our "Critical Accounting Policies" in our 2004 Annual Report, we are providing the following information with respectSEC.32
Summary of Financial Performance
Increase (Decrease)
For the Three Months Ended March 31,
2006 versus 2005
(Dollars in thousands)
2005
2006
Amount
Percent
Results of Operations
Net Interest Income(1)
$
435,662
$
465,093
$
29,431
6.8
%
Noninterest Income
Service charges on deposit accounts
79,267
81,635
2,368
3.0
Trust and investment management fees
41,963
50,115
8,152
19.4
Insurance commissions
22,017
19,518
(2,499
)
(11.4
)
Merchant banking fees
6,266
8,229
1,963
31.3
Gain on private capital investments, net
7,935
2,827
(5,108
)
(64.4
)
Other noninterest income
48,177
55,586
7,409
15.4
Total noninterest income
205,625
217,910
12,285
6.0
Total revenue
641,287
683,003
41,716
6.5
Reversal of provision for loan losses
(12,119
)
(7,000
)
5,119
(42.2
)
Noninterest Expense
Salaries and employee benefits
231,758
252,495
20,737
8.9
Outside services
21,247
28,609
7,362
34.6
Professional services
11,741
14,547
2,806
23.9
Advertising and public relations
7,640
10,231
2,591
33.9
Foreclosed asset expense (income)
406
(7,367
)
(7,773
)
nm
(Reversal of) provision for losses on off-balance sheet commitments
3,000
(3,000
)
(6,000
)
nm
Other noninterest expense
117,160
119,029
1,869
1.6
Total noninterest expense
392,952
414,544
21,592
5.5
Income from continuing operations before income taxes
260,454
275,459
15,005
5.8
Income tax expenses
80,703
94,004
13,301
16.5
Income from Continuing Operations
179,751
181,455
1,704
0.9
Income (loss) from discontinued operations before income taxes
3,639
(13,603
)
(17,242
)
nm
Income tax expenses (benefit)
1,413
(5,093
)
(6,506
)
nm
Income (Loss) from Discontinued Operations
2,226
(8,510
)
(10,736
)
nm
Net Income
$
181,977
$
172,945
$
(9,032
)
(5.0
)%
(1) Net interest income does not include any adjustments for fully taxable equivalence.
nm = not meaningful
The primary contributors to our
discount rate for determining our obligations for pension and other postretirement benefits. The discount rate assumed in measuring the plan obligations is determined by selecting high quality investments rated Aa or higher by a recognized rating agency corresponding to each year's future benefit paymentsfinancial performance for thenext 30 years. The discount rate is calculated based on the weighted average investment yields asfirst quarter ofDecember 31, 2004 and rounded2006 compared to thenearest 0.25 percent. The reduction in the discount rate from 6.25 percent at December 31, 2003 to 5.75 percent at December 31, 2004, reported in our 2004 Annual Report, reflects the annual evaluationfirst quarter ofour discount rate assumptions. 29FINANCIAL PERFORMANCE
SUMMARY OF FINANCIAL PERFORMANCE FOR THE THREE INCREASE FOR THE NINE INCREASE MONTHS ENDED (DECREASE) MONTHS ENDED (DECREASE) SEPTEMBER 30, 2005 VERSUS 2004 SEPTEMBER 30, 2005 VERSUS 2004 ------------- ---------------- ------------- ---------------- (DOLLARS IN THOUSANDS) 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT - ---------------------- ---- ---- ------ ------- ---- ---- ------ -------RESULTS OF OPERATIONS Net interest income(1)........................ $406,578 $464,142 $57,564 14.2%$1,196,245 $1,358,514 $162,269 13.6% Noninterest income Service charges on deposit accounts......... 85,667 84,822 (845) (1.0) 252,974 243,835 (9,139) (3.6) Trust and investment management fees........ 39,089 43,500 4,411 11.3 111,699 127,053 15,354 13.7 Merchant banking fees....................... 11,682 11,257 (425) (3.6) 26,863 35,637 8,774 32.7 Brokerage commissions and fees.............. 8,527 5,290 (3,237) (38.0) 24,847 22,867 (1,980) (8.0) Card processing fees, net................... 4,653 6,597 1,944 41.8 28,901 18,668 (10,233) (35.4) Securities gains (losses), net.............. (6) (320) (314) nm 1,612 (13,289) (14,901) nm Gain on private capital investments, net.... 467 5,692 5,225 nm 7,798 18,888 11,090 nm Gain on sale of merchant card portfolio....... -- -- -- -- 93,000 -- (93,000) nm Other noninterest income.................... 47,041 55,350 8,309 17.7 152,740 167,708 14,968 9.8 -------- -------- ------- ---------- ---------- -------- Total noninterest income...................... 197,120 212,188 15,068 7.6 700,434 621,367 (79,067) (11.3) -------- -------- ------- ---------- ---------- -------- Total revenue................................. 603,698 676,330 72,632 12.0 1,896,679 1,979,881 83,202 4.4 Reversal of allowance for loan losses(2)...... (10,939) (15,000) 4,061 37.1 (29,038) (40,683) 11,645 40.1 Noninterest expense Salaries and employee benefits.............. 209,554 236,124 26,570 12.7 632,463 701,858 69,395 11.0 Outside services............................ 19,572 28,533 8,961 45.8 52,130 76,248 24,118 46.3 Foreclosed asset expense (income)........... (10) (3,435) (3,425) nm 526 (5,606) (6,132) nm Reversal of allowance for losses on off-balance sheet commitments(2).......... -- -- -- -- -- (1,000) (1,000) nm Other noninterest expense................... 130,460 135,474 5,014 3.8 399,632 406,548 6,916 1.7 -------- -------- ------- ---------- ---------- -------- Total noninterest expense..................... 359,576 396,696 37,120 10.3 1,084,751 1,178,048 93,297 8.6 -------- -------- ------- ---------- ---------- -------- Income from continuing operations before income taxes....................................... 255,061 294,634 39,573 15.5 840,966 842,516 1,550 0.2 Income tax expense............................ 98,121 93,388 (4,733) (4.8) 308,989 274,041 (34,948) (11.3) -------- -------- ------- ---------- ---------- -------- Income from continuing operations............. 156,940 201,246 44,306 28.2 531,977 568,475 36,498 6.9 -------- -------- ------- ---------- ---------- -------- Income (loss) from discontinued operations before income taxes......................... 10,592 (25,612) (36,204) nm 32,673 (22,385) (55,058) nm Income tax expense (benefit).................. 4,094 (9,651) (13,745) nm 12,628 (8,354) (20,982) nm -------- -------- ------- ---------- ---------- -------- Income (loss) from discontinued operations.... 6,498 (15,961) (22,459) nm 20,045 (14,031) (34,076) nm -------- -------- ------- ---------- ---------- -------- Net income.................................... $163,438 $185,285 $21,847 13.4% $552,022 $554,444 $2,422 0.4% ======== ======== ======= ========== ========== ======== - ---------------(1) Net interest income does not include any adjustments for fully taxable equivalence. (2) Beginning in the quarter ended March 31, 2005, the net change in the allowance for losses on off-balance sheet commitments was recognized separately from the change in the allowance for loan losses. Prior periods have not been restated for this change. nm = not meaningfulTHE PRIMARY CONTRIBUTORS TO OUR FINANCIAL PERFORMANCE FOR THE THIRD QUARTER OF2005COMPARED TO THE THIRD QUARTER OF 2004 ARE PRESENTED BELOW. oare presented below.· The reversal of our allowance for loan losses in the
thirdfirst quarter of20052006 is primarily due toimprovingfurther improvement in creditquality and the elimination of general reserves held for credit exposures in our discontinued operations.quality. Credit quality continued to improve in our commercial loan portfolio evidenced by reductions in nonperforming assets. However, this trend is balanced by increasing30uncertainty in the economic outlook coupled with indications that the improvement in credit quality could be reachingat its peak. (See our discussion under"Allowance“Allowances for Credit Losses."”)o· Our net interest income was favorably influenced by higher earning asset volumes (including higher volume for commercial loans, residential mortgages
commercial loansandcommercial mortgages),construction loans) and higher average33
yields on our earning
assets and strong deposit growth.assets. Offsetting these positive influences to our net interest margin were higher rates on interest bearing liabilities,andlower hedge income and lower noninterest bearing deposits (See our discussion under"Net“Net Interest Income."”)oThe increase in our noninterest income was due to several factors:
o Higher— Service charges on deposits increased primarily due to higher overdraft fees related to a change in our overdraft and nonsufficient funds fee structure, partly offset by lower account analysis fees stemming from an increase in the earnings credit rates on deposit balances;
— Trust and investment management fees were higher primarily due to continued strong sales and organic growth and a one-time $3.8 million increase in trust fees resulting from a refinement in accrual methodology. Managed assets increased by approximately 4 percent and non-managed assets increased by approximately 5 percent from March 31, 2005 to March 31, 2006. Total assets under administration increased by approximately 5 percent, to $216.8 billion, for the same period;
— Merchant banking fees increased due to a higher volume of syndication transactions than in the prior year quarter; partly offset by
— Lower insurance commissions mainly attributable to lower contingent commission payments due to a revised state fund program and to higher loss ratios experienced by insurance companies;
— Lower net gains on the sales and capital distributions on private capital investments compared to the prior
year quarter; o Trustyear; andinvestment management fees were higher primarily due to continued strong sales, solid organic growth and the acquisition of the business portfolio of CNA Trust Company (renamed TruSource) and the corporate trust business of the BTM Trust Company, New York. Managed assets increased by approximately 11.1 percent and non-managed assets increased by approximately 28 percent from the third quarter 2004 to the third quarter 2005. Total assets under administration increased by approximately 26 percent, to $209.1 billion, for the same period; o Card processing fees increased primarily due to higher Master Money Card (debit card) income; and o— Higher other income
includedincluded:· higher gains on the
impactsale ofa reclassificationassets and higher trading gains ofcertain brokerage commissions and fees (from brokerage fees to other noninterest income) and $2.5 million in COLI income, which was previously reported as an offset to noninterest expense in the third quarter of 2004; partly offset by o Brokerage commissions and fees declined from the change in classification, effective July 1, 2005, mentioned above; and o Service charges on deposits declined primarily due to lower account analysis fees, stemming from an increase in the earnings credit rate on commercial deposit balances, partly offset by higher overdraft fees related to a change in our overdraft and nonsufficient funds fee structure. o$5.0 million.Our higher noninterest expense was due to several factors:
o—Salaries and employee benefits increased primarily as a result of:
o acquisitions and new branch openings, which accounted for approximately 32 percent of the increase in our salaries and other compensation; o· higher performance-related incentive expense from
goal achievementsthe amortization of stock options in the first quarter of 2006 and the increased amortization of restricted stock in thethirdfirst quarter of20052006 as a result ofthea higher level ofissuances in the second quarter of 2005; ogrants;· annual merit increases; and
o· higher employee benefits expense mainly due to the impact of the lower discount rate we used to calculate our future pension and other postretirement liabilities (reduced from
6.25 percent at December 31, 2003 to5.75 percent at December 31,2004)2004 to 5.50 percent at December 31, 2005) and higher health insurance expense;o— Outside services expense increased mainly as a result of higher vendor billings stemming from a higher earnings credit rate in the
thirdfirst quarter of20052006 primarily related to title and escrow deposit balances;and 31o Other noninterest— Professional services expense increased mainly due to
higher software expensesconsulting costs related to compliance related expenses;— Higher marketing cost in the
purchase and development of software to support key technology initiatives, advertising and higher expenses related to the Jackson Federal Bank acquisition;current quarter; partly offset byo— Foreclosed asset income in the
thirdfirst quarter of20052006, which was higher due to a gain on the sale of a foreclosedcommercial property. THE PRIMARY CONTRIBUTORS TO OUR FINANCIAL PERFORMANCE FOR THE FIRST NINE MONTHS OF 2005 COMPARED TO THE FIRST NINE MONTHS OF 2004 ARE PRESENTED BELOW. o The reversal of our allowanceproperty; and— Provision for
loanlossesinon off-balance sheet commitments, which declined by $6.0 million compared to the firstnine monthsquarter of 2005is primarily due to improving credit quality, the elimination of general reserves held for credit exposures in our discontinued operations and year-to-date net recoveries. (See our discussion under "Allowance for Credit Losses.") o Our net interest income was favorably influenced by higher earning asset volumes (including a higher mix of residential mortgages, commercial loans, and commercial mortgages), higher average yields on our earning assets and strong deposit growth. Offsetting these positive influences to our net interest margin were higher rates on interest bearing liabilities and lower hedge income (See our discussion under "Net Interest Income.") o The decrease in our noninterest income was mainly due to several factors: o In the second quarter 2004, we sold our merchant card portfolio to NOVA. In addition, card processing fees, net, decreased in the current yearas a result ofthis sale; o In the first nine months of 2005, service charges on deposits decreased primarily due to lower account analysis fees, stemming from an increaseimprovements in theearningscreditrate on commercial deposit balances; o In the second quarter 2005, we sold $475 millionquality ofU.S. government agency securities for a loss of approximately $13.3 million; and o Brokerage commissions and fees declined primarily from a change in classification of certain fees to other noninterest income, effective July 1, 2005; partly offset by o Trust and investment management fees increased from the first nine months 2004 primarily due to continued strong sales, solid organic growth and the acquisition of the business portfolio of CNA Trust Company (renamed TruSource) and the corporate trust business of the BTM Trust Company, New York; o Higher merchant banking fees mainly due to an increased number of completed syndication deals in the current year compared to the prior year; o Higher net gains on the sales and capital distributions on private capital investments compared to the prior year; and o Higher other income included the impact of a reclassification of certain brokerage commissions and fees (from brokerage fees to other noninterest income) discussed above and $5.7 million in COLI income, which was previously reported as an offset to noninterest expense in the third quarter of 2004. o Our higher noninterest expense was mainly due to several factors: o Salaries and employee benefits increased primarily as a result of: o acquisitions and new branch openings, which accounted for approximately 26 percent of the increase inoursalaries and other compensation; 32o higher performance-related incentive expense from goal achievements and the increased amortization of restricted stock in the third quarter of 2005 as discussed previously; o annual merit increases; and o higher employee benefits expense mainly due to the impact of the lower discount rate we used to calculate our future pension and other postretirement liabilities (reduced from 6.25 percent at December 31, 2003 to 5.75 percent at December 31, 2004) and a $4.7 million reclassification of COLI income to other noninterest income (previously reported as employee benefits expense in the prior year); oborrowers.34
Net
occupancy expense increased mainly from acquisitions, new branch openings, the payment of a lease termination fee in the second quarter of 2005 and the impact of lower rental income from non-bank tenants due to bank employee occupancy as we migrate our operations into fewer downtown San Francisco locations; o Outside services expense increased primarily as a result of higher vendor billings stemming from a higher earnings credit rate in the first nine months of 2005 primarily related to title and escrow balances; o Foreclosed asset income in the first nine months of 2005 was primarily due to gains on the sale of two foreclosed commercial properties; and o Other noninterest expense increased primarily as a result of higher software expenses related to the purchase and development of software to support key technology initiatives, higher expenses related to our acquisitions, including amortization of intangibles, and increased charitable contributions, offset by lower reserve expenses for litigation. 33NET INTEREST INCOMEInterest IncomeThe following table shows the major components of net interest income and net interest margin.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004 SEPTEMBER 30, 2005 INCREASE (DECREASE) IN ------------------ ------------------ ---------------------- INTEREST AVERAGE INCOME/ BALANCE EXPENSE (1) INTEREST AVERAGE INTEREST AVERAGE ------- ---------- AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ (DOLLARS IN THOUSANDS) BALANCE EXPENSE(1) RATE(1)(2) BALANCE EXPENSE(1) RATE(1)(2) AMOUNT PERCENT AMOUNT PERCENT - ---------------------- ------- ---------- ---------- ------- ---------- ---------- ------- ------- ------ -------ASSETS Loans:(3) Domestic............ $26,158,230 $340,348 5.19% $31,949,929 $459,280 5.72% $5,791,699 22.1% $118,932 34.9% Foreign(4).......... 143,684 1,586 4.39 227,887 2,612 4.55 84,203 58.6 1,026 64.7 Securities--taxable.... 11,907,592 105,256 3.54 9,971,085 96,706 3.88 (1,936,507)(16.3) (8,550) (8.1) Securities--tax-exempt. 68,884 1,416 8.22 65,800 1,350 8.21 (3,084) (4.5) (66) (4.7) Interest bearing deposits in banks... 364,505 1,656 1.81 57,042 303 2.11 (307,463)(84.4) (1,353) (81.7) Federal funds sold and securities purchased under resale agreements.......... 431,138 1,616 1.49 770,116 6,777 3.49 338,978 78.6 5,161 nm Trading account assets 327,970 1,250 1.52 329,318 1,115 1.34 1,348 0.4 (135) (10.8) ----------- -------- ----------- -------- ---------- -------- Total earning assets........ 39,402,003 453,128 4.59 43,371,177 568,143 5.21 3,969,174 10.1 115,015 25.4 -------- -------- -------- Allowance for loan losses(5)........... (499,440) (392,651) 106,789 (21.4) Cash and due from banks 2,154,048 2,232,281 78,233 3.6 Premises and equipment, net...... 500,123 514,156 14,033 2.8 Other assets.......... 1,915,970 2,487,066 571,096 29.8 ----------- ----------- ---------- Total assets.... $43,472,704 $48,212,029 $4,739,325 10.9% =========== =========== ========== LIABILITIES Domestic deposits: Interest bearing.... $11,775,553 18,536 0.63 $13,157,103 44,318 1.34 $1,381,550 11.7% 25,782 nm Savings and consumer time.............. 4,382,668 9,027 0.82 4,642,782 15,668 1.34 260,114 5.9 6,641 73.6 Large time.......... 1,932,610 7,162 1.47 2,588,559 18,997 2.91 655,949 33.9 11,835 nm Foreign deposits(4)... 218,131 370 0.67 517,298 3,813 2.92 299,167 nm 3,443 nm ----------- -------- ----------- -------- ---------- -------- Total interest bearing deposits...... 18,308,962 35,095 0.76 20,905,742 82,796 1.57 2,596,780 14.2 47,701 nm ----------- -------- ----------- -------- ---------- -------- Federal funds purchased and securities sold under repurchase agreements.......... 867,988 2,861 1.31 630,272 5,158 3.25 (237,716)(27.4) 2,297 80.3 Net funding allocated from (to) discontinued operations(6)....... 46,149 152 1.31 (593,732) (4,864) 3.25 (639,881) nm (5,016) nm Commercial paper...... 639,345 1,697 1.06 1,207,822 9,394 3.09 568,477 88.9 7,697 nm Other borrowed funds.. 161,290 1,122 2.77 173,853 1,707 3.89 12,563 7.8 585 52.1 Medium and long-term debt................ 792,083 4,369 2.19 817,602 8,520 4.13 25,519 3.2 4,151 95.0 Trust notes........... 15,959 242 6.07 15,506 239 6.15 (453) (2.8) (3) (1.2) ----------- -------- ----------- -------- ---------- -------- Total borrowed funds......... 2,522,814 10,443 1.65 2,251,323 20,154 3.55 (271,491)(10.8) 9,711 93.0 ----------- -------- ----------- -------- ---------- -------- Total interest bearing liabilities... 20,831,776 45,538 0.87 23,157,065 102,950 1.76 2,325,289 11.2 57,412 nm -------- -------- -------- Noninterest bearing deposits............ 17,628,751 19,387,786 1,759,035 10.0 Other liabilities(5).. 944,224 1,392,056 447,832 47.4 ----------- ----------- ---------- Total liabilities 39,404,751 43,936,907 4,532,156 11.5 STOCKHOLDERS' EQUITY Common equity......... 4,067,953 4,275,122 207,169 5.1 ----------- ----------- ---------- Total stockholders' equity........ 4,067,953 4,275,122 207,169 5.1 ----------- ----------- ---------- Total liabilities and stockholders' equity........ $43,472,704 $48,212,029 $4,739,325 10.9% =========== =========== ========== NET INTEREST INCOME/MARGIN Net interest income/margin (taxable-equivalent basis).............. 407,590 4.13% 465,193 4.27% 57,603 14.1 Less: taxable-equivalent adjustment.......... 1,012 1,051 39 3.9 -------- -------- -------- Net interest income........ $406,578 $464,142 $57,564 14.2% ======== ======== ======== Average Assets and Liabilities of Discontinued Operations for the three months ended:SEPTEMBER 30, SEPTEMBER 30, 2004 2005 ---- ----Assets.............. $2,239,965 $1,978,255 Liabilities......... $2,286,114 $1,384,523 Net assets (liabilities)..... $(46,149) $593,732 - ---------------(1)
