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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended September 30, 2008 | ||
OR | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to |
Commission file number 1-15081
UnionBanCal Corporation
(Exact name of registrant as specified in its charter)
Delaware | 94-1234979 | |
(State of Incorporation) | (I.R.S. Employer Identification No.) |
400 California Street
San Francisco, California 94104-1302
(Address and zip code of principal executive offices)
Registrant'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 þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filerþ | Accelerated filero | ||
Non-accelerated filero(Do not check if a smaller reporting company) | Smaller reporting companyo |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Number of shares of Common Stock outstanding at October 31, 2008: 140,121,487
UnionBanCal Corporation and Subsidiaries
TABLE OF CONTENTS
| Page Number | |||
---|---|---|---|---|
PART I | ||||
Financial Information | ||||
Condensed Consolidated Financial Highlights | 6 | |||
ITEM 1. FINANCIAL STATEMENTS: | ||||
Condensed Consolidated Statements of Income | 8 | |||
Condensed Consolidated Balance Sheets | 9 | |||
Condensed Consolidated Statements of Changes in Stockholders' Equity | 10 | |||
Condensed Consolidated Statements of Cash Flows | 11 | |||
Notes to Condensed Consolidated Financial Statements: | ||||
Note 1—Basis of Presentation and Nature of Operations | 12 | |||
Note 2—Recently Issued Accounting Pronouncements | 12 | |||
Note 3—Discontinued Operations | 15 | |||
Note 4—Loans and Allowance for Loan Losses | 19 | |||
Note 5—Goodwill and Intangible Assets | 20 | |||
Note 6—Employee Pension and Other Postretirement Benefits | 22 | |||
Note 7—Borrowed Funds | 23 | |||
Note 8—Medium- and Long-Term Debt | 23 | |||
Note 9—Management Stock Plans | 24 | |||
Note 10—Fair Value of Financial Instruments | 28 | |||
Note 11—Derivative Instruments and Other Financial Instruments Used For Hedging | 32 | |||
Note 12—Earnings Per Share (EPS) | 35 | |||
Note 13—Accumulated Other Comprehensive Income (Loss) | 36 | |||
Note 14—Commitments, Contingencies and Guarantees | 37 | |||
Note 15—Business Segments | 40 | |||
Note 16—Subsequent Event | 43 | |||
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: | ||||
Introduction | 45 | |||
Executive Overview | 45 | |||
Discontinued Operations | 47 | |||
Critical Accounting Policies | 49 | |||
Financial Performance | 51 | |||
Net Interest Income | 54 | |||
Noninterest Income and Noninterest Expense | 57 | |||
Income Tax Expense | 58 | |||
Loans | 59 | |||
Cross-Border Outstandings | 61 | |||
Provision for Credit Losses | 62 | |||
Allowances for Credit Losses | 62 | |||
Nonperforming Assets | 65 | |||
Loans 90 Days or More Past Due and Still Accruing | 67 | |||
Quantitative and Qualitative Disclosures About Market Risk | 67 | |||
Liquidity Risk | 70 | |||
Regulatory Capital | 72 | |||
Business Segments | 73 | |||
Regulatory Matters | 80 |
2
| Page Number | ||
---|---|---|---|
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 81 | ||
ITEM 4. CONTROLS AND PROCEDURES | 81 | ||
PART II | |||
Other Information | |||
ITEM 1. LEGAL PROCEEDINGS | 82 | ||
ITEM 1A. RISK FACTORS | 83 | ||
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS | 89 | ||
ITEM 6. EXHIBITS | 90 | ||
SIGNATURES | 91 |
3
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 compared to our forecasts and expectations. See Part II, Item 1A. "Risk Factors," and the other risks described in this report for factors to be considered when reading any forward-looking statements in this filing.
This document includes forward-looking statements, which are 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 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," "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 objectives, strategies and initiatives, our organizational structure, the growth of our business and our competitive position
- •
- Our assessment of significant factors and developments that have affected or may affect our results
- •
- Pending and recent legal and regulatory actions, and future legislative and regulatory developments, including the effects of the Economic Stimulus Act of 2008 and other legislation introduced in response to the financial crises affecting the banking system and financial markets and likely changes to the Federal Deposit Insurance Corporation's deposit insurance assessment policies
- •
- Regulatory controls and processes and their impact on our business
- •
- The costs and effects of legal actions, investigations, regulatory actions, criminal proceedings or similar matters, or adverse facts and developments related thereto
- •
- Credit quality and provision for credit losses, including the expected need to continue to provide for credit losses due to an expected acceleration of charge offs and further deterioration in our loan portfolio, anticipated loan growth, credit quality and risk grade trends and our delinquency rates compared to the industry average
- •
- Our allowances for credit losses, including the conditions we consider in determining the unallocated allowance
- •
- Our assessment of economic conditions and trends and credit cycles
- •
- Net interest income
- •
- The impact of changes in interest rates
- •
- Loan growth rates and portfolio composition
- •
- Deposit pricing pressures and our deposit base, including trends in customers transferring funds from noninterest bearing deposits to interest bearing deposits or other investment alternatives
4
- •
- Our relatively high proportion of average noninterest bearing deposits to total deposits compared to most of our peers
- •
- Our ability and intent to hold various securities
- •
- Our sensitivity to and management of market risk, including changes in interest rates, and the economic outlook for the U.S. in general and for any particular region of the U.S. including, in particular, California, Oregon and Washington
- •
- The composition and market sensitivity of our securities portfolios, our trading and hedging strategies and our management of the sensitivity of our balance sheet
- •
- Tax rates and taxes, including the possible effect of changes in Mitsubishi UFJ Financial Group's taxable profits on our California State tax obligations
- •
- Critical accounting policies and estimates and the impact of recent accounting pronouncements
- •
- Expected rates of return and projected results
- •
- Decisions to downsize, sell or close units, dissolve subsidiaries, expand our branch network or otherwise restructure, reorganize or change our business mix, their timing and their impact on our business
- •
- The relationship between our business and that of The Bank of Tokyo-Mitsubishi UFJ, Ltd., and Mitsubishi UFJ Financial Group, Inc. and actions that may or may not be taken by The Bank of Tokyo-Mitsubishi UFJ and Mitsubishi UFJ Financial Group, Inc.
- •
- Our strategies and expectations regarding capital levels
- •
- The continued recessionary outlook for the U.S. economy
There are numerous risks and uncertainties that could and will cause actual results to differ materially compared to 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 and Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part I of this Form 10-Q.
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 in this report. 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.
5
PART I. FINANCIAL INFORMATION
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Financial Highlights
(Unaudited)
| As of and for the Three Months Ended | | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands, except per share data) | September 30, 2007 | September 30, 2008 | Percent Change | |||||||||
Results of operations: | ||||||||||||
Net interest income(1) | $ | 428,952 | $ | 522,296 | 21.76 | % | ||||||
Provision for loan losses | 16,000 | 117,000 | nm | |||||||||
Noninterest income | 208,187 | 198,721 | (4.55 | ) | ||||||||
Noninterest expense | 380,847 | 443,812 | 16.53 | |||||||||
Income before income taxes(1) | 240,292 | 160,205 | (33.33 | ) | ||||||||
Taxable-equivalent adjustment | 2,389 | 2,550 | 6.74 | |||||||||
Income tax expense | 87,664 | 47,549 | (45.76 | ) | ||||||||
Income from continuing operations | 150,239 | 110,106 | (26.71 | ) | ||||||||
Loss from discontinued operations, net of taxes | (22,780 | ) | (5,276 | ) | 76.84 | |||||||
Net income | $ | 127,459 | $ | 104,830 | (17.75 | ) | ||||||
Per common share: | ||||||||||||
Basic earnings: | ||||||||||||
From continuing operations | $ | 1.09 | $ | 0.80 | (26.61 | )% | ||||||
Net income | 0.93 | 0.76 | (18.28 | ) | ||||||||
Diluted earnings: | ||||||||||||
From continuing operations | 1.08 | 0.79 | (26.85 | ) | ||||||||
Net income | 0.92 | 0.75 | (18.48 | ) | ||||||||
Dividends(2) | 0.52 | 0.52 | — | |||||||||
Book value (end of period) | 33.71 | 33.50 | (0.62 | ) | ||||||||
Common shares outstanding (end of period)(3)(4) | 138,523,666 | 140,069,898 | 1.12 | |||||||||
Weighted average common shares outstanding—basic(3)(4) | 137,667,976 | 138,197,446 | 0.38 | |||||||||
Weighted average common shares outstanding—diluted(3)(4) | 139,067,952 | 139,969,419 | 0.65 | |||||||||
Balance sheet (end of period): | ||||||||||||
Total assets(5) | $ | 54,343,045 | $ | 62,599,753 | 15.19 | % | ||||||
Total loans | 39,745,341 | 48,306,118 | 21.54 | |||||||||
Nonperforming assets | 52,562 | 304,246 | nm | |||||||||
Total deposits | 42,242,889 | 42,355,853 | 0.27 | |||||||||
Medium- and long-term debt | 1,871,726 | 3,827,164 | nm | |||||||||
Stockholders' equity | 4,669,454 | 4,692,648 | 0.50 | |||||||||
Balance sheet (period average): | ||||||||||||
Total assets | $ | 53,367,191 | $ | 61,145,251 | 14.57 | % | ||||||
Total loans | 39,484,785 | 47,196,204 | 19.53 | |||||||||
Earning assets | 48,901,494 | 56,920,548 | 16.40 | |||||||||
Total deposits | 41,962,726 | 41,661,224 | (0.72 | ) | ||||||||
Stockholders' equity | 4,664,229 | 4,588,441 | (1.62 | ) | ||||||||
Financial ratios(6): | ||||||||||||
Return on average assets(7): | ||||||||||||
From continuing operations | 1.12 | % | 0.72 | % | ||||||||
Net income | 0.95 | 0.68 | ||||||||||
Return on average stockholders' equity(7): | ||||||||||||
From continuing operations | 12.78 | 9.55 | ||||||||||
Net income | 10.84 | 9.09 | ||||||||||
Efficiency ratio(8) | 59.14 | 60.37 | ||||||||||
Net interest margin(1) | 3.51 | 3.67 | ||||||||||
Dividend payout ratio | 47.71 | 65.00 | ||||||||||
Tangible equity ratio | 7.79 | 6.96 | ||||||||||
Tier 1 risk-based capital ratio(5) | 8.40 | 8.02 | ||||||||||
Total risk-based capital ratio(5) | 11.28 | 10.94 | ||||||||||
Leverage ratio(5) | 8.39 | 7.97 | ||||||||||
Allowance for loan losses to:(9) | ||||||||||||
Total loans | 0.88 | 1.20 | ||||||||||
Nonaccrual loans | 683.96 | 200.94 | ||||||||||
Allowance for credit losses to:(10) | ||||||||||||
Total loans | 1.10 | 1.43 | ||||||||||
Nonaccrual loans | 852.52 | 239.50 | ||||||||||
Net loans charged off to average total loans(7) | 0.02 | 0.53 | ||||||||||
Nonperforming assets to total loans and foreclosed assets | 0.13 | 0.63 | ||||||||||
Nonperforming assets to total assets(5) | 0.10 | 0.49 |
- (1)
- Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
- (2)
- Dividends per share reflect dividends declared on UnionBanCal Corporation's common stock outstanding as of the declaration date.
- (3)
- Common shares outstanding reflect common shares issued less treasury shares.
- (4)
- Weighted average common shares outstanding (basic) excludes nonvested restricted shares but includes the impact of those shares in the calculation of diluted 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 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 allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans or total nonperforming loans, as appropriate. These ratios relate to continuing operations only.
- (10)
- The allowance for credit losses ratios are calculated using the sum of the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans or total nonperforming loans, as appropriate. These ratios relate to continuing operations only.
nm= not meaningful
6
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Financial Highlights (Continued)
(Unaudited)
| As of and for the Nine Months Ended | | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands, except per share data) | September 30, 2007 | September 30, 2008 | Percent Change | |||||||||
Results of operations: | ||||||||||||
Net interest income(1) | $ | 1,290,535 | $ | 1,498,287 | 16.10 | % | ||||||
Provision for loan losses | 25,000 | 284,000 | nm | |||||||||
Noninterest income | 600,590 | 593,743 | (1.14 | ) | ||||||||
Noninterest expense | 1,156,517 | 1,266,330 | 9.50 | |||||||||
Income before income taxes(1) | 709,608 | 541,700 | (23.66 | ) | ||||||||
Taxable-equivalent adjustment | 6,755 | 7,405 | 9.62 | |||||||||
Income tax expense | 238,727 | 167,493 | (29.84 | ) | ||||||||
Income from continuing operations | 464,126 | 366,802 | (20.97 | ) | ||||||||
Loss from discontinued operations, net of taxes | (21,702 | ) | (12,037 | ) | 44.54 | |||||||
Net income | $ | 442,424 | $ | 354,765 | (19.81 | ) | ||||||
Per common share: | ||||||||||||
Basic earnings: | ||||||||||||
From continuing operations | $ | 3.37 | $ | 2.67 | (20.77 | )% | ||||||
Net income | 3.21 | 2.58 | (19.63 | ) | ||||||||
Diluted earnings: | ||||||||||||
From continuing operations | 3.33 | 2.65 | (20.42 | ) | ||||||||
Net income | 3.18 | 2.56 | (19.50 | ) | ||||||||
Dividends(2) | 1.51 | 1.56 | 3.31 | |||||||||
Book value (end of period) | 33.71 | 33.50 | (0.62 | ) | ||||||||
Common shares outstanding (end of period)(3)(4) | 138,523,666 | 140,069,898 | 1.12 | |||||||||
Weighted average common shares outstanding—basic(3)(4) | 137,694,682 | 137,473,242 | (0.16 | ) | ||||||||
Weighted average common shares outstanding—diluted(3)(4) | 139,291,920 | 138,584,608 | (0.51 | ) | ||||||||
Balance sheet (end of period): | ||||||||||||
Total assets(5) | $ | 54,343,045 | $ | 62,599,753 | 15.19 | % | ||||||
Total loans | 39,745,341 | 48,306,118 | 21.54 | |||||||||
Nonperforming assets | 52,562 | 304,246 | nm | |||||||||
Total deposits | 42,242,889 | 42,355,853 | 0.27 | |||||||||
Medium- and long-term debt | 1,871,726 | 3,827,164 | nm | |||||||||
Stockholders' equity | 4,669,454 | 4,692,648 | 0.50 | |||||||||
Balance sheet (period average): | ||||||||||||
Total assets | $ | 53,065,919 | $ | 59,023,615 | 11.23 | % | ||||||
Total loans | 38,931,283 | 45,138,144 | 15.94 | |||||||||
Earning assets | 48,568,556 | 54,689,402 | 12.60 | |||||||||
Total deposits | 41,966,403 | 42,821,802 | 2.04 | |||||||||
Stockholders' equity | 4,588,063 | 4,640,908 | 1.15 | |||||||||
Financial ratios(6): | ||||||||||||
Return on average assets(7): | ||||||||||||
From continuing operations | 1.17 | % | 0.83 | % | ||||||||
Net income | 1.11 | 0.80 | ||||||||||
Return on average stockholders' equity(7): | ||||||||||||
From continuing operations | 13.52 | 10.56 | ||||||||||
Net income | 12.89 | 10.21 | ||||||||||
Efficiency ratio(8) | 60.89 | 59.49 | ||||||||||
Net interest margin(1) | 3.54 | 3.65 | ||||||||||
Dividend payout ratio | 44.81 | 58.43 | ||||||||||
Tangible equity ratio | 7.79 | 6.96 | ||||||||||
Tier 1 risk-based capital ratio(5) | 8.40 | 8.02 | ||||||||||
Total risk-based capital ratio(5) | 11.28 | 10.94 | ||||||||||
Leverage ratio(5) | 8.39 | 7.97 | ||||||||||
Allowance for loan losses to:(9) | ||||||||||||
Total loans | 0.88 | 1.20 | ||||||||||
Nonaccrual loans | 683.96 | 200.94 | ||||||||||
Allowance for credit losses to:(10) | ||||||||||||
Total loans | 1.10 | 1.43 | ||||||||||
Nonaccrual loans | 852.52 | 239.50 | ||||||||||
Net loans charged off to average total loans(7) | 0.02 | 0.31 | ||||||||||
Nonperforming assets to total loans and foreclosed assets | 0.13 | 0.63 | ||||||||||
Nonperforming assets to total assets(5) | 0.10 | 0.49 |
- (1)
- Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
- (2)
- Dividends per share reflect dividends declared on UnionBanCal Corporation's common stock outstanding as of the declaration date.
- (3)
- Common shares outstanding reflect common shares issued less treasury shares.
- (4)
- Weighted average common shares outstanding (basic) excludes nonvested restricted shares but includes the impact of those shares in the calculation of diluted 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 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 allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans or total nonperforming loans, as appropriate.These ratios relate to continuing operations only.
- (10)
- The allowance for credit losses ratios are calculated using the sum of the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans or total nonperforming loans, as appropriate. These ratios relate to continuing operations only.
nm = not meaningful
7
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Statements of Income
(Unaudited)
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Amounts in thousands, except per share data) | 2007 | 2008 | 2007 | 2008 | |||||||||||
Interest Income | |||||||||||||||
Loans | $ | 638,779 | $ | 636,870 | $ | 1,857,269 | $ | 1,884,112 | |||||||
Securities | 112,667 | 100,265 | 330,074 | 303,843 | |||||||||||
Interest bearing deposits in banks | 709 | 147 | 3,113 | 503 | |||||||||||
Federal funds sold and securities purchased under resale agreements | 4,683 | 1,787 | 23,644 | 5,573 | |||||||||||
Trading account assets | 1,657 | 1,200 | 4,661 | 4,701 | |||||||||||
Total interest income | 758,495 | 740,269 | 2,218,761 | 2,198,732 | |||||||||||
Interest Expense | |||||||||||||||
Deposits | 259,406 | 135,736 | 727,632 | 500,905 | |||||||||||
Federal funds purchased and securities sold under repurchase agreements | 14,259 | 15,630 | 38,290 | 44,402 | |||||||||||
Commercial paper | 19,753 | 8,056 | 59,446 | 26,127 | |||||||||||
Medium and long-term debt | 26,957 | 25,989 | 75,625 | 65,138 | |||||||||||
Trust notes | 239 | 239 | 715 | 715 | |||||||||||
Other borrowed funds | 11,318 | 34,873 | 33,273 | 70,563 | |||||||||||
Total interest expense | 331,932 | 220,523 | 934,981 | 707,850 | |||||||||||
Net Interest Income | 426,563 | 519,746 | 1,283,780 | 1,490,882 | |||||||||||
Provision for loan losses | 16,000 | 117,000 | 25,000 | 284,000 | |||||||||||
Net interest income after provision for loan losses | 410,563 | 402,746 | 1,258,780 | 1,206,882 | |||||||||||
Noninterest Income | |||||||||||||||
Service charges on deposit accounts | 76,210 | 77,079 | 228,373 | 229,521 | |||||||||||
Trust and investment management fees | 39,546 | 40,638 | 116,062 | 127,828 | |||||||||||
Trading account activities | 21,795 | 12,397 | 50,473 | 40,096 | |||||||||||
Merchant banking fees | 10,031 | 12,789 | 27,917 | 35,667 | |||||||||||
Brokerage commissions and fees | 10,476 | 9,520 | 29,669 | 30,014 | |||||||||||
Card processing fees, net | 7,785 | 8,129 | 22,736 | 24,060 | |||||||||||
Securities gains, net | 171 | 50 | 1,621 | 48 | |||||||||||
Other | 42,173 | 38,119 | 123,739 | 106,509 | |||||||||||
Total noninterest income | 208,187 | 198,721 | 600,590 | 593,743 | |||||||||||
Noninterest Expense | |||||||||||||||
Salaries and employee benefits | 216,812 | 238,129 | 686,175 | 723,098 | |||||||||||
Net occupancy | 37,534 | 38,574 | 104,919 | 113,008 | |||||||||||
Outside services | 19,868 | 20,777 | 54,987 | 58,081 | |||||||||||
Professional services | 17,669 | 21,397 | 45,163 | 51,925 | |||||||||||
Equipment | 15,426 | 14,437 | 47,240 | 44,925 | |||||||||||
Software | 14,278 | 14,812 | 41,551 | 44,016 | |||||||||||
Communications | 9,421 | 9,204 | 26,834 | 27,690 | |||||||||||
Foreclosed asset expense | 37 | 524 | 55 | 696 | |||||||||||
Provision for losses on off-balance sheet commitments | 4,000 | 8,000 | 5,000 | 21,000 | |||||||||||
Other | 45,802 | 77,958 | 144,593 | 181,891 | |||||||||||
Total noninterest expense | 380,847 | 443,812 | 1,156,517 | 1,266,330 | |||||||||||
Income from continuing operations before income taxes | 237,903 | 157,655 | 702,853 | 534,295 | |||||||||||
Income tax expense | 87,664 | 47,549 | 238,727 | 167,493 | |||||||||||
Income from Continuing Operations | 150,239 | 110,106 | 464,126 | 366,802 | |||||||||||
Loss from discontinued operations before income taxes | (23,443 | ) | (8,175 | ) | (21,561 | ) | (22,692 | ) | |||||||
Income tax expense (benefit) | (663 | ) | (2,899 | ) | 141 | (10,655 | ) | ||||||||
Loss from Discontinued Operations | (22,780 | ) | (5,276 | ) | (21,702 | ) | (12,037 | ) | |||||||
Net Income | $ | 127,459 | $ | 104,830 | $ | 442,424 | $ | 354,765 | |||||||
Income from continuing operations per common share—basic | $ | 1.09 | $ | 0.80 | $ | 3.37 | $ | 2.67 | |||||||
Net Income per common share—basic | $ | 0.93 | $ | 0.76 | $ | 3.21 | $ | 2.58 | |||||||
Income from continuing operations per common share—diluted | $ | 1.08 | $ | 0.79 | $ | 3.33 | $ | 2.65 | |||||||
Net Income per common share—diluted | $ | 0.92 | $ | 0.75 | $ | 3.18 | $ | 2.56 | |||||||
Weighted average common shares outstanding—basic | 137,668 | 138,197 | 137,695 | 137,473 | |||||||||||
Weighted average common shares outstanding—diluted | 139,068 | 139,969 | 139,292 | 138,585 | |||||||||||
See accompanying notes to condensed consolidated financial statements.
8
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Balance Sheet
(Dollars in thousands) | (Unaudited) September 30, 2007 | December 31, 2007 | (Unaudited) September 30, 2008 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Assets | ||||||||||||
Cash and due from banks | $ | 1,715,742 | $ | 2,106,927 | $ | 1,959,484 | ||||||
Interest bearing deposits in banks | 151,000 | 104,528 | 16,029 | |||||||||
Federal funds sold and securities purchased under resale agreements | 381,604 | 310,178 | 488,014 | |||||||||
Total cash and cash equivalents | 2,248,346 | 2,521,633 | 2,463,527 | |||||||||
Trading account assets: | ||||||||||||
Pledged as collateral | — | — | 18,124 | |||||||||
Held in portfolio | 507,961 | 603,333 | 711,293 | |||||||||
Securities available for sale: | ||||||||||||
Pledged as collateral | 77,732 | 685,123 | 1,404,463 | |||||||||
Held in portfolio | 8,427,764 | 7,770,037 | 6,890,891 | |||||||||
Loans (net of allowance for loan losses: September 30, 2007, $350,491; December 31, 2007, $402,726; September 30, 2008, $580,474) | 39,394,850 | 40,801,462 | 47,725,644 | |||||||||
Due from customers on acceptances | 18,648 | 16,482 | 21,562 | |||||||||
Premises and equipment, net | 477,697 | 486,034 | 474,519 | |||||||||
Intangible assets | 7,583 | 6,458 | 4,447 | |||||||||
Goodwill | 360,058 | 355,287 | 355,287 | |||||||||
Other assets | 2,698,377 | 2,358,915 | 2,524,839 | |||||||||
Assets of discontinued operations to be disposed or sold | 124,029 | 122,984 | 5,157 | |||||||||
Total assets | $ | 54,343,045 | $ | 55,727,748 | $ | 62,599,753 | ||||||
Liabilities | ||||||||||||
Noninterest bearing | $ | 13,675,884 | $ | 13,802,640 | $ | 13,694,272 | ||||||
Interest bearing | 28,567,005 | 28,877,551 | 28,661,581 | |||||||||
Total deposits | 42,242,889 | 42,680,191 | 42,355,853 | |||||||||
Federal funds purchased and securities sold under repurchase agreements | 1,823,872 | 1,631,602 | 1,760,442 | |||||||||
Commercial paper | 1,706,135 | 1,266,656 | 1,659,935 | |||||||||
Other borrowed funds | 298,548 | 1,875,619 | 6,718,935 | |||||||||
Trading account liabilities | 251,051 | 351,057 | 506,890 | |||||||||
Acceptances outstanding | 18,648 | 16,482 | 21,562 | |||||||||
Other liabilities | 1,322,416 | 1,108,585 | 1,020,085 | |||||||||
Medium- and long-term debt | 1,871,726 | 1,913,622 | 3,827,164 | |||||||||
Junior subordinated debt payable to subsidiary grantor trust | 14,546 | 14,432 | 14,093 | |||||||||
Liabilities of discontinued operations to be extinguished or assumed | 123,760 | 131,521 | 22,146 | |||||||||
Total liabilities | 49,673,591 | 50,989,767 | 57,907,105 | |||||||||
Commitments, contingencies and guarantees—See Note 14 | ||||||||||||
Stockholders' Equity | ||||||||||||
Preferred stock: | ||||||||||||
Authorized 5,000,000 shares; no shares issued or outstanding as of September 30, 2007, December 31, 2007 and September 30, 2008 | — | — | — | |||||||||
Common stock, par value $1 per share: | ||||||||||||
Authorized 300,000,000 shares; issued 157,272,167 shares as of September 30, 2007, 157,559,521 shares as of December 31, 2007 and 159,834,897 shares as of September 30, 2008 | 157,272 | 157,559 | 159,835 | |||||||||
Additional paid-in capital | 1,144,971 | 1,153,737 | 1,299,045 | |||||||||
Treasury stock—18,748,501 shares as of September 30, 2007, 19,723,453 shares as of December 31, 2007 and 19,764,999 shares as of September 30, 2008 | (1,152,157 | ) | (1,202,584 | ) | (1,204,759 | ) | ||||||
Retained earnings | 4,818,477 | 4,912,392 | 5,050,682 | |||||||||
Accumulated other comprehensive loss | (299,109 | ) | (283,123 | ) | (612,155 | ) | ||||||
Total stockholders' equity | 4,669,454 | 4,737,981 | 4,692,648 | |||||||||
Total liabilities and stockholders' equity | $ | 54,343,045 | $ | 55,727,748 | $ | 62,599,753 | ||||||
See accompanying notes to condensed consolidated financial statements.
9
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Statements of Changes in Stockholders' Equity
(Unaudited)
(In thousands, except shares) | Number of shares | Common stock | Additional paid-in capital | Treasury stock | Retained earnings | Accumulated other comprehensive income (loss) | Total stock- holders' equity | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
BALANCE DECEMBER 31, 2006 | 156,460,057 | $ | 156,460 | $ | 1,083,649 | $ | (1,064,606 | ) | $ | 4,655,272 | $ | (259,374 | ) | $ | 4,571,401 | ||||||||||
Comprehensive income | |||||||||||||||||||||||||
Net income—For the nine months | |||||||||||||||||||||||||
ended September 30, 2007 | 442,424 | 442,424 | |||||||||||||||||||||||
Other comprehensive income (loss), net of tax: | |||||||||||||||||||||||||
Net change in unrealized gains on | |||||||||||||||||||||||||
cash flow hedges | 24,289 | 24,289 | |||||||||||||||||||||||
Net change in unrealized losses on | |||||||||||||||||||||||||
securities available for sale | (74,805 | ) | (74,805 | ) | |||||||||||||||||||||
Foreign currency translation adjustment | 602 | 602 | |||||||||||||||||||||||
Net change in pension and other benefits | 10,179 | 10,179 | |||||||||||||||||||||||
Total comprehensive income | 402,689 | ||||||||||||||||||||||||
FIN No. 48 adjustment(1) | (49,300 | ) | (49,300 | ) | |||||||||||||||||||||
FSP FAS 13-2 adjustment(2) | (20,803 | ) | (20,803 | ) | |||||||||||||||||||||
Stock options exercised | 785,072 | 785 | 31,936 | 32,721 | |||||||||||||||||||||
Restricted stock granted, net of forfeitures | 20,062 | 20 | (20 | ) | — | ||||||||||||||||||||
Restricted stock and performance share units vested | 6,976 | 7 | (7 | ) | — | ||||||||||||||||||||
Excess tax benefit—stock-based compensation | 4,920 | 4,920 | |||||||||||||||||||||||
Compensation expense—stock options | 10,366 | 10,366 | |||||||||||||||||||||||
Compensation expense—restricted stock | 10,671 | 10,671 | |||||||||||||||||||||||
Compensation expense—restricted stock units, performance share units and other share-based compensation | 3,456 | 3,456 | |||||||||||||||||||||||
Common stock repurchased(3) | (87,551 | ) | (87,551 | ) | |||||||||||||||||||||
Dividends declared on common stock, | |||||||||||||||||||||||||
$1.51 per share(4) | (209,116 | ) | (209,116 | ) | |||||||||||||||||||||
Net change | 812 | 61,322 | (87,551 | ) | 163,205 | (39,735 | ) | 98,053 | |||||||||||||||||
BALANCE SEPTEMBER 30, 2007 | 157,272,167 | $ | 157,272 | $ | 1,144,971 | $ | (1,152,157 | ) | $ | 4,818,477 | $ | (299,109 | ) | $ | 4,669,454 | ||||||||||
BALANCE DECEMBER 31, 2007 | 157,559,521 | $ | 157,559 | $ | 1,153,737 | $ | (1,202,584 | ) | $ | 4,912,392 | $ | (283,123 | ) | $ | 4,737,981 | ||||||||||
Comprehensive income | |||||||||||||||||||||||||
Net income—For the nine months | |||||||||||||||||||||||||
ended September 30, 2008 | 354,765 | 354,765 | |||||||||||||||||||||||
Other comprehensive income (loss), net of tax: | |||||||||||||||||||||||||
Net change in unrealized gains on cash flow hedges | 11,417 | 11,417 | |||||||||||||||||||||||
Net change in unrealized losses on securities available for sale | (346,866 | ) | (346,866 | ) | |||||||||||||||||||||
Foreign currency translation adjustment | (625 | ) | (625 | ) | |||||||||||||||||||||
Net change in pension and other benefits | 7,042 | 7,042 | |||||||||||||||||||||||
Total comprehensive income | 25,733 | ||||||||||||||||||||||||
EITF 06-4 adjustment(5) | (236 | ) | (236 | ) | |||||||||||||||||||||
EITF 06-11 adjustment(6) | 162 | 162 | |||||||||||||||||||||||
Stock options exercised | 2,255,373 | 2,256 | 104,941 | 107,197 | |||||||||||||||||||||
Restricted stock granted, net of forfeitures | 20,003 | 20 | (20 | ) | — | ||||||||||||||||||||
Excess tax benefit—stock-based compensation | 11,910 | 11,910 | |||||||||||||||||||||||
Compensation expense—stock options | 9,848 | 9,848 | |||||||||||||||||||||||
Compensation expense—restricted stock | 12,731 | 12,731 | |||||||||||||||||||||||
Compensation expense—restricted stock units, performance share units and other share-based compensation | 5,736 | 5,736 | |||||||||||||||||||||||
Common stock repurchased(3) | (2,175 | ) | (2,175 | ) | |||||||||||||||||||||
Dividends declared on common stock, $1.56 per share(4) | (216,239 | ) | (216,239 | ) | |||||||||||||||||||||
Net change | 2,276 | 145,308 | (2,175 | ) | 138,290 | (329,032 | ) | (45,333 | ) | ||||||||||||||||
BALANCE SEPTEMBER 30, 2008 | 159,834,897 | $ | 159,835 | $ | 1,299,045 | $ | (1,204,759 | ) | $ | 5,050,682 | $ | (612,155 | ) | $ | 4,692,648 | ||||||||||
- (1)
- Reflects the adoption of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes—An Interpretation of FASB No. 109" (FIN No. 48).