For the Three Months Ended
Increase (Decrease) in
March 31, 2005
March 31, 2006
Interest
Interest
Average
Interest
Average
Average
Income/
Average
Income/
Yield/
Average
Income/
Yield/
Balance
Expense (1)
(Dollars in thousands)
Balance
Expense(1)
Rate(1)(2)
Balance
Expense(1)
Rate(1)(2)
Amount
Percent
Amount
Percent
Assets
Loans:(3)
$ 29,714,206
$ 405,124
5.51
%
$ 34,052,067
$ 512,988
6.09
%
$ 4,337,861
14.6
%
$ 107,864
26.6
%
Securities—taxable
11,117,365
99,939
3.60
8,233,854
96,053
4.67
(2,883,511
)
(25.9
)
(3,886
)
(3.9
)
Securities—tax-exempt
67,144
1,325
7.89
65,204
1,298
7.96
(1,940
)
(2.9
)
(27
)
(2.0
)
Interest bearing deposits in
banks
160,782
733
1.85
59,847
736
4.99
(100,935
)
(62.8
)
3
0.4
Federal funds sold and securities purchased under resale agreements
377,291
2,373
2.55
345,342
3,845
4.52
(31,949
)
(8.5
)
1,472
62.0
Trading account assets
231,043
908
1.59
328,035
1,530
1.89
96,992
42.0
622
68.5
Total earning assets
41,667,831
510,402
4.94
43,084,349
616,450
5.77
1,416,518
3.4
106,048
20.8
Allowance for loan losses
(403,435
)
(348,626
)
54,809
(13.6
)
Cash and due from banks
2,182,658
2,119,926
(62,732
)
(2.9
)
Premises and equipment, net
524,339
527,001
2,662
0.5
Other assets
2,341,660
2,633,993
292,333
12.5
Total assets
$ 46,313,053
$ 48,016,643
$ 1,703,590
3.7
%
Liabilities
Deposits:
Interest bearing
$ 12,232,585
25,416
0.84
$ 13,261,888
62,358
1.91
$ 1,029,303
8.4
%
$ 36,942
145.3
Savings and consumer time
4,778,029
13,045
1.11
4,467,627
18,487
1.68
(310,402
)
(6.5
)
5,442
41.7
Large time
3,021,684
17,367
2.33
3,608,597
34,464
3.87
586,913
19.4
17,097
98.4
Total interest bearing deposits
20,032,298
55,828
1.13
21,338,112
115,309
2.19
1,305,814
6.5
59,481
106.5
Federal funds purchased and securities sold under repurchase agreements
1,279,862
7,455
2.36
874,055
9,410
4.37
(405,807
)
(31.7
)
1,955
26.2
Net funding allocated from (to) discontinued operations(4)
(422,117
)
(2,457
)
2.36
(57,088
)
(608
)
4.32
Commercial paper
865,460
4,560
2.14
1,242,465
12,448
4.06
377,005
43.6
7,888
173.0
Other borrowed funds
180,519
1,529
3.44
268,262
2,915
4.41
87,743
48.6
1,386
90.6
Medium and long-term debt
808,846
6,532
3.27
800,014
10,397
5.27
(8,832
)
(1.1
)
3,865
59.2
Trust notes
15,733
238
6.06
15,280
238
6.24
(453
)
(2.9
)
—
—
Total borrowed funds
2,728,303
17,857
2.65
3,142,988
34,800
4.49
414,685
15.2
16,943
94.9
Total interest bearing liabilities
22,760,601
73,685
1.31
24,481,100
150,109
2.49
1,720,499
7.6
76,424
103.7
Noninterest bearing deposits
18,167,420
17,517,921
(649,499
)
(3.6
)
Other liabilities
1,176,382
1,478,943
302,561
25.7
Total liabilities
42,104,403
43,477,964
1,373,561
3.3
Stockholders’ Equity
Common equity
4,208,650
4,538,679
330,029
7.8
Total stockholders’ equity
4,208,650
4,538,679
330,029
7.8
Total liabilities and stockholders’ equity
$ 46,313,053
$ 48,016,643
$ 1,703,590
3.7
%
Reported Net Interest Income/Margin
Net interest income/margin (taxable-equivalent basis)
436,717
4.22
%
466,341
4.36
%
29,624
6.8
Less: taxable-equivalent adjustment
1,055
1,248
193
18.3
Net interest income
$ 435,662
$ 465,093
$ 29,431
6.8
%
Average Assets and Liabilities of Discontinued Operations for the Three Months Ended:
March 31,
2005
March 31,
2006
Assets
$ 1,964,673
$ 618,653
Liabilities
$ 1,542,556
$ 561,565
Net assets
$ 422,117
$ 57,088
(1)Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of
35 percent. (2) Annualized. (3) Average balances on loans outstanding include all nonperforming loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield. (4) Foreign loans and deposits are those loans and deposits originated in foreign branches. (5) The average allowance related to off-balance sheet commitments was included in other liabilities starting in the quarter ended March 31, 2005. Prior periods have not been restated. (6) In September 2005, Union Bank of California, N.A. committed to a plan for disposal of its international correspondent banking business. All periods presented have been restated to reflect discontinued operations. Net funding allocated from (to) discontinued operations represents the shortage (excess) of assets over liabilities of discontinued operations. The expense (earnings) on funds allocated from (to) discontinued operations are calculated by taking the net balance of discontinued operations for each quarter and applying an earnings rate or a cost of funds equivalent to the corresponding quarter's fed funds purchased rate. nm--not meaningful3435
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 SEPTEMBER 30, 2005 INCREASE (DECREASE) IN ------------------ ------------------ ---------------------- INTEREST AVERAGE INCOME/ BALANCE EXPENSE (1) INTEREST AVERAGE INTEREST AVERAGE ------- ---------- AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ (DOLLARS IN THOUSANDS) BALANCE EXPENSE(1) RATE(1)(2) BALANCE EXPENSE(1) RATE(1)(2) AMOUNT PERCENT AMOUNT PERCENT - ---------------------- ------- ---------- ---------- ------- ---------- ---------- ------- ------- ------ -------ASSETS Loans:(3) Domestic.............. $25,213,753 $987,987 5.23% $30,633,865 $1,298,240 5.66% $5,420,112 21.5% $310,253 31.4% Foreign(4)............ 114,723 4,053 4.72 209,337 7,567 4.83 94,614 82.5 3,514 86.7 Securities--taxable...... 11,664,022 317,390 3.63 10,678,358 298,317 3.72 (985,664) (8.5) (19,073) (6.0) Securities--tax-exempt... 68,120 4,175 8.17 66,379 4,022 8.08 (1,741) (2.6) (153) (3.7) Interest bearing deposits in banks..... 159,386 1,946 1.63 96,961 1,432 1.97 (62,425)(39.2) (514) (26.4) Federal funds sold and securities purchased under resale agreements............ 786,045 6,503 1.11 615,967 14,406 3.13 (170,078)(21.6) 7,903 nm Trading account assets.. 346,473 2,728 1.05 275,087 3,072 1.49 (71,386)(20.6) 344 12.6 ----------- --------- ---------- ---------- -------- Total earning assets.......... 38,352,522 1,324,782 4.61 42,575,954 1,627,056 5.10 4,223,432 11.0 302,274 22.8 --------- ---------- -------- Allowance for loan losses(5)............. (519,393) (398,404) 120,989 (23.3) Cash and due from banks. 2,144,157 2,240,948 96,791 4.5 Premises and equipment, net................... 508,314 519,915 11,601 2.3 Other assets............ 1,839,780 2,404,271 564,491 30.7 ----------- ----------- ---------- Total assets...... $42,325,380 $47,342,684 $5,017,304 11.9% =========== =========== ========== LIABILITIES Domestic deposits: Interest bearing...... $11,538,769 51,199 0.59 $12,614,932 101,752 1.08 $1,076,163 9.3% 50,553 98.7 Savings and consumer time................ 4,248,057 26,282 0.83 4,707,515 42,841 1.22 459,458 10.8 16,559 63.0 Large time............ 2,185,349 22,712 1.39 2,758,495 53,208 2.58 573,146 26.2 30,496 nm Foreign deposits(4)..... 254,754 951 0.50 431,599 8,247 2.55 176,845 69.4 7,296 nm ----------- --------- ---------- ---------- -------- Total interest bearing deposits 18,226,929 101,144 0.74 20,512,541 206,048 1.34 2,285,612 12.5 104,904 nm ----------- --------- ---------- ---------- -------- Federal funds purchased and securities sold under repurchase agreements............ 537,169 4,094 1.02 1,021,123 20,829 2.73 483,954 90.1 16,735 nm Net funding allocated from (to) discontinued operations(6)......... (124,459) (554) 0.59 (535,998) (11,499) 2.87 (411,539) nm (10,945) nm Commercial paper........ 566,776 3,883 0.92 1,078,558 21,761 2.70 511,782 90.3 17,878 nm Other borrowed funds.... 174,470 3,599 2.76 183,997 5,053 3.67 9,527 5.5 1,454 40.4 Medium and long-term debt.................. 805,863 11,201 1.86 808,686 22,511 3.72 2,823 0.4 11,310 nm Trust notes............. 78,139 2,553 4.36 15,618 715 6.10 (62,521)(80.0) (1,838) (72.0) ----------- --------- ---------- ---------- -------- Total borrowed funds........... 2,037,958 24,776 1.62 2,571,984 59,370 3.09 534,026 26.2 34,594 nm ----------- --------- ---------- ---------- -------- Total interest bearing liabilities..... 20,264,887 125,920 0.83 23,084,525 265,418 1.54 2,819,638 13.9 139,498 nm --------- ---------- -------- Noninterest bearing deposits.............. 17,168,125 18,792,219 1,624,094 9.5 Other liabilities(5).... 908,174 1,256,056 347,882 38.3 ----------- ----------- ---------- Total liabilities. 38,341,186 43,132,800 4,791,614 12.5 STOCKHOLDERS' EQUITY Common equity........... 3,984,194 4,209,884 225,690 5.7 ----------- ----------- ---------- Total stockholders' equity.......... 3,984,194 4,209,884 225,690 5.7 ----------- ----------- ---------- Total liabilities and stockholders' equity.......... $42,325,380 $47,342,684 $5,017,304 11.9% =========== =========== ========== NET INTEREST INCOME/MARGIN Net interest income/margin (taxable-equivalent basis)................ 1,198,862 4.17% 1,361,638 4.27% 162,776 13.6 Less: taxable-equivalent adjustment............ 2,617 3,124 507 19.4 --------- ---------- -------- Net interest income.......... $1,196,245 $1,358,514 $162,269 13.6% ========== ========== ======== Average Assets and Liabilities of Discontinued Operations for the nine months ended:SEPTEMBER 30, SEPTEMBER 30, 2004 2005 ---- ----Assets................ $2,137,241 $1,974,884 Liabilities........... $2,012,782 $1,438,886 Net assets (liabilities)....... $124,459 $535,998 - ---------------(1) Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent. (2) Annualized. (3) Average balances on loans outstanding include all nonperforming loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield. (4) Foreign loans and deposits are those loans and deposits originated in foreign branches. (5) The average allowance related to off-balance sheet commitments was included in other liabilities starting in the quarter ended March 31, 2005. Prior periods have not been restated. (6) In September 2005, Union Bank of California, N.A. committed to a plan for disposal of its international correspondent banking business. All periods presented have been restated to reflect discontinued operations. Net funding allocated from (to) discontinued operations represents the shortage (excess) of assets over liabilities of discontinued operations. The expense (earnings) on funds allocated from (to) discontinued operations are calculated by taking the net balance of discontinued operations for each quarter and applying an earnings rate or a cost of funds equivalent to the corresponding quarter's fed funds purchased rate. The year-to-date expense (earnings) amount is the sum of the quarterly amounts. nm--not meaningfulpercent. (2)Annualized.
(3)Average balances on loans outstanding include all nonperforming loans and loans held for sale. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield.
(4)In September 2005, Union Bank of California, N.A. committed to a plan for disposal of its international correspondent banking business. All periods presented have been restated to reflect discontinued operations. Net funding allocated from (to) discontinued operations represents the shortage (excess) of assets over liabilities of discontinued operations. The expense (earning) on funds allocated from (to) discontinued operations is calculated by taking the net balance and applying an earnings rate or a cost of funds equivalent to the corresponding period’s fed funds purchased rate.
35
Net interest income in the
thirdfirst quarter2005,2006, on a taxable-equivalent basis, increased147 percent, from thethirdfirst quarter2004.2005. Our results were primarily due to the following:o The growth in average· Average earning assets
wasincreased $1.4 billion, or 3 percent, primarily due to an increase in averageloans.loans, partly offset by a decline in average securities. The increase in average loans was largely due to a$1.9$2.0 billion increase in average commercial loans and a$2.2$1.6 billion increase in average residential mortgages, while average securities declined by $2.9 billion as a result of sales of approximately $1.5 billion anda $1.3maturities offset by purchases of $1.0 billionincrease in average commercial mortgages; o Deposit growth contributed favorably to net interest margin in the third quarter 2005. Average noninterest bearing deposits were higher in the third quarterbetween December 2005compared to the third quarter 2004, mainly due to higher average business demand deposits, including an increase in demand deposits from our titleandescrow clients and higher consumer demand deposit growth; oFebruary 2006;·Yields on our earning assets were favorably impacted by the increasing interest rate environment resulting in a higher average yield
of 62 basis pointson average earning assets of 83 basis points, despite being negatively impacted by lower hedge income, which decreased by$16.0$13.9 million;·Average noninterest bearing deposits decreased $649 million, or 4 percent, including a decrease of $381 million, or 14 percent, in average title and
oescrow deposits due to lower residential real estate activity. Average business demand deposits, excluding title and escrow, declined $305 million, or 3 percent, primarily due to disintermediation resulting from rising short-term interest rates. Consumer deposits increased $37 million, or 1 percent. Average noninterest bearing deposits represented 45 percent of average total deposits in first quarter 2006.·In the
thirdfirst quarter2005, our2006, the annualized average all-in cost of funds,on interest bearing liabilities was negatively impacted by the increasing rate environment, resulting in a higher average cost of interest-bearing liabilities of 89 basis points,which included lower hedge incomewhich decreased by $1.5 million.of $2.5 million, was 1.45 percent, reflecting our average deposit-to-loan ratio of 114 percent and the proportion of noninterest bearing deposits to total deposits.As a result of these changes, our net interest margin increased by 14 basis points.
We use derivatives to hedge expected changes in the yields on our variable rate loans and term certificates of deposit (CDs), and to convert our long-term, fixed-rate borrowings to floating rate.
Throughout 2005,For 2006, these derivative positionshave providedare expected to provide less net interest income than in2004,2005, as positionsmaturedmature and, to a lesser extent, as interest ratesrose.rise. However, as we expected, the declines in hedge income have been offset by increased yields on the underlying variable rate loans. For the quarters endedSeptember 30, 2004March 31, 2005 and2005,2006, we had hedge income of$20.4$9.5 million and$2.9hedge expense of $6.9 million, respectively.Net interest income
For the Three Months Ended
March 31,
March 31,
Increase (Decrease)
(Dollars in thousands)
2005
2006
Amount
Percent
Service charges on deposit accounts
$ 79,267
$ 81,635
$ 2,368
3.0
%
Trust and investment management fees
41,963
50,115
8,152
19.4
Insurance commissions
22,017
19,518
(2,499
)
(11.4
)
Merchant banking fees
6,266
8,229
1,963
31.3
Foreign exchange gains, net
8,170
7,818
(352
)
(4.3
)
Brokerage commissions and fees
8,972
7,795
(1,177
)
(13.1
)
Card processing fees, net
5,607
6,697
1,090
19.4
Securities gains (losses), net
344
(214
)
(558
)
nm
Gain on private capital investments, net
7,935
2,827
(5,108
)
(64.4
)
Other
25,084
33,490
8,406
33.5
Total noninterest income
$ 205,625
$ 217,910
$ 12,285
6.0
%
nm = not meaningful
36
For the Three Months Ended
March 31,
March 31,
Increase (Decrease)
(Dollars in thousands)
2005
2006
Amount
Percent
Salaries and other compensation
$
178,957
$
194,259
$
15,302
8.6
%
Employee benefits
52,801
58,236
5,435
10.3
Salaries and employee benefits
231,758
252,495
20,737
8.9
Net occupancy
32,362
32,837
475
1.5
Outside services
21,247
28,609
7,362
34.6
Equipment
17,403
17,922
519
3.0
Software
13,975
16,344
2,369
17.0
Professional services
11,741
14,547
2,806
23.9
Communications
10,380
10,552
172
1.7
Advertising and public relations
7,640
10,231
2,591
33.9
Data processing
8,870
7,398
(1,472
)
(16.6
)
Intangible asset amortization
4,985
3,430
(1,555
)
(31.2
)
Foreclosed asset expense (income)
406
(7,367
)
(7,773
)
nm
(Reversal of) provision for losses on off-balance sheet commitments
3,000
(3,000
)
(6,000
)
nm
Other
29,185
30,546
1,361
4.7
Total noninterest expense
$
392,952
$
414,544
$
21,592
5.5
%
nm = not meaningful
Income tax expense on continuing operations in the first
nine months 2005, on a taxable-equivalent basis, increased 14 percent, from the first nine months 2004. Our results were primarily due to the following: o The growth in average earning assets was primarily due to an increase in average loans. The increase in average loans was largely due to a $2.4 billion increase in average residential mortgages, a $1.6 billion increase in average commercial loans and a $1.2 billion increase in average commercial mortgages; o Deposit growth contributed favorably to net interest margin in the first nine months 2005. Average noninterest bearing deposits were higher in the first nine months 2005, compared to the first nine months 2004, mainly due to higher average business demand deposits, including demand deposits from our title and escrow clients and higher consumer demand deposit growth; o Yields on our earning assets were favorably impacted by the increasing interest rate environment and higher cash basis recoveries, resulting in a higher average yield of 49 basis points on average earning assets, despite being negatively impacted by lower hedge income, which decreased by $53.3 million; and o In the first nine months 2005, our cost of funds on interest bearing liabilities was negatively impacted by the increasing rate environment, resulting in a higher average cost of interest-bearing liabilities of 71 basis points, including lower hedge income, which decreased by $6.3 million. As a result of these changes, our net interest margin increased by 10 basis points. We use derivatives to hedge expected changes in the yields on our variable rate loans and term certificates of deposit (CDs), and to convert our long-term, fixed-rate borrowings to floating rate. Throughout 2005, these derivative positions have provided less net interest income than in 2004, as positions matured and, to a lesser extent, as interest rates rose. However, as we expected, the declines in 36hedge income have been offset by increased yields on the underlying variable rate loans. For the nine months ended September 30, 2004 and 2005, we had hedge income of $79.4 million and $19.8 million, respectively.
NONINTEREST INCOME FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED -------------------------- ------------------------- INCREASE (DECREASE) INCREASE (DECREASE) ------------------ ------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, (DOLLARS IN THOUSANDS) 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT - ---------------------- ---- ---- ------ ------- ---- ---- ------ -------Service charges on deposit accounts.................. $ 85,667 $ 84,822 $ (845) (1.0)% $252,974 $243,835 $ (9,139) (3.6)% Trust and investment management fees........... 39,089 43,500 4,411 11.3 111,699 127,053 15,354 13.7 Insurance commissions....... 17,463 17,819 356 2.0 57,850 59,176 1,326 2.3 Merchant banking fees....... 11,682 11,257 (425) (3.6) 26,863 35,637 8,774 32.7 Foreign exchange gains, net....................... 8,268 8,849 581 nm 24,209 25,570 1,361 5.6 Brokerage commissions and fees...................... 8,527 5,290 (3,237) (38.0) 24,847 22,867 (1,980) (8.0) Card processing fees, net... 4,653 6,597 1,944 41.8 28,901 18,668 (10,233) (35.4) Securities gains (losses), net....................... (6) (320) (314) nm 1,612 (13,289) (14,901) nm Gain on private capital investments, net.......... 467 5,692 5,225 nm 7,798 18,888 11,090 142.2 Gain on sale of merchant card portfolio............ -- -- -- nm 93,000 -- (93,000) nm Other....................... 21,310 28,682 7,372 34.6 70,681 82,962 12,281 17.4 -------- -------- ------- -------- -------- -------- Total noninterest income $197,120 $212,188 $15,068 7.6% $700,434 $621,367 $(79,067) (11.3)% ======== ======== ======= ======== ======== ======== - --------------- nm--not meaningful
NONINTEREST EXPENSE FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED -------------------------- ------------------------- INCREASE (DECREASE) INCREASE (DECREASE) ------------------ ------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, (DOLLARS IN THOUSANDS) 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT - ---------------------- ------------- ------------- ------ ------- ------------- ------------- ------ -------Salaries and other compensation..... $175,619 $190,293 $14,674 8.4% $ 509,646 $ 556,249 $46,603 9.1% Employee benefits................... 33,935 45,831 11,896 35.1 122,817 145,609 22,792 18.6 -------- -------- ------- ---------- ---------- ------- Salaries and employee benefits.... 209,554 236,124 26,570 12.7 632,463 701,858 69,395 11.0 Net occupancy....................... 32,029 34,336 2,307 7.2 93,517 100,251 6,734 7.2 Outside services.................... 19,572 28,533 8,961 45.8 52,130 76,248 24,118 46.3 Equipment........................... 15,949 15,832 (117) (0.7) 49,370 50,176 806 1.6 Software............................ 12,790 14,374 1,584 12.4 37,309 43,072 5,763 15.4 Professional services............... 11,976 11,240 (736) (6.1) 33,410 36,131 2,721 8.1 Communications...................... 10,234 10,808 574 5.6 31,728 30,950 (778) (2.5) Advertising and public relations.... 7,843 9,114 1,271 16.2 27,154 25,657 (1,497) (5.5) Data processing..................... 8,146 7,406 (740) (9.1) 24,416 24,703 287 1.2 Intangible asset amortization....... 5,077 4,985 (92) (1.8) 13,783 14,956 1,173 8.5 Foreclosed asset expense (income)... (10) (3,435) (3,425) nm 526 (5,606) (6,132) nm Reversal of allowance for losses on off-balance sheet commitments(1).. -- -- -- -- -- (1,000) (1,000) nm Other............................... 26,416 27,379 963 3.6 88,945 80,652 (8,293) (9.3) -------- -------- ------- ---------- ---------- ------- Total noninterest expense....... $359,576 $396,696 $37,120 10.3% $1,084,751 $1,178,048 $93,297 8.6% ======== ======== ======= ========== ========== ======= - ---------------(1) Beginning in the quarter ended March 31, 2005, the net change in the allowance for losses on off-balance sheet commitments was recognized separately from the change in the allowance for loan losses. Prior periods have not been restated. nm--not meaningful37INCOME TAX EXPENSE The following discussion of our income tax expense is based upon net income and therefore includes our discontinued operations. Income tax expense in the thirdquarterof 20052006 resulted in a3134 percent effective income tax rate compared with an effective tax rate of38 percent for the third quarter of 2004. In the third quarter of 2005, we recognized reductions to income tax expense of approximately $9.0 million primarily related to the decrease in our California effective tax rate for 2005, the adjustment of 2004 California tax expense to reflect the tax as reported on the tax return filed on the worldwide unitary basis, and to California Enterprise Zone credits, primarily from prior years, for which we qualified during the third quarter. In the third quarter of 2004, we recognized an increase to income tax expense of approximately $7.8 million primarily related to the adjustment of 2003 California tax expense as reported on 2003 worldwide unitary tax return. Income tax expense in the first nine months of 2005 resulted in a 32 percent effective tax rate compared with an effective tax rate of 3731 percent for the firstnine months of 2004. The decrease inquarter 2005. In theyear-to-date tax rate was due primarily tofirst quarter 2005 we recognized a reduction in reserves of $10.0 millionin the first quarter of 2005for estimated amounts owed to the Internal Revenue Service with respect to certain leveraged leasingtransactions, and the third quarter tax adjustments described above.transactions.For further information regarding income tax expense, see
"Management's“Management’s Discussion and Analysis of Financial Condition and Results ofOperations--IncomeOperations—Income TaxExpense"Expense” in our Annual Report on Form 10-K for the year ended December 31,2004. LOANS
The following table shows loans outstanding by loan type. INCREASE (DECREASE) SEPTEMBER 30, 2005 FROM: ------------------------ SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, 2004 2004 2005 2004 2004 ---- ---- ---- ---- ---- (DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT - ---------------------- ------ ------- ------ -------Domestic: Commercial, financial and industrial... $ 9,545,482 $ 9,760,756 $10,791,643 $1,246,161 13.1% $1,030,887 10.6% Construction........................... 1,103,970 1,130,070 1,366,413 262,443 23.8 236,343 20.9 Mortgage: Residential.......................... 8,821,566 9,538,150 10,976,681 2,155,115 24.4 1,438,531 15.1 Commercial........................... 4,356,052 5,409,029 5,590,774 1,234,722 28.3 181,745 3.4 ----------- ----------- ----------- ---------- ---------- Total mortgage..................... 13,177,618 14,947,179 16,567,455 3,389,837 25.7 1,620,276 10.8 Consumer: Installment.......................... 779,857 767,767 834,653 54,796 7.0 66,886 8.7 Revolving lines of credit............ 1,496,581 1,581,863 1,653,275 156,694 10.5 71,412 4.5 ----------- ----------- ----------- ---------- ---------- Total consumer..................... 2,276,438 2,349,630 2,487,928 211,490 9.3 138,298 5.9 Lease financing........................ 612,054 609,090 574,798 (37,256) (6.1) (34,292) (5.6) ----------- ----------- ----------- ---------- ---------- Total loans in domestic offices.... 26,715,562 28,796,725 31,788,237 5,072,675 19.0 2,991,512 10.4 Loans originated in foreign branches..... 184,335 194,790 205,375 21,040 11.4 10,585 5.4 ----------- ----------- ----------- ---------- ---------- Total loans held to maturity....... 26,899,897 28,991,515 31,993,612 5,093,715 18.9 3,002,097 10.4 Total loans held for sale.......... 2,294 117,900 11,135 8,841 385.4 (106,765) (90.6) ----------- ----------- ----------- ---------- ---------- Total loans...................... $26,902,191 $29,109,415 $32,004,747 $5,102,556 19.0% $2,895,332 9.9% =========== =========== =========== ========== ==========COMMERCIAL, FINANCIAL AND INDUSTRIAL LOANS2005.37
The following table shows loans outstanding by loan type.
Increase (Decrease)
March 31, 2006 From:
March 31,
December 31,
March 31,
March 31, 2005
December 31, 2005
(Dollars in thousands)
2005
2005
2006
Amount
Percent
Amount
Percent
Domestic:
Commercial, financial and industrial
$
9,998,843
$
11,450,955
$
11,666,818
$
1,667,975
16.7
%
$
215,863
1.9
%
Construction
1,189,273
1,447,292
1,598,162
408,889
34.4
150,870
10.4
Mortgage:
Residential
10,121,033
11,380,728
11,570,355
1,449,322
14.3
189,627
1.7
Commercial
5,448,741
5,682,624
5,647,089
198,348
3.6
(35,535
)
(0.6
)
Total mortgage
15,569,774
17,063,352
17,217,444
1,647,670
10.6
154,092
0.9
Consumer:
Installment
777,986
891,062
947,881
169,895
21.8
56,819
6.4
Revolving lines of credit
1,612,037
1,610,680
1,532,671
(79,366
)
(4.9
)
(78,009
)
(4.8
)
Total consumer
2,390,023
2,501,742
2,480,552
90,529
3.8
(21,190
)
(0.8
)
Lease financing
596,331
579,593
563,491
(32,840
)
(5.5
)
(16,102
)
(2.8
)
Total loans held to maturity
29,744,244
33,042,934
33,526,467
3,782,223
12.7
483,533
1.5
Total loans held for sale
34,217
52,661
2,401
(31,816
)
(93.0
)
(50,260
)
(95.4
)
Total loans
$
29,778,461
$
33,095,595
$
33,528,868
$
3,750,407
12.6
%
$
433,273
1.3
%
Commercial, Financial and Industrial Loans
Commercial, financial and industrial loans represent one of the largest categories in the loan portfolio. These loans are extended principally to corporations, middle-market businesses, and small businesses, with no industry concentration exceeding 10 percent of total loans.
In addition, we believeAlthough many of our38customers are located in California, the portfolio has a high degree of geographic diversification based upon our customers'customers’ revenue bases, which we believe lowers our vulnerability to changes in theregional and nationaleconomic outlookforof any particular region of the U.S.economy.Our commercial market lending originates primarily through our commercial banking offices. These offices, which rely extensively on relationship-oriented banking, provide a variety of services including
depository andcash management services, lines of credit, accounts receivable and inventory financing. Separately, we originate or participate in a wide variety of financial services to major corporations. These services include traditional commercial banking and specialized financing tailored to the needs of eachcustomer'scustomer’s specific industry. Presently, we are active in, among other sectors, the oil and gas, communications, entertainment, retailing, power and utilities and financial services industries.The commercial, financial and industrial loan portfolio
increaseincreased in thethirdfirst quarterof 20052006 from thethirdfirst quarterof 2004 was2005 mainly due to increased loan demand primarily in the Californiamiddle-marketmiddle market and specialty segments, which reflected the improving economy in those markets.CONSTRUCTION AND COMMERCIAL MORTGAGE LOANSConstruction and Commercial Mortgage Loans
We engage in non-residential real estate lending that includes commercial mortgage loans and construction loans secured by deeds of trust. Construction loans are made primarily to commercial property developers and to residential builders.
The construction loan portfolio increase in the
thirdfirst quarterof 20052006 from thethirdfirst quarterof 20042005 was mainly due toincreaseddemand fornew single-family homes, as well asapartment, condominium,retail buildingshopping center andREITReal Estate Investment Trust financing.ThisAdditionally, improvement in commercial income property markets also accounted for some related growthoccurred despite continued high office vacancy ratesinour markets, which was a factor that impacted the level ofdevelopment and constructionprojects we financed.loans.The commercial mortgage loan portfolio consists of loans on commercial
and industrial projectsincome properties primarily in California. The increase in commercial mortgagesinbetween thethirdfirst quarter of 2006 and the first quarter38
of 2005
from the third quarter of 2004was mainly due toour acquisition of Jackson Federal Bankgeneral improvements inthe fourth quarter of 2004, offset by substantialcommercialmortgage refinancings with other lenders. RESIDENTIAL MORTGAGE LOANSincome property markets, which resulted in increased financings and refinancings.Residential Mortgage Loans
We originate residential mortgage loans, secured by one-to-four family residential properties, through our multiple channel network (including branches, mortgage brokers, and loan-by-phone) throughout California, Oregon and Washington, and we periodically purchase loans in our market area. At
September 30, 2005, 55March 31, 2006, 60 percent of our residential mortgage loans were interest only, of which none are negative amortizing. At origination, these interest only loans had high credit scoreswith anand had weighted averageof 65 percentloan-to-value (LTV)ratio.ratios of approximately 65 percent. The remainder of the portfolio consists of balloon or regular amortizing loans.The increase in residential mortgages in the third quarter of 2005 compared to third quarter of 2004 was primarily driven by adjustable rate mortgages (ARMs). Contributing to this increase were very attractive mortgage rates in the latter half of 2004 and higher home prices.We hold most of the loans we originate, selling only our 30-year, fixed rate loans, except for Community Reinvestment Act (CRA) loans.
CONSUMER LOANSConsumer Loans
We originate consumer loans, such as auto loans and home equity loans and lines, through our branch network. The primary driver of the increase in consumer loans was our
"Flex“Flex Equity Line/Loan"Loan” product. The"Flex“Flex Equity Line/Loan"Loan” allows our customers the flexibility to manage a line of creditandwith as many as four fixed rate loans under a single product.39LEASE FINANCINGWe offer a “Flex Equity High LTV” product, which allows our customers to draw up to 100 percent of the value of their real estate or $100 thousand, whichever is less.Lease Financing
We primarily offer two types of leases to our customers: direct financing leases, where the assets leased are acquired without additional financing from other sources; and leveraged leases, where a substantial portion of the financing is provided by debt with no recourse to us.
The lease financing decrease from September 30, 2004 was attributable to the run-off of our discontinued auto leasing activity. At September 30, 2005, our auto lease portfolio had declined to $4.6 million and will fully mature by mid-year 2006.Included in our lease portfolio are leveraged leases of$561$549 million, which are net of non-recourse debt of approximately$1.2$1.1 billion. We utilize a number of special purpose entities for our leveraged leases. These entities serve legal and tax purposes and do not function as vehicles to shift liabilities to other parties or to deconsolidate affiliates for financial reporting purposes. As allowed by US GAAP and by law, the gross lease receivable is offset by the qualifying non-recourse debt. In leveraged lease transactions, the third-party lender may only look to the collateral value of the leased assets for repayment.CROSS-BORDER OUTSTANDINGSOur cross-border outstandings, including those that are part of our discontinued operations, reflect certain additional economic and political risks that are not reflected in domestic outstandings. These risks include those arising from exchange rate fluctuations and restrictions on the transfer of funds. The following table sets forth our cross-border outstandings as of
September 30, 2004, DecemberMarch 31,2004 and September 30,2005, for any country where such outstandings exceeded 1 percent of total assets. For the periods ending December 31, 2005 and March 31, 2006 we did not meet the 1 percent threshold for disclosure. Thecross- bordercross-border outstandings were compiled based upon category and domicile of ultimate risk and are comprised of balances with banks, trading account assets, securities available for sale, securities purchased under resale agreements, loans, accrued interest receivable, acceptances outstanding and investments with foreign entities. For any country shown in the table below, any significant local currency outstandings are either hedged or funded by local currency borrowings.
PUBLIC CORPORATIONS FINANCIAL SECTOR AND OTHER TOTAL (DOLLARS IN MILLIONS) INSTITUTIONS ENTITIES BORROWERS OUTSTANDINGS - --------------------- ------------ -------- --------- ------------September 30, 2004 Korea...................................................................... $623 $-- $4 $627 December 31, 2004 Korea...................................................................... $615 $-- $3 $618 September 30, 2005 Korea...................................................................... $656 $-- $10 $666REVERSAL OF ALLOWANCE FOR CREDIT LOSSES
Public
Corporations
Financial
Sector
and Other
Total
(Dollars in millions)
Institutions
Entities
Borrowers
Outstandings
March 31, 2005
Korea
$
679
$
—
$
6
$
685
39
We recorded a reversal of the allowance for loan losses of
$15$7 million in thethirdfirst quarter of2005,2006, compared with a reversal of the allowance forcreditloan losses of$11$12 million in thethirdfirst quarter of2004.2005. Provisions for loan losses are charged to income to bring our allowance for loan losses to a level deemed appropriate by management based on the factors discussed under"Allowance“Allowances for CreditLosses"Losses” below.Beginning with first quarter 2005, changes in the allowance for losses related to off-balance sheet commitments are recognized in noninterest expense.There wasno provision ora recovery for losses related to the change in the allowance for losses on off-balance sheet commitments in thethirdfirst quarter2005. ALLOWANCE FOR CREDIT LOSSES ALLOWANCE POLICY AND METHODOLOGY2006 of $3 million compared to a provision for losses on off-balance sheet commitments in the first quarter 2005 of $3 million.Allowance Policy and Methodology
We maintain
an allowanceallowances for credit losses (defined as both the allowance for loan and the allowance for off-balance sheet commitment losses) to absorb losses inherent in the loan portfolio as well as for leases and off-balance sheet commitments. Understanding our policies on theallowanceallowances for credit losses is fundamental to understanding our consolidated financial condition and consolidated results of operations.40Accordingly, our significant policies and methodology on the allowanceallowances for credit losses are discussed in detail in Note 1 in the"Notes“Notes to Consolidated FinancialStatements"Statements” and in the section"Allowance“Allowances for CreditLosses"Losses” included in our"Management's“Management’s Discussion and Analysis of Financial Condition and Results ofOperations"Operations” in our20042005 Annual Report on Form 10-K, which was filed with the SEC.COMPARISON OF THE TOTAL ALLOWANCE AND RELATED PROVISION FOR CREDIT LOSSES FROM DECEMBERComparison of the Total Allowances and Related Provision for Credit Losses from December 31,
20042005At
September 30, 2005,March 31, 2006, our totalallowanceallowances for credit losses was$445$423 million, which consisted of$363$340 million related to loans and$82$83 million related to off-balance sheet commitments. Theallowanceallowances for credit losses consisted of$375$360 million and$70$63 million of allocated and unallocated allowance, respectively. AtSeptember 30, 2005,March 31, 2006, ourallowanceallowances for credit loss coverage ratios were1.391.26 percent of total loans and1,2721,003 percent of total nonaccrual loans. At December 31,2004,2005, our totalallowanceallowances for credit losses wasat $482$438 million, or1.651.32 percent of the total loan portfolio and338744 percent of total nonaccrual loans.In addition, the
allowanceallowances incorporates the results of measuring impaired loans as provided in SFAS No. 114,"Accounting“Accounting by Creditors for Impairment of aLoan"Loan” as amended by SFAS No. 118,"Accounting“Accounting by Creditors for Impairment of aLoan--IncomeLoan—Income Recognition and Disclosures."” These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. AtSeptember 30, 2005,March 31, 2006, total impaired loans were$35$27 million, and the associated impairment allowance was$8$9 million, compared with$88$59 million and$24$13 million, respectively, at December 31,2004.2005.At
September 30, 2005March 31, 2006 and December 31,2004,2005, theallowancesallowance for losses related to off-balance sheet commitments included within our totalallowanceallowances for credit losses,were $82was $83 million and$83$86 million, respectively. In determining the adequacy of ourallowanceallowances for credit losses, we consider both the allowance for loan losses and forlosses onoff-balance sheetcommitments.commitment losses.We recorded a reversal of our allowance for loan losses of $7 million in the first quarter 2006, as a result of management’s assessment of factors, including improvements in the quality of our loan portfolio, growth in the U.S. economy and improving conditions in domestic markets in which we operate, offset by the growth in the loan portfolio.