- (2)
- Reflects the adoption of FASB Staff Position (FSP) FAS 13-2, "Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction."
- (3)
- Common stock repurchased includes commission costs.
- (4)
- Dividends are based on UnionBanCal Corporation's shares outstanding as of the declaration date.
- (5)
- See Note 2 to these condensed consolidated financial statements for a description of the adoption of EITF No. 06-4 "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements."
- (6)
- See Note 2 to these condensed consolidated financial statements for a description of the adoption of EITF No. 06-11 "Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards."
See accompanying notes to condensed consolidated financial statements.
10
UnionBanCal Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| For the Nine Months Ended September 30, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | ||||||||
Cash Flows from Operating Activities: | ||||||||||
Net income | $ | 442,424 | $ | 354,765 | ||||||
Loss from discontinued operations, net of taxes | (21,702 | ) | (12,037 | ) | ||||||
Income from continuing operations, net of taxes | 464,126 | 366,802 | ||||||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||||||
Provision for loan losses | 25,000 | 284,000 | ||||||||
Provision for losses on off-balance sheet commitments | 5,000 | 21,000 | ||||||||
Depreciation, amortization and accretion | 84,514 | 85,125 | ||||||||
Stock-based compensation—stock options and other share-based compensation | 24,493 | 28,315 | ||||||||
Provision for deferred income taxes | 23,359 | 74,771 | ||||||||
Gains on sales of securities available for sale, net | (1,621 | ) | (48 | ) | ||||||
Net decrease in accrued expenses | (34,575 | ) | (427,084 | ) | ||||||
Net increase in trading account assets | (131,640 | ) | (126,084 | ) | ||||||
Net (decrease) increase in trading account liabilities | (7,085 | ) | 155,833 | |||||||
Net increase in prepaid expenses | (50,879 | ) | (12,824 | ) | ||||||
Net increase in fees and other receivables | (166,843 | ) | (63,740 | ) | ||||||
Net increase in other liabilities | 184,028 | 461,277 | ||||||||
Net increase in other assets | (428,388 | ) | (59,916 | ) | ||||||
Loans originated for resale | (615,139 | ) | (430,650 | ) | ||||||
Net proceeds from sale of loans originated for resale | 383,716 | 392,551 | ||||||||
Excess tax benefit—stock-based compensation | (4,920 | ) | (11,910 | ) | ||||||
Other, net | 54,602 | 4,725 | ||||||||
Discontinued operations, net | (7,333 | ) | 80,143 | |||||||
Total adjustments | (663,711 | ) | 455,484 | |||||||
Net cash provided by (used in) operating activities | (199,585 | ) | 822,286 | |||||||
Cash Flows from Investing Activities: | ||||||||||
Proceeds from sales of securities available for sale | 332,450 | 11,388 | ||||||||
Proceeds from matured and called securities available for sale | 1,455,545 | 1,185,604 | ||||||||
Purchases of securities available for sale | (1,656,178 | ) | (1,592,482 | ) | ||||||
Purchases of premises and equipment, net | (64,749 | ) | (53,924 | ) | ||||||
Net increase in loans | (2,927,817 | ) | (7,185,181 | ) | ||||||
Other, net | — | (5,054 | ) | |||||||
Discontinued operations, net | 917 | 3,732 | ||||||||
Net cash used in investing activities | (2,859,832 | ) | (7,635,917 | ) | ||||||
Cash Flows from Financing Activities: | ||||||||||
Net increase (decrease) in deposits | 392,207 | (324,338 | ) | |||||||
Net increase in federal funds purchased and securities sold under repurchase agreements | 739,945 | 128,840 | ||||||||
Net (decrease) increase in commercial paper and other borrowed funds | (85,041 | ) | 5,236,595 | |||||||
Proceeds from issuance of medium- and long-term debt | 749,250 | 1,901,000 | ||||||||
Repayment of medium-term debt | (200,000 | ) | — | |||||||
Common stock repurchased | (87,551 | ) | (2,175 | ) | ||||||
Payments of cash dividends | (202,962 | ) | (215,246 | ) | ||||||
Stock options exercised | 37,641 | 119,107 | ||||||||
Other, net | 1,352 | (625 | ) | |||||||
Discontinued operations, net | (19,143 | ) | (87,460 | ) | ||||||
Net cash provided by financing activities | 1,325,698 | 6,755,698 | ||||||||
Net decrease in cash and cash equivalents | (1,733,719 | ) | (57,933 | ) | ||||||
Cash and cash equivalents at beginning of period | 3,981,435 | 2,521,633 | ||||||||
Effect of exchange rate changes on cash and cash equivalents | 630 | (173 | ) | |||||||
Cash and cash equivalents at end of period | $ | 2,248,346 | $ | 2,463,527 | ||||||
Cash Paid During the Period For: | ||||||||||
Interest | $ | 978,118 | $ | 703,335 | ||||||
Income taxes, net | 223,798 | 235,156 | ||||||||
Supplemental Schedule of Noncash Investing and Financing Activities: | ||||||||||
Loans transferred to foreclosed assets (OREO) | $ | 1,571 | $ | 17,750 |
See accompanying notes to condensed consolidated financial statements.
11
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 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. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. The results of operations for the period ended September 30, 2008 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 UnionBanCal Corporation's Annual Report on Form 10-K for the year ended December 31, 2007 (2007 Form 10-K). 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 compared to those estimates.
UnionBanCal Corporation is a commercial bank holding company whose major subsidiary, Union Bank of California, N.A. (the Bank), is a commercial bank. UnionBanCal Corporation and its subsidiaries (the Company) provide a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, primarily in California, Oregon, and Washington, as well as nationally and internationally.
The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU), which is a wholly-owned subsidiary of Mitsubishi UFJ Financial Group, Inc., owned approximately 64 percent of the Company's outstanding common stock at September 30, 2008. For information on BTMU's acquisition of additional shares of the Company's outstanding common stock, see Note 16 to these condensed consolidated financial statements.
Note 2—Recently Issued Accounting Pronouncements
Accounting for Fair Value Measurements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, "Fair Value Measurements." The Statement defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three-level hierarchy ranks the quality and reliability of information used to determine fair values with the highest priority given to quoted prices in active markets and the lowest priority given to model values that include inputs based on unobservable data. The Statement applies whenever other accounting standards require or permit assets or liabilities to be measured at fair value. The Statement was effective January 1, 2008. However, on February 12, 2008, the FASB issued Staff Position (FSP) FAS 157-2, "Effective Date of FASB Statement 157," which allows companies to delay for one year the effective date of SFAS No. 157 for all nonfinancial assets and liabilities that are measured at fair value on a nonrecurring basis. The Company has elected to delay the effective date of the Statement for its nonfinancial assets and liabilities, including goodwill and intangible assets. Effective January 1, 2008, the Company adopted SFAS No. 157 for its financial assets and liabilities measured and reported at fair value. At adoption, there was no impact on the
12
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 2—Recently Issued Accounting Pronouncements (Continued)
Company's financial position or results of operations. For detailed information on the Company's fair value measurements, see Note 10 to these condensed consolidated financial statements.
Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements
In September 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue No. 06-4, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements." The guidance requires that an agreement by the employer to share a portion of the proceeds of a life insurance policy with the employee during the postretirement period is a postretirement benefit arrangement for which a liability must be recorded. The Company adopted EITF 06-4 on January 1, 2008. At adoption, the Company's retained earnings were reduced by $0.2 million and there was no impact on the Company's results of operations.
The Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115." The Statement permits entities to choose to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis, with changes in fair value recognized in earnings each reporting period. An entity may elect the fair value option for existing assets and liabilities at the date of initial adoption and when first recognizing eligible instruments. The Statement was effective January 1, 2008. Management did not make the fair value option election, and, therefore, there was no impact on the Company's financial position or results of operations.
Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards
In June 2007, the EITF reached a consensus on EITF Issue No. 06-11, "Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards." The EITF requires that the tax benefit related to dividend equivalents paid on restricted stock and restricted stock units, which are expected to vest, be recorded as an increase to additional paid-in-capital. Prior to the issuance of this EITF, the Company recorded this tax benefit as a reduction to income tax expense. The EITF was effective for all tax benefits on dividends declared by the Company after January 1, 2008, with early application permitted as of the beginning of the fiscal year. At adoption, there was no impact on the Company's financial position or results of operations.
Business Combinations
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations," which replaces SFAS No. 141. The Statement requires that all business combinations be accounted for under the "acquisition method." The Statement requires that the assets, liabilities and noncontrolling interests of a business combination be measured at fair value at the acquisition date. The acquisition date is defined as the date an acquirer obtains control of the entity, which is typically the closing date. The Statement requires that all acquisition and restructuring related costs be expensed as incurred and that any contingent consideration be measured at fair value and recorded as either equity or a liability with the liability remeasured at fair value in subsequent periods. The Statement is effective January 1, 2009. Management is currently evaluating the
13
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 2—Recently Issued Accounting Pronouncements (Continued)
impact this Statement may have on the Company's financial position and results of operations related to future acquisitions.
Noncontrolling Interest in Consolidated Financial Statements
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements—an amendment to ARB No. 51." The Statement requires that a noncontrolling interest (formerly minority interest) be measured at fair value at the acquisition date and be presented in the equity section on the balance sheet. The Statement requires that purchases or sales of equity interests that do not result in a change in control be accounted for as equity transactions with no resulting gain or loss. If control is lost, the noncontrolling interest is remeasured to fair value and a gain or loss is recorded. The Statement is effective January 1, 2009. Management believes that adopting this Statement will not have a material impact on the Company's financial position or results of operations.
Disclosures about Derivative Instruments and Hedging Activities
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133." The Statement requires expanded qualitative, quantitative and credit-risk disclosures of derivative instruments and hedging activities. These disclosures include more detailed information about gains and losses, location of derivative instruments in financial statements, and credit-risk-related contingent features in derivative instruments. The Statement also clarifies that derivative instruments are subject to concentration of credit risk disclosures under SFAS No. 107, "Disclosure About Fair Value of Financial Instruments." The Statement, which applies only to disclosures, is effective January 1, 2009.
The Hierarchy of Generally Accepted Accounting Principles
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles." The Statement identifies the sources of accounting principles and establishes a hierarchy for selecting those principles to prepare financial statements in accordance with US GAAP. The Statement is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles." Management believes that the adoption of this Statement will not have an impact on the Company's financial position or results of operations.
Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities
In June 2008, the FASB issued FSP EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities." The FSP requires that unvested share-based payment awards that contain nonforfeitable rights to dividends be treated as participating securities and included in the computation of earnings per share (EPS). Under the FSP, the Company's unvested restricted stock shares are considered participating securities and will be included in the computation of EPS upon adoption of the FSP. The FSP is effective January 1, 2009 and retrospective application is required. Management believes that the adoption of this FSP will not have an impact on the Company's financial position or results of operations.
14
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 2—Recently Issued Accounting Pronouncements (Continued)
Disclosures about Credit Derivatives and Certain Guarantees
In September 2008, the FASB issued FSP FAS 133-1 and FASB Interpretation (FIN) 45-4, "Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161." The FSP requires sellers of credit derivatives to provide expanded disclosures about the nature of their credit derivatives, the maximum potential amount of future payments and the fair value of credit derivatives at the financial statement date. The FIN requires guarantors to disclose the current status of the payment/performance risk of all guarantees. The Statement, which applies only to disclosures, is effective December 31, 2008.
Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active
In October 2008, the FASB issued FSP FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active." The FSP provides guidance clarifying how SFAS No. 157 should be applied when valuing securities in markets that are not active. The guidance states that significant judgment is required in valuing financial assets and clarifies how management's internal assumptions should be considered when relevant observable data does not exist, how observable market information in a market that is not active should be considered when measuring fair value, and how the use of market quotes should be considered when assessing the relevance of observable and unobservable data available to measure fair value. The FSP is effective upon issuance and includes financial statements for the period ended and as of September 30, 2008. At adoption, there was no impact on the Company's financial position or results of operations.
Note 3—Discontinued Operations
The Company's discontinued operations consist of three separate businesses: international correspondent banking, retirement recordkeeping services and insurance brokerage services. In 2005, the Bank sold its international correspondent banking business (ICBB) to Wachovia Bank, N.A. for $245.0 million, and a subsequent $4.0 million purchase price adjustment in 2006. This business consisted of international payment and trade processing along with related lending activities. As of March 31, 2007, substantially all of the assets and liabilities related to this discontinued operation were liquidated.
Although ICBB's operations had substantially ended in 2006, the Bank was responsible for past violations of the Bank Secrecy Act and other anti-money laundering laws and regulations (BSA/AML) associated with ICBB. As a result of the past violations, the Bank entered into a Deferred Prosecution Agreement (DPA) with the United States Department of Justice (DOJ) in the third quarter of 2007. For additional information, refer to Note 14 to these condensed consolidated financial statements.
In the fourth quarter of 2007, the Company sold its retirement recordkeeping business (RRB) to Prudential Retirement, a subsidiary of Prudential Financial, Inc., for $103.0 million. The Company recorded a pre-tax gain of $94.7 million, net of $2.1 million in transaction costs and a $6.2 million elimination of intangible assets, consisting of goodwill of $4.8 million and other intangibles of $1.4 million attributed to this business. The RRB was previously included in the Retail Banking reportable business segment.
In June 2008, the Company sold its insurance brokerage business (IBB) subsidiary, UnionBanc Insurance Services, Inc., to a wholly-owned subsidiary of BB&T Corporation. The Company recorded a pre-tax gain of $9.8 million, net of $1.6 million in transaction costs, and an elimination of intangible assets consisting of
15
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 3—Discontinued Operations (Continued)
goodwill of $74.7 million and other intangibles of $11.0 million. The IBB was previously included in the Wholesale Banking reportable business segment.
These transactions have been accounted for as discontinued operations. All prior period financial statements have been restated to reflect this accounting treatment. The assets and liabilities of the discontinued operations have been separately identified on the condensed consolidated balance sheet and the assets are shown as "held for sale" 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. Interest expense (income) was attributed to discontinued operations based on average net assets (liabilities).
International Correspondent Banking Business Discontinued Operations
The components of expense from the ICBB discontinued operations for the three and nine months ended September 30, 2007 and 2008 are:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | |||||||||
Noninterest expense | $ | 23,297 | $ | — | $ | 23,297 | $ | — | |||||
Loss from discontinued operations before income taxes | (23,297 | ) | — | (23,297 | ) | — | |||||||
Income tax benefit | (661 | ) | — | (661 | ) | — | |||||||
Loss from discontinued operations | $ | (22,636 | ) | $ | — | $ | (22,636 | ) | $ | — | |||
Noninterest expense for the three and nine months ended September 30, 2007 included the $21.6 million paid to the DOJ and related legal and other outside services costs of $1.7 million. The income tax benefit of $0.7 million for the three and nine months ended September 30, 2007 reflects the nondeductibility of the $21.6 million DOJ payment.
16
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 3—Discontinued Operations (Continued)
Retirement Recordkeeping Business Discontinued Operations
At September 30 and December 31, 2007 and September 30, 2008, the assets and liabilities identified as the RRB discontinued operations consisted of the following:
(Dollars in thousands) | September 30, 2007 | December 31, 2007 | September 30, 2008 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Assets | ||||||||||
Premises and equipment | $ | 1,370 | $ | 1,086 | $ | — | ||||
Intangible assets | 1,731 | — | — | |||||||
Other assets | 6,008 | 6,518 | 5,157 | |||||||
Assets of discontinued operations to be disposed or sold | $ | 9,109 | $ | 7,604 | $ | 5,157 | ||||
Liabilities | ||||||||||
Noninterest bearing deposits | $ | 3 | $ | — | $ | — | ||||
Interest bearing deposits | 103,199 | 98,516 | 11,060 | |||||||
Other liabilities | 268 | 9,483 | 9,269 | |||||||
Liabilities of discontinued operations to be extinguished or assumed | $ | 103,470 | $ | 107,999 | $ | 20,329 | ||||
The $9.0 million increase in other liabilities from September 30, 2007 to September 30, 2008 was mainly due to severance accruals recorded in December 2007.
The components of income from the RRB discontinued operations for the three and nine months ended September 30, 2007 and 2008 are:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | |||||||||
Net interest income | $ | 1,103 | $ | 226 | $ | 3,700 | $ | 1,540 | |||||
Noninterest income | 11,717 | 891 | 35,346 | 18,419 | |||||||||
Noninterest expense | 10,433 | 9,037 | 32,654 | 31,217 | |||||||||
Income (loss) from discontinued operations before income taxes | 2,387 | (7,920 | ) | 6,392 | (11,258 | ) | |||||||
Income tax expense (benefit) | 970 | (2,809 | ) | 2,511 | (3,973 | ) | |||||||
Income (loss) from discontinued operations | $ | 1,417 | $ | (5,111 | ) | $ | 3,881 | $ | (7,285 | ) | |||
The RRB's net interest income for the three months ended September 30, 2007 and 2008 included the allocation of interest income (based on its average net liabilities) of $1.2 million and $0.3 million, respectively, and $4.0 million and $1.8 million for the nine months ended September 30, 2007 and 2008, respectively. Noninterest income for the three months ended September 30, 2007 and 2008 included trust fees of $11.7 million and $0.9 million, respectively, and $35.3 million and $7.3 million for the nine months ended September 30, 2007 and 2008, respectively. Noninterest income for the nine months ended September 30, 2008 also included $11.8 million in servicing revenues from Prudential. The majority of these servicing revenues were earned in the first half of 2008, as the migration of customers onto Prudential's accounting
17
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 3—Discontinued Operations (Continued)
systems was completed in June 2008. For the three months ended September 30, 2007 and 2008, noninterest expense included salaries and benefits expense of $6.2 million and $4.7 million, respectively, and $19.3 million and $16.0 million for the nine months ended September 30, 2007 and 2008, respectively.
Insurance Brokerage Business Discontinued Operations
At September 30 and December 31, 2007 and September 30, 2008, the assets and liabilities identified as the IBB discontinued operations consisted of the following:
(Dollars in thousands) | September 30, 2007 | December 31, 2007 | September 30, 2008 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Assets | ||||||||||
Cash and due from banks | $ | 3 | $ | 3 | $ | — | ||||
Securities available for sale | 13 | 11 | ||||||||
Premises and equipment | 4,307 | 4,163 | — | |||||||
Intangible assets | 12,887 | 12,110 | — | |||||||
Goodwill | 93,431 | 93,431 | ||||||||
Other assets | 4,279 | 5,662 | — | |||||||
Assets of discontinued operations to be disposed or sold | $ | 114,920 | $ | 115,380 | $ | — | ||||
Liabilities | ||||||||||
Other borrowed funds | $ | 181 | $ | 4 | $ | — | ||||
Other liabilities | 20,109 | 23,518 | 1,817 | |||||||
Liabilities of discontinued operations to be extinguished or assumed | $ | 20,290 | $ | 23,522 | $ | 1,817 | ||||
The components of income from the IBB discontinued operations for the three and nine months ended September 30, 2007 and 2008 are:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | |||||||||
Net interest expense | $ | (1,221 | ) | $ | — | $ | (3,650 | ) | $ | (993 | ) | ||
Noninterest income | 15,828 | 249 | 52,199 | 35,840 | |||||||||
Noninterest expense | 17,140 | 504 | 53,205 | 46,281 | |||||||||
Loss from discontinued operations before income taxes | (2,533 | ) | (255 | ) | (4,656 | ) | (11,434 | ) | |||||
Income tax benefit | (972 | ) | (90 | ) | (1,709 | ) | (6,682 | ) | |||||
Loss from discontinued operations | $ | (1,561 | ) | $ | (165 | ) | $ | (2,947 | ) | $ | (4,752 | ) | |
The IBB's net interest expense for the three and nine months ended September 30, 2007 and the nine months ended September 30, 2008 was mainly comprised of the allocation of interest expense (based on its average net assets). Noninterest income for the three months ended September 30, 2007 included insurance commissions of $15.9 million, and $52.2 million and $25.7 million for the nine months ended September 30, 2007 and 2008, respectively. Noninterest income for the nine months ended September 30,
18
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 3—Discontinued Operations (Continued)
2008 also included a $9.8 million pre-tax gain from the sale of IBB and $0.2 million in subsequent gain adjustments for the three and nine months ended September 30, 2008. Noninterest expense for the three months ended September 30, 2007 and 2008 included salaries and benefits expense of $13.5 million and $0.5 million, respectively, and $41.0 million and $21.2 million, for the nine months ended September 30, 2007 and 2008, respectively. For the nine months ended September 30, 2008, noninterest expense also included an $18.7 million goodwill impairment charge. This charge was recorded in the first quarter of 2008, when the Company determined that the value of the net assets was greater than the fair value of IBB, which was based on indicative prices for insurance agencies.
Note 4—Loans and Allowance for Loan Losses
A summary of loans, net of unearned interest and deferred fees (costs) of ($13) million, ($15) million and ($9) million, at September 30, 2007, December 31, 2007 and September 30, 2008, respectively, is as follows:
(Dollars in thousands) | September 30, 2007 | December 31, 2007 | September 30, 2008 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial, financial and industrial | $ | 13,837,388 | $ | 14,563,477 | $ | 17,700,604 | |||||||
Construction | 2,411,434 | 2,406,729 | 2,653,945 | ||||||||||
Mortgage: | |||||||||||||
Residential | 13,451,633 | 13,827,241 | 15,691,872 | ||||||||||
Commercial | 6,529,125 | 7,021,299 | 8,032,010 | ||||||||||
Total mortgage | 19,980,758 | 20,848,540 | 23,723,882 | ||||||||||
Consumer: | |||||||||||||
Installment | 1,258,485 | 1,327,348 | 2,166,912 | ||||||||||
Revolving lines of credit | 1,328,747 | 1,334,132 | 1,361,784 | ||||||||||
Total consumer | 2,587,232 | 2,661,480 | 3,528,696 | ||||||||||
Lease financing | 634,524 | 654,467 | 642,642 | ||||||||||
Total loans held to maturity | 39,451,336 | 41,134,693 | 48,249,769 | ||||||||||
Total loans held for sale | 294,005 | 69,495 | 56,349 | ||||||||||
Total loans | 39,745,341 | 41,204,188 | 48,306,118 | ||||||||||
Allowance for loan losses | 350,491 | 402,726 | 580,474 | ||||||||||
Loans, net | $ | 39,394,850 | $ | 40,801,462 | $ | 47,725,644 | |||||||
19
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 4—Loans and Allowance for Loan Losses (Continued)
Changes in the allowance for loan losses were as follows:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | ||||||||||
Allowance for loan losses, beginning of period | $ | 335,952 | $ | 526,401 | $ | 331,077 | $ | 402,726 | ||||||
Loans charged off | (4,501 | ) | (64,548 | ) | (13,066 | ) | (111,093 | ) | ||||||
Recoveries of loans previously charged off | 2,681 | 1,993 | 6,731 | 5,404 | ||||||||||
Total net loans charged off | (1,820 | ) | (62,555 | ) | (6,335 | ) | (105,689 | ) | ||||||
Provision for loan losses | 16,000 | 117,000 | 25,000 | 284,000 | ||||||||||
Foreign translation adjustment and other net additions | 359 | (372 | ) | 749 | (563 | ) | ||||||||
Allowance for loan losses, end of period | $ | 350,491 | $ | 580,474 | $ | 350,491 | $ | 580,474 | ||||||
Allowance for losses on off-balance sheet commitments | 86,374 | 111,374 | 86,374 | 111,374 | ||||||||||
Allowances for credit losses, end of period | $ | 436,865 | $ | 691,848 | $ | 436,865 | $ | 691,848 | ||||||
Nonaccrual loans totaled $51.2 million and $288.9 million at September 30, 2007 and 2008, respectively. There were no troubled debt restructured loans at September 30, 2007 and $1.4 million at September 30, 2008. Loans 90 days past due and still accruing totaled $17.9 million and $49.2 million at September 30, 2007 and 2008, respectively.
Note 5—Goodwill and Intangible Assets
Goodwill
The carrying amount of goodwill at September 30, 2007 and 2008 was $360.1 million and $355.3 million, respectively. There were no changes in the carrying amount of goodwill, which is reported on a continuing operating basis, during the nine months ended September 30, 2007 and 2008.
As a result of softening in the insurance market and declining fair value, the Company performed a goodwill impairment test as of March 31, 2008 on its insurance brokerage business, which was sold in June 2008. As required by SFAS No. 142, "Goodwill and Other Intangible Assets," the Company determined that the value of the net assets was greater than the fair value of the insurance brokerage business, which was based on indicative prices for insurance agencies. Consequently, the Company recorded an $18.7 million goodwill impairment charge, which is included in discontinued operations in the first quarter of 2008. As part of the sale of the IBB in June 2008, the Company eliminated its related goodwill balances. For additional information on the Company's sale of its insurance brokerage business, see Note 3 to these condensed consolidated financial statements.
20
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 5—Goodwill and Intangible Assets (Continued)
Intangible Assets
The table below reflects the Company's identifiable intangible assets, which consist of core deposit intangibles, and accumulated amortization on a continuing operations basis at September 30, 2007 and 2008. The identifiable intangible assets related to the discontinued operations of the retirement recordkeeping business and the insurance brokerage business have been excluded from this table.
| September 30, 2007 | September 30, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||
Core Deposit Intangibles | $ | 51,698 | $ | (44,115 | ) | $ | 7,583 | $ | 43,114 | $ | (38,667 | ) | $ | 4,447 |
Total amortization expense for the three months ended September 30, 2007 and 2008 was $1.1 million and $0.7 million, respectively. Total amortization expense for the nine months ended September 30, 2007 and 2008 was $3.4 million and $2.0 million, respectively.
The table below reflects the Company's expected identifiable intangible amortization expense, after September 30, 2008, on a continuing operations basis.