40
During the
thirdfirst quarter of2005,2006, there were no material changes in estimation methods or assumptions that affected our methodology for assessing the appropriateness of the formula and specificallowanceallowances for credit losses.We recorded a total reversal of our allowance for credit losses of $15 millionChanges in the
third quarter 2005. Approximately $10 million of this reversal reflects the impact on the general allowance from the decision to exit the international correspondent banking businessAllocated (Formula andapproximately $5 million of this reversal was the result of management's assessment of factors, including improvements in the quality of our loan portfolio, the continued improvement in the U.S. economy and improving conditions in domestic markets in which we operate, offset by the growth in the loan portfolio and the adverse impact of increasing fuel costs across the whole economy. CHANGES IN THE ALLOCATED (FORMULA AND SPECIFIC) ALLOWANCESpecific) AllowanceAt
September 30, 2005,March 31, 2006, the formula allowanceincreaseddecreased to$365$348 million, compared to$361$356 million at December 31,2004.2005. Theincreasenet decrease was due primarily to the impact of a decrease in criticized loans offset by growth inour pass-graded and homogeneous pooled loans.the commercial loan portfolio.At
September 30, 2005,March 31, 2006, the specific allowance decreased to$10$12 million, compared to$38$17 million at December 31,2004.2005. This decrease is primarily reflective of lower nonaccrual loans and leases.CHANGES IN THE UNALLOCATED ALLOWANCEChanges in the Unallocated Allowance
At
September 30, 2005,March 31, 2006, the unallocated allowance decreased modestly to$70$63 million from$83$65 million at December 31,2004,2005, reflecting management’s belief that maintaining thedeclineunallocated allowance near our December 31, 2005 assessment is appropriate based on continuing uncertainty associated with our principal portfolio segments as we approach a turning point inexposures in our leasing portfolio as a result of the charge-off of certain aircraft leases, and improvements in both the commercial real estate and power company portfolios.credit quality trends. Additionally, the reasons for which we believe an unallocated allowance is warranted are detailed below.In our assessment as of
September 30, 2005,March 31, 2006, management focused, in particular, on the factors and conditions set out below. There can be no assurance that the adverse impact of any of these conditions on us will not be in excess of the ranges set forth.41Although in certain instances the downgrading of a loan resulting from the effects of the conditions described below has been reflected in the formula allowance, management believes that the impact of these events on the collectibility of the applicable loans may not have been reflected in the level of nonperforming loans or in the internal risk grading process with respect to such loans. In addition, our formula allowance does not take into consideration sector-specific changes in the severity of losses that are expected to arise from current economic conditions compared with our historical losses. Accordingly, our evaluation of the probable losses related to the impact of these factors was reflected in the unallocated allowance. The evaluations of the inherent losses with respect to these factors are subject to higher degrees of uncertainty because they are not identified with specific problem credits.
The following describes the specific conditions we considered.
o· With respect to fuel prices, we considered the ability of borrowers to absorb higher oil prices without anticipated negative effects, the prospects of high
and increasing pricescosts of oil and petroleum products and the impact across virtually all sectors of the economy, which could be inthea range of$10$6 million to$39$29 million.o· With respect to commercial real estate, we considered
slightly improved vacancy rates and rent growth being experienced nationally,an improvement in the commercial real estate sector, partly offset by weakness in the residential construction market, whichreduced our attribution to acould be in the range of $8 million to $18 million.o With respect to leasing, we considered an improvement for some electric service providers, the realization of losses in the aircraft lease portfolio and the remaining aircraft lease exposures, which reduced our attribution to a range of $3 million to $6 million. o· With respect to concentrated sales, which include suppliers of
"big box'“big box” stores like Costco, Wal-Mart, Home Depot,Lowe'sLowe’s and other companies that generate 15 percent or more of their revenues from one customer, we considered the potential negative impact competitive market pricing would have on their profit margins, which could be in the range of $5 million to $9 million.· With respect to contractors, we considered the decline in new home sales and the impact of higher commodity prices on contractor margins, which could be in the range of $4 million to $6 million.
· With respect to leasing, we considered the uncertain state of the airline industry, as well as improving positions in our utilities portfolio, which could be in the range of $3 million to $6 million.
41
Accordingly, our evaluation of the probable losses related to the impact of these factors was reflected in the unallocated allowance.
42CHANGE IN THE TOTAL ALLOWANCE FOR CREDIT LOSSESChange in the Total Allowances for Credit Losses
The following table sets forth a reconciliation of changes in our
allowanceallowances for credit losses:
FOR THE THREE MONTHS FOR THE NINE MONTHS -------------------- ------------------- ENDED SEPTEMBER 30, INCREASE (DECREASE) ENDED SEPTEMBER 30, INCREASE (DECREASE) ------------------- ------------------- ------------------- ------------------- (DOLLARS IN THOUSANDS) 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT - ---------------------- ---- ---- ------ ------- ---- ---- ------ -------Balance, beginning of period... $499,580 $394,972 $(104,608) (20.9)% $532,910 $399,156 $(133,754) (25.1)% Loans charged off: Commercial, financial and industrial................. 13,700 8,629 (5,071) (37.0) 52,888 15,992 (36,896) (69.8) Construction................. 200 -- (200) (100.0) 200 118 (82) (41.0) Commercial mortgage.......... -- 8 8 nm 43 1,315 1,272 nm Consumer..................... 1,520 1,136 (384) (25.3) 4,795 3,238 (1,557) (32.5) Lease financing.............. 183 19,656 19,473 nm 2,207 19,857 17,650 799.7 -------- -------- --------- -------- -------- --------- Total loans charged off.... 15,603 29,429 13,826 88.6 60,133 40,520 (19,613) (32.6) Recoveries of loans previously charged off: Commercial, financial and industrial................. 8,216 12,632 4,416 53.7 29,127 44,073 14,946 51.3 Construction................. -- -- -- -- -- 34 34 nm Commercial mortgage.......... -- -- -- -- 1,571 48 (1,523) (96.9) Consumer..................... 350 361 11 3.1 1,241 1,362 121 9.8 Lease financing.............. 40 12 (28) (70.0) 191 149 (42) (22.0) -------- -------- --------- -------- -------- --------- Total recoveries of loans previously charged off... 8,606 13,005 4,399 51.1 32,130 45,666 13,536 42.1 -------- -------- --------- -------- -------- --------- Net loans charged off (recovered)............ 6,997 16,424 9,427 134.7 28,003 (5,146) (33,149) (118.4) Reversal of allowance for loan losses....................... (10,939) (15,000) (4,061) 37.1 (29,038) (40,683) (11,645) 40.1 Foreign translation adjustment and other net additions (deductions)(1).............. (2) 123 125 nm 5,773 52 (5,721) (99.1) -------- -------- --------- -------- -------- --------- Ending balance of allowance for loan losses(2)............... $481,642 $363,671 $(117,971) (24.5)% $481,642 $363,671 $(117,971) (24.5)% Allowance for losses on off-balance sheet commitments(2)............... -- 81,375 81,375 nm -- 81,375 81,375 nm -------- -------- --------- -------- -------- --------- Allowance for credit losses.... $481,642 $445,046 $ (36,596) (7.6)% $481,642 $445,046 $ (36,596) (7.6)% ======== ======== ========= ======== ======== ========= Allowance for credit losses to total loans.................. 1.79% 1.39% 1.79% 1.39% Reversal of allowance for loan losses to net loans charged off (recovered).............. nm nm nm 790.58 Net loans charged off (recovered) to average loans outstanding for the period(3) 0.11 0.20 0.15 (0.02) - ---------------(1) Includes $5.7 million related to the Business Bank of California acquisition in the first quarter of 2004. (2) On December 31, 2004, UnionBanCal Corporation transferred the allowance for losses on off-balance sheet commitments of $83 million from allowance for loan losses to other liabilities. At September 30, 2005, the allowance for losses on off-balance commitments was $82 million. Periods prior to December 31, 2004 have not been restated. (3) Annualized. nm--not meaningful
For the Three Months
Ended March 31,
Increase (Decrease)
(Dollars in thousands)
2005
2006
Amount
Percent
Balance, beginning of period
$
399,156
$
351,532
$
(47,624
)
(11.9
)%
Loans charged off:
Commercial, financial and industrial
3,337
10,744
7,407
nm
Construction
118
—
(118
)
(100.0
)
Mortgage
1,296
—
(1,296
)
(100.0
)
Consumer
1,083
918
(165
)
(15.2
)
Lease financing
131
19
(112
)
(85.5
)
Total loans charged off
5,965
11,681
5,716
95.8
Recoveries of loans previously charged off:
Commercial, financial and industrial
19,600
1,909
(17,691
)
(90.3
)
Mortgage
23
2
(21
)
(91.3
)
Consumer
590
440
(150
)
(25.4
)
Lease financing
17
4,228
4,211
nm
Total recoveries of loans previously charged off
20,230
6,579
(13,651
)
(67.5
)
Net loans charged off (recovered)
(14,265
)
5,102
19,367
nm
Reversal of allowance for loan losses
(12,119
)
(7,000
)
5,119
(42.2
)
Foreign translation adjustment and other net additions (deductions)
(27
)
13
40
nm
Ending balance of allowance for loan losses
$
401,275
$
339,443
$
(61,832
)
(15.4
)
Allowance for losses on off-balance sheet commitments
85,374
83,374
(2,000
)
(2.3
)
Allowances for credit losses
$
486,649
$
422,817
$
(63,832
)
(13.1
)%
Allowances for credit losses to total loans
1.63
%
1.26
%
Reversal of allowance for loan losses to net loans charged off (recovered)
nm
nm
Net loans charged off (recovered) to average loans outstanding for the period(1)
(0.19
)
0.06
(1) Annualized.
nm = not meaningful
Total loans charged off in the
thirdfirst quarter20052006 increased from thethirdfirst quarter2004,2005, primarilyattributabledue to the charge-off ofcertain aircraft leases. Totalfour commercial loans,charged offeach inthe nine months ended September 2005 decreased from the nine months ended September 30, 2004, primarily attributable to the improvements in the credit qualityexcess ofour portfolio, partly offset by the charge-off of certain aircraft leases.$1 million. Charge-offs reflect the realization of losses in the portfolio that were recognized previously through provision for credit losses. Inboth the three and nine months ended September 30, 2005,addition, first quarter 2006 recoveries of loans previously charged offincreaseddecreased from thesamefirst quarter of 2005 primarily a result of the higher levels of loans charged-off in periodsin 2004, primarily attributableprior tohigher 43recoveries of commercial loans. FluctuationsMarch 31, 2005. Such fluctuations in loan recoveries from year-to-year are due to variability in timing of recoveries and tend to trail the periods in which charge-offs are recorded.NONPERFORMING ASSETS42
Nonperforming assets consist of nonaccrual loans and foreclosed assets. Nonaccrual loans are those for which management has discontinued accrual of interest because there exists significant uncertainty as to the full and timely collection of either principal or interest or such loans have become contractually past due 90 days with respect to principal or interest. For a more detailed discussion of the accounting for nonaccrual loans, see Note 1 to our Consolidated Financial Statements included in our
2004Annual Report on Form10-K.10-K for the year ended December 31, 2005.Foreclosed assets include property where we acquired title through foreclosure or
"deed“deed inlieu"lieu” of foreclosure.The following table sets forth an analysis of nonperforming assets.
INCREASE (DECREASE) SEPTEMBER 30, 2005 FROM: ------------------------ SEPTEMBER 30, DECEMBER 31, 2004 2004 ---- ---- SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, (DOLLARS IN THOUSANDS) 2004 2004 2005 AMOUNT PERCENT AMOUNT PERCENT - ---------------------- ---- ---- ---- ------ ------- ------ -------Commercial, financial and industrial $ 90,506 $ 58,538 $ 24,654 $ (65,852) (72.8)% $ (33,884) (57.9)% Construction....................... 6,180 2,622 -- (6,180) (100.0) (2,622) (100.0) Commercial mortgage................ 28,396 26,519 10,326 (18,070) (63.6) (16,193) (61.1) Lease financing.................... 53,758 54,894 -- (53,758) (100.0) (54,894) (100.0) -------- -------- -------- --------- --------- Total nonaccrual loans......... 178,840 142,573 34,980 (143,860) (80.4) (107,593) (75.5) Foreclosed assets.................. 10,607 7,282 2,527 (8,080) (76.2) (4,755) (65.3) -------- -------- -------- --------- --------- Total nonperforming assets..... $189,447 $149,855 $ 37,507 $(151,940) (80.2) $(112,348) (75.0) ======== ======== ======== ========= ========= Allowances for credit losses(1).... $481,642 $481,531 $445,046 $ (36,596) (7.6)% $ (36,485) (7.6)% ======== ======== ======== ========= ========= Nonaccrual loans to total loans.... 0.66% 0.49% 0.11% Allowances for credit losses to nonaccrual loans................. 269.31 337.74 1,272.29 Nonperforming assets to total loans and foreclosed assets............ 0.70 0.51 0.12 Nonperforming assets to total assets........................... 0.40 0.31 0.07 - ---------------(1) Includes allowance for losses on off-balance sheet commitments.
Increase (Decrease)
March 31, 2006 From:
March 31,
December 31,
March 31,
March 31, 2005
December 31, 2005
(Dollars in thousands)
2005
2005
2006
Amount
Percent
Amount
Percent
Commercial, financial and industrial
$
30,089
$
50,073
$
18,691
$
(11,398
)
(37.9
)%
$
(31,382
)
(62.7
)%
Construction
1,425
—
—
(1,425
)
(100.0
)
—
nm
Commercial mortgage
9,587
8,819
8,257
(1,330
)
(13.9
)
(562
)
(6.4
)
Lease financing
54,893
—
15,187
(39,706
)
(72.3
)
15,187
nm
Total nonaccrual loans
95,994
58,892
42,135
(53,859
)
(56.1
)
(16,757
)
(28.5
)
Foreclosed assets
5,232
2,753
257
(4,975
)
(95.1
)
(2,496
)
(90.7
)
Total nonperforming
assets
$
101,226
$
61,645
$
42,392
$
(58,834
)
(58.1
)
$
(19,253
)
(31.2
)
Allowances for credit losses(1)
$
486,649
$
437,907
$
422,817
$
(63,832
)
(13.1
)%
$
(15,090
)
(3.4
)%
Nonaccrual loans to total loans
0.32
%
0.18
%
0.13
%
Allowances for credit losses to nonaccrual loans
506.96
743.58
1,003.48
Nonperforming assets to total loans and foreclosed assets
0.34
0.19
0.13
Nonperforming assets to total assets
0.20
0.12
0.09
(1)Includes allowance for losses related to off-balance sheet commitments.
nm = not meaningful
At
September 30, 2005,March 31, 2006, our nonperforming assets included approximately$9.5$5 million in acquired syndicated loans. Thedecreasesdecrease in nonaccrual commercial, financial, and industrial financings were primarily due to pay-downs, note sales, and charge-offs. The increase in nonaccrual lease financings was primarily due to leases in thecharge-off of certain aircraft leases.utilities sector. During thethirdfirst quarter2005,2006, we sold$4.0approximately $18 million of nonperforming loans compared tonone$35 million in thethirdfirst quarter2004.2005. Losses andgains, torecoveries that result when theextent previously charged-off, from these salessale decision is made are reflected in our net charge-offs.44
LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING INCREASE (DECREASE) SEPTEMBER 30, 2005 FROM: ------------------------ SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, 2004 2004 2005 2004 2004 ---- ---- ---- ---- ---- (DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT - ---------------------- ------ ------- ------ -------Commercial, financial and industrial....... $1,892 $1,315 $ 778 $(1,114) (58.9)% $(537) (40.8)% Construction............................... 2,137 -- -- (2,137) (100.0) -- nm Residential mortgage....................... 3,353 1,385 3,042 (311) (9.3) 1,657 119.6 Consumer and other......................... 1,249 1,157 883 (366) (29.3) (274) (23.7) ------ ------ ------ ------- ----- Total loans 90 days or more past due and still accruing........................... $8,631 $3,857 $4,703 $(3,928) (45.5)% $ 846 21.9% ====== ====== ====== ======= ===== - ---------------nm = not meaningfulQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK43
Loans 90 Days or More Past Due and Still Accruing
Increase (Decrease)
March 31, 2006 From:
March 31,
December 31,
March 31,
March 31, 2005
December 31, 2005
(Dollars in thousands)
2005
2005
2006
Amount
Percent
Amount
Percent
Commercial, financial and industrial
$
271
$
187
$
412
$
141
52.0
%
$
225
120.3
%
Construction
629
677
—
(629
)
(100.0
)
(677
)
(100.0
)
Mortgage:
Residential
1,580
2,784
2,968
1,388
87.8
184
6.6
Commercial
878
499
1,007
129
14.7
508
101.8
Total mortgage
2,458
3,283
3,975
1,517
61.7
692
21.1
Consumer and other
616
819
812
196
31.8
(7
)
(0.9
)
Total loans 90 days or more past due and still accruing
$
3,974
$
4,966
$
5,199
$
1,225
30.8
%
$
233
4.7
%
Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk exists primarily in interest rate risk in our non-trading balance sheet and, to a much lesser degree, in price risk in our trading portfolio for our customer-focused trading and sales activities. The objective of market risk management is to mitigate an undue adverse impact on earnings and capital arising from changes in interest rates and other market variables. This risk management objective supports our broad objective of
preservingenhancing shareholder value, which encompasses stable earnings growth over time and capital stability.The Board of Directors, through its Finance and Capital Committee, approves our
Asset-Liability Management (ALM)ALM Policy, which governs the management of market risk and liquidity. In the administration of market risk management, theChief Executive Officer (CEO)CEO Forum provides broad and strategic guidance and, as appropriate, specific direction to the Asset & Liability Management Committee (ALCO) whose voting members are comprised of senior executives. ALCO is responsible for ongoing management of interest rate and price risks as well as liquidity risk, including formulation of risk management strategies, in accordance with the CEOForum'sForum’s directives. The Treasurer is primarily responsible for the implementation of risk management strategies approved by the CEO Forum or ALCO and for operating management of market risk through the funding, investment, and derivatives hedging activities of Corporate Treasury. The Manager of the Global Markets Division is responsible for operating management of price risk through the trading activities conducted in that division.The Market Risk Monitoring
(MRM)unit is responsible for the monitoringand reportingof marketrisk, including ensuring that ALCO, our senior management and the Board are kept fully informed as to our market risk profile and compliance with applicable limits, guidelines and policies. MRMrisk. Market Risk Monitoring functions independently of all operating and management units.We have separate and distinct methods for managing the market risk associated with our
ALMasset and liability management activities and our tradingactivities. INTEREST RATE RISK MANAGEMENT (OTHER THAN TRADING)activities, as described below.Interest Rate Risk Management (Other Than Trading)
During the
thirdfirst quarter2005,of 2006, our asset sensitivity decreased as a result of several factors. Firstly, we added new floor hedges to reduce our downside asset-sensitivitywas reduced, reversing the upward trend(see our discussion ofthe first six months of 2005. The reduction“ALM Derivatives” below). Additionally, changes inasset-sensitivity during the third quarter 2005 reflected the combination of a shift in ALM strategy that took place in the third quarter 2005 and changes underway in the coreour balance sheet(for additional information see "ALM Activities" section below). In particular wascomposition and refinements we made to our deposit-pricing model to reflect theinterest rate risk impact of changes in deposit market pricing conditions. We observed anincreasing45responsiveness of non-maturity deposit rates to changes in short-termmarket rates in recent monthsespecially during the current quarter. This has occurred as a result of the delayed response of deposit rateshave also contributed tothe increases in market rates since 2004. Our modeling of this change in the deposit-pricing environment resulted ina reduction inthe reportedour asset sensitivity.At March 31, 2006, Economic NII showed modest asset-sensitivity
of our earnings during the third quarter 2005. In the table below, ato parallel rate shifts. A +200 basispointspoint parallelrate shift at September 30, 2005 would have produced an estimated 1.04 percent increase in Economic NII (net interest income), while a -200 basis pointsshift wouldhave loweredraise 12-month Economic NII byan estimated 2.221.01 percent, while a similar downward shift would reduce it by 1.21 percent. This compares with an estimated0.811.93 percent and negative1.702.58 percent, respectively, atSeptember 30, 2004.March 31, 2005. We cautionhowever,that ongoing enhancements to our interest rate risk modelingchanges implemented over this periodmay makeyear-over-yearprior-year comparisonsno longerof Economic NII less meaningful.44
Economic NII adjusts our reported NII for the effect of certain non-interest, DDA-related, fee and expense items. Those adjustment items are innately liability-sensitive, meaning that reported NII is more asset-sensitive than is Economic NII.
ECONOMICEconomic NII
SEPTEMBER 30, JUNE 30, SEPTEMBER 30, (DOLLARS IN MILLIONS) 2004 2005 2005 - --------------------- ---- ---- ----+200 basis points..................................................................... $13.1 $51.3 $20.4 as a percentage of base case NII...................................................... 0.81% 2.68% 1.04% - -200 basis points..................................................................... $(27.6) $(66.5) $(43.3) as a percentage of base case NII...................................................... 1.70% 3.48% 2.22%
(Dollars in millions)
March 31,
2005
December 31,
2005
March 31,
2006
+200 basis points
$
36.4
$
18.9
$
20.4
as a percentage of basc case NII
1.93
%
0.93
%
1.01
%
-200 basis points
$
(48.6
)
$
(40.2
)
$
(24.5
)
as a percentage of basc case NII
2.58
%
1.97
%
1.21
%
The figures in the above table are reported on a continuing operations basis, with all assets and liabilities associated with the disposal of the international correspondent banking business eliminated. We believe that this approach provides the best representation of our risk profiles. In the case of non-parallel yield curve changes,
we remainour Economic NII is relatively neutral to short rates changes (with long rates held constant) and modestly asset-sensitivebothto changes in long-term rates (with short-term rates held constant)and to the converse. The table above presents the impact on economic NII on a consolidated basis, which represents the true economic interest rate risk, reflecting the assets and liabilities of the international correspondent banking business as they are expected to run off in coming months under the terms of the recently announced sale of that unit (see discussion under "Discontinued Operations").On a continuing operations basis, our asset-sensitivity at September 30, 2005, was affected only marginally. Economic NII would have risen by 1.09 percent under a +200 basis points parallel shift and would have fallen by 2.27 percent had rates moved down by 200 basis points.ALM
ACTIVITIESActivitiesIn general, our unhedged, core balance sheet is
asset-sensitive,relatively asset sensitive, meaning that our loans generally re-price more quickly than our core deposits. In managing the interest sensitivity of our balance sheet, we use the ALM investment securities portfolio and derivatives positions as the primary tools to adjust ourprimary tools.risk profile. During thethirdfirst quarter2005,of 2006, wecontinuedcompleted our ALM portfolio rebalancing strategy as described below while continuing to allowrunoff in our relatively short durationmaturing ALM securities runoff to help support loan growth.However, newNew derivative hedges were also added during thethirdquarter2005as described below, to help reduce ouroverall asset-sensitivity.asset sensitivity.ALM
INVESTMENTSInvestmentsAt
September 30,March 31, 2005 and 2006, our securities available for sale portfolio included$8.3$10.0 billion and $6.6 billion, respectively, of securities for ALMpurposes, compared with $11.2 billion at September 30, 2004.purposes. During thethirdfirst quarter of 2006, we purchased approximately $646 million of AAA-rated Non-Agency mortgage-backed securities to complete our portfolio rebalancing strategy, initiated in the fourth quarter of 2005, to diversify our Agency concentration risk. The composition of the portfolio is expected to remain relatively stable for the remainder of 2006. Also, approximately$700$380 million of ALM securities matured or were calleddivided evenly between direct Agency obligations and mortgage-backed securities.during the quarter. The estimated ALM portfolio effective duration was2.02.3 atSeptember 30, 2005,March 31, 2006, compared to2.42.2 atSeptember 30, 2004. 46March 31, 2005. Effective duration is a measure of price sensitivity of a bond portfolio to immediate parallel shifts in interest rates. An effective duration of
2.02.3 suggests an expected price change of approximately minus2.02.3 percent for an immediate one percentriseincrease in interest rates.ALM
DERIVATIVESDerivativesDuring the
thirdfirst quarter2005,2006, we purchased $1 billion notional amountin new derivative hedgesof LIBOR floors in order toreducemoderate the downside asset-sensitivity of our overallbalance sheet. Together withrisk position while retaining the$300 millionupside sensitivity should rates rise further. During the first quarter of 2006, we also allowed $1.8 billion of caps and cap corridors, which hedged our CD portfolios to mature. The net effect of the purchases and maturities was a reduction inmaturing positions,our ALM derivatives portfolioincreased by $700 million between June 30 and September 30, 2005. During the nine months ended September 30, 2005, the ALM derivatives portfolio has declined by a net $1.73 billion notional, as $2.73 billion notionalofcontracts have matured, offset by the $1 billion notional of interest rate swaps added in the most recent quarter.approximately $750 million. The fair value of the ALM derivative contracts have declined throughout the year as several"in-the-money"“in-the-money” contracts have matured and as the value of our remaining receive fixed and floor positions have declined with rising interest rates.45
For additional discussion of derivative instruments and our hedging strategies, see Note 8 to our Condensed Consolidated Financial Statements included in this report and Note
1819 to our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31,2004.2005.The following table provides the notional value and the fair value of our ALM derivatives portfolio as of March 31, 2005, December 31,
2004, June 302005, andSeptember 30, 2005March 31, 2006 and the change in fair value betweenJune 30December 31, 2005 andSeptember 30, 2005.
INCREASE / (DECREASE) FROM JUNE 30, 2005 DECEMBER 31, JUNE 30, SEPTEMBER 30, TO SEPTEMBER 30, (DOLLARS IN THOUSANDS) 2004 2005 2005 2005 - ---------------------- ---- ---- ---- ----Total gross notional amount of positions held for purposes other than trading:......................................... $9,880,000 $7,450,000 $8,150,000 $700,000 Of which, interest rate swaps pay fixed rates of interest:.. $ -- $ -- $ -- $-- ---------- ---------- ---------- -------- Fair value of positions held for purposes other than trading: Gross positive fair value................................... $45,434 $ 36,596 $ 15,690 $(20,906) Gross negative fair value................................... $ (15,461) $ (23,259) $ (48,118) $(24,859) ---------- ---------- ---------- -------- Fair value of position.................................... $ 29,973 $ 13,337 $ (32,428) $(45,765) ========== ========== ========== ========TRADING ACTIVITIESMarch 31, 2006.
Increase / (Decrease)
March 31,
December 31,
March 31,
From December 31, 2005
(Dollars in thousands)
2005
2005
2006
to March 31, 2006
Total gross notional amount of positions held for purposes other than trading:
$
8,680,000
$
7,550,000
$
6,800,000
$
(750,000
)
Of which, interest rate swaps pay fixed rates of interest:
—
—
—
—
Fair value of positions held for purposes other than trading:
Gross positive fair value
20,040
5,721
13,370
7,649
Gross negative fair value
43,305
55,943
69,746
13,803
Fair value of position
$
(23,265
)
$
(50,222
)
$
(56,376
)
$
(6,154
)
Trading Activities
Effective January 1, 2005, the Securities Trading and Institutional Sales department, which serves the fixed-income needs of our institutional clients, was combined with the retail brokerage operations of our broker/dealer subsidiary, UnionBanc Investment Services LLC. The great majority of our securities trading income comes from customer-related transactions. UnionBanc Investment Services
LLC'sLLC’s trading risk is monitored and controlled using the existing Value-at-Risk methodology.We began marketing energy derivatives contracts to existing energy industry customers, primarily oil and gas producers, in late 2004, in order to meet their hedging needs. Volume increased from
$42 million$1.1 billion in notional amount of contracts outstanding as of December 31,20042005 to$832 million$1.5 billion as ofSeptember 30, 2005.March 31, 2006. Consistent with our customer interest rate derivatives business, all transactions are fully matched to remove our exposure to market risk, with income produced from the credit spread earned.For information about the market risk in our trading activities, please see
"Quantitative“Quantitative and Qualitative Disclosures about MarketRisk"Risk” in"Management's“Management’s Discussion and Analysis of Financial47Condition and Results of Operations"Operations” in our Annual Report on Form 10-K for the year ended December 31,2004. LIQUIDITY RISK2005.Liquidity risk
representsis thepotential for loss as aundue risk to the Bank’s earnings and capital, which would resultof limitations on our ability to adjust our future cash flowsfrom the Bank’s inability to meet its obligations as they come due without incurring unacceptable costs. Liquidity risk management is governed by theneeds of depositors and borrowers and to fund operations on a timely and cost-effective basis. TheALM Policy, which is approved by the Finance and Capital Committee of theBoard requires regular reviews of our liquidity by ALCO.Board. ALCO conducts monthly ongoing reviews of our liquidity situationas well asand provides regular updates to our CEO Forum who approve ourliquidity contingency plan.Liquidity Contingency Plan. Liquidity is managed through this ALCO coordination process on an entity-wide basis, encompassing all major business units.The operatingOur liquidity managementof liquidityis implemented throughthe funding and investment functions. Our liquidity management drawsour three primary sources of liquidity: core deposits, drawing upon the strengths of our extensive retail and commercial core depositfranchise, coupled with the ability to obtainfranchise; asset liquidation, including selling securities under repurchase agreements; and wholesale funding, which includes fundsfor various terms in a variety ofraised from interbank and other sources, both domestic andinternational money markets. Our securities portfolio represents a significant source of additional liquidity.offshore.46
Core deposits provide us with a sizable source of relatively stable and low-cost funds. Our average core deposits, which include demand deposits, money market demand accounts, and savings and consumer time deposits,
(of $100 thousand or less),combined with average commonstockholders'stockholders’ equity, funded over7683 percent of average total assets of approximately $48 billion in thethirdfirst quarter of2005.2006. Most of the remaining funding was provided by short-term borrowings in the form ofnegotiablecertificates of deposit, large time deposits, foreign deposits, federal funds purchased, securities sold under repurchase agreements, commercial paper, and other borrowings.TheOur securities portfolio provides
additionaladditional enhancement to our liquidity position, which may be created through either securities sales or repurchase agreements. AtSeptember 30, 2005,March 31, 2006, we could have sold or transferred under repurchase agreementsalmost $6approximately $4 billion of our available for sale securities. Liquidity may also be provided by the sale or maturity of other assets such as interest-bearing deposits in banks, federal funds sold, and trading account securities.For the quarter ended September 30, 2005, theThe aggregate balance of these assets averaged$1 billion.$733 million in the first quarter of 2006. Additional liquidity may be provided through loan maturities and sales.REGULATORY CAPITALThe following tables summarize our risk-based capital, risk-weighted assets, and risk-based capital ratios. The tables include assets of discontinued operations.
UNIONBANCAL CORPORATION MINIMUM SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, REGULATORY (DOLLARS IN THOUSANDS) 2004 2004 2005 REQUIREMENT - ---------------------- ----------- ----------- ----------- -----------CAPITAL COMPONENTS Tier 1 capital.............$ 3,760,291 $ 3,817,698 $ 3,963,712 Tier 2 capital............. 949,091 968,294 883,832 ----------- ----------- ----------- Total risk-based capital...$ 4,709,382 $ 4,785,992 $ 4,847,544 =========== =========== =========== Risk-weighted assets.......$37,622,266 $39,324,859 $44,630,199 =========== =========== =========== Quarterly average assets $45,444,623 $47,168,683 $49,819,315 =========== =========== ===========CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - -------------- ------ ----- ------ ----- ------ ----- ------ -----Total capital (to risk-weighted assets).......... $4,709,382 12.52% $4,785,992 12.17% $4,847,544 10.86% > $3,570,416 8.0% - Tier 1 capital (to risk-weighted assets).......... 3,760,291 9.99 3,817,698 9.71 3,963,712 8.88 > 1,785,208 4.0 - Leverage(1)........ 3,760,291 8.27 3,817,698 8.09 3,963,712 7.96 > 1,992,773 4.0 - --------------- -(1) Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).48
UNION BANK OF CALIFORNIA, N.A. MINIMUM "WELL-CAPITALIZED" SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, REGULATORY REGULATORY (DOLLARS IN THOUSANDS) 2004 2004 2005 REQUIREMENT REQUIREMENT - ---------------------- ------------- ------------ ------------- ----------- ------------------CAPITAL COMPONENTS Tier 1 capital.......... $ 3,791,489 $ 3,597,738 $ 4,068,332 Tier 2 capital.......... 487,480 493,756 441,350 ----------- ----------- ----------- Total risk-based capital.............. $ 4,278,969 $ 4,091,494 $ 4,509,682 =========== =========== =========== Risk-weighted assets.... $36,919,037 $38,711,682 $43,966,515 =========== =========== Quarterly average assets $44,943,543 $46,588,762 $49,138,592 =========== =========== ===========CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - -------------- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----Total capital (to risk-weighted assets)........ $4,278,969 11.59% $4,091,494 10.57% $4,509,682 10.26% > $3,517,321 8.0% > $4,396,652 10.0% - - Tier 1 capital (to risk-weighted assets)........ 3,791,489 10.27 3,597,738 9.29 4,068,332 9.25 > 1,758,661 4.0 > 2,637,991 6.0 - - Leverage(1)...... 3,791,489 8.44 3,597,738 7.72 4,068,332 8.28 > 1,965,544 4.0 > 2,456,930 5.0 - --------------- - -(1) Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).UnionBanCal Corporation
Minimum
March 31,
December 31,
March 31,
Regulatory
(Dollars in thousands)
2005
2005
2006
Requirement
Capital Components
Tier 1 capital
$
3,728,822
$
4,178,160
$
4,243,053
Tier 2 capital
968,292
876,713
862,051
Total risk-based capital
$
4,697,114
$
5,054,873
$
5,105,104
Risk-weighted assets
$
41,167,052
$
45,540,448
$
46,657,433
Quarterly average assets
$
47,892,405
$
49,789,877
$
48,200,458
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
Capital Ratios
Total capital (to risk-weighted assets)
$
4,697,114
11.41
%
$
5,054,873
11.10
%
$
5,105,104
10.94
% ³
$
3,732,595
8.0
%
Tier 1 capital (to risk-weighted assets)
3,728,822
9.06
4,178,160
9.17
4,243,053
9.09
³
1,866,297
4.0
Leverage(1)
3,728,822
7.79
4,178,160
8.39
4,243,053
8.80
³
1,928,018
4.0
(1)Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).
47
Union Bank of California, N.A.
Minimum
“Well-Capitalized”
March 31,
December 31
March 31,
Regulatory
Regulatory
(Dollars in thousands)
2005
2005
2006
Requirement
Requirement
Capital Components
Tier 1 capital
$
3,719,837
$
4,315,471
$
4,377,832
Tier 2 capital
492,259
433,353
426,955
Total risk-based capital
$
4,212,096
$
4,748,824
$
4,804,787
Risk-weighted assets
$
40,563,339
$
44,851,154
$
45,943,246
Quarterly average
assets
$
47,267,803
$
49,127,241
$
47,563,560
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
Capital Ratios
Total capital (to risk-weighted assets)
$
4,212,096
10.38
%
$
4,748,824
10.59
%
$
4,804,787
10.46
%
³$ 3,675,460
8.0
%
³$ 4,594,325
10.0
%
Tier 1 capital (to risk-weighted assets)
3,719,837
9.17
4,315,471
9.62
4,377,832
9.53
³ 1,837,730
4.0
³ 2,756,595
6.0
Leverage(1)
3,719,837
7.87
4,315,471
8.78
4,377,832
9.20
³ 1,902,542
4.0
³ 2,378,178
5.0
(1)Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).
We and Union Bank of California, N.A. are subject to various regulations of the federal banking agencies, including minimum capital requirements. We both are required to maintain minimum ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to quarterly average assets (the Leverage ratio).
The decrease in
ourthe Total capitalratiosratio for UnionBanCal Corporation fromSeptember 30, 2004, was attributable to higher risk-weighted assets and also stock repurchase. Our Leverage ratio decreaseMarch 31, 2005 was primarily due toa $4 billion, or 10 percent,an increase inquarterly averagerisk-weighted assets, which was substantially the result of increases inbothourresidential mortgageloan andcommercial loan portfolios.lease financing receivables and unused off-balance sheet commitments. The increase in our leverage ratios from March 31, 2005 was due to the increase in our Tier 1 capital.As of
September 30, 2005,March 31, 2006, management believes the capital ratios of Union Bank of California, N.A. met all regulatory requirements of"well-capitalized"“well-capitalized” institutions, which are 10 percent for the Total risk-based capital ratio, 6 percent for the Tier 1 risk-based capital ratio and 5 percent for the Leverage ratio.BUSINESS SEGMENTSIn April 2005, we announced several organizational changes that affected our business segments. The Global Markets Group has been eliminated and the activities of this group have been transferred. Corporate Treasury, which is responsible for ALM and the investment portfolio, is now included in
"Other."“Other.” The trading of securities and foreign exchange contracts, as well as the responsibilities for customer accommodated derivative contracts, are now included in the"Global“Global MarketsDivision"Division” of the Community Banking and Investment Services Group. In addition, the discontinued operations resulting from the sale of most of our International Banking Group is also reflected in"Other."“Other.” We are now organized around the target markets we serve and operate in two principal areas, as shown in the table that follows. The results show the financial performance of our major business units.The risk-adjusted return on capital (RAROC) methodology used seeks to attribute economic capital to business units consistent with the level of risk they assume. These risks are primarily credit, market and operational. Credit risk is the potential loss in economic value due to the likelihood that the obligor will not perform as agreed. Market risk is the potential loss in fair value due to changes in interest rates, currency rates and equity prices. Operational risk is the potential loss due to all other factors, such as failures in internal control, system failures, or external events. RAROC is one of several measures that is used to measure business unit compensation.
48
The following tables reflect the condensed income statements, selected average balance sheet items, and selected financial ratios, including changes from the prior year, for each of our primary business units. The information presented does not necessarily represent the business
units'units’ financial condition and results of operations as if they were independent entities.Also,In thetable has been expandedfirst quarter of 2006, we changed our reporting toinclude 49performance center earnings. A performance centerreflect a “market view” perspective in measuring our business segments. The market view is aspecial unit whose income generating activities, unlike typical profit centers, are based on other business segment units'measurement of our customerbase. Themarkets aggregated to show all revenues generated and expenses incurredforfrom all products and services sold to thosetransactions entered into to accommodate ourcustomers regardless of where product areas organizationally report. Therefore, revenues and expenses areallocated to otherincluded in both the businesssegments wheresegment that provides the service and the business segment that manages the customerrelationships reside. A performance center's purpose is to fosterrelationship. The duplicative results from this internal management accounting view are reflected in “Reconciling Items.” The market view approach fosters cross-selling with a total profitability view of the products and servicesit manages.being managed. For example, the Securities Trading and Sales unit within the Global Markets Division, is aperformance centerbusiness unit that manages the fixed income securitiesactivities.activities for all retail and corporate customers throughout the Bank.Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to US GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies.
The RAROC measurement methodology recognizes credit expense for expected losses arising from credit risk and attributes economic capital related to unexpected losses arising from credit, market and operational risks. As a result of the methodology used by the RAROC model to calculate expected losses, differences between the provision for credit losses and credit expense in any one period could be significant. However, over an economic cycle, the cumulative provision for credit losses and credit expense for expected losses should be substantially the same. Business unit results are based on an internal management reporting system used by management to measure the performance of the units and UnionBanCal Corporation as a whole. Our management reporting system identifies balance sheet and income statement items for each business unit based on internal management accounting policies. Net interest income is determined using our internal funds transfer pricing system, which assigns a cost of funds to assets or a credit for funds to liabilities and capital, based on their type, maturity or repricing characteristics. Noninterest income and expense directly or indirectly attributable to a business unit are assigned to that business. The business units are assigned the costs of products and services directly attributable to their business activity through standard unit cost accounting based on volume of usage. All other corporate expenses (overhead) are allocated to the business units based on a predetermined percentage of usage.
50The business
units'unit results for the prior periods have beenrestatedadjusted to reflect changes in the transfer pricing methodology, the organizational changes that have occurred,andour discontinuedoperations.