(Dollars in thousands) | Core Deposit Intangibles | ||||
---|---|---|---|---|---|
Estimated amortization expense for the years ending: | |||||
Remaining 2008 | $ | 670 | |||
2009 | 1,571 | ||||
2010 | 800 | ||||
2011 | 443 | ||||
2012 | 336 | ||||
2013 | 240 | ||||
thereafter | 387 | ||||
Total amortization expense after September 30, 2008 | $ | 4,447 | |||
21
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 6—Employee Pension and Other Postretirement Benefits
The following tables summarize the components of net periodic benefit cost for the three and nine months ended September 30, 2007 and 2008.
| Pension Benefits | Other Benefits | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Three Months Ended September 30, | For the Three Months Ended September 30, | ||||||||||||
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | ||||||||||
Components of net periodic benefit cost | ||||||||||||||
Service cost | $ | 12,559 | $ | 12,784 | $ | 1,929 | $ | 2,018 | ||||||
Interest cost | 17,797 | 19,411 | 2,571 | 2,821 | ||||||||||
Expected return on plan assets | (31,586 | ) | (33,411 | ) | (3,478 | ) | (3,369 | ) | ||||||
Amortization of prior service cost | 64 | — | (24 | ) | (22 | ) | ||||||||
Amortization of transition amount | — | — | 508 | 509 | ||||||||||
Recognized net actuarial loss | 4,002 | 2,483 | 633 | 816 | ||||||||||
Total net periodic benefit cost | $ | 2,836 | $ | 1,267 | $ | 2,139 | $ | 2,773 | ||||||
| Pension Benefits | Other Benefits | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Nine Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | ||||||||||
Components of net periodic benefit cost | ||||||||||||||
Service cost | $ | 37,676 | $ | 38,351 | $ | 6,095 | $ | 6,055 | ||||||
Interest cost | 53,393 | 58,234 | 8,253 | 8,463 | ||||||||||
Expected return on plan assets | (94,759 | ) | (100,232 | ) | (10,434 | ) | (10,108 | ) | ||||||
Amortization of prior service cost | 192 | — | (72 | ) | (70 | ) | ||||||||
Amortization of transition amount | — | — | 1,526 | 1,527 | ||||||||||
Recognized net actuarial loss | 12,006 | 7,449 | 2,831 | 2,497 | ||||||||||
Total net periodic benefit cost | $ | 8,508 | $ | 3,802 | $ | 8,199 | $ | 8,364 | ||||||
For further discussion of the Company's employee pension and other postretirement benefits, see Note 9 to the Consolidated Financial Statements in the Company's 2007 Form 10-K.
22
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 7—Borrowed Funds
The following is a summary of the major categories of borrowed funds:
(Dollars in Thousands) | September 30, 2007 | December 31, 2007 | September 30, 2008 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
Federal funds purchased and securities sold under repurchase agreements, with weighted average interest rates of 4.75%, 4.29% and 1.90% at September 30, 2007, December 31, 2007 and September 30, 2008, respectively(1) | $ | 1,823,872 | $ | 1,631,602 | $ | 1,760,442 | ||||||
Commercial paper, with weighted average interest rates of 4.97%, 4.25%, and 2.26% at September 30, 2007, December 31, 2007 and September 30, 2008, respectively(1) | 1,706,135 | 1,266,656 | 1,659,935 | |||||||||
Other borrowed funds:(2) | ||||||||||||
Federal Home Loan Bank borrowings, with weighted average interest rates of 6.77%, 4.52% and 2.63% at September 30, 2007, December 31, 2007, and September 30, 2008 respectively(1) | 1,000 | 949,000 | 2,600,000 | |||||||||
Term federal funds purchased, with weighted average interest rates of 5.45%, 4.79% and 2.63% at September 30, 2007, December 31, 2007 and September 30, 2008, respectively(1) | 204,420 | 805,970 | 807,730 | |||||||||
Federal Reserve Bank Term Borrowings, with weighted average interest rate of 3.14% at September 30, 2008(1) | — | — | 3,000,000 | |||||||||
Borrowings from Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU), with weighted average interest rate of 5.59% at September 30, 2008(1) | — | — | 200,000 | |||||||||
All other borrowed, with weighted average interest rates of 4.25%, 5.24% and 2.49% at September 30, 2007, December 31, 2007, and September 30, 2008, respectively(1) | 93,128 | 120,649 | 111,205 | |||||||||
Total borrowed funds | $ | 3,828,555 | $ | 4,773,877 | $ | 10,139,312 | ||||||
- (1)
- Weighted average interest rates provided relate to external funding and do not reflect expenses (earnings) allocated on net funding to discontinued operations. For further information, see Note 3 to these condensed consolidated financial statements.
- (2)
- Reflects borrowings with maturities of one year or less.
In September 2008, the Company established a $500 million, three-year unsecured revolving credit facility with BTMU. As of September 30, 2008, the Company had $200 million outstanding under this facility.
Note 8—Medium- and Long-Term Debt
In the second quarter of 2008, the Bank began borrowing from the Federal Home Loan Bank (FHLB) on a medium-term basis. The FHLB advances are secured by certain of the Bank's assets and bear either a fixed or
23
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 8—Medium- and Long-Term Debt (Continued)
floating interest rate. The floating rate advances are tied to the 3-month LIBOR plus a spread, with reset dates every 90 days. At September 30, 2008, the Bank's outstanding borrowings from the FHLB were $1.9 billion with a weighted average interest rate of 3.13 percent and a weighted average remaining maturity of 17 months.
Note 9—Management Stock Plans
The Company has two management stock plans. The Year 2000 UnionBanCal Corporation Management Stock Plan, as amended (the 2000 Stock Plan), and the UnionBanCal Corporation Management Stock Plan, restated effective June 1, 1997 (the 1997 Stock Plan), have 27.0 million and 6.6 million shares, respectively, of the Company's common stock authorized to be awarded to key employees, outside directors and consultants of the Company at the discretion of the Executive Compensation and Benefits Committee of the Board of Directors (the Committee). Employees on rotational assignment from BTMU are not eligible for stock awards. For further discussion of the Company's stock plans, see Note 16 to the Consolidated Financial Statements in the Company's 2007 Form 10-K.
See Note 16 to these condensed consolidated financial statements for information on the privatization of the Company. On November 4, 2008, outstanding awards under the management stock plans discussed below were canceled in exchange for the right to receive the cash value of those awards. No additional awards are expected to be granted under these plans. The following discussion within Note 9 is as of September 30, 2008, and does not take into consideration the impact of the Company's privatization.
The Committee determines the term of each 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 be less than the fair market value on the date the option is granted. The value of options is recognized as compensation expense over the vesting period during which the employees are required to provide service. The value of the restricted stock at the date of grant is recognized as compensation expense over its vesting period with a corresponding credit adjustment to additional paid-in capital. All cancelled or forfeited options and restricted stock become available for future grants.
Under the 2000 Stock Plan, the Company grants stock options and restricted stock. Additionally, under this plan, the Company issues shares of common stock upon the vesting and settlement of performance shares settled in common stock and restricted stock units, as well as upon the settlement of stock units. Under the 1997 Stock Plan, the Company issues shares of common stock upon exercise of outstanding stock options. The Company issues new shares of common stock for all awards under the stock plans. A total of 7,141,032 shares were available for future grants under the 2000 Stock Plan at September 30, 2008. These available shares have taken into account the outstanding number of shares of stock options and restricted stock, as well as the maximum number of shares that may be issued upon the vesting and settlement of outstanding performance shares settled in common stock and restricted stock units, and upon the settlement of outstanding stock units. The remaining shares under the 1997 Stock Plan are not available for future grants.
24
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 9—Management Stock Plans (Continued)
Stock Options
The following table summarizes stock option transactions under the stock plans for the nine months ended September 30, 2008.
| For the Nine Months Ended September 30, 2008 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Number of Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term (in years) | Aggregate Intrinsic Value (in thousands) | |||||||||||
Options outstanding, beginning of the period(1) | 9,673,146 | $ | 51.14 | ||||||||||||
Granted | 823,610 | 51.06 | |||||||||||||
Exercised | (2,255,373 | ) | 47.53 | ||||||||||||
Forfeited | (101,195 | ) | 58.11 | ||||||||||||
Options outstanding, end of the period(1) | 8,140,188 | $ | 52.05 | 4.80 | $ | 172,900 | |||||||||
Options exercisable, end of the period | 5,094,342 | $ | 50.29 | 4.08 | $ | 117,152 | |||||||||
- (1)
- Options not expected to vest are included in options outstanding. Amounts are not material.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. The Black-Scholes option pricing model uses tranches based on expected terms that result in ranges of input assumptions. Expected volatilities are based on historical data and implied volatilities compared to trade options on the Company's stock, and other factors. The Company uses historical data to estimate option exercise and employee terminations within the 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 and represents the period of time 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 Nine Months Ended September 30, 2008 | |||
---|---|---|---|---|
Weighted-average fair value—per share | $ | 7.21 | ||
Risk-free interest rate | 2.2 - 3.3 | % | ||
Expected volatility | 22.2 - 27.4 | % | ||
Weighted-average expected volatility | 24.3 | % | ||
Expected term (in years) | 3.9 - 4.4 | |||
Expected dividend yield | 4.4 - 5.2 | % | ||
Weighted-average expected dividend yield | 4.4 | % |
The total intrinsic value of options exercised during the nine months ended September 30, 2007 and 2008 was $15.7 million and $43.2 million, respectively, with a corresponding tax benefit of $5.6 million and $15.5 million, respectively. The total fair value of options vested during the nine months ended September 30, 2007 and 2008 was $20.2 million and $10.3 million, respectively.
25
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 9—Management Stock Plans (Continued)
The Company recognized $10.4 million and $9.8 million of compensation cost for share-based payment arrangements related to stock option awards with a $4.0 million and $3.8 million corresponding tax benefit during the nine months ended September 30, 2007 and 2008, respectively. As of September 30, 2008, the total unrecognized compensation cost related to nonvested stock option awards was $13.4 million and the weighted-average period over which the cost is expected to be recognized was 1.1 years.
Restricted Stock
In general, restricted stock awards are granted under the 2000 Stock Plan to key employees, and in 2005, to non-employee directors. The awards of restricted stock granted to employees vest pro-rata on each anniversary of the grant date and become fully vested four years from the grant date, provided that the employee has completed the specified continuous service requirement. Generally, 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. Restricted stockholders have the right to vote their restricted shares and receive dividends. The grant date fair value of awards is equal to the closing price on date of grant.
The following is a summary of the Company's nonvested restricted stock awards as of September 30, 2008 and changes during the nine months ended September 30, 2008.
| For the Nine Months Ended September 30, 2008 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| Number of Shares | Weighted-Average Grant Date Fair Value | |||||||
Nonvested restricted awards, beginning of the period | 881,117 | $ | 59.00 | ||||||
Granted | 50,787 | 46.64 | |||||||
Vested | (123,646 | ) | 62.36 | ||||||
Forfeited | (31,745 | ) | 58.16 | ||||||
Nonvested restricted awards, end of the period | 776,513 | $ | 57.71 | ||||||
The total fair value of the restricted stock awards vested during the nine months ended September 30, 2007 and 2008, was $7.0 million, and $7.7 million, respectively, with a corresponding tax benefit of $2.4 million and $2.3 million, respectively.
The Company recognized $10.7 million and $12.7 million of compensation cost for share-based payment arrangements related to restricted stock awards with a $4.2 million and $4.9 million corresponding tax benefit during the nine months ended September 30, 2007 and 2008, respectively. At September 30, 2008, the total unrecognized compensation cost related to nonvested restricted stock awards was $28.8 million and the weighted-average period over which it is expected to be recognized was 1.3 years.
Restricted Stock Units and Stock Units
Starting in July 2006, the Company granted restricted stock units to non-employee directors. These restricted stock units consist of an annual grant, and in the case of new non-employee directors, an annual grant and an initial grant. In general, the annual grant vests in full on the first anniversary of the grant date, and the initial grant vests in three equal installments on each of the first three anniversaries of the grant date. The grant date fair value of awards is equal to the closing price on date of grant. During the nine months ended
26
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 9—Management Stock Plans (Continued)
September 30, 2008, the Company granted 25,410 restricted stock units with a weighted-average grant date fair value of $41.41 per unit. There were no restricted stock units forfeited during the nine months ended September 30, 2008. The total fair value of the restricted stock units that vested during the nine months ended September 30, 2008 was $0.8 million. The Company recognized $0.6 million and $1.1 million of compensation cost with a corresponding $0.3 million and $0.4 million tax benefit related to these grants during the nine months ended September 30, 2007 and 2008, respectively. As of September 30, 2008, the total unrecognized compensation cost related to restricted stock units was $1.1 million and the weighted-average period over which it is expected to be recognized was 8 months.
The restricted stock unit participants do not have voting or other stockholder rights. However, the participants' stock unit accounts receive dividend equivalents, reflecting the aggregate dividends earned based on the total number of restricted stock units outstanding, in the form of additional restricted stock units. Participants may elect to defer the delivery of vested shares of common stock at predetermined dates as defined in the plan agreements. The Company will issue new shares under the 2000 Stock Plan upon vesting and settlement of these grants, which are redeemable only in shares.
Non-employee directors may irrevocably elect to defer all or a portion of the cash retainer and/or fees payable to them for services on the Board of Directors and its committees in the form of stock units. At the time of deferral, a bookkeeping account is established on behalf of the director and credited with a number of fully vested stock units. The director will receive a number of stock units equal to the number of shares of common stock when the deferred compensation is payable. Dividend equivalents are credited to the stock unit accounts. Stock units have no voting rights. The Company will issue new shares under the 2000 Stock Plan upon settlement of the stock units.
Performance Share Plan
Effective January 1, 1997, the Company established a Performance Share Plan. At the discretion of the Committee, eligible participants may earn performance share awards to be redeemed in cash and/or shares three years after the date of grant. Performance shares are linked to stockholder value in two ways: (1) the market price of the Company's common stock; and (2) return on equity, a performance measure closely linked to value creation. Eligible participants generally receive grants of performance shares annually. The plan was amended in 2004 increasing the total number of shares that can be granted under the plan to 2.6 million shares. Beginning in 2006, the Committee determined that performance share awards granted were to be redeemed in shares. The following is a summary of shares granted and available for future grants under the Performance Share Plan.
| For the Nine Months Ended September 30, 2008 | ||||
---|---|---|---|---|---|
Performance shares: | |||||
Granted | 91,750 | ||||
Available for future grant, end of period | 1,971,469 |
Performance Shares—Redeemable in Cash
All performance shares granted prior to 2006 are redeemable in cash and therefore are accounted for as liabilities. The value of a performance share under the liability method is equal to the average month-end
27
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 9—Management Stock Plans (Continued)
closing price of the Company's common stock for the final six months of the performance period. All cancelled or forfeited performance shares become available for future grants. The following is a summary of performance shares that are redeemable in cash under the Performance Share Plan.
| For the Nine Months Ended September 30, | ||||||
---|---|---|---|---|---|---|---|
(Dollars in millions) | 2007 | 2008 | |||||
Performance shares granted | — | — | |||||
Performance shares forfeited | — | — | |||||
Fair value of performance shares that vested | $ | 7.4 | $ | — | |||
Cash payments made for performance shares that vested | $ | 7.4 | $ | 5.7 | |||
Fair value of performance shares that vested and deferred | $ | — | $ | — | |||
Performance shares compensation expense | $ | 0.8 | $ | — | |||
Tax benefit related to compensation expense | $ | 0.3 | $ | — | |||
Liability for cash settlement of performance shares, end of the period | $ | 5.1 | $ | — |
The compensation cost related to these grants that are redeemable in cash was fully recognized as of September 30, 2008.
Performance Shares—Redeemable in Shares
The following is a summary of performance shares that are redeemable in shares under the Performance Share Plan.
| For the Nine Months Ended September 30, | ||||||
---|---|---|---|---|---|---|---|
(Dollars in millions, except per share) | 2007 | 2008 | |||||
Performance shares granted | 68,677 | 91,750 | |||||
Weighted average grant date fair value—per share | $ | 63.42 | $ | 51.42 | |||
Performance shares forfeited | 1,500 | — | |||||
Fair value of performance shares that vested during the period | $ | 0.3 | $ | — | |||
Performance shares compensation expense | $ | 2.7 | $ | 4.6 | |||
Tax benefit related to compensation expense | $ | 1.1 | $ | 1.8 |
As of September 30, 2008, the total unrecognized compensation cost related to grants that are redeemable in shares was $4.7 million and the weighted-average period over which it is expected to be recognized was 1 year. The Company issues new shares under the 2000 Stock Plan upon vesting and settlement of these grants that are redeemable in shares.
Note 10—Fair Value of Financial Instruments
Effective January 1, 2008, the Company adopted SFAS No. 157, "Fair Value Measurements" for all financial assets and liabilities measured and reported on a fair value basis. At adoption, there was no effect on the Company's financial position or results of operations.
28
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 10—Fair Value of Financial Instruments (Continued)
Fair Value Hierarchy
As defined in SFAS No.157, fair value is the price that would be received to sell an asset or paid to transfer a liability (i.e., exit price) in an orderly transaction between market participants at the measurement date. In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect the Company's estimate about market data. Based on the observability of the inputs used in the valuation techniques, the Company classifies its financial assets and liabilities measured and disclosed at fair value in accordance with the three-level hierarchy established under SFAS No. 157. This hierarchy ranks the quality and reliability of the information used to determine fair values.
Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.
Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and include management judgment and estimation which may be significant.
In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to SFAS No. 157. In certain cases, the inputs used to measure fair value of an asset or liability may fall into different levels of the fair value hierarchy. The level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Therefore, an item may be classified in Level 3 even though there may be some significant inputs that are readily observable.
Valuation Methodologies
The Company has an established and documented process for determining fair value for financial assets and financial liabilities within the scope of SFAS No. 157. When available, quoted market prices are used to determine fair value. If quoted market prices are not available, fair value is based upon valuation techniques that use, where possible, current market-based or independently sourced parameters, such as interest rates, yield curves, foreign exchange rates, volatilities and credit curves. Valuation adjustments may be made to ensure the financial instruments are recorded at fair value. These adjustments include amounts that reflect counterparty credit quality and, with the adoption of SFAS No. 157, that consider the Company's creditworthiness in determining the fair value of its trading liabilities. A description of the valuation methodologies used for certain financial assets and financial liabilities measured at fair value is as follows.
Trading Account Assets: Trading account assets are recorded at fair value and primarily consist of securities and derivatives held for trading purposes. See discussion below on securities available for sale, which utilize the same valuation methodology as trading account securities. See also discussion below on derivatives valuation.
29
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 10—Fair Value of Financial Instruments (Continued)
Securities Available for Sale: Securities available for sale are recorded at fair value based on quoted market prices, if available. If quoted market prices are not available, management utilizes third-party pricing services or broker quotations from dealers in the specific instruments. Level 1 securities include those traded on an active exchange, as well as U.S. government and its agencies securities. Level 2 securities include mortgage-backed securities and certain asset-backed securities. Level 3 securities include collateralized loan obligations (CLOs).
Loans Held for Sale: Residential mortgage and commercial loans held for sale are recorded at the lower of cost or fair value. The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from government sponsored enterprises. These loans are classified as Level 2. The fair value of commercial loans held for sale is based on secondary market offerings for loans with similar characteristics. These loans are classified as Level 3.
Loans Impaired under SFAS No. 114: Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. As a practical expedient, fair value may be measured based on a loan's observable market price or the underlying collateral securing the loan. Collateral may be real estate or business assets including equipment. The value of collateral is determined based on independent appraisals. Appraised values may be adjusted based on management's historical knowledge, changes in market conditions from the time of valuation, and management's knowledge of the client and the client's business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. Loans impaired under SFAS No. 114 that are valued based on underlying collateral are classified as Level 3.
Derivatives: The Company's derivatives are traded in over-the-counter markets where quoted market prices are not readily available. The Company values its derivatives using pricing models that are widely accepted in the financial services industry with inputs that are observable in the market or can be derived from or corroborated by observable market data. These models reflect the contractual terms of the derivatives including the period to maturity and market observable inputs such as yield curves and option volatility. Valuation adjustments are made to reflect counterparty credit quality and to consider the creditworthiness of the Company. Derivatives, which are included in trading account assets, trading account liabilities and other assets, are generally classified as Level 2.
Private Equity Investments: Private equity investments are recorded at cost and evaluated for impairment. The valuation of these investments requires significant management judgment due to the absence of quoted market prices, lack of liquidity and the long-term nature of these assets. The fair value of the investments is estimated quarterly based on a company's business model, current and projected financial performance, liquidity and overall economic and market conditions. Private equity investments are classified as Level 3.
Financial Instruments Not Measured at Fair Value: The Company also has financial instruments that are not measured at fair value on a recurring or nonrecurring basis and therefore do not have disclosure requirements pursuant to SFAS No. 157. Such financial assets and financial liabilities include: cash and due from banks, interest bearing deposits in banks, federal funds sold and securities purchased under resale agreements, federal funds purchased and securities sold under repurchase agreements, commercial paper issued by the Company, and other borrowed funds.
30
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 10—Fair Value of Financial Instruments (Continued)
Fair Value Measurements on a Recurring Basis
The following table presents financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2008, by caption on the consolidated balance sheet and by SFAS No. 157 valuation hierarchy.
| September 30, 2008 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | Level 1 | Level 2 | Level 3 | Netting Adjustment(1) | Fair Value | ||||||||||||
Assets | |||||||||||||||||
Trading account assets | $ | 77,751 | $ | 679,181 | — | $ | (27,515 | ) | $ | 729,417 | |||||||
Securities available for sale | 866,544 | 6,151,816 | $ | 1,276,994 | — | 8,295,354 | |||||||||||
Other assets(2) | — | 128,876 | — | (23,360 | ) | 105,516 | |||||||||||
Total assets | $ | 944,295 | $ | 6,959,873 | $ | 1,276,994 | $ | (50,875 | ) | $ | 9,130,287 | ||||||
Liabilities | |||||||||||||||||
Trading account liabilities | $ | 5,343 | $ | 552,422 | $ | — | $ | (50,875 | ) | $ | 506,890 | ||||||
Total liabilities | $ | 5,343 | $ | 552,422 | $ | — | $ | (50,875 | ) | $ | 506,890 | ||||||
- (1)
- Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.
- (2)
- Other assets include nontrading derivative assets.
The following table presents a reconciliation of the assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months and nine months ended September 30, 2008. Level 3 available for sale securities include CLOs. The CLOs were valued using broker quotes that are derived from pricing models whose assumptions are based on observable inputs adjusted for unobservable liquidity spreads.
(Dollars in thousands) | For the Three Months Ended September 30, 2008 | For the Nine Months Ended September 30, 2008 | |||||||
---|---|---|---|---|---|---|---|---|---|
Balance, beginning of period. | $ | 1,518,339 | $ | 1,769,880 | |||||
Total gains/(losses) (realized/unrealized): | |||||||||
Included in income before taxes | 61 | 183 | |||||||
Included in other comprehensive income | (241,367 | ) | (493,030 | ) | |||||
Purchases, issuances and settlements | (39 | ) | (39 | ) | |||||
Transfers in/out Level 3 | — | — | |||||||
Balance, end of period | $ | 1,276,994 | $ | 1,276,994 | |||||
Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at September 30, 2008 | $ | 29 | $ | 87 |
31
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 10—Fair Value of Financial Instruments (Continued)
Fair Value Measurement on a Nonrecurring Basis
Certain financial assets may be measured at fair value on a nonrecurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets. The following table presents the carrying value of financial instruments by level within the fair value hierarchy as of September 30, 2008, for which a nonrecurring change in fair value has been recorded during the three-month period ended September 30, 2008.
| September 30, 2008 | | | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | Carrying Value | Level 1 | Level 2 | Level 3 | Losses for the Three Months Ended September 30, 2008 | Losses for the Nine Months Ended September 30, 2008 | ||||||||||||||
Loans | $ | 41,133 | $ | — | $ | — | $ | 41,133 | $ | (3,304 | ) | $ | (9,141 | ) | ||||||
Other assets | 1,000 | — | — | 1,000 | (1,000 | ) | (1,000 | ) | ||||||||||||
Total | $ | 42,133 | $ | — | $ | — | $ | 42,133 | $ | (4,304 | ) | $ | (10,141 | ) | ||||||
Loans include a loan held for sale and loans impaired under SFAS No. 114 that are valued based on the fair value of the underlying collateral. The fair value of the loan held for sale was determined using quoted prices for similar assets, adjusted for management's judgment. The fair value of SFAS No. 114 loans was determined based on appraised values of the underlying collateral adjusted for management's judgment. Other assets include private equity investments that were written down to fair value during the period as a result of an impairment. The fair value of private equity investments was estimated based on the company's current and projected financial performance.
Note 11—Derivative Instruments and Other Financial Instruments Used For Hedging
Derivative positions are integral components of the Company's designated asset and liability management activities. The Company uses interest rate derivatives to manage the sensitivity of the Company's net interest income to changes in interest rates. These instruments are used to manage interest rate risk relating to specified groups of assets and liabilities, primarily LIBOR-based commercial loans, certificates of deposit and subordinated debt. The following describes the significant hedging strategies of the Company.
Cash Flow Hedges
Hedging Strategies for Variable Rate Loans and Certificates of Deposit and Other Time Deposits
The Company engages in several types of cash flow hedging strategies for which the hedged transactions are forecasted future loan interest payments, and the hedged risk is the variability in those payments due to changes in the designated benchmark rate, i.e., U.S. dollar LIBOR. In these strategies, the hedging instruments are matched with groups of variable rate loans such that the tenor of the variable rate loans and that of the hedging instrument are identical. Cash flow hedging strategies include the utilization of purchased floor, cap, collars and corridor options and interest rate swaps. At September 30, 2008, the weighted average remaining life of the currently active (excluding any forward positions) cash flow hedges was approximately 1.3 years.
32
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 11—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)
The Company uses purchased interest rate floors to hedge the variable cash flows associated with 1-month 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 the floor's strike rate.
The Company uses interest rate floor corridors to hedge the variable cash flows associated with 1-month 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 the corridor'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 the corridor's lower strike rate.
The Company uses interest rate collars to hedge the variable cash flows associated with 1-month 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 the collar'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 the collar's cap strike rate.
The Company uses interest rate swaps to hedge the variable cash flows associated with 1-month 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 the 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 CDs. In these hedging relationships, the Company hedges the LIBOR component of the CD rates, which is 3-month LIBOR, based on the CDs' original term to maturity, which reflects their repricing frequency. Net payments to be received under the cap contract offset the increase in interest expense caused by the relevant LIBOR index rising above the cap'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. In these hedging relationships, the Company hedges the LIBOR component of the CD rates, either 1-month, 3-month, or 6-month LIBOR, based on the original term to maturity of the CDs, 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 the corridor'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 the corridor'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, the index and repricing frequencies of the hedge match those of the loans or CDs, 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 or CDs. In the third quarter of 2008, the Company recognized a net gain of $292 thousand due to ineffectiveness, which is recognized in other noninterest expense, compared to a net gain of $16 thousand in the third quarter of 2007.
33
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 11—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)
Fair Value Hedges
Hedging Strategy for Subordinated Debt
The Company engages in an interest rate hedging strategy in which one or more interest rate swaps are associated with a specified interest bearing liability, 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 transactions for the issuances of subordinated debt were structured at inception to mirror all of the provisions of the subordinated debt, which allows the Company to assume that no ineffectiveness exists.
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.
Economic 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 CD 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.
34
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 12—Earnings Per Share (EPS)
Basic EPS ratio 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, nonvested restricted stock, restricted stock units, stock units and performance shares are common stock equivalents.
The following table presents a reconciliation of basic and diluted EPS for the three and nine months ended September 30, 2007 and 2008.
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2007 | 2008 | 2007 | 2008 | ||||||||||||||||||||||
(Amounts in thousands, except per share data) | ||||||||||||||||||||||||||
Basic | Diluted | Basic | Diluted | Basic | Diluted | Basic | Diluted | |||||||||||||||||||
Income from continuing operations | $ | 150,239 | $ | 150,239 | $ | 110,106 | $ | 110,106 | $ | 464,126 | $ | 464,126 | $ | 366,802 | $ | 366,802 | ||||||||||
Loss from discontinued operations | (22,780 | ) | (22,780 | ) | (5,276 | ) | (5,276 | ) | (21,702 | ) | (21,702 | ) | (12,037 | ) | (12,037 | ) | ||||||||||
Net income | $ | 127,459 | $ | 127,459 | $ | 104,830 | $ | 104,830 | $ | 442,424 | $ | 442,424 | $ | 354,765 | $ | 354,765 | ||||||||||
Weighted average common shares outstanding | 137,668 | 137,668 | 138,197 | 138,197 | 137,695 | 137,695 | 137,473 | 137,473 | ||||||||||||||||||
Additional shares due to: | ||||||||||||||||||||||||||
Assumed conversion of dilutive share-based compensation | — | 1,400 | — | 1,772 | — | 1,597 | — | 1,112 | ||||||||||||||||||
Adjusted weighted average common shares outstanding | 137,668 | 139,068 | 138,197 | 139,969 | 137,695 | 139,292 | 137,473 | 138,585 | ||||||||||||||||||
Income from continuing operations per share | $ | 1.09 | $ | 1.08 | $ | 0.80 | $ | 0.79 | $ | 3.37 | $ | 3.33 | $ | 2.67 | $ | 2.65 | ||||||||||
Loss from discontinued operations per share | (0.16 | ) | (0.16 | ) | (0.04 | ) | (0.04 | ) | (0.16 | ) | (0.15 | ) | (0.09 | ) | (0.09 | ) | ||||||||||
Net income per share | $ | 0.93 | $ | 0.92 | $ | 0.76 | $ | 0.75 | $ | 3.21 | $ | 3.18 | $ | 2.58 | $ | 2.56 | ||||||||||
The following table provides the number of options and the corresponding exercise prices for those options that were not included in the computation of diluted earnings per share for the three and nine months ended September 30, 2007 and 2008 because they were antidilutive.
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||
---|---|---|---|---|---|---|---|---|
| 2007 | 2008 | 2007 | 2008 | ||||
Options outstanding | 2,922,892 | 1,570,251 | 1,801,862 | 2,420,564 | ||||
Exercise price of options | $59.74 - $71.23 | $61.56 - $71.23 | $61.56 - $71.23 | $53.43 - $71.23 |
35
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 13—Accumulated Other Comprehensive Income (Loss)
The following table presents the change in each of the components of other comprehensive loss and the related tax effect of the change allocated to each component.
(Dollars in thousands) | Before Tax Amount | Tax Effect | Net of Tax | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
For the Nine Months Ended September 30, 2007: | ||||||||||||
Cash flow hedge activities: | ||||||||||||
Unrealized net gains on hedges arising during the period | $ | 13,940 | $ | (5,332 | ) | $ | 8,608 | |||||
Reclassification adjustment for net losses on hedges included in net income | 25,395 | (9,714 | ) | 15,681 | ||||||||
Net change in unrealized losses on hedges | 39,335 | (15,046 | ) | 24,289 | ||||||||
Securities available for sale: | ||||||||||||
Unrealized holding losses arising during the period on securities available for sale | (119,521 | ) | 45,717 | (73,804 | ) | |||||||
Reclassification adjustment for net gains on securities available for sale included in net income | (1,621 | ) | 620 | (1,001 | ) | |||||||
Net change in unrealized losses on securities available for sale | (121,142 | ) | 46,337 | (74,805 | ) | |||||||
Foreign currency translation adjustment | 975 | (373 | ) | 602 | ||||||||
Reclassification adjustment for pension and other benefits included in net income: | ||||||||||||
Amortization of prior service costs | 120 | (46 | ) | 74 | ||||||||
Amortization of transition amount | 1,526 | (583 | ) | 943 | ||||||||
Recognized net actuarial loss | 14,837 | (5,675 | ) | 9,162 | ||||||||
Net change in pension and other benefits | 16,483 | (6,304 | ) | 10,179 | ||||||||
Net change in accumulated other comprehensive loss | $ | (64,349 | ) | $ | 24,614 | $ | (39,735 | ) | ||||
For the Nine Months Ended September 30, 2008: | ||||||||||||
Cash flow hedge activities: | ||||||||||||
Unrealized net gains on hedges arising during the period | $ | 80,007 | $ | (30,603 | ) | $ | 49,404 | |||||
Reclassification adjustment for net gains on hedges included in net income | (61,517 | ) | 23,530 | (37,987 | ) | |||||||
Net change in unrealized gains on hedges | 18,490 | (7,073 | ) | 11,417 | ||||||||
Securities available for sale: | ||||||||||||
Unrealized holding losses arising during the period on securities available for sale | (561,678 | ) | 214,842 | (346,836 | ) | |||||||
Reclassification adjustment for net gains on securities available for sale included in net income | (48 | ) | 18 | (30 | ) | |||||||
Net change in unrealized losses on securities available for sale | (561,726 | ) | 214,860 | (346,866 | ) | |||||||
Foreign currency translation adjustment | (1,012 | ) | 387 | (625 | ) | |||||||
Reclassification adjustment for pension and other benefits included in net income: | ||||||||||||
Amortization of prior service costs | (70 | ) | 27 | (43 | ) | |||||||
Amortization of transition amount | 1,527 | (584 | ) | 943 | ||||||||
Recognized net actuarial loss | 9,946 | (3,804 | ) | 6,142 | ||||||||
Net change in pension and other benefits | 11,403 | (4,361 | ) | 7,042 | ||||||||
Net change in accumulated other comprehensive loss | $ | (532,845 | ) | $ | 203,813 | $ | (329,032 | ) | ||||
36
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 13—Accumulated Other Comprehensive Income (Loss) (Continued)
The following table presents accumulated other comprehensive loss balances.
(Dollars in thousands) | Net Unrealized Gains (Losses) on Cash Flow Hedges | Net Unrealized Gains (Losses) on Securities Available For Sale | Foreign Currency Translation Adjustment | Pension and Other Benefits Adjustment | Accumulated Other Comprehensive Loss | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance, December 31, 2006 | $ | (27,405 | ) | $ | (57,878 | ) | $ | 223 | $ | (174,314 | ) | $ | (259,374 | ) | ||
Change during the period | 24,289 | (74,805 | ) | 602 | 10,179 | (39,735 | ) | |||||||||
Balance, September 30, 2007 | $ | (3,116 | ) | $ | (132,683 | ) | $ | 825 | $ | (164,135 | ) | $ | (299,109 | ) | ||
Balance, December 31, 2007 | $ | 23,563 | $ | (129,163 | ) | $ | 740 | $ | (178,263 | ) | $ | (283,123 | ) | |||
Change during the period | 11,417 | (346,866 | ) | (625 | ) | 7,042 | (329,032 | ) | ||||||||
Balance, September 30, 2008 | $ | 34,980 | $ | (476,029 | ) | $ | 115 | $ | (171,221 | ) | $ | (612,155 | ) | |||
Note 14—Commitments, Contingencies and Guarantees
The following table summarizes the Company's significant commitments.
(Dollars in thousands) | September 30, 2008 | |||
---|---|---|---|---|
Commitments to extend credit | $ | 22,657,911 | ||
Standby letters of credit | 4,481,382 | |||
Commercial letters of credit | 70,095 | |||
Risk participations in bankers' acceptances | 12,100 | |||
Commitments to fund principal investments | 107,734 | |||
Commitments to fund low-income housing credit (LIHC) investments | 147,189 |
Commitments to extend credit are legally binding agreements to lend to a customer provided there are no violations of any condition established in the contract. Commitments have fixed expiration dates or other termination clauses and may require maintenance of compensatory balances. Since many of the commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements.
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. Additionally, the Company enters into risk participations in bankers' acceptances wherein a fee is received to guarantee a portion of the credit risk on an acceptance of another bank. The majority of these types of commitments have terms of one year or less. At September 30, 2008, the carrying value of the Company's risk participations in bankers' acceptances, standby and commercial letters of credit totaled $5.7 million. Estimated exposure to loss related to these commitments is covered by the allowance for losses on off-balance sheet commitments. The carrying value of the standby and commercial letters of credit and the allowance for losses on off-balance sheet commitments are included in other liabilities on the condensed consolidated balance sheet.
37
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 14—Commitments, Contingencies and Guarantees (Continued)
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 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.
The Company invests in either guaranteed or unguaranteed LIHC investments. The guaranteed LIHC investments carry a minimum rate of return guarantee by a creditworthy entity. The unguaranteed LIHC investments carry partial guarantees covering the timely completion of projects, availability of tax credits and operating deficit thresholds from the issuer. For these LIHC investments, the Company has committed to provide additional funding as stipulated by its investment participation.
The Company is a fund manager for 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 a minimum rate of return throughout the investment term of over an eleven-year weighted average period. Additionally, the Company receives guarantees which include the timely completion of projects, availability of tax credits and operating deficit thresholds from the limited liability partnerships/corporations issuing the LIHC investments that reduce the Company's ultimate exposure to loss. As of September 30, 2008, the Company's maximum exposure to loss under these guarantees is limited to a return of investor capital and minimum investment yield, or $172.1 million. The Company maintains a reserve of $6.6 million for these guarantees included in other liabilities.
The Company has guarantees that obligate it to perform if its affiliates are unable to discharge their obligations. These obligations include guarantees of commercial paper obligations and leveraged lease transactions. The guarantee issued by the Bank for an affiliate's commercial paper program is done in order to facilitate the sale of the commercial paper. As of September 30, 2008, the Bank had a maximum exposure to loss under the commercial paper program guarantee of $1.7 billion. The Bank's guarantee has an average term of less than nine months and is fully collateralized by a pledged deposit placed with the Bank. The Company guarantees its subsidiaries' leveraged lease transactions with terms ranging from fifteen to thirty years. Following the original funding of these leveraged lease transactions, the Company does not have any material obligation to be satisfied. As of September 30, 2008, the Company did not have any exposure to loss for these 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 $2.5 billion at September 30, 2008. The market value of the associated collateral was $2.6 billion at September 30, 2008.
38
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 14—Commitments, Contingencies and Guarantees (Continued)
In the third quarter of 2008, due to unprecedented market volatility, the Company experienced $9.8 million in losses related to the securities lending program.
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 or option 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 them by their customer. As of September 30, 2008, the maximum exposure to loss under these contracts totaled $30.6 million. At September 30, 2008, the Company maintained a reserve of $1.3 million for losses related to these guarantees included in trading account liabilities.
The Company is a member of the Visa USA network (Visa). Visa's bylaws obligate its members to indemnify Visa for losses in connection with the settlement of certain antitrust lawsuits. The Company's indemnification obligation is limited to its proportionate share. Under FIN No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others—An Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34," the Company had a liability of $9.5 million and $6.6 million at December 31, 2007 and September 30, 2008, respectively, representing the estimated fair value of the Company's obligations under the indemnity provisions. The reduction in this liability from December 31, 2007 to September 30, 2008 was primarily due to the establishment of an escrow account by Visa, during its initial public offering in March 2008, to pay for settlements of its antitrust lawsuits. On October 27, 2008, VISA announced the settlement terms of their antitrust litigation with Discover Financial Services. The Company has concluded that its $6.6 million liability at September 30, 2008 adequately provides for the settlement. The Company's maximum exposure to loss for the remaining pending Visa antitrust lawsuits is not determinable, as it is dependent on the outcome of the litigation, but any loss will be proportionate to the Company's ownership interest in Visa.
The Company is subject to various pending and threatened legal actions that arise in the normal course of business. Reserves for losses from legal actions that are both probable and estimable are recorded at the time of that determination. Management believes that the disposition of all claims currently pending will not have a material adverse effect on the Company's consolidated financial condition, operating results or liquidity.
On September 14, 2007, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order, and a Consent Order to a Civil Money Penalty and to Cease and Desist (the Order) with the Office of the Comptroller of the Currency (OCC). The Order imposed a civil money penalty of $10 million and required the Bank to take actions to improve compliance with the Bank Secrecy Act and other anti-money laundering laws and regulations (BSA/AML). On the same day, the U.S. Treasury Department's Financial Crimes Enforcement Network (FinCEN) executed an Assessment of Civil Money Penalty (the Assessment) in the amount of $10 million. The Assessment provided that the $10 million penalty was deemed to be satisfied by the Bank's payment of the civil money penalty of $10 million to the OCC. On September 17, 2007, the Bank entered into a Deferred Prosecution Agreement (DPA) with the Department of Justice (DOJ). Under the DPA, the DOJ agreed to defer prosecution for past violations of BSA/AML that occurred in the Bank's now discontinued international banking business, and to dismiss prosecution completely if the Bank met the conditions of the Order for one year. Pursuant to the DPA, the Bank also paid $21.6 million in the third quarter of 2007 to the DOJ. The OCC terminated the Order on September 25, 2008. On October 1, 2008, the DPA was also terminated and the criminal case to which it related was dismissed.
39
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 15—Business Segments
The various operating segments reporting under the Chief Operating Officer and the Group Head of Pacific Rim Corporate Group have been aggregated into two reportable business segments entitled "Retail Banking" and "Wholesale Banking" based upon the aggregation criteria prescribed in SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information.
- •
- Retail Banking aggregates those operating segments that offer a range of banking services, primarily to individuals and small businesses, delivered generally through a network of branches and ATMs located in the western United States. These services include mortgages, home equity lines of credit, consumer and commercial loans, deposit services and cash management, as well as fiduciary, private banking, investment and asset management services, and risk management for small businesses and individuals. At September 30, 2007 and 2008, Retail Banking had $222.2 million and $217.5 million, respectively, of goodwill. In December 2007, $4.8 million of goodwill attributed to the retirement recordkeeping business was eliminated against the gain on sale of this business. For further information on this sale, see Note 3 to these condensed consolidated financial statements.
- •
- Wholesale Banking aggregates those operating segments that provide credit, depository and cash management services, investment and risk management products to businesses, individuals and target 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 capital markets products. At both September 30, 2007 and 2008, Wholesale Banking had $137.8 million of goodwill. In March 2008, a goodwill impairment charge of $18.7 million, which is included in discontinued operations, was recorded related to the insurance brokerage business. The remaining goodwill associated with the insurance brokerage business of $74.7 million was eliminated in June 2008, when the business was sold. Refer to Note 5 to these condensed consolidated financial statements for further information on the impairment and Note 3 to these condensed consolidated financial statements for further information on the sale of the insurance brokerage business.
The information, set forth in the tables that follow, reflects selected income statement and balance sheet items by reportable business segment. The information presented does not necessarily represent the business 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 the tables, within total assets, are the amounts of goodwill for both reportable business segments as of September 30, 2007 and 2008.
The information in the tables is derived from the internal management reporting system used by management to measure the performance of the individual segments and the Company overall. The management reporting system assigns balance sheet and income statement items to each operating segment based on internal management accounting policies. Net interest income is determined by the Company'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 an operating segment are assigned to that operating 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 an operating segment based on a predetermined percentage of usage. Under the Company's risk-adjusted return on capital (RAROC) methodology, credit expense is charged to an operating segment based upon expected losses arising from
40
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 15—Business Segments (Continued)
credit risk. In addition, the attribution of economic capital is related to unexpected losses arising from credit, market and operational risks.
"Other" is comprised of certain non-bank subsidiaries of UnionBanCal Corporation, the elimination of the fully taxable-equivalent basis amount, the transfer pricing center, the amount of the provision for credit losses over/(under) the RAROC expected loss for the period, the earnings associated with the unallocated equity capital and allowances for credit losses, and the residual costs of support groups. In addition, "Other" includes Corporate Treasury, which is responsible for Asset-Liability Management (ALM), wholesale funding, and the ALM investment securities and derivatives hedging portfolios, and the results of discontinued operations. Discontinued operations consists of three separate businesses: international correspondent banking, retirement recordkeeping services and insurance brokerage services. For further detail on discontinued operations, see Note 3 to these condensed consolidated financial statements. Except as discussed above, none of the items in "Other" is significant to the Company's business.
The Company reflects 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."
The reportable business segment results for prior periods have been adjusted to reflect changes in the transfer pricing methodology, the organizational changes that have occurred and discontinued operations.
41
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 15—Business Segments (Continued)
| Retail Banking | Wholesale Banking | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | As of and for the Three Months Ended September 30, | ||||||||||||
| 2007 | 2008 | 2007 | 2008 | ||||||||||
Results of operations—Market View (dollars in thousands): | ||||||||||||||
Net interest income (expense) | $ | 221,023 | $ | 251,559 | $ | 241,467 | $ | 306,895 | ||||||
Noninterest income | 123,802 | 122,546 | 93,834 | 92,489 | ||||||||||
Total revenue | 344,825 | 374,105 | 335,301 | 399,384 | ||||||||||
Noninterest expense | 218,197 | 251,561 | 140,144 | 156,304 | ||||||||||
Credit expense (income) | 6,361 | 7,056 | 28,231 | 49,115 | ||||||||||
Income (loss) from continuing operations before income taxes | 120,267 | 115,488 | 166,926 | 193,965 | ||||||||||
Income tax expense (benefit) | 46,002 | 44,174 | 50,834 | 55,457 | ||||||||||
Income (loss) from continuing operations | 74,265 | 71,314 | 116,092 | 138,508 | ||||||||||
Loss from discontinued operations, net of income taxes | — | — | — | — | ||||||||||
Net income (loss) | $ | 74,265 | $ | 71,314 | $ | 116,092 | $ | 138,508 | ||||||
Total assets, end of period—Market View (dollars in millions): | $ | 18,508 | $ | 21,577 | $ | 27,188 | $ | 32,807 | ||||||
| Other | Reconciling Items | UnionBanCal Corporation | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | As of and for the Three Months Ended September 30, | As of and for the Three Months Ended September 30, | |||||||||||||||||
| 2007 | 2008 | 2007 | 2008 | 2007 | 2008 | ||||||||||||||
Results of operations—Market View (dollars in thousands): | ||||||||||||||||||||
Net interest income (expense) | $ | (33,690 | ) | $ | (35,921 | ) | $ | (2,237 | ) | $ | (2,787 | ) | $ | 426,563 | $ | 519,746 | ||||
Noninterest income | 7,245 | 2,973 | (16,694 | ) | (19,287 | ) | 208,187 | 198,721 | ||||||||||||
Total revenue | (26,445 | ) | (32,948 | ) | (18,931 | ) | (22,074 | ) | 634,750 | 718,467 | ||||||||||
Noninterest expense | 32,938 | 47,741 | (10,432 | ) | (11,794 | ) | 380,847 | 443,812 | ||||||||||||
Credit expense (income) | (18,570 | ) | 60,870 | (22 | ) | (41 | ) | 16,000 | 117,000 | |||||||||||
Income (loss) from continuing operations before income taxes | (40,813 | ) | (141,559 | ) | (8,477 | ) | (10,239 | ) | 237,903 | 157,655 | ||||||||||
Income tax expense (benefit) | (5,930 | ) | (48,166 | ) | (3,242 | ) | (3,916 | ) | 87,664 | 47,549 | ||||||||||
Income (loss) from continuing operations | (34,883 | ) | (93,393 | ) | (5,235 | ) | (6,323 | ) | 150,239 | 110,106 | ||||||||||
Loss from discontinued operations, net of income taxes | (22,780 | ) | (5,276 | ) | — | — | (22,780 | ) | (5,276 | ) | ||||||||||
Net income (loss) | $ | (57,663 | ) | $ | (98,669 | ) | $ | (5,235 | ) | $ | (6,323 | ) | $ | 127,459 | $ | 104,830 | ||||
Total assets, end of period—Market View (dollars in millions): | $ | 8,667 | $ | 8,274 | $ | (20 | ) | $ | (58 | ) | $ | 54,343 | $ | 62,600 | ||||||
42
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 15—Business Segments (Continued)
| Retail Banking | Wholesale Banking | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | As of and for the Nine Months Ended September 30, | ||||||||||||
| 2007 | 2008 | 2007 | 2008 | ||||||||||
Results of operations—Market View (dollars in thousands): | ||||||||||||||
Net interest income (expense) | $ | 672,832 | $ | 718,033 | $ | 725,514 | $ | 873,260 | ||||||
Noninterest income | 358,122 | 369,293 | 275,440 | 258,266 | ||||||||||
Total revenue | 1,030,954 | 1,087,326 | 1,000,954 | 1,131,526 | ||||||||||
Noninterest expense | 668,730 | 725,208 | 420,690 | 451,692 | ||||||||||
Credit expense (income) | 18,896 | 20,337 | 80,156 | 135,682 | ||||||||||
Income (loss) from continuing operations before income taxes | 343,328 | 341,781 | 500,108 | 544,152 | ||||||||||
Income tax expense (benefit) | 131,323 | 130,731 | 153,630 | 156,485 | ||||||||||
Income (loss) from continuing operations | 212,005 | 211,050 | 346,478 | 387,667 | ||||||||||
Loss from discontinued operations, net of income taxes | — | — | — | — | ||||||||||
Net income (loss) | $ | 212,005 | $ | 211,050 | $ | 346,478 | $ | 387,667 | ||||||
Total assets, end of period—Market View (dollars in millions): | $ | 18,508 | $ | 21,577 | $ | 27,188 | $ | 32,807 | ||||||
| Other | Reconciling Items | UnionBanCal Corporation | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | As of and for the Nine Months Ended September 30, | As of and for the Nine Months Ended September 30, | |||||||||||||||||
| 2007 | 2008 | 2007 | 2008 | 2007 | 2008 | ||||||||||||||
Results of operations—Market View (dollars in thousands): | ||||||||||||||||||||
Net interest income (expense) | $ | (108,063 | ) | $ | (92,317 | ) | $ | (6,503 | ) | $ | (8,094 | ) | $ | 1,283,780 | $ | 1,490,882 | ||||
Noninterest income | 15,694 | 23,517 | (48,666 | ) | (57,333 | ) | 600,590 | 593,743 | ||||||||||||
Total revenue | (92,369 | ) | (68,800 | ) | (55,169 | ) | (65,427 | ) | 1,884,370 | 2,084,625 | ||||||||||
Noninterest expense | 97,214 | 124,307 | (30,117 | ) | (34,877 | ) | 1,156,517 | 1,266,330 | ||||||||||||
Credit expense (income) | (73,982 | ) | 128,083 | (70 | ) | (102 | ) | 25,000 | 284,000 | |||||||||||
Income (loss) from continuing operations before income taxes | (115,601 | ) | (321,190 | ) | (24,982 | ) | (30,448 | ) | 702,853 | 534,295 | ||||||||||
Income tax expense (benefit) | (36,670 | ) | (108,077 | ) | (9,556 | ) | (11,646 | ) | 238,727 | 167,493 | ||||||||||
Income (loss) from continuing operations | (78,931 | ) | (213,113 | ) | (15,426 | ) | (18,802 | ) | 464,126 | 366,802 | ||||||||||
Loss from discontinued operations, net of income taxes | (21,702 | ) | (12,037 | ) | — | — | (21,702 | ) | (12,037 | ) | ||||||||||
Net income (loss) | $ | (100,633 | ) | $ | (225,150 | ) | $ | (15,426 | ) | $ | (18,802 | ) | $ | 442,424 | $ | 354,765 | ||||
Total assets, end of period—Market View (dollars in millions): | $ | 8,667 | $ | 8,274 | $ | (20 | ) | $ | (58 | ) | $ | 54,343 | $ | 62,600 | ||||||
Note 16—Subsequent Event
On November 4, 2008, the Company became a privately held company pursuant to the Agreement and Plan of Merger, dated as of August 18, 2008, by and among the Company, The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU), a joint stock company (kabushiki kaisha) incorporated in Japan under the Commercial
43
UnionBanCal Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
(Unaudited)
Note 16—Subsequent Event (Continued)
Code of Japan and a wholly owned subsidiary of Mitsubishi UFJ Financial Group, Inc., a joint stock company (kabushiki kaisha) incorporated in Japan under the Commercial Code of Japan (MUFG), and Blue Jackets, Inc., a Delaware corporation and a wholly owned subsidiary of BTMU (Merger Sub) (the Merger Agreement). All of the Company's issued and outstanding shares of common stock are now owned by MUFG and its affiliates.
The Merger Agreement provided, among other things, for a cash tender offer by BTMU (the Offer) to purchase all of the publicly held outstanding shares of the Company's common stock at a price of $73.50 per share in cash (the Offer Price). The offer expired on September 26, 2008, with purchase of the shares being effective on October 1, 2008. After the Offer, MUFG and its subsidiaries owned approximately 97% of the Company's outstanding common stock. On November 4, 2008, pursuant to the Merger Agreement, Merger Sub was merged with and into the Company (the Merger), the separate corporate existence of Merger Sub ceased and the Company continued as the surviving corporation in the Merger. All remaining publicly held shares of the Company's common stock issued and outstanding immediately prior to the closing of the Merger, other than the shares of common stock of holders who have perfected appraisal rights, were converted into the right to receive an amount in cash equal to the Offer Price.
Effective October 1, 2008, the Company will estimate the fair value of its tangible assets and liabilities and record goodwill and other intangibles relating to the proportionate incremental shares acquired by BTMU.
44
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 compared to our forecasts and expectations. Please refer to Part II Item 1A "Risk Factors" of our Quarterly Report on Form 10-Q (this Form 10-Q) for a discussion of some factors that may cause results to differ.
You should read the following discussion and analysis of our consolidated financial condition and results of operations for the period ended September 30, 2008 in this 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, 2007 (2007 Form 10-K). Averages, as presented in the following tables, are substantially all based upon daily average balances.
As used in this Form 10-Q, the term "UnionBanCal" and terms such as "we," "us" and "our" refer to UnionBanCal Corporation, Union Bank of California, N.A., one or more of their condensed consolidated subsidiaries, or to all of them together.
Introduction
We are a California-based, bank holding company whose major subsidiary, Union Bank of California, N.A. (the Bank), is a commercial bank. We had consolidated assets of $63 billion at September 30, 2008. At September 30, 2008, The Bank of Tokyo-Mitsubishi UFJ, Ltd., our majority owner, owned approximately 64 percent of our outstanding common stock.
On November 4, 2008, we became a privately held company pursuant to the Agreement and Plan of Merger, dated as of August 18, 2008, by and among UnionBanCal, The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU), a joint stock company (kabushiki kaisha) incorporated in Japan under the Commercial Code of Japan and a wholly owned subsidiary of Mitsubishi UFJ Financial Group, Inc., a joint stock company (kabushiki kaisha) incorporated in Japan under the Commercial Code of Japan (MUFG), and Blue Jackets, Inc., a Delaware corporation and a wholly owned subsidiary of BTMU (Merger Sub) (the Merger Agreement). All of our issued and outstanding shares of common stock are now owned by MUFG and its affiliates.
The Merger Agreement provided, among other things, for a cash tender offer by BTMU (the Offer) to purchase all of the publicly held outstanding shares of our common stock at a price of $73.50 per share in cash (the Offer Price). The offer expired on September 26, 2008, with purchase of the shares being effective on October 1, 2008. After the Offer, MUFG and its subsidiaries owned approximately 97% of our outstanding common stock. On November 4, 2008, pursuant to the Merger Agreement, Merger Sub was merged with and into UnionBanCal (the Merger), the separate corporate existence of Merger Sub ceased and UnionBanCal continued as the surviving corporation in the Merger. All remaining publicly held shares of our common stock issued and outstanding immediately prior to the closing of the Merger, other than the shares of common stock of holders who have perfected appraisal rights, were converted into the right to receive an amount in cash equal to the Offer Price.
Effective October 1, 2008, we will estimate the fair value of our tangible assets and liabilities and record goodwill and other intangibles relating to the proportionate incremental shares acquired by BTMU.
Executive Overview
We are providing you with an overview of what we believe are the most significant factors and developments that impacted our third quarter 2008 results and that could impact our future results. Further detailed information can be found elsewhere in this Form 10-Q. In addition, we ask that you carefully read this entire document and any other reports that we refer to in this Form 10-Q for more detailed information that will assist your understanding of trends, events and uncertainties that impact us.
45
Dramatic and unprecedented overall financial market conditions afflicted the banking industry in the third quarter of 2008. Despite the uncertain market, we continued to generate loan growth, maintain stable deposits, and grow net interest income.
In the third quarter of 2008, our average total loans grew 20 percent from the third quarter of 2007 to $47.2 billion. This strong growth was spread across all major categories, including commercial, residential and commercial real estate, due to increased loan demand.
During the third quarter of 2008, we provided $125 million for our allowance for credit losses compared to $20 million in the third quarter of 2007. The increase was primarily attributable to higher criticized assets, increases in certain loss factors related to our consumer and small business portfolios and strong loan growth. We anticipate a continued recessionary environment during the remainder of 2008, resulting in deterioration in our loan portfolio. Consequently, we expect a significant increase in our full year provision for credit losses as compared to 2007. See further discussion below in "Allowances for Credit Losses."
Our nonperforming assets totaled $57 million and $304 million at December 31, 2007 and September 30, 2008, respectively. The increase in nonperforming assets was primarily due to increases in the commercial and industrial portfolio of $125 million, construction portfolio of $93 million, and commercial real estate portfolio of $19 million. Net charge offs were $63 million in the third quarter of 2008, compared to $2 million in the third quarter of 2007.
At December 31, 2007 and September 30, 2008, our allowances for credit losses as a percent of total loans were 1.20 percent and 1.43 percent, respectively. At December 31, 2007 and September 30, 2008, our allowances for credit losses as a percent of nonaccrual loans were 885 percent and 240 percent, respectively. At December 31, 2007 and September 30, 2008, our allowance for loan losses as a percent of total loans were 0.98 percent and 1.20 percent, respectively. At December 31, 2007 and September 30, 2008, our allowance for loan losses as a percent of nonaccrual loans were 723 percent and 201 percent, respectively.
In the third quarter of 2008, our average noninterest bearing deposits declined 10 percent to $12.4 billion compared to the third quarter of 2007. The decline was primarily due to lower commercial noninterest bearing deposits as a result of a mix shift toward interest bearing deposit accounts, and lower title and escrow deposits resulting from reduced residential real estate activity. Average noninterest bearing deposits represented 30 percent of average total deposits in the third quarter of 2008, compared to 33 percent in the third quarter of 2007. In addition, the annualized average all-in-cost of funds improved to 1.60 percent, compared to 2.78 percent in the third quarter of 2007.
In the third quarter of 2008, our net interest income increased 22 percent from the third quarter of 2007 to $520 million, primarily due to lower rates paid on interest bearing liabilities, including other borrowings, and strong loan growth, partially offset by lower yields on earning assets.
In the third quarter of 2008, our noninterest income declined 5 percent from the third quarter of 2007 to $199 million primarily due to lower trading account revenues, which were negatively impacted by higher provision for credit losses on derivative contracts.
In the third quarter of 2008, our noninterest expense grew by 17 percent from the third quarter of 2007 to $444 million. The increase was primarily due to higher salaries and employee benefits resulting from annual merit increases and higher staff levels, as well as higher costs related to the provision for credit losses on off-balance sheet commitments. The increase was also due to losses related to our securities lending program, higher regulatory agency fees, and higher expenses related to our low income housing investments (LIHC).
Our effective tax rate was 30.2 percent in the third quarter of 2008, compared to 36.9 percent in the third quarter of 2007. The higher effective tax rate in the third quarter of 2007 was primarily due to an income tax adjustment of $11.6 million for the difference between the estimate of California state tax expense for 2006 and the taxes reported in our 2006 return.
During the third quarter of 2008, we declared $72.7 million in dividends, compared to $72.0 million in the third quarter of 2007. There were no significant repurchases of our common stock in the third quarter of 2008.
46
Discontinued Operations
Our discontinued operations consist of three separate businesses: retirement recordkeeping services (RRB), international correspondent banking (ICBB), and insurance brokerage services (IBB). The ICBB business was sold to Wachovia Bank, N.A. in 2005 for $245.0 million and we recognized a pre-tax gain of $228.8 million. We received a subsequent $4.0 million purchase price adjustment and recorded this pre-tax gain in 2006. The business consisted of international payment and trade processing along with related lending activities. Substantially all of the assets and liabilities of ICBB were liquidated in the first quarter of 2007.