COMMUNITY BANKING COMMERCIAL AND INVESTMENT FINANCIAL SERVICES GROUP SERVICES GROUP -------------- -------------- AS OF THE THREE AS OF THE THREE MONTHS 2005 VS. 2004 MONTHS 2005 VS. 2004 ENDED SEPTEMBER 30, INCREASE/(DECREASE) ENDED SEPTEMBER 30, INCREASE/(DECREASE) ------------------- ------------------- ------------------- ------------------- 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT ---- ---- ------ ------- ---- ---- ------ -------RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income......................... $197,024 $235,907 $38,883 20% $176,381 $227,476 $51,095 29% Noninterest income (expense)................ 127,907 138,885 10,978 9 63,020 67,994 4,974 8 -------- -------- ------- -------- -------- ------- Total revenue............................... 324,931 374,792 49,861 15 239,401 295,470 56,069 23 Noninterest expense......................... 242,406 246,936 4,530 2 104,361 122,404 18,043 17 Credit expense.............................. 8,450 8,783 333 4 24,738 20,458 (4,280) (17) -------- -------- ------- -------- -------- ------- Income from continuing operations before income taxes.............................. 74,075 119,073 44,998 61 110,302 152,608 42,306 38 Income tax expense.......................... 28,334 45,545 17,211 61 35,233 51,493 16,260 46 -------- -------- ------- -------- -------- ------- Income from continuing operations........... $ 45,741 $ 73,528 $27,787 61 $ 75,069 $101,115 $26,046 35 Income (loss) from discontinued operations, net of income taxes....................... -- -- -- na -- -- -- na -------- -------- ------- -------- -------- ------- Net income.................................. $ 45,741 $ 73,528 $27,787 61 $ 75,069 $101,115 $26,046 35 ======== ======== ======= ======== ======== ======= PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income......................... $ 73 $ (50) $ (123) (168)%$ (47) $ (20) $ 27 57% Noninterest income.......................... (13,762) (15,323) (1,561) (11) 10,447 11,858 1,411 14 Noninterest expense......................... (4,669) (5,722) (1,053) (23) 4,063 4,919 856 21 Income (loss) from continuing operations.... (9,110) (9,811) (701) (8) 6,433 6,994 561 9 Total loans (dollars in millions)........... 21 17 (4) (19) (42) (42) -- nm AVERAGE BALANCES OF CONTINUING OPERATIONS (DOLLARS IN MILLIONS): Total loans(1).............................. $ 13,105 $ 15,539 $ 2,434 19% $ 12,712 $ 16,391 $ 3,679 29% Total assets................................ 14,508 17,062 2,554 18 15,383 19,995 4,612 30 Total deposits(1)........................... 19,406 20,319 913 5 14,345 16,861 2,516 18 FINANCIAL RATIOS (ON A CONTINUING OPERATIONS): Risk adjusted return on capital(2)............ 25% 28% 20% 23% Return on average assets(2)................... 1.25 1.71 1.94 2.01 Efficiency ratio(3)........................... 74.60 65.89 43.59 41.43
UNIONBANCAL OTHER CORPORATION ----- ----------- AS OF THE THREE AS OF THE THREE MONTHS 2005 VS. 2004 MONTHS 2005 VS. 2004 ENDED SEPTEMBER 30, INCREASE/(DECREASE) ENDED SEPTEMBER 30, INCREASE/(DECREASE) ------------------- ------------------- ------------------- ------------------- 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT ---- ---- ------ ------- ---- ---- ------ -------RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income....................... $33,173 $ 759 $(32,414) (98)% $406,578 $464,142 $57,564 14% Noninterest income (expense).............. 6,193 5,309 (884) (14) 197,120 212,188 15,068 8 ------- ------- -------- -------- -------- ------- Total revenue............................. 39,366 6,068 (33,298) (85) 603,698 676,330 72,632 12 Noninterest expense....................... 12,809 27,356 14,547 114 359,576 396,696 37,120 10 Credit expense............................ (44,127) (44,241) (114) nm (10,939) (15,000) (4,061) (37) ------- ------- -------- -------- -------- ------- Income from continuing operations before income taxes............................ 70,684 22,953 (47,731) (68) 255,061 294,634 39,573 16 Income tax expense........................ 34,554 (3,650) (38,204) (111) 98,121 93,388 (4,733) (5) ------- ------- -------- -------- -------- ------- Income from continuing operations......... $36,130 $26,603 $ (9,527) (26) $156,940 $201,246 $44,306 28 Income (loss) from discontinued operations, net of income taxes..................... 6,498 (15,961) (22,459) (346) 6,498 (15,961) (22,459) (346) ------- ------- -------- -------- -------- ------- Net income................................ $42,628 $10,642 $(31,986) (75) $163,438 $185,285 $21,847 13 ======= ======= ======== ======== ======== ======= PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income....................... $ (26) $ 70 $ 96 369% $ -- $ -- $ -- na Noninterest income........................ 3,315 3,465 150 5 -- -- -- na Noninterest expense....................... 606 803 197 33 -- -- -- na Income (loss) from continuing operations.. 2,677 2,817 140 5 -- -- -- na Total loans (dollars in millions)......... 21 25 4 19 -- -- -- na AVERAGE BALANCES OF CONTINUING OPERATIONS (DOLLARS IN MILLIONS): Total loans(1)............................ $ 485 $ 248 $ (237) (49)% $ 26,302 $ 32,178 $ 5,876 22% Total assets.............................. 13,582 11,155 (2,427) (18) 43,473 48,212 4,739 11 Total deposits(1)......................... 2,187 3,114 927 42 35,938 40,294 4,356 12 FINANCIAL RATIOS (ON A CONTINUING OPERATIONS): Risk adjusted return on capital(2).......... na na na na Return on average assets(2)............... na na 1.44% 1.66% Efficiency ratio(3)....................... na na 59.46 59.07 - ---------------(1) Represents loans and deposits for each business segment after allocation between the segments of loans and deposits originated in one segment but managed by another segment. (2) Annualized. (3) The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income) and provision for losses on off-balance sheet commitments, as a percentage of net interest income and noninterest income. nm = not meaningful na = not applicable51
COMMUNITY BANKING COMMERCIAL AND INVESTMENT FINANCIAL SERVICES GROUP SERVICES GROUP -------------- -------------- AS OF THE NINE AS OF THE NINE MONTHS 2005 VS. 2004 MONTHS 2005 VS. 2004 ENDED SEPTEMBER 30, INCREASE/(DECREASE) ENDED SEPTEMBER 30, INCREASE/(DECREASE) ------------------- ------------------- ------------------- ------------------- 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT ---- ---- ------ ------- ---- ---- ------ -------RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income...................... $553,095 $ 692,546 $139,451 25% $495,870 $646,283 $150,413 30% Noninterest income (expense)............. 379,818 410,391 30,573 8 202,629 206,445 3,816 2 -------- --------- -------- -------- -------- -------- Total revenue............................ 932,913 1,102,937 170,024 18 698,499 852,728 154,229 22 Noninterest expense...................... 695,739 763,189 67,450 10 311,470 346,525 35,055 11 Credit expense........................... 24,134 25,423 1,289 5 82,443 65,500 (16,943) (21) -------- --------- -------- -------- -------- -------- Income from continuing operations before income taxes........................... 213,040 314,325 101,285 48 304,586 440,703 136,117 45 Income tax expense....................... 81,488 120,229 38,741 48 97,187 147,343 50,156 52 -------- --------- -------- -------- -------- -------- Income from continuing operations........ $131,552 $ 194,096 $ 62,544 48 $207,399 $293,360 $ 85,961 41 Income (loss) from discontinued operations, net of income taxes........ -- -- -- na -- -- -- na -------- --------- -------- -------- -------- -------- Net income............................... $131,552 $ 194,096 $ 62,544 48 $207,399 $293,360 $ 85,961 41 ======== ========= ======== ======== ======== ======== PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income...................... $ 399 $ 102 $ (297) (74) $ (286) $ (266) $ 20 7 Noninterest income....................... (53,242) (44,157) 9,085 17 42,337 34,095 (8,242) (19) Noninterest expense...................... (24,764) (16,413) 8,351 34 21,654 13,893 (7,761) (36) Income (loss) from continuing operations. (28,384) (28,207) 177 1 20,611 20,303 (308) (1) Total loans (dollars in millions)........ 25 22 (3) (12) (44) (49) (5) (11) AVERAGE BALANCES OF CONTINUING OPERATIONS (DOLLARS IN MILLIONS): Total loans(1)........................... $ 12,486 $ 15,037 $ 2,551 20 $ 12,314 $ 15,530 $ 3,216 26 Total assets............................. 13,846 16,499 2,653 19 14,685 18,928 4,243 29 Total deposits(1)........................ 19,150 20,342 1,192 6 14,022 15,761 1,739 12 FINANCIAL RATIOS (ON A CONTINUING OPERATIONS): Risk adjusted return on capital(2)....... 24% 30% 19% 24% Return on average assets(2).............. 1.27 1.57 1.89 2.07 Efficiency ratio(3)...................... 74.58 69.20 44.59 40.64
UNIONBANCAL OTHER CORPORATION ----- ----------- AS OF THE NINE AS OF THE NINE MONTHS 2005 VS. 2004 MONTHS 2005 VS. 2004 ENDED SEPTEMBER 30, INCREASE/(DECREASE) ENDED SEPTEMBER 30, INCREASE/(DECREASE) ------------------- ------------------- ------------------- ------------------- 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT ---- ---- ------ ------- ---- ---- ------ -------RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income..................... $147,280 $ 19,685 $(127,595) (87)% $1,196,245 $1,358,514 $162,269 14% Noninterest income (expense)............ 117,987 4,531 (113,456) (96) 700,434 621,367 (79,067) (11) -------- -------- --------- ---------- ---------- -------- Total revenue........................... 265,267 24,216 (241,051) (91) 1,896,679 1,979,881 83,202 4 Noninterest expense..................... 77,542 68,334 (9,208) (12) 1,084,751 1,178,048 93,297 9 Credit expense.......................... (135,615) (131,606) 4,009 3 (29,038) (40,683) (11,645) (40) -------- -------- --------- ---------- ---------- -------- Income from continuing operations before income taxes.......................... 323,340 87,488 (235,852) (73) 840,966 842,516 1,550 nm Income tax expense...................... 130,314 6,469 (123,845) (95) 308,989 274,041 (34,948) (11) -------- -------- --------- ---------- ---------- -------- Income from continuing operations....... $193,026 $ 81,019 $(112,007) (58) $ 531,977 $ 568,475 $ 36,498 7 Income (loss) from discontinued operations, net of income taxes....... 20,045 (14,031) (34,076) (170) 20,045 (14,031) (34,076) (170) -------- -------- --------- ---------- ---------- -------- Net income............................ $213,071 $ 66,988 $(146,083) (69) $ 552,022 $ 554,444 $ 2,422 nm ======== ======== ========= ========== ========== ======== PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income..................... $ (113) $ 164 $ 277 245 $ -- $ -- $ -- na Noninterest income...................... 10,905 10,062 (843) (8) -- -- -- na Noninterest expense..................... 3,110 2,520 (590) (19) -- -- -- na Income (loss) from continuing operations 7,773 7,904 131 2 -- -- -- na Total loans (dollars in millions)....... 19 27 8 42 -- -- -- na AVERAGE BALANCES OF CONTINUING OPERATIONS (DOLLARS IN MILLIONS): Total loans(1).......................... $ 528 $ 276 $ (252) (48) $ 25,328 $ 30,843 $ 5,515 22 Total assets............................ 13,794 11,916 (1,878) (14) 42,325 47,343 5,018 12 Total deposits(1)....................... 2,223 3,202 979 44 35,395 39,305 3,910 11 FINANCIAL RATIOS (ON A CONTINUING OPERATIONS): Risk adjusted return on capital(2)...... na na na na Return on average assets(2)............. na na 1.68% 1.61% Efficiency ratio(3)..................... na na 57.09 59.74 - ---------------(1) Represents loans and deposits for each business segment after allocation between the segments of loans and deposits originated in one segment but managed by another segment. (2) Annualized. (3) The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income) and the provision for losses on off-balance sheet commitments, as a percentage of net interest income and noninterest income. nm = not meaningful na = not applicable52COMMUNITY BANKING AND INVESTMENT SERVICES GROUPoperations and the market view contribution.49
Community Banking
and Investment
Services Group
Commercial Financial
Services Group
As of and for the
Three Months
Ended March 31,
Increase/(decrease)
As of and for the
Three Months
Ended March 31,
Increase/(decrease)
2005
2006
Amount
Percent
2005
2006
Amount
Percent
Results of operations—Market View
(dollars in thousands):
Net interest income (expense)
$ 222,860
$ 242,829
$ 19,969
9
%
$ 203,576
$ 224,687
$ 21,111
10
%
Noninterest income (expense)
149,747
162,311
12,564
8
65,110
65,936
826
1
Total revenue
372,607
405,140
32,533
9
268,686
290,623
21,937
8
Noninterest expense (income)
269,271
279,312
10,041
4
108,203
122,513
14,310
13
Credit expense
8,933
8,931
(2
)
0
23,511
22,563
(948
)
(4
)
Income from continuing operations before income taxes
94,403
116,897
22,494
24
136,972
145,547
8,575
6
Income tax expense (income)
35,415
43,949
8,534
24
45,594
47,899
2,305
5
Income from continuing operations
58,988
72,948
13,960
24
91,378
97,648
6,270
7
Income (loss) from discontinued operations, net of income taxes
—
—
—
na
—
—
—
na
Net income (loss)
$ 58,988
$ 72,948
$ 13,960
24
$ 91,378
$ 97,648
$ 6,270
7
Average balances—Market View (dollars in millions):
Total loans
$ 14,550
$ 16,348
$ 1,798
12
$ 14,909
$ 17,540
$ 2,631
18
Total assets
16,053
17,993
1,940
12
18,075
21,438
3,363
19
Total deposits
20,362
19,615
(747
)
(4
)
14,874
15,660
786
5
Financial ratios—Market View
Risk adjusted return on capital(1)
29
%
33
%
23
%
21
%
Return on average assets(1)
1.49
1.64
2.05
1.85
Efficiency ratio(2)
72.27
68.94
40.16
44.69
Other
Reconciling Items
UnionBanCal Corporation
As of and for the
Three Months
Ended March 31,
Increase/(decrease)
As of and for the
Three Months
Ended March 31,
As of and for the
Three Months
Ended March 31,
Increase/(decrease)
2005
2006
Amount
Percent
2005
2006
2005
2006
Amount
Percent
Results of operations—Market View (dollars in thousands):
Net interest income
(expense)
$ 9,816
$ (1,916
)
$ (11,732
)
(120
)%
$ (590
)
$ (507
)
$ 435,662
$ 465,093
$ 29,431
7
%
Noninterest income
(expense)
6,498
7,508
1,010
16
(15,730
)
(17,845
)
205,625
217,910
12,285
6
Total revenue
16,314
5,592
(10,722
)
(66
)
(16,320
)
(18,352
)
641,287
683,003
41,716
7
Noninterest expense
(income)
21,225
20,232
(993
)
(5
)
(5,747
)
(7,513
)
392,952
414,544
21,592
5
Credit expense
(44,414
)
(38,451
)
5,963
13
(149
)
(43
)
(12,119
)
(7,000
)
5,119
42
Income from
continuing
operations before
income taxes
39,503
23,811
(15,692
)
(40
)
(10,424
)
(10,796
)
260,454
275,459
15,005
6
Income tax expense
(income)
3,681
6,285
2,604
71
(3,987
)
(4,129
)
80,703
94,004
13,301
16
Income from
continuing
operations
35,822
17,526
(18,296
)
(51
)
(6,437
)
(6,667
)
179,751
181,455
1,704
1
Income (loss) from discontinued operations, net of income taxes
2,226
(8,510
)
(10,736
)
(482
)
—
—
2,226
(8,510
)
(10,736
)
(482
)
Net income (loss)
$ 38,048
$ 9,016
$ (29,032
)
(76
)
$ (6,437
)
$ (6,667
)
$ 181,977
$ 172,945
$ (9,032
)
(5
)
Average balances—Market View (dollars in millions):
Total loans
$ 317
$ 208
$ (109
)
(34
)
$ (62
)
$ (44
)
$ 29,714
$ 34,052
$ 4,338
15
Total assets
12,254
8,638
(3,616
)
(30
)
(69
)
(52
)
46,313
48,017
1,704
4
Total deposits
2,981
3,599
618
21
(17
)
(18
)
38,200
38,856
656
2
Financial ratios—Market View
Risk adjusted return on capital(1)
na
na
na
na
na
na
Return on average
assets(1)
na
na
na
na
1.57
%
1.53
%
Efficiency ratio(2)
na
na
na
na
60.64
62.10
(1)Annualized.
(2)The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income) and the provision for losses on off-balance sheet commitments, as a percentage of net interest income (taxable-equivalent basis) and noninterest income and is calculated for continuing operations only.
na = not applicable
50
Community Banking and Investment Services Group
The Community Banking and Investment Services Group provides financial products including
a set ofcredit, deposit, trust, investment management, risk management, and insurance products delivered through our branches, relationship managers, private bankers, trust administrators, and insurance agents to individuals, small businesses andsmall businesses.institutional clients.During the
thirdfirst quarter2005,of 2006, net income of the group increased by6124 percent over the same period in2004,2005, reflecting thegroup'sgroup’s continued focus on growing the consumer asset portfolio and attracting retail and small business deposits. Net interest income increased by 9 percent due to a higher margin on deposits.The
group'sgroup’s strategy is to grow assets through an expanded small business sales force, increased emphasis on realestate securedestate-secured and Small Business Administration (SBA) guaranteed loans to small business, and a stronger network of residential real estate brokers.Increasing demand forThe focus on home equity loans and more effective cross-sellingtacticsefforts have led to an overall growth in consumer loans, despite run-off of discontinued auto dealer and auto lease lines of business. In addition, the group expects a larger branch network, created from new branches and acquired branches, to improve growth prospects when combined with more robust efforts in the telephone and internet channels.TotalDespite the decrease of 4 percent in core
deposit growth demonstratesdeposits from thegroup's continued success inprior year, primarily reflecting increased competition for interest bearing deposits, the group continues to focus on attractingmass retail, affluent consumersconsumer and small business deposits through marketing activities, relationship management, increased and improved sales resources, new locations, and new products.These activities, in the aggregate, have resulted in a year-over-year increase of approximately 5 percent in core deposits.Among the more successful marketing activities has been the"Power Bank"“Power Bank” network, in Fresno,California and in the Central Coast region ofCalifornia. These branches offer an expanded set of service options, extended hours and have been remodeled to improve the customer experience with facility enhancements.We do not, however, intend to expandOf the
"Power Bank" to additional markets in 2005 until we better understand the return on our investment in facilities and improved service. The focus on enterprise-wide cross-sell has been particularly effective in our affluent market where a key strategy of The Private Bank is to expand its business by leveraging existing Bank client relationships. The largest portion of the 98 percent increase in the group’s noninterest income,wastrust fees contributed 5 percent of the growth, primarily due toancontinued strong sales and organic growth, as well as a one-time $3.8 million increase resulting from a refinement in accrual methodology. In addition, deposit feesand trust fees fromcontributed 3 percent to therecently acquired portfolios from CNA Trust (renamed TruSource) and the BTM Trust Company, New York.increase. Overall, total revenues for thethirdfirst quarter20052006 increased by over159 percent compared to thethirdfirst quarter2004.2005.The Community Banking and Investment Services Group is comprised of five major divisions: Community Banking, Wealth Management, Institutional Services and Asset Management, Consumer Asset Management and Global Markets.
COMMUNITY BANKINGCommunity Banking serves its customers through
315317 full-service branches in California, 4 full-service branches in Oregon and Washington, and a network of596603 proprietary ATMs. Customers may also access our services 24 hours a day by telephone or through ourWEBSITEwebsite atWWW.UBOC.COM.www.uboc.com. In addition, the division offers automated teller and point-of-sale merchant services.This division is organized by service delivery method, by markets and by geography. We serve our customers in the following ways:
o· through community banking branches, which serve consumers and businesses with checking and deposit services, as well as various types of consumer financing;
o· through access to our internet banking services, which augment our physical delivery channels by providing an array of customer transaction, bill payment and loan payment services;
o· through branches and business banking centers, which serve small businesses with annual sales up to $5 million; and
o· through in-store branches, which also serve consumers and small businesses.
53WEALTH MANAGEMENT51
Wealth Management provides comprehensive private banking services to our affluent clientele.
o· The Private Bank focuses primarily on delivering financial services to high net worth individuals with sophisticated financial needs as well as to professional service firms. Specific products and services include trust and estate services, investment account management services, and deposit and credit products. A key strategy of The Private Bank is to expand its business by leveraging existing Bank client relationships. Through 14 existing locations, The Private Bank relationship managers offer all of our available products and services.