Although ICBB's operations had substantially ended in 2006, the Bank was responsible for past violations of the Bank Secrecy Act and other anti-money laundering laws and regulations (BSA/AML) associated with ICBB. As a result of the past violations, the Bank entered into a Deferred Prosecution Agreement (DPA) with the United States Department of Justice (DOJ) in the third quarter of 2007 and paid $21.6 million to the DOJ. For additional information, see discussion under "Regulatory Matters."
In the fourth quarter of 2007, we sold our RRB to Prudential Retirement, a subsidiary of Prudential Financial, Inc., for $103.0 million. We recorded a pre-tax gain of $94.7 million, net of $2.1 million in transaction costs and a $6.2 million elimination of intangible assets, which includes goodwill of $4.8 million attributed to this business. The RRB was previously included in the Retail Banking reportable business segment.
In June 2008, we sold our IBB subsidiary, UnionBanc Insurance Services, Inc., to a wholly-owned subsidiary of BB&T Corporation. We recorded a pre-tax gain of $9.8 million, net of $1.6 million in transaction costs, and an elimination of intangible assets, consisting of goodwill of $74.7 million and other intangibles of $11.0 million. The IBB was previously included in the Wholesale Banking reportable business segment.
All transactions have been accounted for as discontinued operations and all prior period financial statements have been restated to reflect this accounting treatment. All of the assets and liabilities of the discontinued operations have been separately identified on our condensed consolidated 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 of our discontinued operations, see Note 3 to the condensed consolidated financial statements in this Form 10-Q.
International Correspondent Banking Business Discontinued Operations
The components of expense from the ICBB discontinued operations for the three and nine months ended September 30, 2007 and 2008 are:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | |||||||||
Noninterest expense | $ | 23,297 | $ | — | $ | 23,297 | $ | — | |||||
Loss from discontinued operations before income taxes | (23,297 | ) | — | (23,297 | ) | — | |||||||
Income tax benefit | (661 | ) | — | (661 | ) | — | |||||||
Loss from discontinued operations | $ | (22,636 | ) | $ | — | $ | (22,636 | ) | $ | — | |||
Noninterest expense for the three and nine months ended September 30, 2007 included the $21.6 million paid to the DOJ and related legal and other outside services costs of $1.7 million. The income tax benefit of $0.7 million for the three and nine months ended September 30, 2007 reflects the nondeductibility of the $21.6 million DOJ payment.
47
Retirement Recordkeeping Business (RRB) Discontinued Operations
The results of the RRB included in our net income for the three and nine months ended September 30, 2007 and 2008, consisted of the following:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | |||||||||
Net interest income | $ | 1,103 | $ | 226 | $ | 3,700 | $ | 1,540 | |||||
Noninterest income | 11,717 | 891 | 35,346 | 18,419 | |||||||||
Noninterest expense | 10,433 | 9,037 | 32,654 | 31,217 | |||||||||
Income (loss) from discontinued operations before income taxes | 2,387 | (7,920 | ) | 6,392 | (11,258 | ) | |||||||
Income tax expense (benefit) | 970 | (2,809 | ) | 2,511 | (3,973 | ) | |||||||
Income (loss) from discontinued operations | $ | 1,417 | $ | (5,111 | ) | $ | 3,881 | $ | (7,285 | ) | |||
The RRB's net interest income for the three months ended September 30, 2007 and 2008 included the allocation of interest income (based on its average net liabilities) of $1.2 million and $0.3 million, respectively, and $4.0 million and $1.8 million for the nine months ended September 30, 2007 and 2008, respectively. Noninterest income for the three months ended September 30, 2007 and 2008 included trust fees of $11.7 million and $0.9 million, respectively, and $35.3 million and $7.3 million for the nine months ended September 30, 2007 and 2008, respectively. Noninterest income for the nine months ended September 30, 2008 also included $11.8 million in servicing revenues from Prudential. The majority of these servicing revenues were earned in the first half of 2008, as the migration of customers onto Prudential's accounting system was completed in June 2008. For the three months ended September 30, 2007 and 2008, noninterest expense included salaries and benefits expense of $6.2 million and $4.7million, respectively, and $19.3 million and $16.0 million for the nine months ended September 30, 2007 and 2008, respectively.
Insurance Brokerage Business (IBB) Discontinued Operations
The components of income from the IBB discontinued operations for the three and nine months ended September 30, 2007 and 2008 are:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | 2007 | 2008 | |||||||||
Net interest expense | $ | (1,221 | ) | $ | — | $ | (3,650 | ) | $ | (993 | ) | ||
Noninterest income | 15,828 | 249 | 52,199 | 35,840 | |||||||||
Noninterest expense | 17,140 | 504 | 53,205 | 46,281 | |||||||||
Loss from discontinued operations before income taxes | (2,533 | ) | (255 | ) | (4,656 | ) | (11,434 | ) | |||||
Income tax benefit | (972 | ) | (90 | ) | (1,709 | ) | (6,682 | ) | |||||
Loss from discontinued operations | $ | (1,561 | ) | $ | (165 | ) | $ | (2,947 | ) | $ | (4,752 | ) | |
The IBB's net interest expense for the three and nine months ended September 30, 2007 and the nine months ended September 30, 2008 was mainly comprised of the allocation of interest expense (based on its average net assets). Noninterest income for the three months ended September 30, 2007 included insurance commissions of $15.9 million, and $52.2 million and $25.7 million for the nine months ended September 30, 2007 and 2008, respectively. Noninterest income for the nine months ended September 30, 2008 also included a $9.8 million pre-tax gain from the sale of IBB and $0.2 million in subsequent gain adjustments for the three and nine months ended September 30, 2008. Noninterest expense for the three months ended September 30, 2007 and 2008 included salaries and benefits expense of $13.5 million and $0.5 million, respectively, and $41.0 million and $21.2 million, for the nine months ended September 30,
48
2007 and 2008, respectively. For the nine months ended September 30, 2008, noninterest expense also included an $18.7 million goodwill impairment charge. This charge was recorded in the first quarter of 2008, when we determined that the value of the net assets was greater than the fair value of IBB, which was based on indicative prices for insurance agencies.
The remaining discussion of our financial results is based on results from continuing operations, unless otherwise stated.
Critical Accounting Policies
UnionBanCal Corporation'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 compared to 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 generally swaps and option contracts indexed to 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 or information that can be extrapolated to approximate a market price. 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 Forum (CEO Forum), which is comprised of our most senior officers. For each financial reporting period, a review of these estimates is 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, both our Critical Accounting Policies and our significant accounting policies are discussed in detail in our 2007 Form 10-K filed with the Securities and Exchange Commission (the SEC) and as follows.
Fair Valuation of Financial Instruments
Effective January 1, 2008, we adopted Statement of Financial Accounting Standards (SFAS) No. 157, "Fair Value Measurements" for all financial assets and liabilities measured and reported on a fair value basis. At adoption, there was no impact on our financial position or results of operations. For detailed information on our use of fair valuation of financial instruments and our related valuation methodologies, see Note 10 to the condensed consolidated financial statements in this Form 10-Q.
As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or paid to transfer a liability (i.e., exit price) in an orderly transaction between market participants at the measurement date. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimate about market data. Based on the observability of the inputs used in the valuation techniques, we classify our financial assets
49
and liabilities measured and disclosed at fair value in accordance with the three-level hierarchy (i.e., Level 1, Level 2 and Level 3) established under SFAS No. 157. This hierarchy ranks the quality and reliability of the information used to determine fair values. The degree of management judgment increases with the higher the level of inputs.
Included in the Level 3 category are collateralized loan obligations (CLOs), which are highly illiquid with limited market activity. All of our CLO securities are known as "Cash Flow CLOs." A Cash Flow CLO is a structured finance product that securitizes a diversified pool of loan assets into multiple classes of notes from the cash flows generated by such loans. Cash Flow CLOs repay the note holders through the receipt of interest and principal repayments from the underlying loans unlike other types of CLOs that repay note holders through the trading and sale of underlying collateral. In general, our CLOs are valued using an average of two indicative broker quotes that are derived from pricing models whose assumptions are based upon observable inputs adjusted for unobservable liquidity spreads. There have been no significant changes to the valuation methodology to value CLOs during the third quarter of 2008. The fair value of our CLOs declined by $251.2 million from December 31, 2007 to $1.3 billion at September 30, 2008. Since no observable credit quality issues were present in our CLO portfolio at September 30, 2008, and we have the ability and intent to hold the CLO securities until maturity, we consider the unrealized loss to be temporary.
We have an established and documented process for determining fair value. When available, quoted market prices are used to determine fair value. If quoted market prices are not available, fair value is based upon valuation techniques that use, where possible, current market-based or independently sourced parameters, such as interest rates, yield curves, foreign exchange rates, volatilities and credit curves. Valuation adjustments may be made to ensure the financial instruments are recorded at fair value. These adjustments include amounts that reflect counterparty credit quality and, with the adoption of SFAS No. 157, that consider our creditworthiness in determining the fair value of our trading liabilities.
The following table reflects financial instruments measured at fair value on a recurring basis as of September 30, 2008.
(Dollars in thousands) | Fair Value | Percentage of Total | |||||||
---|---|---|---|---|---|---|---|---|---|
Financial instruments recorded at fair value on a recurring basis | |||||||||
Assets: | |||||||||
Level 1 | $ | 944,295 | 11 | % | |||||
Level 2 | 6,959,873 | 76 | % | ||||||
Level 3 | 1,276,994 | 14 | % | ||||||
Netting Adjustment(1) | (50,875 | ) | (1 | )% | |||||
Total | $ | 9,130,287 | 100 | % | |||||
As a percentage of total Company assets | 15 | % | |||||||
Liabilities: | |||||||||
Level 1 | $ | 5,343 | 1 | % | |||||
Level 2 | 552,422 | 109 | % | ||||||
Level 3 | — | 0 | % | ||||||
Netting Adjustment(1) | (50,875 | ) | (10 | )% | |||||
Total | $ | 506,890 | 100 | % | |||||
As a percentage of total Company liabilities | 1 | % | |||||||
- (1)
- Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.
50
Financial Performance
Summary of Financial Performance
| | | Increase (Decrease) | | | Increase (Decrease) | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||||||
| 2008 versus 2007 | 2008 versus 2007 | ||||||||||||||||||||||||
(Dollars in thousands) | 2007 | 2008 | Amount | Percent | 2007 | 2008 | Amount | Percent | ||||||||||||||||||
Results of Operations | ||||||||||||||||||||||||||
Net interest income(1) | $ | 426,563 | $ | 519,746 | $ | 93,183 | 21.8 | % | $ | 1,283,780 | $ | 1,490,882 | $ | 207,102 | 16.1 | % | ||||||||||
Noninterest income | ||||||||||||||||||||||||||
Trust and investment management fees | 39,546 | 40,638 | 1,092 | 2.8 | 116,062 | 127,828 | 11,766 | 10.1 | ||||||||||||||||||
Trading account activities | 21,795 | 12,397 | (9,398 | ) | (43.1 | ) | 50,473 | 40,096 | (10,377 | ) | (20.6 | ) | ||||||||||||||
Merchant banking fees | 10,031 | 12,789 | 2,758 | 27.5 | 27,917 | 35,667 | 7,750 | 27.8 | ||||||||||||||||||
Gains on private capital investments, net | 12,203 | 5,597 | (6,606 | ) | (54.1 | ) | 41,469 | 7,949 | (33,520 | ) | (80.8 | ) | ||||||||||||||
Gain on the VISA IPO redemption | — | — | — | — | — | 14,211 | 14,211 | nm | ||||||||||||||||||
Other noninterest income | 124,612 | 127,300 | 2,688 | 2.2 | 364,669 | 367,992 | 3,323 | 0.9 | ||||||||||||||||||
Total noninterest income | 208,187 | 198,721 | (9,466 | ) | (4.5 | ) | 600,590 | 593,743 | (6,847 | ) | (1.1 | ) | ||||||||||||||
Total revenue | 634,750 | 718,467 | 83,717 | 13.2 | 1,884,370 | 2,084,625 | 200,255 | 10.6 | ||||||||||||||||||
Provision for loan losses | 16,000 | 117,000 | 101,000 | nm | 25,000 | 284,000 | 259,000 | nm | ||||||||||||||||||
Noninterest expense | ||||||||||||||||||||||||||
Salaries and employee benefits | 216,812 | 238,129 | 21,317 | 9.8 | 686,175 | 723,098 | 36,923 | 5.4 | ||||||||||||||||||
Net occupancy | 37,534 | 38,574 | 1,040 | 2.8 | 104,919 | 113,008 | 8,089 | 7.7 | ||||||||||||||||||
Professional services | 17,669 | 21,397 | 3,728 | 21.1 | 45,163 | 51,925 | 6,762 | 15.0 | ||||||||||||||||||
Provision for losses on off-balance sheet commitments | 4,000 | 8,000 | 4,000 | 100.0 | 5,000 | 21,000 | 16,000 | nm | ||||||||||||||||||
Other noninterest expense | 104,832 | 137,712 | 32,880 | 31.4 | 315,260 | 357,299 | 42,039 | 13.3 | ||||||||||||||||||
Total noninterest expense | 380,847 | 443,812 | 62,965 | 16.5 | 1,156,517 | 1,266,330 | 109,813 | 9.5 | ||||||||||||||||||
Income from continuing operations before income taxes | 237,903 | 157,655 | (80,248 | ) | (33.7 | ) | 702,853 | 534,295 | (168,558 | ) | (24.0 | ) | ||||||||||||||
Income tax expense | 87,664 | 47,549 | (40,115 | ) | (45.8 | ) | 238,727 | 167,493 | (71,234 | ) | (29.8 | ) | ||||||||||||||
Income from continuing operations | $ | 150,239 | $ | 110,106 | $ | (40,133 | ) | (26.7 | )% | $ | 464,126 | $ | 366,802 | $ | (97,324 | ) | (21.0 | )% | ||||||||
- (1)
- Net interest income does not include any adjustments for fully taxable equivalence.
nm = not meaningful
The primary contributors to our financial performance for the third quarter of 2008 compared to the third quarter of 2007 are presented below.
- •
- We provided a total of $125 million for credit losses ($117 million for loan losses and $8 million for losses on off-balance sheet commitments) in the third quarter of 2008. The provision increases were primarily attributable to higher criticized assets, increases in certain loss factors related to our consumer and small business loan portfolios, and strong loan growth.
- •
- Our net interest income was favorably influenced by lower average rates on our interest bearing liabilities, as well as by higher volumes in most of our major loan categories. Partly offsetting these positive influences to our net interest income were lower average demand deposit balances, which resulted in a shift to more costly interest bearing liabilities, and lower average yields on our earning assets (see discussion under "Net Interest Income").
51
The decrease in our noninterest income was due to several factors:
- —
- Net gains on private capital investments were lower compared to the prior year due to lower sales and capital distributions;
- —
- Trading account activities were lower compared to the prior year primarily due to higher provision for losses on derivative contracts;
- —
- Merchant banking income was higher compared to the prior year primarily due to higher referral fees and risk participation fees; and
- —
- Other income increased primarily due to higher Federal Home Loan Bank (FHLB) dividends and higher renewable energy investment income.
The increase in noninterest expense was due to several factors:
- —
- Salaries and employee benefits increased mainly due to annual merit increases and higher employee benefits;
- —
- Net operating losses included a $9.8 million charge in the third quarter of 2008 related to losses on certain securities lending transactions;
- —
- Professional services costs increased mainly due to higher legal costs, which included costs for our privatization and lease-related litigation;
- —
- Provision for losses on off-balance sheet commitments increased primarily due to higher criticized credits and increases in certain loss factors; and
- —
- Other expenses increased due to higher regulatory fees related to federal deposit insurance costs as credits available from prior quarters were exhausted and higher expense related to low income housing projects.
The primary contributors to our financial performance for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007 are presented below.
- •
- We provided a total of $305 million for credit losses ($284 million for loan losses and $21 million for losses on off-balance sheet commitments) in the nine months ended September 30, 2008. The provision increases were primarily attributable to higher criticized assets, increases in certain loss factors and strong loan growth.
- •
- Our net interest income was favorably influenced by higher volumes in most of our major loan categories, as well as by lower average rates on our interest bearing liabilities. Partly offsetting these positive influences to our net interest income were lower average demand deposit balances which resulted in a shift to more costly interest bearing liabilities, and lower average yields on our earning assets (see discussion under "Net Interest Income").
The decrease in our noninterest income was due to several factors:
- —
- Net gains on private capital investments were lower compared to the prior year due to lower sales and capital distributions;
- —
- Trading account activities were lower compared to the prior year primarily due to higher credit provision for losses on derivative contracts and losses on distressed debt trading;
- —
- Trust and investment management fees were higher primarily due to higher total assets under administration (on which fees are based) for the first half of 2008. At September 30, 2008, total assets under administration decreased 0.5 percent from September 30, 2007 to $231.6 billion. Managed assets decreased by 15 percent, while non-managed assets increased by 1 percent from September 30, 2007 to September 30, 2008;
52
- —
- Merchant banking income was higher compared to the prior year primarily due to higher referral fees, and risk participation fees; and
- —
- In the first quarter of 2008, we recognized a $14.2 million gain on the partial redemption of Visa Inc. common stock related to the initial public offering (IPO), and, in the second quarter of 2008, a gain of $7.1 million on the partial redemption of our MasterCard Inc. common stock. These gains were partly offset by other gains in the prior year, including gains on the sale of fixed assets and syndicated loans held for sale.
The increase in noninterest expense was due to several factors:
- —
- Salaries and employee benefits increased mainly due to annual merit increases, higher performance-related incentives and higher other employee benefits;
- —
- Net occupancy costs increased mainly due to several new leases related to branch expansions, higher vacancy reserves, as well as a prior year refund of property taxes related to a reassessment;
- —
- Professional services costs increased mainly due to higher legal costs, which included additional costs for our privatization and lease-related litigation costs;
- —
- Provision for losses on off-balance sheet commitments increased primarily due to higher criticized credits and increases in certain loss factors; and
- —
- Other expenses increased due to higher regulatory fees related to federal deposit insurance costs as credits available from prior quarters were exhausted and higher writedowns related to Community Reinvestment Act (CRA) investments.
53
Net Interest Income
The following tables show the major components of net interest income and net interest margin.
| For the Three Months Ended | Increase (Decrease) in | |||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2007 | September 30, 2008 | Average Balance | Interest Income/ Expense(1) | |||||||||||||||||||||||||||||
| Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | |||||||||||||||||||||||||||
(Dollars in thousands) | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||||
Assets | |||||||||||||||||||||||||||||||||
Loans:(3) | |||||||||||||||||||||||||||||||||
Commercial, financial and industrial | $ | 14,342,095 | $ | 246,275 | 6.81 | % | $ | 17,262,407 | $ | 229,377 | 5.29 | % | $ | 2,920,312 | 20 | % | $ | (16,898 | ) | (7 | )% | ||||||||||||
Construction | 2,371,833 | 46,043 | 7.70 | 2,579,582 | 30,352 | 4.68 | 207,749 | 9 | (15,691 | ) | (34 | ) | |||||||||||||||||||||
Residential mortgage | 13,196,677 | 178,589 | 5.41 | 15,285,171 | 211,965 | 5.55 | 2,088,494 | 16 | 33,376 | 19 | |||||||||||||||||||||||
Commercial mortgage | 6,386,963 | 112,743 | 7.00 | 8,008,618 | 111,816 | 5.58 | 1,621,655 | 25 | (927 | ) | (1 | ) | |||||||||||||||||||||
Consumer | 2,570,234 | 50,601 | 7.81 | 3,421,338 | 49,286 | 5.73 | 851,104 | 33 | (1,315 | ) | (3 | ) | |||||||||||||||||||||
Lease financing | 616,983 | 6,260 | 4.06 | 639,088 | 6,066 | 3.80 | 22,105 | 4 | (194 | ) | (3 | ) | |||||||||||||||||||||
Total Loans | 39,484,785 | 640,511 | 6.45 | 47,196,204 | 638,862 | 5.40 | 7,711,419 | 20 | (1,649 | ) | (0 | ) | |||||||||||||||||||||
Securities—taxable | 8,593,945 | 111,933 | 5.21 | 8,348,785 | 99,614 | 4.77 | (245,160 | ) | (3 | ) | (12,319 | ) | (11 | ) | |||||||||||||||||||
Securities—tax-exempt | 55,236 | 1,150 | 8.33 | 51,831 | 1,045 | 8.06 | (3,405 | ) | (6 | ) | (105 | ) | (9 | ) | |||||||||||||||||||
Interest bearing deposits in banks | 44,185 | 709 | 6.37 | 13,642 | 147 | 4.27 | (30,543 | ) | (69 | ) | (562 | ) | (79 | ) | |||||||||||||||||||
Federal funds sold and securities purchased under resale agreements | 355,111 | 4,683 | 5.23 | 361,361 | 1,787 | 1.97 | 6,250 | 2 | (2,896 | ) | (62 | ) | |||||||||||||||||||||
Trading account assets | 368,232 | 1,898 | 2.04 | 948,725 | 1,364 | 0.57 | 580,493 | nm | (534 | ) | (28 | ) | |||||||||||||||||||||
Total earning assets | 48,901,494 | 760,884 | 6.20 | 56,920,548 | 742,819 | 5.21 | 8,019,054 | 16 | (18,065 | ) | (2 | ) | |||||||||||||||||||||
Allowance for loan losses | (335,932 | ) | (506,452 | ) | (170,520 | ) | (51 | ) | |||||||||||||||||||||||||
Cash and due from banks | 1,845,328 | 1,606,632 | (238,696 | ) | (13 | ) | |||||||||||||||||||||||||||
Premises and equipment, net | 480,054 | 475,408 | (4,646 | ) | (1 | ) | |||||||||||||||||||||||||||
Other assets | 2,476,247 | 2,649,115 | 172,868 | 7 | |||||||||||||||||||||||||||||
Total assets | $ | 53,367,191 | $ | 61,145,251 | $ | 7,778,060 | 15 | % | |||||||||||||||||||||||||
Liabilities | |||||||||||||||||||||||||||||||||
Deposits: | |||||||||||||||||||||||||||||||||
Transaction accounts | $ | 14,288,967 | $ | 108,653 | 3.02 | $ | 15,552,783 | $ | 61,636 | 1.58 | $ | 1,263,816 | 9 | % | $ | (47,017 | ) | (43 | ) | ||||||||||||||
Savings and consumer time | 4,371,913 | 30,362 | 2.76 | 3,899,687 | 13,237 | 1.35 | (472,226 | ) | (11 | ) | (17,125 | ) | (56 | ) | |||||||||||||||||||
Large time | 9,515,315 | 120,391 | 5.02 | 9,847,584 | 60,863 | 2.46 | 332,269 | 3 | (59,528 | ) | (49 | ) | |||||||||||||||||||||
Total interest bearing deposits | 28,176,195 | 259,406 | 3.65 | 29,300,054 | 135,736 | 1.84 | 1,123,859 | 4 | (123,670 | ) | (48 | ) | |||||||||||||||||||||
Federal funds purchased and securities sold under repurchase agreements | 1,130,404 | 14,284 | 5.01 | 3,496,184 | 15,365 | 1.75 | 2,365,780 | nm | 1,081 | 8 | |||||||||||||||||||||||
Net funding allocated from (to) discontinued operations(4) | (1,912 | ) | (25 | ) | 5.19 | 55,121 | 265 | 1.91 | 57,033 | nm | 290 | nm | |||||||||||||||||||||
Commercial paper | 1,559,098 | 19,753 | 5.03 | 1,432,207 | 8,056 | 2.24 | (126,891 | ) | (8 | ) | (11,697 | ) | (59 | ) | |||||||||||||||||||
Other borrowed funds | 828,448 | 11,318 | 5.42 | 4,886,263 | 34,873 | 2.84 | 4,057,815 | nm | 23,555 | nm | |||||||||||||||||||||||
Medium and long-term debt | 1,846,674 | 26,957 | 5.79 | 3,300,675 | 25,989 | 3.13 | 1,454,001 | 79 | (968 | ) | (4 | ) | |||||||||||||||||||||
Trust notes | 14,601 | 239 | 6.53 | 14,148 | 239 | 6.73 | (453 | ) | (3 | ) | — | — | |||||||||||||||||||||
Total borrowed funds | 5,377,313 | 72,526 | 5.35 | 13,184,598 | 84,787 | 2.56 | 7,807,285 | nm | 12,261 | 17 | |||||||||||||||||||||||
Total interest bearing liabilities | 33,553,508 | 331,932 | 3.92 | 42,484,652 | 220,523 | 2.06 | 8,931,144 | 27 | (111,409 | ) | (34 | ) | |||||||||||||||||||||
Noninterest bearing deposits | 13,786,531 | 12,361,170 | (1,425,361 | ) | (10 | ) | |||||||||||||||||||||||||||
Other liabilities | 1,362,923 | 1,710,988 | 348,065 | 26 | |||||||||||||||||||||||||||||
Total liabilities | 48,702,962 | 56,556,810 | 7,853,848 | 16 | |||||||||||||||||||||||||||||
Stockholders' Equity | |||||||||||||||||||||||||||||||||
Common equity | 4,664,229 | 4,588,441 | (75,788 | ) | (2 | ) | |||||||||||||||||||||||||||
Total stockholders' equity | 4,664,229 | 4,588,441 | (75,788 | ) | (2 | ) | |||||||||||||||||||||||||||
Total liabilities and stockholders' equity | $ | 53,367,191 | $ | 61,145,251 | $ | 7,778,060 | 15 | % | |||||||||||||||||||||||||
Net Interest Income/Margin | |||||||||||||||||||||||||||||||||
Net interest income/margin (taxable-equivalent basis) | 428,952 | 3.51 | % | 522,296 | 3.67 | % | 93,344 | 22 | |||||||||||||||||||||||||
Less: taxable-equivalent adjustment | 2,389 | 2,550 | 161 | 7 | |||||||||||||||||||||||||||||
Net interest income | $ | 426,563 | $ | 519,746 | $ | 93,183 | 22 | % | |||||||||||||||||||||||||
Average Assets and Liabilities of Discontinued Operations for the Three Months Ended: | September 30, 2007 | September 30, 2008 | | ||||||
---|---|---|---|---|---|---|---|---|---|
Assets | $ | 128,494 | $ | 5,738 | |||||
Liabilities | $ | 126,582 | $ | 60,859 | |||||
Net assets (liabilities) | $ | 1,912 | $ | (55,121 | ) |
- (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 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)
- 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 Federal funds purchased rate.
nm = not meaningful
54
| For the Nine Months Ended | Increase (Decrease) in | |||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2007 | September 30, 2008 | Average Balance | Interest Income/ Expense(1) | |||||||||||||||||||||||||||||
| Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | |||||||||||||||||||||||||||
(Dollars in thousands) | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||||
Assets | |||||||||||||||||||||||||||||||||
Loans:(3) | |||||||||||||||||||||||||||||||||
Commercial, financial and industrial | $ | 14,544,388 | $ | 721,728 | 6.63 | % | $ | 16,623,490 | $ | 697,292 | 5.60 | % | $ | 2,079,102 | 14 | % | $ | (24,436 | ) | (3 | )% | ||||||||||||
Construction | 2,300,862 | 132,865 | 7.72 | 2,551,348 | 97,763 | 5.12 | 250,486 | 11 | (35,102 | ) | (26 | ) | |||||||||||||||||||||
Residential mortgage | 12,728,651 | 509,697 | 5.34 | 14,593,755 | 604,506 | 5.52 | 1,865,104 | 15 | 94,809 | 19 | |||||||||||||||||||||||
Commercial mortgage | 6,222,590 | 331,429 | 7.12 | 7,694,956 | 336,508 | 5.83 | 1,472,366 | 24 | 5,079 | 2 | |||||||||||||||||||||||
Consumer | 2,556,710 | 149,159 | 7.80 | 3,030,042 | 140,129 | 6.18 | 473,332 | 19 | (9,030 | ) | (6 | ) | |||||||||||||||||||||
Lease financing | 578,082 | 17,339 | 4.00 | 644,553 | 13,534 | 2.80 | 66,471 | 11 | (3,805 | ) | (22 | ) | |||||||||||||||||||||
Total Loans | 38,931,283 | 1,862,217 | 6.39 | 45,138,144 | 1,889,732 | 5.59 | 6,206,861 | 16 | 27,515 | 1 | |||||||||||||||||||||||
Securities—taxable | 8,574,149 | 327,874 | 5.10 | 8,332,647 | 301,810 | 4.83 | (241,502 | ) | (3 | ) | (26,064 | ) | (8 | ) | |||||||||||||||||||
Securities—tax-exempt | 56,316 | 3,468 | 8.21 | 52,641 | 3,232 | 8.19 | (3,675 | ) | (7 | ) | (236 | ) | (7 | ) | |||||||||||||||||||
Interest bearing deposits in banks | 70,650 | 3,113 | 5.89 | 36,936 | 503 | 1.82 | (33,714 | ) | (48 | ) | (2,610 | ) | (84 | ) | |||||||||||||||||||
Federal funds sold and securities purchased under resale agreements | 596,492 | 23,644 | 5.30 | 301,153 | 5,573 | 2.47 | (295,339 | ) | (50 | ) | (18,071 | ) | (76 | ) | |||||||||||||||||||
Trading account assets | 339,666 | 5,200 | 2.05 | 827,881 | 5,287 | 0.85 | 488,215 | nm | 87 | 2 | |||||||||||||||||||||||
Total earning assets | 48,568,556 | 2,225,516 | 6.12 | 54,689,402 | 2,206,137 | 5.38 | 6,120,846 | 13 | (19,379 | ) | (1 | ) | |||||||||||||||||||||
Allowance for loan losses | (332,690 | ) | (454,191 | ) | (121,501 | ) | (37 | ) | |||||||||||||||||||||||||
Cash and due from banks | 1,931,368 | 1,675,293 | (256,075 | ) | (13 | ) | |||||||||||||||||||||||||||
Premises and equipment, net | 482,373 | 480,705 | (1,668 | ) | (0 | ) | |||||||||||||||||||||||||||
Other assets | 2,416,312 | 2,632,406 | 216,094 | 9 | |||||||||||||||||||||||||||||
Total assets | $ | 53,065,919 | $ | 59,023,615 | $ | 5,957,696 | 11 | % | |||||||||||||||||||||||||
Liabilities | |||||||||||||||||||||||||||||||||
Deposits: | |||||||||||||||||||||||||||||||||
Transaction accounts | $ | 13,969,058 | $ | 302,991 | 2.90 | $ | 15,323,611 | $ | 204,064 | 1.78 | $ | 1,354,553 | 10 | % | $ | (98,927 | ) | (33 | ) | ||||||||||||||
Savings and consumer time | 4,332,052 | 86,075 | 2.66 | 3,974,976 | 50,684 | 1.70 | (357,076 | ) | (8 | ) | (35,391 | ) | (41 | ) | |||||||||||||||||||
Large time | 9,045,417 | 338,566 | 5.00 | 10,909,525 | 246,157 | 3.01 | 1,864,108 | 21 | (92,409 | ) | (27 | ) | |||||||||||||||||||||
Total interest bearing deposits | 27,346,527 | 727,632 | 3.56 | 30,208,112 | 500,905 | 2.21 | 2,861,585 | 10 | (226,727 | ) | (31 | ) | |||||||||||||||||||||
Federal funds purchased and securities sold under repurchase agreements | 986,589 | 37,928 | 5.14 | 2,628,257 | 43,628 | 2.22 | 1,641,668 | nm | 5,700 | 15 | |||||||||||||||||||||||
Net funding allocated from (to) discontinued operations(4) | 9,310 | 362 | 5.20 | 45,520 | 774 | 2.27 | 36,210 | nm | 412 | nm | |||||||||||||||||||||||
Commercial paper | 1,576,745 | 59,446 | 5.04 | 1,375,789 | 26,127 | 2.54 | (200,956 | ) | (13 | ) | (33,319 | ) | (56 | ) | |||||||||||||||||||
Other borrowed funds | 821,270 | 33,273 | 5.42 | 3,224,146 | 70,563 | 2.92 | 2,402,876 | nm | 37,290 | nm | |||||||||||||||||||||||
Medium and long-term debt | 1,752,240 | 75,625 | 5.77 | 2,594,875 | 65,138 | 3.35 | 842,635 | 48 | (10,487 | ) | (14 | ) | |||||||||||||||||||||
Trust notes | 14,713 | 715 | 6.48 | 14,261 | 715 | 6.68 | (452 | ) | (3 | ) | — | — | |||||||||||||||||||||
Total borrowed funds | 5,160,867 | 207,349 | 5.37 | 9,882,848 | 206,945 | 2.80 | 4,721,981 | 91 | (404 | ) | (0 | ) | |||||||||||||||||||||
Total interest bearing liabilities | 32,507,394 | 934,981 | 3.85 | 40,090,960 | 707,850 | 2.36 | 7,583,566 | 23 | (227,131 | ) | (24 | ) | |||||||||||||||||||||
Noninterest bearing deposits | 14,619,876 | 12,613,690 | (2,006,186 | ) | (14 | ) | |||||||||||||||||||||||||||
Other liabilities | 1,350,586 | 1,678,057 | 327,471 | 24 | |||||||||||||||||||||||||||||
Total liabilities | 48,477,856 | 54,382,707 | 5,904,851 | 12 | |||||||||||||||||||||||||||||
Stockholders' Equity | |||||||||||||||||||||||||||||||||
Common equity | 4,588,063 | 4,640,908 | 52,845 | 1 | |||||||||||||||||||||||||||||
Total stockholders' equity | 4,588,063 | 4,640,908 | 52,845 | 1 | |||||||||||||||||||||||||||||
Total liabilities and stockholders' equity | $ | 53,065,919 | $ | 59,023,615 | $ | 5,957,696 | 11 | % | |||||||||||||||||||||||||
Net Interest Income/Margin | |||||||||||||||||||||||||||||||||
Net interest income/margin (taxable-equivalent basis) | 1,290,535 | 3.54 | % | 1,498,287 | 3.65 | % | 207,752 | 16 | |||||||||||||||||||||||||
Less: taxable-equivalent adjustment | 6,755 | 7,405 | 650 | 10 | |||||||||||||||||||||||||||||
Net interest income | $ | 1,283,780 | $ | 1,490,882 | $ | 207,102 | 16 | % | |||||||||||||||||||||||||
Average Assets and Liabilities of Discontinued Operations for the Nine Months Ended: | September 30, 2007 | September 30, 2008 | | ||||||
---|---|---|---|---|---|---|---|---|---|
Assets | $ | 130,672 | $ | 74,723 | |||||
Liabilities | $ | 139,982 | $ | 120,243 | |||||
Net liabilities | $ | (9,310 | ) | $ | (45,520 | ) |
- (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 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)
- 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 Federal funds purchased rate. The year-to-date expense (earnings) amount is the sum of the quarterly amounts.
nm = not meaningful
55
Net interest income in the third quarter of 2008, on a taxable-equivalent basis, increased 22 percent compared to the third quarter of 2007. Our net interest margin increased by 16 basis points. These results were primarily due to the following:
- •
- Average earning assets increased $8.0 billion, or 16 percent, primarily due to an increase in average loans. The increase in average loans was largely due to a $2.9 billion increase in average commercial loans, a $2.1 billion increase in average residential mortgages and a $1.6 billion increase in average commercial mortgages, partially offset by a $0.7 billion decrease in lower yielding loans related to title and escrow customers;
- •
- Yields on our earning assets were unfavorably impacted by the decreasing interest rate environment resulting in a lower average yield on average earning assets of 99 basis points, despite being positively impacted by higher hedge income, which increased by $30.4 million;
- •
- Average noninterest bearing deposits decreased $1.4 billion, or 10 percent. Average commercial noninterest bearing deposits, excluding title and escrow deposits, declined $0.5 billion, or 5 percent. Title and escrow deposits declined $0.8 billion, or 50 percent, primarily due to the slowdown in the real estate market. Consumer demand deposits decreased $0.1 billion, or 5 percent. Average noninterest bearing deposits represented 30 percent of average total deposits in the third quarter of 2008 compared to 33 percent in the third quarter of 2007; and
- •
- In the third quarter of 2008, the annualized average all-in cost of funds was 1.60 percent, reflecting an average deposit-to-loan ratio of 88 percent and what we believe is a relatively high proportion of average noninterest bearing deposits to total deposits compared to most of our peers. In the third quarter of 2007, the annualized all-in cost of funds was 2.78 percent and our average deposit-to-loan ratio was 106 percent.
We use derivatives to hedge expected changes in the yields on our variable rate loans and term certificates of deposit and other time deposits (CDs), and to convert certain fixed-rate borrowings to floating rate. For loans, we had hedge income of $21.4 million and hedge expense of $9.0 million for the quarters ended September 30, 2008 and 2007, respectively. For long-term fixed rate borrowings, we had hedge income of $6.9 million and hedge expense of $0.6 million for the quarters ended September 30, 2008 and 2007, respectively.
Net interest income in the nine months ended September 30, 2008, on a taxable-equivalent basis, increased 16 percent compared to the nine months ended September 30, 2007. Our net interest margin increased by 11 basis points. These results were primarily due to the following:
- •
- Average earning assets increased $6.1 billion, or 13 percent, primarily due to an increase in average loans. The increase in average loans was largely due to a $2.1 billion increase in average commercial loans, a $1.9 billion increase in average residential mortgages and a $1.5 billion increase in average commercial mortgages, partially offset by a $0.9 billion decrease in lower yielding loans related to title and escrow customers;
- •
- Yields on our earning assets were unfavorably impacted by the declining interest rate environment resulting in a lower average yield on average earning assets of 74 basis points, despite being positively impacted by higher hedge income, which increased by $78.8 million;
- •
- Average noninterest bearing deposits decreased $2.0 billion, or 14 percent. Average commercial noninterest bearing deposits, excluding title and escrow deposits, declined $0.8 billion, or 8 percent. Title and escrow deposits declined $1.0 billion, or 51 percent, primarily due to the slowdown in the real estate market. Consumer demand deposits decreased $0.2 billion, or 8 percent. Average noninterest bearing deposits represented 29 percent of average total deposits in the nine months ended September 30, 2008 compared to 35 percent in the nine months ended September 30, 2007; and
56
- •
- In the nine months ended September 30, 2008, the annualized average all-in cost of funds was 1.79 percent, reflecting an average deposit-to-loan ratio of 95 percent and what we believe is a relatively high proportion of average noninterest bearing deposits to total deposits compared to most of our peers. In the nine months ended September 30, 2007, the annualized all-in cost of funds was 2.65 percent and our average deposit-to-loan ratio was 108 percent.
We use derivatives to hedge expected changes in the yields on our variable rate loans and CDs, and to convert certain fixed-rate borrowings to floating rate. For loans, we had hedge income of $49.5 million and hedge expense of $29.3 million for the nine months ended September 30, 2008 and 2007, respectively. For long-term fixed rate borrowings, we had hedge income of $19.2 million and hedge expense of $0.5 million for the nine months ended September 30, 2008 and 2007, respectively.
Noninterest Income and Noninterest Expense
The following tables detail our noninterest income and noninterest expense that exceeded 1 percent of our total revenues for the three and nine months ended September 30, 2007 and 2008.
Noninterest Income
| For the Three Months Ended | For the Nine Months Ended | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Increase (Decrease) | | | Increase (Decrease) | ||||||||||||||||||||
| September 30, 2007 | September 30, 2008 | September 30, 2007 | September 30, 2008 | ||||||||||||||||||||||
(Dollars in thousands) | Amount | Percent | Amount | Percent | ||||||||||||||||||||||
Service charges on deposit accounts | $ | 76,210 | $ | 77,079 | $ | 869 | 1.1 | % | $ | 228,373 | $ | 229,521 | $ | 1,148 | 0.5 | % | ||||||||||
Trust and investment management fees | 39,546 | 40,638 | 1,092 | 2.8 | 116,062 | 127,828 | 11,766 | 10.1 | ||||||||||||||||||
Trading account activities | 21,795 | 12,397 | (9,398 | ) | (43.1 | ) | 50,473 | 40,096 | (10,377 | ) | (20.6 | ) | ||||||||||||||
Merchant banking fees | 10,031 | 12,789 | 2,758 | 27.5 | 27,917 | 35,667 | 7,750 | 27.8 | ||||||||||||||||||
Brokerage commissions and fees | 10,476 | 9,520 | (956 | ) | (9.1 | ) | 29,669 | 30,014 | 345 | 1.2 | ||||||||||||||||
Card processing fees, net | 7,785 | 8,129 | 344 | 4.4 | 22,736 | 24,060 | 1,324 | 5.8 | ||||||||||||||||||
Securities gains, net | 171 | 50 | (121 | ) | (70.8 | ) | 1,621 | 48 | (1,573 | ) | (97.0 | ) | ||||||||||||||
Gains on private capital investments, net | 12,203 | 5,597 | (6,606 | ) | (54.1 | ) | 41,469 | 7,949 | (33,520 | ) | (80.8 | ) | ||||||||||||||
Gain on the VISA IPO redemption | — | — | — | — | — | 14,211 | 14,211 | nm | ||||||||||||||||||
Other | 29,970 | 32,522 | 2,552 | 8.5 | 82,270 | 84,349 | 2,079 | 2.5 | ||||||||||||||||||
Total noninterest income | $ | 208,187 | $ | 198,721 | $ | (9,466 | ) | (4.5 | )% | $ | 600,590 | $ | 593,743 | $ | (6,847 | ) | (1.1 | )% | ||||||||
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57
Noninterest Expense
| For the Three Months Ended | For the Nine Months Ended | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Increase (Decrease) | | | Increase (Decrease) | ||||||||||||||||||||
(Dollars in thousands) | September 30, 2007 | September 30, 2008 | September 30, 2007 | September 30, 2008 | ||||||||||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||||||||||||
Salaries and other compensation | $ | 187,359 | $ | 204,389 | $ | 17,030 | 9.1 | % | $ | 568,245 | $ | 600,477 | $ | 32,232 | 5.7 | % | ||||||||||
Employee benefits | 29,453 | 33,740 | 4,287 | 14.6 | 117,930 | 122,621 | 4,691 | 4.0 | ||||||||||||||||||
Salaries and employee benefits | 216,812 | 238,129 | 21,317 | 9.8 | 686,175 | 723,098 | 36,923 | 5.4 | ||||||||||||||||||
Net occupancy | 37,534 | 38,574 | 1,040 | 2.8 | 104,919 | 113,008 | 8,089 | 7.7 | ||||||||||||||||||
Outside services | 19,868 | 20,777 | 909 | 4.6 | 54,987 | 58,081 | 3,094 | 5.6 | ||||||||||||||||||
Professional services | 17,669 | 21,397 | 3,728 | 21.1 | 45,163 | 51,925 | 6,762 | 15.0 | ||||||||||||||||||
Equipment | 15,426 | 14,437 | (989 | ) | (6.4 | ) | 47,240 | 44,925 | (2,315 | ) | (4.9 | ) | ||||||||||||||
Software | 14,278 | 14,812 | 534 | 3.7 | 41,551 | 44,016 | 2,465 | 5.9 | ||||||||||||||||||
Advertising and public relations | 10,145 | 12,624 | 2,479 | 24.4 | 28,536 | 33,579 | 5,043 | 17.7 | ||||||||||||||||||
Communications | 9,421 | 9,204 | (217 | ) | (2.3 | ) | 26,834 | 27,690 | 856 | 3.2 | ||||||||||||||||
Data processing | 8,086 | 8,945 | 859 | 10.6 | 24,831 | 23,805 | (1,026 | ) | (4.1 | ) | ||||||||||||||||
Intangible asset amortization | 1,126 | 670 | (456 | ) | (40.5 | ) | 3,377 | 2,011 | (1,366 | ) | (40.5 | ) | ||||||||||||||
Foreclosed asset expense | 37 | 524 | 487 | nm | 55 | 696 | 641 | nm | ||||||||||||||||||
Provision for losses on off-balance sheet commitments | 4,000 | 8,000 | 4,000 | 100.0 | 5,000 | 21,000 | 16,000 | nm | ||||||||||||||||||
Other | 26,445 | 55,719 | 29,274 | nm | 87,849 | 122,496 | 34,647 | 39.4 | ||||||||||||||||||
Total noninterest expense | $ | 380,847 | $ | 443,812 | $ | 62,965 | 16.5 | % | $ | 1,156,517 | $ | 1,266,330 | $ | 109,813 | 9.5 | % | ||||||||||
nm = not meaningful
Income Tax Expense
Our effective tax rate in the third quarter of 2008 was 30.2 percent, compared to 36.9 percent for the third quarter of 2007. The higher effective tax rate in 2007 was due primarily to an adjustment of $11.6 million to income tax expense to recognize the difference between the estimate of California state tax expense for 2006 and the taxes reported in our 2006 return.
Our effective tax rate in the nine months ended September 30, 2008 was 31.4 percent, compared to 34.0 percent for the nine months ended September 30, 2007.
For further information regarding income tax expense, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Income Tax Expense" in our 2007 Form 10-K.
58
Loans
The following table shows loans outstanding by loan type at the end of each period presented.
| | | | Increase (Decrease) September 30, 2008 From: | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | September 30, 2007 | December 31, 2007 | ||||||||||||||||||||
| September 30, 2007 | December 31, 2007 | September 30, 2008 | ||||||||||||||||||||||
(Dollars in thousands) | Amount | Percent | Amount | Percent | |||||||||||||||||||||
Commercial, financial and industrial | $ | 13,837,388 | $ | 14,563,477 | $ | 17,700,604 | $ | 3,863,216 | 27.9 | % | $ | 3,137,127 | 21.5 | % | |||||||||||
Construction | 2,411,434 | 2,406,729 | 2,653,945 | 242,511 | 10.1 | 247,216 | 10.3 | ||||||||||||||||||
Mortgage: | |||||||||||||||||||||||||
Residential | 13,451,633 | 13,827,241 | 15,691,872 | 2,240,239 | 16.7 | 1,864,631 | 13.5 | ||||||||||||||||||
Commercial | 6,529,125 | 7,021,299 | 8,032,010 | 1,502,885 | 23.0 | 1,010,711 | 14.4 | ||||||||||||||||||
Total mortgage | 19,980,758 | 20,848,540 | 23,723,882 | 3,743,124 | 18.7 | 2,875,342 | 13.8 | ||||||||||||||||||
Consumer: | |||||||||||||||||||||||||
Installment | 1,258,485 | 1,327,348 | 2,166,912 | 908,427 | 72.2 | 839,564 | 63.3 | ||||||||||||||||||
Revolving lines of credit | 1,328,747 | 1,334,132 | 1,361,784 | 33,037 | 2.5 | 27,652 | 2.1 | ||||||||||||||||||
Total consumer | 2,587,232 | 2,661,480 | 3,528,696 | 941,464 | 36.4 | 867,216 | 32.6 | ||||||||||||||||||
Lease financing | 634,524 | 654,467 | 642,642 | 8,118 | 1.3 | (11,825 | ) | (1.8 | ) | ||||||||||||||||
Total loans held to maturity | 39,451,336 | 41,134,693 | 48,249,769 | 8,798,433 | 22.3 | 7,115,076 | 17.3 | ||||||||||||||||||
Total loans held for sale | 294,005 | 69,495 | 56,349 | (237,656 | ) | (80.8 | ) | (13,146 | ) | (18.9 | ) | ||||||||||||||
Total loans | $ | 39,745,341 | $ | 41,204,188 | $ | 48,306,118 | $ | 8,560,777 | 21.5 | % | $ | 7,101,930 | 17.2 | % | |||||||||||
nm = not meaningful
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.
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 cash 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 each customer's specific industry. 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 increased from September 30, 2007 to September 30, 2008 mainly due to increased loan demand primarily in the power and utilities, oil and gas and national corporate segments, as well as in the California middle market.
Construction and Commercial Mortgage Loans
We engage in real estate lending that includes commercial mortgage loans and construction loans secured by deeds of trust.
Construction loans are extended primarily to commercial property developers and to residential builders. As of September 30, 2008, the construction loan portfolio consisted of approximately three-quarters in the commercial income producing real estate industry and approximately one-quarter with residential homebuilders. The construction loan portfolio increased from September 30, 2007 to September 30, 2008 primarily due to loan advances for income property projects with apartment, office and retail financing representing the largest components. During the same period, the homebuilder portfolio fell by approximately
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30%, or $280 million. Operating conditions continue to weaken for our commercial property developers and residential builders, and as a result we continue to experience negative risk grade trends in the overall portfolio.
Geographically, the outstanding homebuilder loan portfolio is distributed as follows: approximately one-third in the San Francisco bay area, approximately one-third in the Los Angeles/Orange County region, including the Inland Empire, approximately one-fifth from out-of-state, approximately one-tenth in San Diego, and the remainder in other parts of California.
The commercial mortgage loan portfolio consists of loans on commercial income properties primarily in California. The commercial mortgage portfolio increased from September 30, 2007 to September 30, 2008 mainly due to demand in the California middle market sector for real estate related financing.
Residential Mortgage Loans
We originate residential mortgage loans, secured by one-to-four family residential properties, through our multiple channel network (including branches, private bankers, mortgage brokers, and loan-by-phone) throughout California, Oregon and Washington, and we periodically purchase loans in our market area.
At September 30, 2008, 68 percent of our residential mortgage loans were interest only, none of which are negative amortizing. At origination, these interest only loans had relatively high credit scores and had weighted average loan-to-value (LTV) ratios of approximately 66 percent. The remainder of the portfolio consists of balloon or regular amortizing loans.
We do not have a program for originating or purchasing subprime loan products. However, we do have loan products that allow a customer to move more quickly through the loan origination process by reducing the need to verify the income or assets of the customer. We refer to these loans as "no doc" (which we discontinued offering in August 2008), "low doc" and portfolio express loans. Portfolio express loans are only available through the Retail Banking channel to existing clients for no-cash-out/rate and term refinance of existing residential mortgages with the Bank and eliminate the verification of both income and assets. "Low doc" loans are offered through all channels and require the verification of assets. In both cases, these loans require lower LTV ratios and higher FICO® credit scores than for fully documented residential loans. Although these loans comprise nearly half of our residential loan portfolio, the delinquency rates relative to the outstanding balances at September 30, 2008 were lower than fully documented loans. At September 30, 2008, the total amount of "no doc" and "low doc" loans past due 30 days or more was $44.0 million, compared to $13.2 million at September 30, 2007. The total amount of residential mortgages delinquent 30 days or more was $114.7 million at September 30, 2008, compared to $33.5 million at September 30, 2007. Although delinquencies have risen since September 30, 2007, the delinquency ratio remains low compared to the industry average for California prime loans.
We hold most of the loans we originate. However, we do sell our 30-year, fixed rate loans, except for CRA qualifying loans.
On February 13, 2008, President Bush signed into law the Economic Stimulus Act of 2008, which, among other provisions, authorizes the three federal mortgage loan conduits, the Federal National Mortgage Association (known as Fannie Mae), the Federal Home Loan Mortgage Corporation (known as Freddie Mac) and the Federal Housing Administration, to purchase new and existing "jumbo" residential mortgage loans originated after June 30, 2007. The legislation has taken effect and sets higher loan limits for each Standard Metropolitan Statistical Area, based on average housing prices, and increases the current limit on conforming loans which can be purchased by Fannie Mae and Freddie Mac to up to $729,750 from its prior maximum of $417,000. The purpose of the increased purchase authority, applies to all loans originated through the end of 2008, although legislation has been proposed to permanently extend this provision. The intent of the higher limits is to provide increased liquidity to the secondary market for "jumbo" residential loans, particularly on residential properties in a number of counties in the State of California where housing prices remain relatively high. To date, the impact in the marketplace has been minimal due to pricing and underwriting factors, but that
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could change over time, especially if the provision becomes permanent. Improved pricing and more flexible underwriting could result in an increased rate of loan originations and refinancing of loans on such properties, including properties secured by loans made by us. The degree to which this will occur and its overall effect on our residential mortgage loan portfolio is still not clear at this time. On September 7, 2008, Fannie Mae and Freddie Mac were placed into conservatorship by federal regulators. The long-term affect of this development on their role as major mortgage market conduits cannot be predicted at this time.
On July 30, 2008, President Bush signed into law a housing bill which grants the Treasury Department broad authority to safeguard Fannie Mae and Freddie Mac and authorizes the Federal Housing Administration to insure up to $300 billion in refinanced mortgages. It cannot be predicted whether this recent legislation will result in significant improvement in financial and economic conditions affecting the banking and mortgage industries.
Consumer Loans
We originate consumer loans, such as auto loans and home equity loans and lines, through our branch network and Private Banking Offices. The increase in consumer loans from September 30, 2007 was primarily in our FlexEquity line/loan product. The FlexEquity line/loan allows our customers the flexibility to manage a line of credit with as many as four fixed rate loans under a single product. When customers convert all or a portion of their FlexEquity lines to fixed rate loans, these new loans are classified as installment loans. Our total home equity loans and lines delinquent 30 days or more were $15.5 million at September 30, 2008, compared to $5.9 million at September 30, 2007. Although the percentage increase from September 30, 2007 is high, we believe the dollar amount of the increase is not significant as compared to the industry average for California.
Lease Financing
We 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. At September 30, 2008, we had leveraged leases of $549.6 million, which were net of non-recourse debt of approximately $1.2 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 Outstandings
Our cross-border outstandings 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 and December 31, 2007 and September 30, 2008 for Canada, the only country where such outstandings exceeded 1 percent of total assets. The cross-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
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outstanding and investments with foreign entities. For the country shown in the table below, any significant local currency outstandings are either hedged or funded by local currency borrowings.
(Dollars in millions) | Financial Institutions | Public Sector Entities | Corporations and Other Borrowers | Total Outstandings | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September 30, 2007 | ||||||||||||||
Canada | $ | 8 | $ | — | $ | 1,039 | $ | 1,047 | ||||||
December 31, 2007 | ||||||||||||||
Canada | $ | 6 | $ | — | $ | 817 | $ | 823 | ||||||
September 30, 2008 | ||||||||||||||
Canada | $ | 49 | $ | — | $ | 792 | $ | 841 |
Provision for Credit Losses
We recorded a provision for loan losses of $16 million and $117 million in the third quarters of 2007 and 2008, respectively. We recorded a provision for loan losses of $25 million and $284 million for the nine months ended September 30, 2007 and 2008, respectively. We recorded a $4 million and $8 million provision for losses on off-balance sheet commitments in the third quarters of 2007 and 2008, respectively. We recorded a $5 million and $21 million provision for losses on off-balance sheet commitments for the nine months ended September 30, 2007 and 2008, respectively. The provisions for loan losses and for losses on off-balance sheet commitments are charged to income to bring our total allowances for credit losses to a level deemed appropriate by management based on the factors discussed under "Allowances for Credit Losses" below.
Allowances for Credit Losses
Allowance Policy and Methodology
We maintain allowances for credit losses (defined as both the allowance for loan losses 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 the allowances for credit losses is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly, our significant policies and methodology on the allowances for credit losses are discussed in detail in Note 1 to our Consolidated Financial Statements and in the section "Allowances for Credit Losses" included in our "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2007 Form 10-K.
Comparison of the Total Allowances and Related Provision for Credit Losses Compared to December 31, 2007
At September 30, 2008, our total allowances for credit losses were $692 million, which consisted of $581 million for loan losses and $111 million for losses on off-balance sheet commitments. The allowances for credit losses consisted of $623 million and $69 million of allocated and unallocated allowance, respectively. At September 30, 2008, our allowances for credit loss coverage ratios were 1.43 percent of total loans and 240 percent of total nonaccrual loans. At December 31, 2007, our total allowances for credit losses were $493 million, or 1.20 percent of the total loan portfolio and 885 percent of total nonaccrual loans.
In addition, the allowances incorporate the results of measuring impaired loans as provided in SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan—Income Recognition and Disclosures." These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. At September 30, 2008 and December 31, 2007, total impaired loans were $290 million and $56 million, respectively, and the associated impairment allowances were $42 million and $11 million, respectively.
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At September 30, 2008 and December 31, 2007, the allowance for losses on off-balance sheet commitments included within our total allowances for credit losses was $111 million and $90 million, respectively. In determining the adequacy of our allowances for credit losses, we consider both the allowance for loan losses and for off-balance sheet commitment losses. Net charge offs were $63 million in the third quarter of 2008, compared to $2 million in the third quarter of 2007.
As a result of management's assessment of the relevant factors, including the credit quality of our loan portfolio, the impact of continued deterioration of commercial real estate and the significant growth and changes in the composition of the loan portfolio, we recorded a provision for loan losses of $117 million in the third quarter of 2008, compared to a provision for loan losses of $16 million in the third quarter of 2007. Overall, our loan portfolio experienced higher criticized assets and increases in certain loss factors related to our consumer and small business portfolios, reflecting the continued deterioration in the economic environment. In addition, we experienced strong loan growth, which resulted in additional provision during the third quarter of 2008.
We expect the elevated levels of quarterly provisions for credit losses, which we experienced in the first three quarters of 2008, to continue in the fourth quarter of 2008. The factors driving the increase in our projected provision during the remaining quarter of 2008 include management's belief that we are in a continued recessionary economic environment, which we believe will result in further deterioration in our loan portfolio.
During the third quarter of 2008, there were no material changes in estimation methods or assumptions that affected our methodology for assessing the appropriateness of the formula and specific allowances for credit losses.
Changes in the Allocated (Formula and Specific) Allowance
At September 30, 2008, the formula allowance increased to $577 million, compared to $395 million at December 31, 2007. The net increase was due primarily to an increase in criticized assets and higher loss factors for our consumer loan and small business portfolios. At September 30, 2008, the specific allowance was $46 million, compared to $12 million at December 31, 2007.
Changes in the Unallocated Allowance
At September 30, 2008, the unallocated allowance decreased to $69 million, compared to $86 million at December 31, 2007, primarily resulting from management's belief that the impact of high fuel prices has been captured and the impact of continued weakness in the homebuilder market has been more fully captured in our total allocated allowance. Furthermore, management believes that the current level of unallocated allowance is appropriate based on the weakening credit cycle and the level of uncertainty of the impact of the current economic conditions on our principal portfolio segments. Additionally, the reasons for which we believe an unallocated allowance is warranted are detailed below.
In our assessment as of September 30, 2008, 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.
Although 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 collectability of the applicable loans may not have been fully 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 the 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. In certain cases, we believe that credit migration is likely to be somewhat more severe than the long-run average, but a greater share of the inherent probable loss associated with this credit migration is captured in the allocated
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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 some of the specific conditions we considered.
- •
- With respect to commercial real estate, we considered the significant weakness in the residential building market, deteriorating trends in income property markets, and the tightening of the credit markets, which would be in the range of $25 million to $38 million.
- •
- With respect to building material suppliers, we considered the weakness in the homebuilding industry, including weak home sales, and the effects on suppliers, which would be in the range of $7 million to $13 million.
- •
- With respect to concentrated sales, which include suppliers of "big box" stores and other companies that generate 15 percent or more of their revenues from one customer, we considered quarterly declines in same-store sales for certain home improvement stores, which would be in the range of $7 million to $12 million.
- •
- With respect to our customers whose revenues are dependent on advertising, we considered the pressures on earnings of newspapers and radio and television stations due to decreases in advertising sale revenues, which would be in the range of $3 million to $6 million.