INSTITUTIONAL SERVICES AND ASSET MANAGEMENTInstitutional Services and Asset Management provides investment management and administration services for a broad range of individuals and institutions.
o· HighMark Capital Management, Inc., a registered investment advisor, provides investment management and advisory services to institutional clients as well as investment advisory, administration and support services to our proprietary mutual funds, the affiliated HighMark Funds. It also provides
advisoryinvestment management services tomostUnion Bank of California, N.A. with respect to most of its trust and agency clients, including corporations, pension funds and individuals. HighMark Capital Management, Inc.'s’s strategy is toincrease assets under management by broadeningbroaden its client base andhelpingin turn toexpandincrease thedistributionassets ofshares of its mutual fund clients. othe HighMark Funds.· Institutional Services provides custody, corporate trust, and retirement plan services. Custody Services provides both domestic and international safekeeping/settlement services in addition to securities lending. Corporate Trust acts as trustee for corporate and municipal debt issues,
andprovides escrowservices.services and trustee services for project finance. Retirement Services provides a full range of defined benefit and defined contribution administrative services, including trustee services, administration, investment management, and 401(k) valuation services. The client base of Institutional Services includes financial institutions, corporations, government agencies, unions, insurance companies, mutual funds, investment managers, and non-profit organizations. InstitutionalServices'Services’ strategy is to continue to leverage and expand its position in our target markets.The acquisition of CNA Trust Company (renamed TruSource) expanded our retirement processing capability by providing outsourcing services for direct distributors of retirement products, and strengthened capacity to support smaller plans. The acquisition of the corporate trust portfolio of the BTM Trust Company, New York enhanced our capability in the areas of municipal and project finance trustee and agent services. CONSUMER ASSET MANAGEMENTConsumer Asset Management provides the centralized origination, underwriting, processing, servicing, collection and administration for consumer assets including residential mortgages.
GLOBAL MARKETSGlobal Marketsserves our customers with their insurance, foreign exchange and interest rate risk management and investment needs. Since the fourth quarter 2004, the Global Markets Division has been offering energy derivative contracts, on a limited basis, to serve our energy sector client base. The division takes market risk when buying and selling securities and foreign exchange contracts for its own account, but takes no market risk when providing insurance or derivative contracts, since the market risk for these products is offset with third parties.
Insurance Servicesproducts are sold through UBOC Insurance, Inc. (through its insurance agency subsidiaries) and securities are sold through UnionBanc Investment Services LLC, both of which are subsidiaries of Union Bank of California, N.A. Effective January 1, 2006, our insurance agency subsidiaries were combined into UnionBanc Insurance Services, Inc.
Through alliances with other financial institutions, the Community Banking and Investment Services Group offers additional products and services, such as credit cards, merchant bank cards, leasing, and asset-based and leveraged financing.
The group competes with larger banks by attempting to provide service quality superior to that of its major competitors. The
group'sgroup’s primary means of competing with community banks include its branch network and its technology to deliver banking services. The group also offers convenient banking hours to54consumers through our drive-through banking locations and selected branches that are open seven days a week. 52
The group competes with a number of commercial banks, internet banks, savings associations and credit unions, as well as more specialized financial service providers such as investment brokerage companies, consumer finance companies, and residential real estate lenders.
COMMERCIAL FINANCIAL SERVICES GROUPCommercial Financial Services Group
The Commercial Financial Services Group offers financing, depository and cash management services to middle market and large corporate businesses primarily headquartered in the western United States. The group has continued to focus on specific geographic markets and industry segments such as energy, entertainment, and real estate. Relationship managers provide credit services, including commercial loans, accounts receivable and inventory financing, project financing, lease financing, trade financing, and real estate financing. In addition to credit services, the group offers cash management services delivered through deposit managers with significant industry expertise and experience in cash management solutions for businesses, U.S. correspondent banks and government entities.
In the
thirdfirst quarter2005,of 2006, the 7 percent increase in net income was due to significant growth in both loans and deposits. Net interest income increased by2910 percent due to higherdemand depositsdeposit balances and a higher margin ondeposits, resulting in a $51 million improvement over the prior year.deposits. Deposit growth came primarily from sales successes inmiddle market, corporate andreal estateindustries.industries and government markets. In addition to new sales, pricing strategies to retain volume helped to offset the disintermediation associated with a rising interest rate environment.ThirdFirst quarter
20052006 average loans increased by2918 percent over the same period last year. This was primarily due tothe acquisition of Jackson Federal andcontinued improvement in our approach to the commercial real estatemarket. The increase in noninterest income was mainly due to gains on our private capital portfolio, primarily offset by lower deposit fees due to an increasemarket and increased loan demand in theearnings credit available to our wholesale customers.California middle-market and specialty segments.Noninterest income did not change significantly, increasing 1 percent from the first quarter of 2005. The increase in noninterest expense during the
thirdfirst quarter2005,2006, compared to thethirdfirst quarter2004,2005, was mainly due to outside services expense fromvendor bills paid primarily forhigher costs of services related to title and escrowcustomers.balances, stemming from a higher earnings credit rate, as well as higher performance-related incentive expense.The
group'sgroup’s initiativesduring 2005will continue to include expanding wholesale deposit activities and increasing domestic trade financing. Loan strategies include originating, underwriting and syndicating loans in core competency markets, such as the California middle-market, corporate banking, commercial real estate, energy, entertainment, equipment leasing and commercial finance. The group is particularly strong in processing services, including services such as Automated Clearing House (ACH), check processing, and cash vault services.The Commercial Financial Services Group is comprised of the following business units:
o· the Commercial Banking Division, which serves California middle-market and large corporate companies with commercial lending, trade financing, and asset-based loans;
o· the Commercial Deposit and Treasury Management Division, which provides deposit and cash management expertise to middle-market and large corporate clients, government agencies and specialized industries. This division also manages
the Bank'sUnion Bank of California’s web strategies for retail, small business, wealth management and commercial clients, as well as product development and management forthe Bank as a whole. oour entire banking franchise;· the Real Estate Industries Division, which provides real estate lending products such as construction loans, commercial mortgages and bridge financing;
55o· the Energy Capital Services Division, which provides corporate financing and project financing to oil and gas companies, as well as power and utility companies, nationwide; and
o53
· the Corporate Capital Markets Division, which provides financing to middle-market and large corporate clients in their defined industries and geographic markets, together with limited merchant and investment banking related products and services.
The
group'sgroup’s main strategy is to target industries and companies for which the group can reasonably expect to be one of acustomer'scustomer’s primary banks. Consistent with its strategy, the group attempts to serve a large part of its targetedcustomers'customers’ credit and depository needs. The group competes with other banks primarily on the basis of the quality of its relationship managers, the level of industry expertise, the delivery of quality customer service, and its reputation as a"business“business bank."” The group also competes with a variety of other financial services companies as well as non-bank companies. Competitors include other major California banks, as well as regional, national and international banks. In addition, the group competes with investment banks, commercial finance companies, leasing companies, and insurance companies.OTHER "Other"Other
“Other” includes the following items:
o· corporate activities that are not directly attributable to one of the two major business units. Included in this category are certain other
nonrecurringitems such as the results of operations of certain parent company non-bank subsidiaries and the elimination of the fully taxable-equivalent basis amount;o· the funds transfer pricing results for the entire company, which allocates to the other business segments their cost of funds on all asset categories and credit for funds on all liability categories;
o· the adjustment between the credit expense under RAROC and the provision for credit losses under US GAAP and earnings associated with unallocated equity capital;
o· the adjustment between the tax expense calculated under RAROC using a tax rate of 38.25 percent and our effective tax rates;
o· the Pacific Rim Corporate Group, with assets of
$250$254 million atSeptember 30, 2005,March 31, 2006, which offers a range of credit, deposit, and investment management products and services to companies in the U.S., which are affiliated with companies headquartered in Japan;o· Corporate Treasury, which is responsible for our ALM, wholesale funding, and the
investmentALM Investment and derivatives hedging portfolios. These treasury management activities are carried out to counter-balance the residual risk positions of our core balance sheet and to manage those risks within conservative guidelines. (For additional discussion regarding these risk management activities, see"Quantitative“Quantitative and Qualitative Disclosures About Market Risk."”)o;· the discontinued operations resulting from the sale of
most ofourInternational Banking Group;international correspondent banking business; ando· the residual costs of support groups.
The
thirdfirst quarter20052006 financial results were impacted by the following factors:o· credit expense (income) of ($
44.2)38.5) million was due to the difference between the$15.0$7.0 million reversal of provision for loan losses calculated under our US GAAP methodology and the$29.2$31.5 million in expected losses for the reportable business segments, which utilizes the RAROC methodology;o· net interest income included
the result of differences between the credit for equity for the reportable segments under RAROC and the net interest income earned by UnionBanCal 56Corporation, a credit for deposits in the Pacific Rim Corporate Group and transfer pricing results. Net interest income declined $32.4 million compared to the three months ended September 30, 2004 primarily as a result of a decrease in income from ALM derivatives hedges and from the net impact of changes in transfer pricing rates over prior period as market rates increased; o noninterest income of $5.3 million; o noninterest expense of $27.4 million, included increased corporate benefits and performance related incentives; o loss from discontinued operations of $16.0 million. The third quarter 2004 financial results were impacted by the following factors: o credit expense (income) of ($44.1) million was due to the difference between the $10.9 million reversal in provision for loan losses calculated under our US GAAP methodology and the $33.2 million in expected losses for the reportable business segments, which utilizes the RAROC methodology; o net interest income isthe result of differences between the credit for equity for the reportable segments under RAROC and the net interest income earned by UnionBanCal Corporation, a credit for deposits in the Pacific Rim Corporate Group andnettransfer pricingresults reported by Corporate Treasury; o noninterestresults. Net interest incomeof $6.2 million; o noninterest expense of $12.8 million; and o income from discontinued operations of $6.5 million. The following discussesdeclined $11.7 million compared to thesignificant changes in "Other" between the ninethree months endedSeptember 30, 2004 and 2005. o the decline in net interest incomeMarch 31, 2005 primarily as a result54
of a decrease in income from ALM derivatives hedges and from the
decrease of hedge income and thenet impact of changes in transfer pricing ratesoover therecognitionprior period as market rates increased;· noninterest income of $7.5 million;
· noninterest expense of $20.2 million;
· loss from discontinued operations of $8.5 million.
The first quarter 2005 financial results were impacted by the following factors:
· credit expense (income) of ($44.4) million was due to the difference between the $12.1 million reversal of provision for loan losses calculated under our US GAAP methodology and the $32.3 million in expected losses for the reportable business segments, which utilizes the RAROC methodology;
· net interest income is the result of differences between the credit for equity for the reportable segments under RAROC, the net transfer pricing results, the net interest income earned by UnionBanCal Corporation, and a
$93credit for deposits in the Pacific Rim Corporate Group;· noninterest income $6.5 million;
· noninterest expense of $21.2 million; and
· income tax expense included a credit adjustment of $10.0 million
gain fromto reflect a reduction in reserves to thesaleInternal Revenue Service with respect to the tax treatment ofour merchant card portfolio which occurred in 2004. REGULATORY MATTERS Oncertain leasing transactions.In October
18,2004, Union Bank of California International entered into a written agreement with the Federal Reserve Bank of New Yorkrequiringrelating to Union Bank of CaliforniaInternational to strenghten itsInternational’s Bank Secrecy Act and anti-money laundering controls and processes. Union Bank of California International,is wholly-owned bya wholly owned subsidiary of Union Bank of California, N.A.,which is wholly-owned by UnionBanCal Corporation. Union Bank of California International is headquartered in New York Cityand as an Edge Act subsidiary, is limited to engaging in international banking activities, most of whichhave been sold.were sold in October 2005. We expect to dissolve this subsidiary inthe second quarter2006. Although the principal business activities ofUnion Bank of California International werethis subsidiary have been sold,to Wachovia Bank, N.A. on October 6, 2005,we remain legally responsibleand committed tofor resolving the issues raised by theregulators and continue to take action aimed at resolving these matters. OnFederal Reserve Bank of New York.In March
23,2005, Union Bank of California, N.A. entered into a memorandum of understanding with the Office of the Comptroller of the Currency,its principal regulator,which requires Union Bank of California, N.A. to strengthen its Bank Secrecy Act and anti-money laundering controls and processes.TheseDuring 2005, we began the process of strengthening those controls and processes, which will continue in 2006.Management is committed to resolving the issues raised by the regulators and continues to take actions it believes to be appropriate to achieve this objective.
Until resolved, these pending regulatory matters, or any future regulatory actions concerning anti-money laundering controls and processes, may adversely affect UnionBanCal
Corporation'sCorporation’s and Union Bank of California, N.A.'s’s ability to obtain regulatory approvals for future initiatives requiring regulatory approval,57including acquisitions. Also, any future regulatory actions relating to this subject could result in the imposition of fines or penalties as has occurred with a number of other banks in recent years. However, neither this effect,Union Bank of California, N.A.’s memorandum of understanding with theregulatory agreements,Office of the Comptroller of the Currency, Union Bank of California International’s agreement with the Federal Reserve Bank of New York, nor the financial impact of enhanced Bank Secrecy Act and anti-money laundering controls and processes, are expected to have a material adverse impact on the financial condition or results of operations of Union Bank of California, N.A. or UnionBanCal Corporation.FACTORS THAT MAY AFFECT FUTURE RESULTS This document includes forward-looking information, which is subject to the "safe harbor" created by section 27A of the Securities Act of 1933, as amended,55
Item 3. Quantitative and
section 21E of the Securities Exchange Act of 1934, as amended. We may make forward-looking statements in our Securities and Exchange Commission (SEC) filings, press releases, news articles, conference calls with analysts and stockholders and when we are speaking on behalf of UnionBanCal Corporation. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include the words "believe," "expect," "target," "anticipate," "intend," "plan," "estimate," "potential," "project," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," or "may." These forward-looking statements are intended to provide investors with additional information with which they may assess our future potential. All of these forward-looking statements are based on assumptions about an uncertain future and are based on information available to us at the date of these statements. We do not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward- looking statements are made. In this document, for example, we make forward-looking statements, which discuss our expectations about: o Pending legal and regulatory actions o Credit quality and provision for credit losses o Net interest income including income from derivative hedges o The impact of increases in interest rates and growth in our commercial loan portfolio on our net interest margin o The impact of strategic investments on our business o The unallocated portion of our allowance for credit losses o Our sensitivity to changes in interest rates o The asset sensitivity of our balance sheet o Increased regulatory controls and processes regarding Bank Secrecy Act and anti-money laundering matters o Future legislative and regulatory developments o The costs and effects of litigation, investigations, or similar matters, or adverse facts and developments related thereto o Decisions to downsize, sell or close units or otherwise change the business mix of any of the company o Potential dividend restrictions o Integration of acquired companies o Impact of the sale of our international correspondent banking business There are numerous risks and uncertainties that could and will cause actual results to differ materially from those discussed in our forward-looking statements. Many of these factors are beyond our ability to 58control or predict and could have a material adverse effect on our stock price, financial condition, and results of operations or prospects. Such risks and uncertainties include, but are not limited to those listed below in "Industry Factors" and "Company Factors." Readers of this document should not rely solely on forward-looking information and should consider all uncertainties and risks disclosed throughout this document and in our other reports to the SEC, including, but not limited to, those discussed below. Any factor described in this report could by itself, or together with one or more other factors, adversely affect our business, future prospects, results of operations or financial condition. There are also other factors that we have not described in this report and our other reports that could cause our results to differ from our expectations. INDUSTRY FACTORS FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR BUSINESS Significant increases in market interest rates, or the perception that an increase may occur, could adversely affect both our ability to originate new loans and our ability to grow. Conversely, decreases in interest rates could result in an acceleration of loan prepayments. An increase in market interest rates could also adversely affect the ability of our floating-rate borrowers to meet their higher payment obligations. If this occurred, it could cause an increase in nonperforming assets and charge-offs, which could adversely affect our business. FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR MARGIN SPREAD Changes in market interest rates, including changes in the relationship between short-term and long-term market interest rates or between different interest rate indices, can impact our margin spread, that is, the difference between the interest rates we charge on interest earning assets, such as loans, and the interest rates we pay on interest bearing liabilities, such as deposits or other borrowings. The impact could result in a decrease in our interest income relative to interest expense. THE CONTINUING WAR ON TERRORISM COULD ADVERSELY AFFECT U.S. AND GLOBAL ECONOMIC CONDITIONS Acts or threats of terrorism and actions taken by the U.S. or other governments as a result of such acts or threats and other international hostilities may result in a disruption of U.S. and global economic and financial conditions and could adversely affect business and economic and financial conditions in the U.S. and globally generally and in our principal markets. SUBSTANTIAL COMPETITION COULD ADVERSELY AFFECT US Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business in California, Oregon and Washington, as well as nationally and internationally. Our competitors include a large number of state and national banks, thrift institutions, credit unions and major foreign-affiliated or foreign banks, as well as many financial and nonfinancial firms that offer services similar to those offered by us, including many large securities firms. Some of our competitors are community or regional banks that have strong local market positions. Other competitors include large financial institutions that have substantial capital, technology and marketing resources that are well in excess of ours. Such large financial institutions may have greater access to capital at a lower cost than us, which may adversely affect our ability to compete effectively. 