- •
- With respect to contractors, we considered the slowdown in the residential housing construction market and its potential impact on commercial real estate (based on existing trends between the housing and non-residential construction markets), which would be in the range of $3 million to $5 million.
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Change in the Total Allowances for Credit Losses
The following table sets forth a reconciliation of changes in our allowances for credit losses.
| For the Three Months Ended September 30, | Increase (Decrease) | For the Nine Months Ended September 30, | Increase (Decrease) | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) | 2007 | 2008 | Amount | Percent | 2007 | 2008 | Amount | Percent | ||||||||||||||||||||
Balance, beginning of period | $ | 335,952 | $ | 526,401 | $ | 190,449 | 56.7 | % | $ | 331,077 | $ | 402,726 | $ | 71,649 | 21.6 | % | ||||||||||||
Loans charged off: | ||||||||||||||||||||||||||||
Commercial, financial and industrial | 2,719 | 42,004 | 39,285 | nm | 8,559 | 70,184 | 61,625 | nm | ||||||||||||||||||||
Construction | — | 15,463 | 15,463 | nm | — | 25,013 | 25,013 | nm | ||||||||||||||||||||
Mortgage | 86 | 2,818 | 2,732 | nm | 91 | 5,093 | 5,002 | nm | ||||||||||||||||||||
Consumer | 1,696 | 4,263 | 2,567 | nm | 4,416 | 10,803 | 6,387 | 144.6 | ||||||||||||||||||||
Total loans charged off | 4,501 | 64,548 | 60,047 | nm | 13,066 | 111,093 | 98,027 | nm | ||||||||||||||||||||
Recoveries of loans previously charged off: | ||||||||||||||||||||||||||||
Commercial, financial and industrial | 2,098 | 1,811 | (287 | ) | (13.7 | ) | 5,550 | 4,288 | (1,262 | ) | (22.7 | ) | ||||||||||||||||
Mortgage | 336 | 2 | (334 | ) | nm | 336 | 2 | (334 | ) | (99.4 | ) | |||||||||||||||||
Consumer | 245 | 175 | (70 | ) | (28.6 | ) | 756 | 901 | 145 | 19.2 | ||||||||||||||||||
Lease financing | 2 | 5 | 3 | 150.0 | 89 | 213 | 124 | 139.3 | ||||||||||||||||||||
Total recoveries of loans previously charged off | 2,681 | 1,993 | (688 | ) | (25.7 | ) | 6,731 | 5,404 | (1,327 | ) | (19.7 | ) | ||||||||||||||||
Net loans charged off | 1,820 | 62,555 | 60,735 | nm | 6,335 | 105,689 | 99,354 | nm | ||||||||||||||||||||
Provision for loan losses | 16,000 | 117,000 | 101,000 | nm | 25,000 | 284,000 | 259,000 | nm | ||||||||||||||||||||
Foreign translation adjustment and other net additions | 359 | (372 | ) | (731 | ) | (203.6 | ) | 749 | (563 | ) | (1,312 | ) | (175.2 | ) | ||||||||||||||
Ending balance of allowance for loan losses | $ | 350,491 | $ | 580,474 | $ | 229,983 | 65.6 | % | $ | 350,491 | $ | 580,474 | $ | 229,983 | 65.6 | % | ||||||||||||
Allowance for losses on off-balance sheet commitments | 86,374 | 111,374 | 25,000 | 28.9 | 86,374 | 111,374 | 25,000 | 28.9 | ||||||||||||||||||||
Allowances for credit losses | $ | 436,865 | $ | 691,848 | $ | 254,983 | 58.4 | % | $ | 436,865 | $ | 691,848 | $ | 254,983 | 58.4 | % | ||||||||||||
Allowance for loan losses to total loans(1) | 0.88 | % | 1.20 | % | 0.88 | % | 1.20 | % | ||||||||||||||||||||
Allowances for credit losses to total loans(2) | 1.10 | % | 1.43 | % | 1.10 | % | 1.43 | % | ||||||||||||||||||||
(Reversal of) provision for loan losses to net loans charged off | 879.12 | % | 187.04 | % | 394.63 | % | 268.71 | % | ||||||||||||||||||||
Net loans charged off to average loans outstanding for the period(3) | 0.02 | % | 0.53 | % | 0.02 | % | 0.31 | % |
- (1)
- The allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans or total nonperforming loans, as appropriate. These ratios relate to continuing operations only.
- (2)
- The allowance for credit losses ratios are calculated using the sum of the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans or total nonperforming loans, as appropriate. These ratios relate to continuing operations only.
- (3)
- Annualized.
nm = not meaningful
Nonperforming Assets
Nonperforming assets consist of nonaccrual loans, restructured 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 the Consolidated Financial Statements included in our 2007 Form 10-K. Restructured loans are loans in which the Bank has formally restructured all or a significant portion
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of the loan and provided a concession in the form of debt forgiveness, a modification of interest rate and/or payment terms. The impairment (the shortfall between the present value of the loan under modified terms and the carrying value) is normally recorded in noninterest expense at the date of restructuring. Restructured loans are disclosed as nonperforming assets for the calendar year of restructuring, and, if in current status during this period may be disclosed as performing assets thereafter. Foreclosed assets include property where we acquired title through foreclosure or "deed in lieu" of foreclosure.
The following table sets forth an analysis of nonperforming assets.
| | | | Increase (Decrease) September 30, 2008 From: | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | September 30, 2007 | December 31, 2007 | |||||||||||||||||||
| September 30, 2007 | December 31, 2007 | September 30, 2008 | |||||||||||||||||||||
(Dollars in thousands) | Amount | Percent | Amount | Percent | ||||||||||||||||||||
Commercial, financial and industrial | $ | 36,979 | $ | 29,293 | $ | 162,294 | $ | 125,315 | nm | $ | 133,001 | nm | ||||||||||||
Construction | — | 13,662 | 93,028 | 93,028 | nm | 79,366 | nm | |||||||||||||||||
Commercial mortgage | 14,265 | 12,775 | 33,553 | 19,288 | nm | 20,778 | nm | |||||||||||||||||
Total nonaccrual loans | 51,244 | 55,730 | 288,875 | 237,631 | nm | 233,145 | nm | |||||||||||||||||
Restructured Loans | ||||||||||||||||||||||||
Mortgage—Residential | — | — | 1,449 | 1,449 | nm | 1,449 | nm | |||||||||||||||||
Foreclosed assets | 1,318 | 795 | 13,922 | 12,604 | nm | 13,127 | nm | |||||||||||||||||
Total nonperforming assets | $ | 52,562 | $ | 56,525 | $ | 304,246 | $ | 251,684 | nm | $ | 247,721 | nm | ||||||||||||
Allowance for loan losses | $ | 350,491 | $ | 402,726 | $ | 580,474 | $ | 229,983 | 65.6 | % | $ | 177,748 | 44.1 | % | ||||||||||
Allowances for credit losses | $ | 436,865 | $ | 493,100 | $ | 691,848 | $ | 254,983 | 58.4 | % | $ | 198,748 | 40.3 | % | ||||||||||
Nonaccrual loans to total loans | 0.13 | % | 0.14 | % | 0.60 | % | ||||||||||||||||||
Allowance for loan losses to nonaccrual loans(1) | 683.96 | 722.64 | 200.94 | |||||||||||||||||||||
Allowances for credit losses to nonaccrual loans(2) | 852.52 | 884.80 | 239.50 | |||||||||||||||||||||
Nonperforming assets to total loans and foreclosed assets | 0.13 | 0.14 | 0.63 | |||||||||||||||||||||
Nonperforming assets to total assets | 0.10 | 0.10 | 0.49 |
- (1)
- The allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans or total nonperforming loans, as appropriate. These ratios relate to continuing operations only.
- (2)
- The allowances for credit losses ratios are calculated using the sum of the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans or total nonperforming loans, as appropriate. These ratios relate to continuing operations only.
nm = not meaningful
The increase in nonaccrual loans from September 30, 2007 to September 30, 2008 was primarily due to an increase in commercial and construction loans (primarily related to our homebuilder loan portfolio), partially offset by loan pay downs and charge offs. During the nine months ended September 30, 2008, we had three restructured residential loans totaling $1.4 million for which we recorded a $0.2 million impairment charge. During the third quarters of 2007 and 2008, we had no sales and $3.6 million in sales of nonperforming loans, respectively.
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Loans 90 Days or More Past Due and Still Accruing
| | | | Increase (Decrease) September 30, 2008 From: | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | September 30, 2007 | December 31, 2007 | ||||||||||||||||
| September 30, 2007 | December 31, 2007 | September 30, 2008 | ||||||||||||||||||
(Dollars in thousands) | Amount | Percent | Amount | Percent | |||||||||||||||||
Commercial, financial and industrial | $ | 3,076 | $ | 3,797 | $ | 1,921 | $ | (1,155 | ) | (37.5)% | $ | (1,876 | ) | (49.4)% | |||||||
Construction | 3,052 | — | — | (3,052 | ) | (100.0) | — | nm | |||||||||||||
Mortgage: | |||||||||||||||||||||
Residential | 10,975 | 13,359 | 39,655 | 28,680 | nm | 26,296 | nm | ||||||||||||||
Commercial | — | — | 1,781 | 1,781 | nm | 1,781 | — | ||||||||||||||
Total mortgage | 10,975 | 13,359 | 41,436 | 30,461 | nm | 28,077 | nm | ||||||||||||||
Consumer and other | 819 | 2,982 | 5,873 | 5,054 | nm | 2,891 | 96.9 | ||||||||||||||
Total loans 90 days or more past due and still accruing | $ | 17,922 | $ | 20,138 | $ | 49,230 | $ | 31,308 | nm | $ | 29,092 | nm | |||||||||
nm = not meaningful
Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk primarily exists 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 any undue adverse impact on earnings and capital arising from changes in interest rates and other market variables and to ensure the Bank has adequate sources of liquidity. This risk management objective supports our broad objective of enhancing 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 and Liability Management, Investment and Derivatives Policy (ALM Policy), which governs the management of market risk and guides our investment, derivatives and trading activities. The ALM Policy establishes the Bank's risk tolerance guidelines by outlining standards for measuring market risk, creates Board-level limits for specific market risks, establishes guidelines for reporting market risk and requires independent review and oversight of market risk activities.
In an effort to ensure that the Bank has an effective process to identify, measure, monitor and manage market risk, the ALM Policy requires the Bank to establish an Asset Liability Management Committee (ALCO), which is comprised of the members of the CEO Forum and the Treasurer. ALCO provides the broad and strategic guidance of market risk management by formulating high-level strategies for market risk management and defining the risk/return direction for the Bank, and by approving the investment, derivatives and trading policies that govern the Bank's activities. ALCO is also responsible for the ongoing management of market risk and approves specific risk management programs, including those related to interest rate hedging, investment securities, wholesale funding and trading activities.
The Treasurer is primarily responsible for the implementation of risk management strategies approved by ALCO and for operational management of market risk through the funding, investment and derivatives hedging activities of Corporate Treasury. The managers of the Global Markets Division and the Capital Markets Division are responsible for operational management of price risk through the trading activities conducted in their respective divisions. The Market Risk Monitoring (MRM) unit is responsible for the monitoring of market risk and MRM functions independently of all operating and management units.
We have separate and distinct methods for managing the market risk associated with our asset and liability management activities and our trading activities, as described below. For additional information about our market risk management, please see "Quantitative and Qualitative Disclosures about Market Risk" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2007 Form 10-K.
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Interest Rate Risk Management (Other Than Trading)
During the third quarter of 2008, our interest rate risk profile became less liability sensitive primarily as a result of the termination of ALM derivative floors and swaps and elevated short LIBOR rates towards the end of the quarter. During the first quarter of 2008, we added $500 million of interest rate floor hedges to maintain the Bank's liability sensitive interest rate risk profile (see discussion of "ALM Derivatives" below).
At September 30, 2008, Economic Net Interest Income (NII) sensitivity was liability sensitive to parallel rate shifts. A +200 basis point parallel shift would reduce 12-month Economic NII by 0.62 percent, while a similar downward shift would increase it by 0.67 percent. At September 30, 2007, a +200 basis point parallel shift would reduce 12-month Economic NII by 0.13 percent, while a similar downward shift would increase it by 0.74 percent. We caution that ongoing enhancements to our interest rate risk modeling may make prior-year comparisons of Economic NII less meaningful. Economic NII adjusts our reported NII for the effect of certain noninterest bearing deposit related fee and expense items. Those adjustment items are innately liability sensitive, meaning that reported NII is less liability sensitive than Economic NII.
Economic NII
(Dollars in millions) | September 30, 2007 | December 31, 2007 | September 30, 2008 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
+200 basis points | $ | (2.6 | ) | $ | (17.4 | ) | $ | (14.2 | ) | |
as a percentage of base case NII | (0.13 | )% | (0.93 | )% | (0.62 | )% | ||||
-200 basis points | $ | 14.7 | $ | 35.2 | $ | 15.3 | ||||
as a percentage of base case NII | 0.74 | % | 1.87 | % | 0.67 | % |
The above table is presented on a continuing operations basis, with all assets and liabilities associated with the insurance brokerage business eliminated for September 30, 2008 and all assets and liabilities of the retirement recordkeeping business eliminated for December 31, 2007 and September 30, 2008. We believe that this approach provides the best representation of our risk profiles.
In the case of non-parallel yield curve changes, our Economic NII is liability sensitive to changes in short-term rates (with long-term rates held constant) and asset sensitive to changes in long-term rates (with short-term rates held constant). In other words, our Economic NII will benefit from curve steepening with short-term rates dropping and will contract from the curve further inverting with long-term rates dropping.
ALM Activities
During the first nine months of 2008, the Bank has maintained a liability sensitive interest rate risk profile to stay protected from falling rates. The significant growth in loans during the period was supported largely by shorter term funding coupled with lower rates on our interest bearing short-term liabilities, among other dynamics, has enabled us to position the Bank favorably for lower rates. The elevated short rates towards the end of the third quarter reduced the liability sensitivity position of the Bank at September 30, 2008. In addition, $2.6 billion in floors and swaps were terminated in the third quarter of 2008 to reduce the overall liability sensitivity to a more moderate risk profile. The remaining ALM derivatives portfolio continues to protect the bank from falling rates. In managing the interest rate sensitivity of our balance sheet, we use the ALM investment securities portfolio and derivatives positions as the primary tools to adjust our interest rate risk profile, if necessary. During the third quarter of 2008, we reinvested proceeds from maturing ALM securities into securities with like terms and asset allocation. New derivative hedges were also added during the year as described below.
ALM Securities
At September 30, 2007 and 2008, our available for sale securities portfolio included $6.6 billion and $6.8 billion, respectively, of securities respectively for ALM purposes. At September 30, 2008, $6.6 billion of the portfolio was pledged to secure trust and public deposits and for other purposes as required or permitted by
68
law. During the third quarter of 2008, we purchased $462 million par value of securities, while $380 million par value of ALM securities matured or were called.
The composition of the portfolio is expected to remain relatively stable in 2008. Based on current prepayment projections, the estimated ALM portfolio's effective duration was 2.3 at September 30, 2008, compared to 2.2 at September 30, 2007. Effective duration is a measure of price sensitivity of a bond portfolio to immediate parallel shifts in interest rates. An effective duration of 2.3 suggests an expected price decrease of approximately 2.3 percent for an immediate 1.0 percent parallel increase in interest rates.
ALM Derivatives
During the first nine months of 2008, the ALM derivatives portfolio decreased by $3.9 billion notional amount as $0.5 billion notional amount of LIBOR floor contracts were purchased to maintain the downside liability sensitivity of our overall risk position, offset by maturities of $1.8 billion and terminations of $2.6 billion notional amount of receive fixed interest rate swaps and floors.
The fair value of the ALM derivative contracts decreased primarily due to maturities and terminations despite the increase in fair value of remaining interest rate swaps and floor option contracts from the Federal Reserve Board's interest rate reductions, the expectation of lower future interest rates and higher volatility in interest rates. For additional discussion of derivative instruments and our hedging strategies, see Note 11 to the condensed consolidated financial statements in this Form 10-Q and Note 19 to our consolidated financial statements included in our 2007 Form 10-K.
The following table provides the notional value and the fair value of our ALM derivatives portfolio as of September 30, 2007, December 31, 2007, and September 30, 2008 and the change in fair value between December 31, 2007 and September 30, 2008.
(Dollars in thousands) | September 30, 2007 | December 31, 2007 | September 30, 2008 | Decrease From December 31, 2007 to September 30, 2008 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Total gross notional amount of positions held for purposes other than trading: | $ | 7,750,000 | $ | 9,250,000 | $ | 5,400,000 | $ | (3,850,000 | ) | ||||||
of which, interest rate swaps pay fixed rates of interest | — | — | — | — | |||||||||||
Fair value of positions held for purposes other than trading: | |||||||||||||||
Gross positive fair value | $ | 55,189 | $ | 148,036 | $ | 128,876 | $ | (19,160 | ) | ||||||
Gross negative fair value | 8,643 | 2,015 | — | (2,015 | ) | ||||||||||
Positive (Negative) fair value of positions, net | $ | 46,546 | $ | 146,021 | $ | 128,876 | $ | (17,145 | ) | ||||||
Trading Activities
We enter into trading account activities primarily as a financial intermediary for customers and, to some extent, for our own account. By acting as a financial intermediary, we are able to provide our customers with access to a range of products supporting the securities, foreign exchange and derivatives markets. In acting for our own account, we may take positions in certain securities, foreign exchange and interest rate instruments, subject to various limits in amount, tenor and other respects, with the objective of generating trading profits.
As of September 30, 2008, we had $17.9 billion notional amount of interest rate derivative contracts. We enter into these agreements for customer accommodations, and use a combination of offsetting derivatives,
69
futures and securities positions to neutralize to the extent possible the market risk associated with customer transactions. Additionally, we enter into contracts for our own trading purposes.
We market energy derivative contracts to existing energy industry customers, primarily oil and gas producers, in order to meet their hedging needs. All transactions are fully matched to remove our exposure to market risk, with income earned on the credit spread. As of September 30, 2008, we had $4.8 billion notional amount of energy derivative contracts with approximately half of these energy derivative contracts entered into as an accommodation for customers and the remaining half entered into as matching contracts to remove our exposure to market risk on our customer accommodation transactions.
The following table provides the notional value and the fair value of our trading derivatives portfolio as of September 30, 2007, December 31, 2007, and September 30, 2008 and the change in fair value between December 31, 2007 and September 30, 2008.
(Dollars in thousands) | September 30, 2007 | December 31, 2007 | September 30, 2008 | Increase / (Decrease) From December 31, 2007 to September 30, 2008 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Total gross notional amount of positions held for trading purposes: | ||||||||||||||
Interest rate | $ | 11,295,073 | $ | 12,585,978 | $ | 17,946,872 | $ | 5,360,894 | ||||||
Foreign exchange | 5,914,225 | 4,665,760 | 4,993,475 | 327,715 | ||||||||||
Energy | 3,017,533 | 2,900,690 | 4,808,754 | 1,908,064 | ||||||||||
Total | $ | 20,226,831 | $ | 20,152,428 | $ | 27,749,101 | $ | 7,596,673 | ||||||
Fair value of positions held for trading purposes: | ||||||||||||||
Gross positive fair value | $ | 279,494 | $ | 405,709 | $ | 552,179 | $ | 146,470 | ||||||
Gross negative fair value | 259,914 | 380,313 | 534,286 | 153,973 | ||||||||||
Positive fair value of positions, net | $ | 19,580 | $ | 25,396 | $ | 17,893 | $ | (7,503 | ) | |||||
Liquidity Risk
Liquidity risk is the undue risk to the Bank's earnings and capital, which would result from the Bank's inability to meet its obligations as they come due without incurring unacceptable costs. The management of liquidity risk is governed by the ALM Policy under the oversight of ALCO. Liquidity is managed using a total balance sheet perspective that analyzes both funding capacity available through increased liabilities and liquidation of assets relative to projected demands for liquidity. The primary sources of liquidity are core deposits, asset liquidation, including securities sold under repurchase agreements, and wholesale funding, which includes funds raised from interbank and other sources, both domestic and offshore. The Treasurer is responsible for operational management of liquidity through the funding and investment functions of Corporate Treasury. ALCO also maintains a Liquidity Contingency Plan that identifies actions to be taken to ensure adequate liquidity if an event should occur that disrupts or adversely affects the Bank's normal funding activities.
Core deposits provide us with a sizable source of relatively stable and low-cost funds. Our $31.8 billion in average core deposits, which includes demand deposits, money market demand accounts, savings and consumer time deposits, combined with average common stockholders' equity, funded 59.5 percent of average total assets of $61.1 billion in the third quarter of 2008. Most of the remaining funding was provided by variable rate wholesale borrowings from secured and unsecured sources.
70
Our securities portfolio provides additional enhancement to our liquidity position, which may be created through either securities sales or repurchase agreements. At September 30, 2008, we could have sold or transferred under repurchase agreements approximately $0.5 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 assets. The aggregate balance of these assets averaged $1.3 billion in the third quarter of 2008. Additional liquidity may be provided through loan maturities and sales.
The Bank has a $4 billion unsecured Bank Note Program. As of September 30, 2008, the remaining available funding under the Bank Note Program is $2.6 billion. We do not have firm commitments in place to sell securities under the Bank Note Program. The Bank has pledged collateral under secured borrowing facilities with the Federal Home Loan Bank of San Francisco (FHLB) and the Federal Reserve Bank (FRB). The Bank increased its reliance on secured funding during the third quarter of 2008 due to rate advantages and reduced term lending activity in the market. As of September 30, 2008, the Bank had $4.5 billion of borrowing outstanding with the FHLB, of which $2.6 billion is short-term and included in Other Borrowed Funds. As of September 30, 2008, the Bank had $3.0 billion in short-term borrowing outstanding with the FRB under the Term Auction Facility program, which provides access to short-term funds at generally favorable rates. As of September 30, 2008, the Bank had remaining unused borrowing capacity totaling a combined $16.9 billion from the FHLB and the FRB. The Bank has the capability to pledge additional portions of its unencumbered loan and securities portfolios to the FHLB and the FRB, which would increase the Bank's borrowing capacity.
We believe that these sources, in addition to our core deposit and equity capital, provide a stable funding base. Management does not rely on any one source of liquidity and manages availability in response to changing balance sheet needs. The costs and ability to raise funds are influenced by our credit ratings. The following table provides our credit ratings as of September 30, 2008.
| | Union Bank of California, N.A. | UnionBanCal Corporation | |||
---|---|---|---|---|---|---|
Standard & Poor's | Long-term | A+ | A | |||
Short-term | A-1 | A-1 | ||||
Moody's | Long-term | Aa3 | — | |||
Short-term | P-1 | — | ||||
Fitch | Long-term | A+ | A+ | |||
Short-term | F1 | F1 | ||||
DBRS | Long-term | A (high) | A | |||
Short-term | R-1 (middle) | R-1 (low) |
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Regulatory Capital
The following tables summarize our risk-based capital, risk-weighted assets, and risk-based capital ratios.
UnionBanCal Corporation
(Dollars in thousands) | September 30, 2007 | December 31, 2007 | September 30, 2008 | Minimum Regulatory Requirement | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Capital Components | |||||||||||||
Tier 1 capital | $ | 4,476,759 | $ | 4,533,763 | $ | 4,923,929 | |||||||
Tier 2 capital | 1,533,891 | 1,590,160 | 1,788,995 | ||||||||||
Total risk-based capital | $ | 6,010,650 | $ | 6,123,923 | $ | 6,712,924 | |||||||
Risk-weighted assets | $ | 53,287,524 | $ | 54,606,527 | $ | 61,365,714 | |||||||
Quarterly average assets | $ | 53,368,377 | $ | 54,843,792 | $ | 61,771,614 | |||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Capital Ratios | |||||||||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 6,010,650 | 11.28 | % | $ | 6,123,923 | 11.21 | % | $ | 6,712,924 | 10.94 | % | > | $4,909,257 | 8.0 | % | |||||||||
Tier 1 capital (to risk-weighted assets) | 4,476,759 | 8.40 | 4,533,763 | 8.30 | 4,923,929 | 8.02 | > | 2,454,629 | 4.0 | ||||||||||||||||
Leverage(1) | 4,476,759 | 8.39 | 4,533,763 | 8.27 | 4,923,929 | 7.97 | ³ | 2,470,865 | 4.0 |
- (1)
- Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).
Union Bank of California, N.A.
(Dollars in thousands) | September 30, 2007 | December 31, 2007 | September 30, 2008 | Minimum Regulatory Requirement | "Well-Capitalized" Regulatory Requirement | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Capital Components | ||||||||||||||||
Tier 1 capital | $ | 4,351,532 | $ | 4,449,368 | $ | 5,012,492 | ||||||||||
Tier 2 capital | 1,125,260 | 1,181,796 | 1,378,628 | |||||||||||||
Total risk-based capital | $ | 5,476,792 | $ | 5,631,164 | $ | 6,391,120 | ||||||||||
Risk-weighted assets | $ | 52,802,713 | $ | 54,234,495 | $ | 61,318,242 | ||||||||||
Quarterly average assets | $ | 52,775,720 | $ | 54,277,811 | $ | 61,477,326 | ||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Capital Ratios | |||||||||||||||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 5,476,792 | 10.37 | % | $ | 5,631,164 | 10.38 | % | $ | 6,391,120 | 10.42 | % | ³ | $4,905,459 | 8.0 | % | ³ | $6,131,824 | 10.0 | % | |||||||||||
Tier 1 capital (to risk-weighted assets) | 4,351,532 | 8.24 | 4,449,368 | 8.20 | 5,012,492 | 8.17 | ³ | 2,452,730 | 4.0 | ³ | 3,679,095 | 6.0 | |||||||||||||||||||
Leverage(1) | 4,351,532 | 8.25 | 4,449,368 | 8.20 | 5,012,492 | 8.15 | ³ | 2,459,093 | 4.0 | ³ | 3,073,866 | 5.0 |
- (1)
- Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).
We and Union Bank of California 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 the UnionBanCal Corporation Tier 1 and Total capital ratios from December 31, 2007 was primarily due to an increase in risk-weighted assets stemming from growth in our loan portfolio. The decrease in the UnionBanCal Corporation and Union Bank of California leverage ratios from December 31, 2007 was primarily due to the increase in our quarterly average assets, which was due to growth in our loan portfolio.
As of September 30, 2008 management believes the capital ratios of Union Bank of California met all regulatory requirements of "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.
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Business Segments
The various operating segments reporting under our Chief Operating Officer and the Group Head of Pacific Rim Corporate Group have been aggregated into two reportable business segments entitled "Retail Banking" and "Wholesale Banking" based upon the aggregation criteria prescribed in SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information."
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.
The tables that follow reflect the condensed income statements, selected average balance sheet items, and selected financial ratios, including changes compared to the prior year, for both of our reportable business segments. The information presented does not necessarily represent the businesses' financial condition and results of operations as if they were independent entities. We reflect a "market view" perspective in measuring our operating segments. The market view is a measurement of our 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 operating segment that provides the service and the operating segment that manages the customer relationship. 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 services being managed. For example, the Securities Trading and Sales unit within the Global Markets Division is a business unit that manages the fixed income securities activities for all retail and corporate customers throughout the Bank. This unit retains and also allocates revenues and expenses to divisions responsible for such retail and commercial customer relationships.
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.