59Adverse effects of, or changes in, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us We are subject to significant federal and state regulation and supervision, which is primarily for the benefit and protection of our customers and not for the benefit of investors. In the past, our business has been materially affected by these regulations. This will likely continue in the future. Laws, regulations or policies, including accounting standards and interpretations, currently affecting us and our subsidiaries may change at any time. Regulatory authorities may also change their interpretation of these statutes and regulations. Therefore, our business may be adversely affected by future changes in laws, regulations, policies or interpretations or regulatory approaches to compliance and enforcement. International laws, regulations and policies affecting us, our subsidiaries and the business we conduct may change at any time and affect our business opportunities and competitiveness in these jurisdictions. Due to The Bank of Tokyo-Mitsubishi, Ltd.'s controlling ownership of us, laws, regulations and policies adopted or enforced by the Government of Japan and the Federal Reserve Board may adversely affect our activities and investments and those of our subsidiaries in the future. Additionally, our business is affected significantly by the fiscal and monetary policies of the U.S. federal government and its agencies. We are particularly affected by the policies of the Federal Reserve Board, which regulates the supply of money and credit in the U.S. Under long-standing policy of the Federal Reserve Board, a bank holding company is expected to act as a source of financial strength for its subsidiary banks. As a result of that policy, we may be required to commit financial and other resources to our subsidiary bank in circumstances where we might not otherwise do so. Among the instruments of monetary policy available to the Federal Reserve Board are (a) conducting open market operations in U.S. government securities, (b) changing the discount rates on borrowings by depository institutions, and (c) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the Federal Reserve Board may have a material effect on our business, prospects, results of operations and financial condition. Refer to "Supervision and Regulation" in our Annual Report on Form 10-K for the year ended December 31, 2004, and above in "Regulatory Matters" for discussion of other laws and regulations, including the Bank Secrecy Act and other anti-money laundering laws and regulations that may have a material effect on our business, prospects, results of operations and financial condition. CHANGES IN ACCOUNTING STANDARDS COULD MATERIALLY IMPACT OUR FINANCIAL STATEMENTS From time to time the Financial Accounting Standards Board, the SEC and bank regulators change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be very difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements. THERE ARE AN INCREASING NUMBER OF NON-BANK COMPETITORS PROVIDING FINANCIAL SERVICES Technology and other changes increasingly allow parties to complete financial transactions electronically, and in many cases, without banks. For example, consumers can pay bills and transfer funds over the internet and by telephone without banks. Many non-bank financial service providers have lower overhead costs and are subject to fewer regulatory constraints. If consumers do not use banks to complete their financial transactions, we could potentially lose fee income, deposits and income generated from those deposits. 60COMPANY FACTORS ADVERSE CALIFORNIA ECONOMIC CONDITIONS COULD ADVERSELY AFFECT OUR BUSINESS A substantial majority of our assets, deposits and fee income are generated in California. As a result, poor economic conditions in California may cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio. Economic conditions in California are subject to various uncertainties at this time, including the pace and scope of the recovery in the technology sector, and the California state government's continuing budgetary and fiscal difficulties. If economic conditions in California decline, we expect that our level of problem assets could increase and our prospects for growth could be impaired. The State of California continues to face fiscal challenges, the long-term impact of which on the State's economy cannot be predicted with any certainty. ADVERSE ECONOMIC FACTORS AFFECTING CERTAIN INDUSTRIES WE SERVE COULD ADVERSELY AFFECT OUR BUSINESS We are subject to certain industry-specific economic factors. For example, a significant and increasing portion of our total loan portfolio is related to residential real estate, especially in California. Accordingly, a downturn in the real estate and housing industries in California could have an adverse effect on our operations and the quality of our real estate loan portfolio. Increases in residential mortgage loan interest rates could also have an adverse effect on our operations by depressing new mortgage loan originations. We provide financing to businesses in a number of other industries that may be particularly vulnerable to industry- specific economic factors, including the commercial real estate industry, the communications/media industry, the retail industry, the power industry and the technology industry. Recent increases in fuel prices and energy costs have adversely affected businesses in several of these industries. Industry-specific risks are beyond our control and could adversely affect our portfolio of loans, potentially resulting in an increase in nonperforming loans or charge-offs and a slowing of growth or reduction in our loan portfolio. WE ARE NOT ABLE TO OFFER ALL OF THE FINANCIAL SERVICES AND PRODUCTS OF A FINANCIAL HOLDING COMPANY Banks, securities firms, and insurance companies can now combine as a "financial holding company." Financial holding companies can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Many of our competitors have elected to become financial holding companies. Recently, a number of foreign banks have acquired financial holding companies in the U.S., further increasing competition in the U.S. market. Under current regulatory interpretations, Mitsubishi UFJ Financial Group, Inc. would be required to make a financial holding company election in order for us to have the benefits of their status. We do not expect that Mitsubishi UFJ Financial Group, Inc. will make such an election in the near future. OUR STOCKHOLDER VOTES ARE CONTROLLED BY THE BANK OF TOKYO-MITSUBISHI, LTD.; OUR INTERESTS AND THOSE OF OUR MINORITY STOCKHOLDERS MAY NOT BE THE SAME AS THOSE OF THE BANK OF TOKYO-MITSUBISHI, LTD. The Bank of Tokyo-Mitsubishi, Ltd., a wholly-owned subsidiary of Mitsubishi UFJ Financial Group, Inc., owns a majority of the outstanding shares of our common stock. As a result, The Bank of Tokyo-Mitsubishi, Ltd. can elect all of our directors and can control the vote on all matters, including: approval of mergers or other business combinations; a sale of all or substantially all of our assets; issuance of any additional common stock or other equity securities; incurrence of debt other than in the ordinary course of business; the selection and tenure of our Chief Executive Officer; payment of dividends with respect to our common stock or other equity securities; and other matters that might be favorable to The Bank of Tokyo-Mitsubishi, Ltd. A majority of our directors are independent of The Bank of Tokyo-Mitsubishi, Ltd. and are not officers or employees of UnionBanCal Corporation or any of our affiliates, including The Bank of Tokyo-Mitsubishi, Ltd. However, because of The Bank of Tokyo-Mitsubishi, Ltd.'s control over the election of our directors, we could designate ourselves as a "controlled company" under the New York Stock Exchange Rules and could change the composition of our Board of Directors so that 61the Board would not have a majority of independent directors. The Bank of Tokyo-Mitsubishi, Ltd.'s ability to prevent an unsolicited bid for us or any other change in control could also have an adverse effect on the market price for our common stock. POSSIBLE FUTURE SALES OF OUR SHARES BY THE BANK OF TOKYO-MITSUBISHI, LTD. COULD ADVERSELY AFFECT THE MARKET FOR OUR STOCK The Bank of Tokyo-Mitsubishi, Ltd. may sell shares of our common stock in compliance with the federal securities laws. By virtue of The Bank of Tokyo-Mitsubishi, Ltd.'s current control of us, The Bank of Tokyo-Mitsubishi, Ltd. could sell large amounts of shares of our common stock by causing us to file a registration statement that would allow it to sell shares more easily. In addition, The Bank of Tokyo-Mitsubishi, Ltd. could sell shares of our common stock without registration under certain circumstances, such as in a "private placement." Although we can make no prediction as to the effect, if any, that such sales would have on the market price of our common stock, sales of substantial amounts of our common stock, or the perception that such sales could occur, could adversely affect the market price of our common stock. If The Bank of Tokyo-Mitsubishi, Ltd. sells or transfers shares of our common stock as a block, another person or entity could become our controlling stockholder. THE BANK OF TOKYO-MITSUBISHI, LTD.'S AND MITSUBISHI UFJ FINANCIAL GROUP, INC.'S FINANCIAL CONDITION COULD ADVERSELY AFFECT OUR OPERATIONS We fund our operations independently of The Bank of Tokyo-Mitsubishi, Ltd. and Mitsubishi UFJ Financial Group, Inc. and believe our business is not necessarily closely related to the business or outlook of The Bank of Tokyo-Mitsubishi, Ltd. or Mitsubishi UFJ Financial Group, Inc. However, The Bank of Tokyo-Mitsubishi, Ltd.'s and Mitsubishi UFJ Financial Group, Inc.'s credit ratings may affect our credit ratings. The Bank of Tokyo-Mitsubishi, Ltd. and Mitsubishi UFJ Financial Group, Inc. are also subject to regulatory oversight and review by Japanese and U.S. regulatory authorities. Our business operations and expansion plans could be negatively affected by regulatory concerns related to the Japanese financial system, The Bank of Tokyo-Mitsubishi, Ltd. or Mitsubishi UFJ Financial Group, Inc., and other developments concerning The Bank of Tokyo-Mitsubishi, Ltd. or Mitsubishi UFJ Financial Group, Inc., which may result in capital constraints as well as additional Japanese and U.S. regulatory constraints. POTENTIAL CONFLICTS OF INTEREST WITH THE BANK OF TOKYO-MITSUBISHI, LTD. COULD ADVERSELY AFFECT US The Bank of Tokyo-Mitsubishi, Ltd.'s view of possible new businesses, strategies, acquisitions, divestitures or other initiatives may differ from ours. This may delay or hinder us from pursuing such initiatives. Also, as part of The Bank of Tokyo-Mitsubishi, Ltd.'s normal risk management processes, The Bank of Tokyo-Mitsubishi, Ltd. manages global credit and other types of exposures and concentrations on an aggregate basis, including exposures and concentrations at UnionBanCal Corporation. Therefore, at certain levels or in certain circumstances, our ability to approve certain credits or other banking transactions and categories of customers is subject to the concurrence of The Bank of Tokyo-Mitsubishi, Ltd. We may wish to extend credit or furnish other banking services to the same customers as The Bank of Tokyo-Mitsubishi, Ltd. Our ability to do so may be limited for various reasons, including The Bank of Tokyo-Mitsubishi, Ltd.'s aggregate exposure and marketing policies. Certain directors' and officers' ownership interests in The Bank of Tokyo-Mitsubishi, Ltd.'s common stock or service as a director or officer or other employee of both us and The Bank of Tokyo-Mitsubishi, Ltd. could create or appear to create potential conflicts of interest, especially since both of us compete in U.S. banking markets. 62RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS COULD LIMIT AMOUNTS PAYABLE TO US As a holding company, a substantial portion of our cash flow typically comes from dividends our bank and nonbank subsidiaries pay to us. Various statutory provisions restrict the amount of dividends our subsidiaries can pay to us without regulatory approval. In addition, if any of our subsidiaries were to liquidate, that subsidiary's creditors will be entitled to receive distributions from the assets of that subsidiary to satisfy their claims against it before we, as a holder of an equity interest in the subsidiary, will be entitled to receive any of the assets of the subsidiary. OUR ABILITY TO MAKE ACQUISITIONS IS SUBJECT TO REGULATORY CONSTRAINTS AND RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR DIVESTITURES OR RESTRUCTURINGS MAY ADVERSELY AFFECT US Our ability to obtain regulatory approval of acquisitions is subject to constraints related to the Bank Secrecy Act, as described in "Supervision and Regulation" in our Annual Report on Form 10-K for the year ended December 31, 2004, and above in "Regulatory Matters." Subject to our ability to address successfully these regulatory concerns, we may seek to acquire or invest in financial and non-financial companies that complement our business. There can be no assurance that we will be successful in completing any such acquisition or investment as this will depend on the availability of prospective target opportunities at valuation levels we find attractive and the competition for such opportunities from other parties. In addition, we continue to evaluate the performance of all of our businesses and business lines and may sell a business or business line. Any acquisitions, divestitures or restructurings may result in the issuance of potentially dilutive equity securities, significant write-offs, including those related to goodwill and other intangible assets, and/or the incurrence of debt, any of which could have a material adverse effect on our business, results of operations and financial condition. Acquisitions, divestitures or restructurings could involve numerous additional risks including difficulties in obtaining any required regulatory approvals and in the assimilation or separation of operations, services, products and personnel, the diversion of management's attention from other business concerns, higher than expected deposit attrition (run-off), divestitures required by regulatory authorities, the disruption of our business, and the potential loss of key employees. There can be no assurance that we will be successful in addressing these or any other significant risks encountered in such transactions. PRIVACY RESTRICTIONS COULD ADVERSELY AFFECT OUR BUSINESS Our business model relies, in part, upon cross-marketing the services offered by us and our subsidiaries to our customers. Laws that restrict our ability to share information about customers within our corporate organization could adversely affect our business, results of operations and financial condition. WE RELY ON THIRD PARTIES FOR IMPORTANT PRODUCTS AND SERVICES Third party vendors provide key components of our business infrastructure such as internet connections, network access and mutual fund distribution. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense. SIGNIFICANT LEGAL ACTIONS COULD SUBJECT US TO SUBSTANTIAL UNINSURED LIABILITIES We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs. To protect ourselves from the cost of these claims, we maintain insurance coverage in amounts and with deductibles that we believe are appropriate for our operations. However, our insurance coverage may 63not cover all claims against us or continue to be available to us at a reasonable cost. As a result, we may be exposed to substantial uninsured liabilities, which could adversely affect our business, prospects, results of operations and financial condition. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKQualitative Disclosures About Market RiskA discussion of our market risk exposure is incorporated by reference to Part I, Item 2 of this document under the captions
"Quantitative“Quantitative and Qualitative Disclosures About Market Risk," "Liquidity” “Liquidity Risk,"” and"Factors That May Affect Future Results." ITEMPart II, Item 1A “Risk Factors” and in Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2005.Item 4.
CONTROLS AND PROCEDURESControls and ProceduresOur Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) have concluded that the design and operation of our disclosure controls and procedures are effective as of
September 30, 2005.March 31, 2006. This conclusion is based on an evaluation conducted under the supervision and with the participation of management. Disclosure controls and procedures are those controls and procedures which ensure that information required to be disclosed in this filing is accumulated and communicated to management and is recorded, processed, summarized and reported in a timely manner and in accordance with Securities and Exchange Commission rules and regulations.During the quarter ended
September 30, 2005,March 31, 2006, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.6456
PART II. OTHER INFORMATION
ITEMItem 1.
LEGAL PROCEEDINGSLegal ProceedingsWe are subject to various pending and threatened legal actions that arise in the normal course of business. We maintain reserves for losses from legal actions that are both probable and estimable.
Grafton Partners LP v. Union Bank of California is pending in Alameda County Superior Court (filed March 12, 2003). That suit concerns a "Ponzi" scheme perpetrated by PinnFund, USA, located in San Diego, California. We have reached an agreement to resolveIn addition, we believe theGrafton matter, which calls for a payment of $22 million, $15.8 million of which will be paid by the Company's insurance carriers. This agreement has been documented, and has received preliminary court approval. Thedisposition ofthis claim, on the basis described above, assuming that the settlement becomes final,all claims currently pending will not have a material adverse effect on our financialconditionposition or results of operations.ITEMFor a discussion of risk factors relating to our business, please refer to Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2005, which is incorporated by reference herein.
Item 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS REPURCHASES OF EQUITY SECURITIES We did not repurchase anyUnregistered Sales of Equity Securities and Use of ProceedsRepurchases of Equity Securities
The following table presents repurchases by us of our equity securities during the
thirdfirst quarter2005. The dollar value2006:
Period
Total Number of
Shares Purchased
Average Price Paid
per Share
Total Number
of Shares Purchased
as Part of Publicly
Announced Programs
Approximate
Dollar
Value of Shares That
May Yet Be
Purchased
Under the Programs
January 2006
(January 1-31, 2006)
—
$
—
—
$
102,334,370
February 2006
(February 2-28, 2006)
769,700
$
68.18
769,700
$
49,857,016
March 2006
(March 1-20, 2006)
398,000
$
69.19
398,000
$
22,318,422
(1)
Total
1,167,700
$
68.52
1,167,700
(1) In the first quarter of
shares that may yet be purchased2006, UnionBanCal Corporation used $80.0 million from the $200 million repurchase program announced on April 21, 2005.57
Item 4. Submission of Matters to a Vote of Security Holders
Set forth below is information concerning each matter submitted to a vote at the Annual Meeting of Stockholders on April 26, 2006 (“Annual Meeting”):
Election of Directors: Each of the following persons was elected as a director to hold office until the 2007 Annual Meeting of Stockholders or until earlier retirement, resignation or removal.
NOMINEE
FOR
WITHHELD
Aida M. Alvarez
137,994,921
345,846
David R. Andrews
138,088,668
252,099
L. Dale Crandall
137,827,185
513,582
Richard D. Farman
136,681,925
1,658,841
Stanley F. Farrar
135,953,253
2,387,514
Philip B. Flynn
136,552,631
1,788,136
Michael J. Gillfillan
137,825,352
515,415
Ronald L. Havner, Jr.
138,081,638
259,128
Norimichi Kanari
136,626,956
1,713,811
Mary S. Metz
136,884,189
1,456,578
Shigemitsu Miki
112,235,456
26,105,311
Takashi Morimura
136,640,280
1,703,686
J. Fernando Niebla
137,781,823
558,944
Masashi Oka
136,527,965
1,812,801
Tetsuo Shimura
136,548,234
1,792,533
Proposal No. 2:To approve the Amended and Restated 1997 UnionBanCal Corporation Performance Share Plan to enable awards under
our repurchase programs is $162,078,928. ITEM 6. EXHIBITS NO. DESCRIPTION --- ----------- 10.1 Purchase and Assumption Agreement by and amongthe Plan to qualify as deductible, performance-based compensation under Section 162(m) of the Internal Revenue Code received the following votes:
FOR
135,941,571
AGAINST
2,076,881
ABSTAIN
322,314
BROKER NON-VOTES
3,200
Proposal No. 3: To approve the Union Bank of California
N.A., Union BankSenior Executive Bonus Plan to enable bonuses paid under the Plan to qualify as deductible, performance-based compensation under Section 162(m) ofCalifornia International, and Union Bankthe Internal Revenue Code received the following votes:
FOR
134,287,157
AGAINST
3,734,905
ABSTAIN
318,704
BROKER NON-VOTES
3,200
Proposal No. 4:To ratify the selection of
California Servicos LTDA. and Wachovia Bank, N.A. dated September 21, 2005(1) 10.2 Written DescriptionDeloitte & Touche LLP as independent registered public accounting firm ofCompensation Arrangement forUnionBanCal CorporationNon-Employee Directors(2) 31.1 Certificationfor 2006 received the following votes:
FOR
136,637,650
AGAINST
1,620,754
ABSTAIN
85,562
BROKER NON-VOTES
0
58
(a) Restricted Stock Agreement.
Effective as of January 3, 2006, the Executive Compensation & Benefits Committee of the
Chief Executive OfficerBoard of Directors of UnionBanCal Corporation granted 2,000 shares of restricted stock to Linda Betzer pursuant toSection 302a restricted stock agreement, a form ofthe Sarbanes-Oxley Act of 2002(1) 31.2which is filed herewith as Exhibit 10.3 and incorporated by reference herein.
No.
Description
10.1
Form of 2006 Nonqualified Stock Option Agreement under the Year 2000 UnionBanCal Corporation Management Stock Plan(1)
10.2
Form of Performance Share Agreement under the 1997 UnionBanCal Corporation Performance Share Plan(2)
10.3
Form of Restricted Stock Agreement under the Year 2000 UnionBanCal Corporation Management Stock Plan(1)
10.4
Amended and Restated 1997 UnionBanCal Corporation Performance Share Plan(3)
10.5
Union Bank of California, N.A. Senior Executive Bonus Plan(4)
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)
32.1
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)
32.2
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)
(1) Filed herewith.
(2) Incorporated by reference to
Section 302 of the Sarbanes-Oxley Act of 2002(1) 32.1 Certification of the Chief Executive Officer pursuantExhibit 10.1 to18 U.S.C. Section 1350, as adopted pursuantUnionBanCal Corporation’s Current Report on Form 8-K dated March 24, 2006 (SEC File No. 001-15081).(3) Incorporated by reference to
Section 906 of the Sarbanes-Oxley Act of 2002(1) 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1) - --------------- (1) Filed herewith. (2) Filed asAppendix A to the UnionBanCalCorporation'sCorporation Definitive Proxy Statement on Schedule 14Afor its 2005 Annual Meeting of Stockholders and incorporatedfiled on March 23, 2006 (SEC File No. 001-15081).(4) Incorporated by reference
herein. 65SIGNATURESto Appendix B to the UnionBanCal Corporation Definitive Proxy Statement on Schedule 14A filed on March 23, 2006 (SEC File No. 001-15081).59
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.
UNIONBANCAL CORPORATION (Registrant) Date: November 8, 2005 By: /s/ TAKASHI MORIMURA ---------------------------------------- Takashi Morimura PRESIDENT AND CHIEF EXECUTIVE OFFICER (Principal Executive Officer) Date: November 8, 2005 By: /s/ DAVID I. MATSON ---------------------------------------- David I. Matson VICE CHAIRMAN AND CHIEF FINANCIAL OFFICER (Principal Financial Officer) Date: November 8, 2005 By: /s/ DAVID A. ANDERSON ---------------------------------------- David A. Anderson SENIOR VICE PRESIDENT AND CONTROLLER (Chief Accounting Officer) 66
UNIONBANCAL CORPORATION (Registrant)
Date: May 8, 2006
By:
/s/ TAKASHI MORIMURA
Takashi Morimura
President and Chief Executive Officer
(Principal Executive Officer)
Date: May 8, 2006
By:
/s/ DAVID I. MATSON
David I. Matson
Vice Chairman and Chief Financial Officer
(Principal Financial Officer)
Date: May 8, 2006
By:
/s/ DAVID A. ANDERSON
David A. Anderson
Executive Vice President and Controller
(Chief Accounting Officer)
60
No.
Description
10.1
Form of 2006 Nonqualified Stock Option Agreement under the Year 2000 UnionBanCal Corporation Management Stock Plan(1)
10.2
Form of Performance Share Agreement under the 1997 UnionBanCal Corporation Performance Share Plan(2)
10.3
Form of Restricted Stock Agreement under the Year 2000 UnionBanCal Corporation Management Stock Plan(1)
10.4
Amended and Restated 1997 UnionBanCal Corporation Performance Share Plan(3)
10.5
Union Bank of California, N.A. Senior Executive Bonus Plan(4)
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)
32.1
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)
32.2
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)
(1) Filed herewith.
(2) Incorporated by reference to Exhibit 10.1 to UnionBanCal Corporation’s Current Report on Form 8-K dated March 24, 2006 (SEC File No. 001-15081).
(3) Incorporated by reference to Appendix A to the UnionBanCal Corporation Definitive Proxy Statement on Schedule 14A filed on March 23, 2006 (SEC File No. 001-15081).
(4) Incorporated by reference to Appendix B to the UnionBanCal Corporation Definitive Proxy Statement on Schedule 14A filed on March 23, 2006 (SEC File No. 001-15081).