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The reportable business segment results for the prior periods have been adjusted to reflect changes in the transfer pricing methodology, the organizational changes that have occurred and our discontinued operations. For further information on discontinued operations, see Note 3 to the condensed consolidated financial statements in this Form 10-Q.
| Retail Banking | | | Wholesale Banking | | | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | Increase/ (decrease) | As of and for the Three Months Ended September 30, | Increase/ (decrease) | ||||||||||||||||||||||
| 2007 | 2008 | Amount | Percent | 2007 | 2008 | Amount | Percent | ||||||||||||||||||
Results of operations—Market View (dollars in | ||||||||||||||||||||||||||
Net interest income (expense) | $ | 221,023 | $ | 251,559 | $ | 30,536 | 14 | % | $ | 241,467 | $ | 306,895 | $ | 65,428 | 27 | % | ||||||||||
Noninterest income | 123,802 | 122,546 | (1,256 | ) | (1 | ) | 93,834 | 92,489 | (1,345 | ) | (1 | ) | ||||||||||||||
Total revenue | 344,825 | 374,105 | 29,280 | 8 | 335,301 | 399,384 | 64,083 | 19 | ||||||||||||||||||
Noninterest expense | 218,197 | 251,561 | 33,364 | 15 | 140,144 | 156,304 | 16,160 | 12 | ||||||||||||||||||
Credit expense (income) | 6,361 | 7,056 | 695 | 11 | 28,231 | 49,115 | 20,884 | 74 | ||||||||||||||||||
Income (loss) from continuing operations before income taxes | 120,267 | 115,488 | (4,779 | ) | (4 | ) | 166,926 | 193,965 | 27,039 | 16 | ||||||||||||||||
Income tax expense (benefit) | 46,002 | 44,174 | (1,828 | ) | (4 | ) | 50,834 | 55,457 | 4,623 | 9 | ||||||||||||||||
Income (loss) from continuing operations | 74,265 | 71,314 | (2,951 | ) | (4 | ) | 116,092 | 138,508 | 22,416 | 19 | ||||||||||||||||
Loss from discontinued operations, net of income taxes | — | — | — | na | — | — | — | na | ||||||||||||||||||
Net income (loss) | $ | 74,265 | $ | 71,314 | $ | (2,951 | ) | (4 | ) | $ | 116,092 | $ | 138,508 | $ | 22,416 | 19 | ||||||||||
Average balances—Market View (dollars in millions): | ||||||||||||||||||||||||||
Total loans | $ | 17,050 | $ | 20,089 | $ | 3,039 | 18 | $ | 22,450 | $ | 27,163 | $ | 4,713 | 21 | ||||||||||||
Total assets | 17,858 | 20,945 | 3,087 | 17 | 27,043 | 31,973 | 4,930 | 18 | ||||||||||||||||||
Total deposits | 18,954 | 18,842 | (112 | ) | (1 | ) | 18,374 | 17,727 | (647 | ) | (4 | ) | ||||||||||||||
Financial ratios—Market View | ||||||||||||||||||||||||||
Risk adjusted return on capital(1) | 49 | % | 43 | % | 21 | % | 21 | % | ||||||||||||||||||
Return on average assets(1) | 1.65 | 1.35 | 1.70 | 1.72 | ||||||||||||||||||||||
Efficiency ratio(2) | 63.27 | 67.10 | 41.80 | 39.14 |
| Other | | �� | Reconciling Items | UnionBanCal Corporation | | | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | Increase/ (decrease) | As of and for the Three Months Ended September 30, | As of and for the Three Months Ended September 30, | Increase/ (decrease) | |||||||||||||||||||||||||||
| 2007 | 2008 | Amount | Percent | 2007 | 2008 | 2007 | 2008 | Amount | Percent | ||||||||||||||||||||||
Results of operations—Market View (dollars in thousands): | ||||||||||||||||||||||||||||||||
Net interest income (expense) | $ | (33,690 | ) | $ | (35,921 | ) | $ | (2,231 | ) | (7 | )% | $ | (2,237 | ) | $ | (2,787 | ) | $ | 426,563 | $ | 519,746 | $ | 93,183 | 22 | % | |||||||
Noninterest income | 7,245 | 2,973 | (4,272 | ) | (59 | ) | (16,694 | ) | (19,287 | ) | 208,187 | 198,721 | (9,466 | ) | (5 | ) | ||||||||||||||||
Total revenue | (26,445 | ) | (32,948 | ) | (6,503 | ) | (25 | ) | (18,931 | ) | (22,074 | ) | 634,750 | 718,467 | 83,717 | 13 | ||||||||||||||||
Noninterest expense | 32,938 | 47,741 | 14,803 | 45 | (10,432 | ) | (11,794 | ) | 380,847 | 443,812 | 62,965 | 17 | ||||||||||||||||||||
Credit expense (income) | (18,570 | ) | 60,870 | 79,440 | nm | (22 | ) | (41 | ) | 16,000 | 117,000 | 101,000 | nm | |||||||||||||||||||
Income (loss) from continuing operations before income taxes | (40,813 | ) | (141,559 | ) | (100,746 | ) | nm | (8,477 | ) | (10,239 | ) | 237,903 | 157,655 | (80,248 | ) | (34 | ) | |||||||||||||||
Income tax expense (benefit) | (5,930 | ) | (48,166 | ) | (42,236 | ) | nm | (3,242 | ) | (3,916 | ) | 87,664 | 47,549 | (40,115 | ) | (46 | ) | |||||||||||||||
Income (loss) from continuing operations | (34,883 | ) | (93,393 | ) | (58,510 | ) | nm | (5,235 | ) | (6,323 | ) | 150,239 | 110,106 | (40,133 | ) | (27 | ) | |||||||||||||||
Loss from discontinued operations, net of income taxes | (22,780 | ) | (5,276 | ) | 17,504 | 77 | — | — | (22,780 | ) | (5,276 | ) | 17,504 | 77 | ||||||||||||||||||
Net income (loss) | $ | (57,663 | ) | $ | (98,669 | ) | $ | (41,006 | ) | (71 | ) | $ | (5,235 | ) | $ | (6,323 | ) | $ | 127,459 | $ | 104,830 | $ | (22,629 | ) | (18 | ) | ||||||
Average balances—Market View (dollars in millions): | ||||||||||||||||||||||||||||||||
Total loans | $ | 5 | $ | 1 | $ | (4 | ) | (80 | ) | $ | (20 | ) | $ | (57 | ) | $ | 39,485 | $ | 47,196 | $ | 7,711 | 20 | ||||||||||
Total assets | 8,488 | 8,286 | (202 | ) | (2 | ) | (22 | ) | (59 | ) | 53,367 | 61,145 | 7,778 | 15 | ||||||||||||||||||
Total deposits | 5,254 | 5,704 | 450 | 9 | (619 | ) | (612 | ) | 41,963 | 41,661 | (302 | ) | (1 | ) | ||||||||||||||||||
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 | 1.12 | % | 0.72 | % | ||||||||||||||||||||||||
Efficiency ratio(2) | na | na | na | na | 59.14 | 60.37 |
- (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 and noninterest income.
na = not applicable
nm = not meaningful
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| Retail Banking | | | Wholesale Banking | | | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | Increase/ (decrease) | As of and for the Nine Months Ended September 30, | Increase/ (decrease) | ||||||||||||||||||||||
| 2007 | 2008 | Amount | Percent | 2007 | 2008 | Amount | Percent | ||||||||||||||||||
Results of operations—Market View (dollars in thousands): | ||||||||||||||||||||||||||
Net interest income (expense) | $ | 672,832 | $ | 718,033 | $ | 45,201 | 7 | % | $ | 725,514 | $ | 873,260 | $ | 147,746 | 20 | % | ||||||||||
Noninterest income | 358,122 | 369,293 | 11,171 | 3 | 275,440 | 258,266 | (17,174 | ) | (6 | ) | ||||||||||||||||
Total revenue | 1,030,954 | 1,087,326 | 56,372 | 5 | 1,000,954 | 1,131,526 | 130,572 | 13 | ||||||||||||||||||
Noninterest expense | 668,730 | 725,208 | 56,478 | 8 | 420,690 | 451,692 | 31,002 | 7 | ||||||||||||||||||
Credit expense (income) | 18,896 | 20,337 | 1,441 | 8 | 80,156 | 135,682 | 55,526 | 69 | ||||||||||||||||||
Income (loss) from continuing operations before income taxes | 343,328 | 341,781 | (1,547 | ) | 0 | 500,108 | 544,152 | 44,044 | 9 | |||||||||||||||||
Income tax expense (benefit) | 131,323 | 130,731 | (592 | ) | 0 | 153,630 | 156,485 | 2,855 | 2 | |||||||||||||||||
Income (loss) from continuing operations | 212,005 | 211,050 | (955 | ) | 0 | 346,478 | 387,667 | 41,189 | 12 | |||||||||||||||||
Loss from discontinued operations, net of income taxes | — | — | — | na | — | — | — | na | ||||||||||||||||||
Net income (loss) | $ | 212,005 | $ | 211,050 | $ | (955 | ) | 0 | $ | 346,478 | $ | 387,667 | $ | 41,189 | 12 | |||||||||||
Average balances—Market View (dollars in millions): | ||||||||||||||||||||||||||
Total loans | $ | 16,590 | $ | 18,975 | $ | 2,385 | 14 | $ | 22,342 | $ | 26,203 | $ | 3,861 | 17 | ||||||||||||
Total assets | 17,405 | 19,806 | 2,401 | 14 | 27,053 | 30,986 | 3,933 | 15 | ||||||||||||||||||
Total deposits | 18,790 | 18,577 | (213 | ) | (1 | ) | 18,481 | 18,160 | (321 | ) | (2 | ) | ||||||||||||||
Financial ratios—Market View | ||||||||||||||||||||||||||
Risk adjusted return on capital(1) | 46 | % | 44 | % | 22 | % | 20 | % | ||||||||||||||||||
Return on average assets(1) | 1.63 | 1.42 | 1.71 | 1.67 | ||||||||||||||||||||||
Efficiency ratio(2) | 64.86 | 66.63 | 42.03 | 39.92 |
| Other | | | Reconciling Items | UnionBanCal Corporation | | | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | Increase/ (decrease) | As of and for the Nine Months Ended September 30, | As of and for the Nine Months Ended September 30, | Increase/ (decrease) | |||||||||||||||||||||||||||
| 2007 | 2008 | Amount | Percent | 2007 | 2008 | 2007 | 2008 | Amount | Percent | ||||||||||||||||||||||
Results of operations—Market View (dollars in thousands): | ||||||||||||||||||||||||||||||||
Net interest income (expense) | $ | (108,063 | ) | $ | (92,317 | ) | $ | 15,746 | 15 | % | $ | (6,503 | ) | $ | (8,094 | ) | $ | 1,283,780 | $ | 1,490,882 | $ | 207,102 | 16 | % | ||||||||
Noninterest income | 15,694 | 23,517 | 7,823 | 50 | (48,666 | ) | (57,333 | ) | 600,590 | 593,743 | (6,847 | ) | (1 | ) | ||||||||||||||||||
Total revenue | (92,369 | ) | (68,800 | ) | 23,569 | 26 | (55,169 | ) | (65,427 | ) | 1,884,370 | 2,084,625 | 200,255 | 11 | ||||||||||||||||||
Noninterest expense | 97,214 | 124,307 | 27,093 | 28 | (30,117 | ) | (34,877 | ) | 1,156,517 | 1,266,330 | 109,813 | 9 | ||||||||||||||||||||
Credit expense (income) | (73,982 | ) | 128,083 | 202,065 | nm | (70 | ) | (102 | ) | 25,000 | 284,000 | 259,000 | nm | |||||||||||||||||||
Income (loss) from continuing operations before income taxes | (115,601 | ) | (321,190 | ) | (205,589 | ) | nm | (24,982 | ) | (30,448 | ) | 702,853 | 534,295 | (168,558 | ) | (24 | ) | |||||||||||||||
Income tax expense (benefit) | (36,670 | ) | (108,077 | ) | (71,407 | ) | nm | (9,556 | ) | (11,646 | ) | 238,727 | 167,493 | (71,234 | ) | (30 | ) | |||||||||||||||
Income (loss) from continuing operations | (78,931 | ) | (213,113 | ) | (134,182 | ) | nm | (15,426 | ) | (18,802 | ) | 464,126 | 366,802 | (97,324 | ) | (21 | ) | |||||||||||||||
Loss from discontinued operations, net of income taxes | (21,702 | ) | (12,037 | ) | 9,665 | 45 | — | — | (21,702 | ) | (12,037 | ) | 9,665 | 45 | ||||||||||||||||||
Net income (loss) | $ | (100,633 | ) | $ | (225,150 | ) | $ | (124,517 | ) | (124 | ) | $ | (15,426 | ) | $ | (18,802 | ) | $ | 442,424 | $ | 354,765 | $ | (87,659 | ) | (20 | ) | ||||||
Average balances—Market View (dollars in millions): | ||||||||||||||||||||||||||||||||
Total loans | $ | 20 | $ | 8 | $ | (12 | ) | (60 | ) | $ | (21 | ) | $ | (48 | ) | $ | 38,931 | $ | 45,138 | $ | 6,207 | 16 | ||||||||||
Total assets | 8,631 | 8,282 | (349 | ) | (4 | ) | (23 | ) | (50 | ) | 53,066 | 59,024 | 5,958 | 11 | ||||||||||||||||||
Total deposits | 5,364 | 6,687 | 1,323 | 25 | (669 | ) | (603 | ) | 41,966 | 42,821 | 855 | 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 | 1.17 | % | 0.83 | % | ||||||||||||||||||||||||
Efficiency ratio(2) | na | na | na | na | 60.89 | 59.49 |
- (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 and noninterest income.
na = not applicable
nm = not meaningful
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Retail Banking
Retail Banking provides financial products including credit, deposit, trust, investment management, cash management and risk management delivered through our branches, relationship managers, private bankers, portfolio managers and trust administrators, to individuals, small businesses, institutional clients and professional services firms, foundations and endowments. Retail banking is focused on executing a segment based strategy that will identify targeted opportunities within the consumer, professional service firms, foundations and endowments and small business markets, and develop product, marketing and sales strategies to attract new customers in these identified target markets. While the primary focus of Retail Banking's segment based strategy is deposit growth, additional focus continues to be on consumer and small business loan generation and fee generation from trust and investment management.
During the nine months ended September 30, 2008, Retail Banking's net income was flat compared to the same period in 2007. The flat net income reflects higher net interest income and higher noninterest income, partially offset by higher noninterest expense. The increase in net interest income in 2008 is primarily due to strong loan growth and lower rates paid on interest bearing liabilities, partially offset by lower yields on earning assets and a deposit mix shift from noninterest bearing and low-cost deposits into higher-cost deposits.
Average assets grew by 14 percent during the nine months ended September 30, 2008, compared to the same period in 2007. This increase was primarily driven by a 15 percent growth in average residential mortgage loans. Additionally, the focus on home equity loans and more effective cross-selling efforts resulted in a 19 percent growth in consumer loans during the nine months ended September 30, 2008.
Average deposits decreased 1 percent during the nine months ended September 30, 2008, compared to the same period in 2007. Retail Banking's strategy continues to focus on attracting consumer and small business deposits through marketing activities, increasing customer cross-sell, relationship management, increasing and improving sales resources, establishing new locations and new products. We expect that a larger branch network, along with this Retail Banking strategy, will improve growth prospects when combined with more robust efforts in the telephone and internet channels.
Noninterest income increased 3 percent during the nine months ended September 30, 2008, compared to the same period in 2007. This increase was primarily due to growth in trust fees, partially offset by a decrease in deposit fees. Noninterest expense increased 8 percent during the nine months ended September 30, 2008, compared to the same period in 2007, primarily due to higher salaries and employee benefits and occupancy expenses. Noninterest expense was also negatively impacted by higher operating losses and regulatory expenses.
Retail Banking is comprised of the following major divisions: Retail Banking Branches, Consumer Asset Management, Wealth Management and Institutional Services and Asset Management.
- •
- Retail Banking Branches serves its customers through 333 full-service branches in California, 4 full-service branches in Oregon and Washington and 2 international offices. We own property occupied by 116 of the domestic offices and lease the remaining properties for periods of five to twenty years. Customers may also access our services 24 hours-a-day by telephone or through our website at www.unionbank.com. In addition, the branches offer automated teller and point-of-sale merchant services.
Retail Banking Branches is organized geographically. We serve our customers in the following ways:
- —
- through conveniently located banking branches, which serve consumers and businesses with checking and deposit services, as well as various types of consumer financing and investment services;
- —
- through our internet banking services, which augment our physical delivery channels by providing an array of customer transaction, bill payment and loan payment services;
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- —
- through business banking centers, which serve small businesses; and
- —
- through in-store branches.
- •
- Consumer Asset Management provides the centralized origination, underwriting, processing, servicing, collection and administration for consumer assets including residential mortgages.
Through alliances with other financial institutions, Consumer Asset Management offers additional products and services, such as credit cards and merchant bank cards.
Our Retail Banking Branches and Consumer Asset Management divisions compete with larger banks by attempting to provide service quality superior to that of our major competitors. The primary means of competing with community banks include our branch network and our technology to deliver banking services. We also offer convenient banking hours to consumers through our drive-through banking locations and selected branches that are open seven days a week.
These divisions compete 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.
- •
- Wealth Management provides comprehensive private banking services to our individual wealth market clientele, professional service firms, foundations and endowments. 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, as well as attracting new relationships. Through 15 existing locations, The Private Bank relationship managers offer all of our available products and services.
- •
- Institutional Services and Asset Management provides investment management and administration services for a broad range of individuals and institutions.
- —
- 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 investment management services to Union Bank of California with respect to most of its trust and agency clients, including corporations, pension funds and individuals. HighMark Capital Management, Inc.'s strategy is to broaden its client base and to increase the assets of the 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, and provides escrow services and trustee services for project finance. Retirement Plan Services provides defined benefit services, including trustee services and investment management. The client base of Institutional Services includes financial institutions, corporations, government agencies, unions, insurance companies, mutual funds, investment managers and non-profit organizations. Institutional Services' strategy is to continue to leverage and expand its position in our target markets.
Wholesale Banking
Wholesale Banking offers financing, depository and cash management services to middle market and large corporate businesses primarily headquartered in the western U.S. Wholesale Banking continues 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
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financing, project financing, lease financing, trade financing and real estate financing. In addition to credit services, Wholesale Banking 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, as well as investment and risk management products.
During the nine months ended September 30, 2008, Wholesale Banking's net income increased by 12 percent, compared to the same period in 2007, due to higher net interest income, partially offset by higher credit expense and higher noninterest expense.
For the nine months ended September 30, 2008, net interest income increased 20 percent, compared to the same period in 2007. The increase in net interest income was primarily due to a 17 percent increase in average loan balances, mainly in the Energy Capital Services and National Banking divisions, as well as the California middle market. Net interest income was negatively impacted by a decrease in noninterest bearing deposits and an increase in interest bearing deposits, as well as lower yields on earning assets.
Noninterest income decreased by 6 percent during the nine months ended September 30, 2008, compared to the same period in 2007, primarily due to lower gains on private capital investments, partially offset by higher merchant banking, and deposit fees. Noninterest expense increased by 7 percent during the nine months ended September 30, 2008, compared to the same period in 2007, mainly due to higher salaries and employee benefits.
Wholesale Banking initiatives continue to include expanded deposit activities and loan strategies that include originating, underwriting and syndicating loans in core competency markets, such as the California middle-market, corporate banking, commercial real estate, energy, equipment leasing and commercial finance. The Commercial Deposit and Treasury Management Division provides processing services, including services such as Automated Clearing House (ACH), check processing and cash vault services.
Wholesale Banking is comprised of the following main divisions:
- •
- theCommercial Banking Division, which serves California, Oregon and Washington middle-market and large corporate companies with commercial lending, trade financing and asset-based loans;
- •
- theReal Estate Industries Division, which provides real estate lending products such as construction loans, commercial mortgages and bridge financing;
- •
- theEnergy Capital Services Division, which provides corporate financing and project financing to oil and gas companies, as well as power and utility companies, in the U.S. and Canada;
- •
- theEquipment Leasing Division, which provides lease financing services to corporate customers nationwide;
- •
- theNational Banking Division, which provides financing, deposits and traditional banking services to corporate clients in defined industries, nationwide;
- •
- theCommercial Deposit and Treasury Management Division, which provides deposit and cash management expertise to middle-market and large corporate clients, government agencies, specialized industries and lending products to correspondent banks, title companies and municipalities. This division also manages Union Bank of California's web strategies for retail, small business, wealth management and commercial clients, as well as commercial product development;
- •
- theCapital Markets Division, which provides limited merchant banking and investment banking related products and services to middle-market and large corporate clients in their defined industries and geographic markets;
- •
- theGlobal Markets Division, which serves our customers with their foreign exchange and interest rate risk management and investment needs. The Global Markets Division offers energy derivative contracts to assist our energy sector client base with their hedging needs. The division takes market risk when
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- •
- Pacific Rim Corporate Group, 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.
buying and selling securities and entering into foreign exchange and interest rate derivative contracts for its own account, but takes no market risk when providing energy derivative contracts, since the market risk for this product is offset with third parties. The division also includes UnionBanc Investment Services LLC, which is a subsidiary of Union Bank of California; and
The main strategy of our Wholesale Banking business units is to target industries and companies for which we can reasonably expect to be one of a customer's primary banks. Consistent with this strategy, Wholesale Banking business units attempt to serve a large part of the targeted customers' credit and depository needs. The Wholesale Banking business units compete with other banks primarily on the basis of the quality of our relationship managers, the level of industry expertise, the delivery of quality customer service, and our reputation as a "business bank." We also compete 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, we compete with investment banks, commercial finance companies, leasing companies and insurance companies.
Other
Net loss increased by $124.5 million in the nine months ended September 30, 2008, compared to the same period in 2007, primarily due to higher credit expenses related to the significant increase in our loan loss provision and higher noninterest expense, partially offset by lower net interest expense and higher noninterest income.
"Other" includes the following items:
- •
- the funds transfer pricing results for our 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;
- •
- Corporate Treasury, which is responsible for our ALM, wholesale funding and the ALM investment and derivatives hedging portfolios. These treasury management activities are carried out to counter-balance the residual risk positions of our balance sheet and to manage those risks within the guidelines established by ALCO. (For additional discussion regarding these risk management activities, see "Quantitative and Qualitative Disclosures About Market Risk");
- •
- the adjustment between the credit expense under RAROC and the provision for credit losses under US GAAP and earnings associated with unallocated equity capital;
- •
- the residual costs of support groups;
- •
- corporate activities that are not directly attributable to one of the two business segments. Included in this category are certain other items such as the results of operations of certain non-bank subsidiaries of UnionBanCal and the elimination of the fully taxable-equivalent basis amount;
- •
- the discontinued operations resulting from the sales of our insurance brokerage and retirement recordkeeping businesses; and
- •
- the adjustment between the tax expenses calculated under RAROC using a tax rate of 38.25 percent and our effective tax rates.
The financial results for the nine months ended September 30, 2008 were impacted by the following factors:
- •
- net interest income (expense) is the result of differences between the net interest income earned by the consolidated enterprise and transfer pricing results, which include the credit for equity for the
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- •
- credit expense (income) of $128.1 million was due to the difference between the $284.0 million provision for loan losses calculated under our US GAAP methodology and the $155.9 million in expected losses for the reportable business segments, which utilizes the RAROC methodology;
- •
- noninterest income of $23.5 million was driven by a $14.2 million gain from the partial redemption of Visa Inc. common stock and a $7.1 million gain from the partial redemption of MasterCard Inc. common stock;
- •
- noninterest expense of $124.3 million related to residual costs of support groups and corporate activities not directly related to either of the two business segments. Additionally, noninterest expense in the nine months ended September 30, 2008 included a $21.0 million provision for losses on off-balance sheet commitments, compared to a $5.0 million provision in the same period of 2007;
- •
- income tax expense (benefit) of ($108.1) million resulted from the difference between the $167.5 million, or 31.4 percent effective tax rate, for our consolidated results and the actual tax expense calculated for reportable segments of $275.6 million using the RAROC effective rate; and
- •
- loss from discontinued operations of $12.0 million.
reportable segments under RAROC. Net interest expense decreased $15.7 million to $92.3 million compared to the same period in 2007 primarily due to the changes in transfer pricing rates as market rates decreased;
The financial results for the nine months ended September 30, 2007 were impacted by the following factors:
- •
- net interest income (expense) of ($108.1) million;
- •
- credit expense (income) of ($74.0) million was due to the difference between the $25.0 million provision for loan losses calculated under our US GAAP methodology and the $99.0 million in expected losses for the reportable business segments, which utilizes the RAROC methodology;
- •
- noninterest income of $15.7 million;
- •
- noninterest expense of $97.2 million related to residual costs of support groups and corporate activities not directly related to either of the two business segments;
- •
- income tax expense (benefit) of ($36.7) million was due to the difference between the $238.7 million, or 34.0 percent effective tax rate, for our consolidated results and the actual tax expense calculated for reportable segments of $275.4 million using the RAROC effective rate; and
- •
- loss from discontinued operations of $21.7 million.
Regulatory Matters
On September 14, 2007, Union Bank of California entered into a Stipulation and Consent to the Issuance of a Consent Order, and a Consent Order to a Civil Money Penalty and to Cease and Desist (the Order) with the Office of the Comptroller of the Currency (OCC). The Order imposed a civil money penalty of $10 million and required Union Bank of California to take actions to improve compliance with the Bank Secrecy Act and other anti-money laundering laws and regulations (BSA/AML). On the same day, the U.S. Treasury Department's Financial Crimes Enforcement Network (FinCEN) executed an Assessment of Civil Money Penalty (the Assessment) in the amount of $10 million. The Assessment provided that the $10 million penalty was deemed to be satisfied by Union Bank of California's payment of the civil money penalty of $10 million to the OCC. On September 17, 2007, Union Bank of California entered into a Deferred Prosecution Agreement (DPA) with the Department of Justice (DOJ). Under the DPA, the DOJ agreed to defer prosecution for past violations of BSA/AML that occurred in Union Bank of California's now discontinued international banking business, and to dismiss prosecution completely if Union Bank of California met the conditions of the Order for one year.
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Pursuant to the DPA, Union Bank of California also paid $21.6 million in the third quarter of 2007 to the DOJ. The OCC terminated the order on September 28, 2008. On October 1, 2008, the DPA was also terminated and the criminal case to which it related was dismissed.
In December 2006, Mitsubishi UFJ Financial Group, The Bank of Tokyo-Mitsubishi UFJ and its wholly owned subsidiary, Bank of Tokyo-Mitsubishi UFJ Trust Company, entered into a series of agreements with the Federal Deposit Insurance Corporation, the Federal Reserve Bank of San Francisco, the Federal Reserve Bank of New York and the New York State Banking Department, which require a strengthening of their BSA/AML controls and processes. On September 29, 2008, these agreements were terminated.
Any future regulatory or other government actions concerning BSA/AML controls and processes may adversely affect UnionBanCal Corporation's and Union Bank of California's ability to obtain regulatory approvals for future initiatives, including acquisitions. Also, any future actions relating to noncompliance or repeat violations of BSA/AML laws, regulations or orders could result in the assessment of additional civil money penalties or the imposition of additional fines, which could be substantial.
The SEC is conducting an inquiry regarding certain practices related to our mutual fund activities. The inquiry concerns the use of a portion of the fees received under an agreement from the HighMark Funds by an unaffiliated administrator to pay expenses related to the marketing and distribution of fund shares. The HighMark Funds is a family of mutual funds managed by HighMark Capital Management, Inc., the investment management subsidiary of Union Bank of California. We are cooperating with this inquiry.
On October 6, 2008, both UnionBanCal Corporation and Mitsubishi UFJ Financial Group obtained approval from the Board of Governors of the Federal Reserve to become financial holding companies under the Bank Holding Company Act of 1956, as amended (the BHC Act). We sought this new status from the Federal Reserve Bank (FRB) to provide us maximum flexibility and stability to pursue new business opportunities as the financial marketplace undergoes rapid and profound changes. UnionBanCal remains subject to the consolidated supervision and regulation of the FRB and the Bank remains subject to the supervision and regulation of the OCC. The FDIC will continue to insure deposits at the Bank. We do not expect significant adverse tax or accounting effects from this new status.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
A discussion of our market risk exposure is incorporated by reference to Part I, Item 2 of this Form 10-Q under the caption "Quantitative and Qualitative Disclosures About Market Risk" and to Part II, Item 1A of this Form 10-Q under the caption "Risk Factors."
Item 4. Controls and Procedures
Our 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, 2008. 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, 2008, 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.
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For a discussion of the action filed by Data Treasury Corporation, please refer to Item 3 of Part I of our 2007 Form 10-K.
For information relating to the Bank Secrecy Act and other anti-money laundering laws and regulations (BSA/AML) matters, please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations—Regulatory Matters," in Item 2 of Part I of this Form 10-Q.
On August 14, 2008, an alleged stockholder filed a purported class action captionedKahn v. Mitsubishi UFJ Financial Group, Inc. in the Superior Court of California, County of San Francisco. The Kahn complaint was amended on September 4, 2008. The amended complaint asserted claims for breach of fiduciary duty against us, our directors, MUFG and its affiliates in connection with the Offer and the Merger and challenged the adequacy of our disclosures regarding the Offer. The amended complaint sought compensatory and punitive damages and declaratory, rescissory and injunctive relief with respect to the Offer and the Merger.
On August 15, 2008, another alleged stockholder filed a purported class action captionedJaroslawicz v. UnionBanCal Corp., et al. in the Superior Court of California, County of San Francisco. The Jaroslawicz complaint was amended on August 19, 2008, asserting claims for breach of fiduciary duty against our directors, MUFG and BTMU, and for aiding and abetting an alleged breach of fiduciary duty against us, MUFG and BTMU. The amended complaint sought declaratory, injunctive and rescissory relief with respect to the Offer.
On August 15, 2008, another alleged stockholder filed a purported class and derivative action captionedVirgin Islands Government Employees' Retirement System v. Alvarez, et al. (VIGERS) in the Court of Chancery of the State of Delaware. The VIGERS complaint was amended on August 27, 2008 and again on September 5, 2008. The second amended VIGERS complaint asserted class action claims for breach of fiduciary duty against our current directors, MUFG and BTMU, and claims for self-dealing against MUFG and BTMU, in connection with the Offer. The complaint also asserted derivative claims for breach of fiduciary duty against our current directors, except for Nicholas Binkley, and some of our former directors arising out of alleged non-compliance by specified subsidiaries with the Bank Secrecy Act and other anti-money laundering laws and regulations. The amended complaint also asserted claims alleging that our disclosures regarding the Offer were materially false and misleading in several respects. The second amended VIGERS complaint sought declaratory and injunctive relief and damages.
On August 29, 2008, another alleged stockholder filed a purported class action captionedPires v. UnionBanCal Corp., et al. in the Superior Court of California, County of San Francisco. The Pires complaint asserted a claim of breach of fiduciary duty against us and our directors and against MUFG for aiding and abetting the alleged breach of fiduciary duty in connection with the Offer. The Pires complaint sought declaratory and injunctive relief and damages.
While we believe all of the allegations of wrongdoing in the complaints and amended complaints filed in these actions lack merit, in order to resolve the litigation and avoid further cost and delay in the VIGERS and Jaroslawicz actions, we and the other defendants, without admitting any wrongdoing, agreed to make further disclosures in connection with the Offer and the Merger and signed a Stipulation of Settlement to settle all class claims asserted in such actions but not the derivative claim asserted in the VIGERS action. Pursuant to the Stipulation of Settlement, on September 26, 2008, the Delaware Chancery Court entered a Scheduling Order setting a schedule for class notice and objections, and setting a Settlement Hearing for December 2, 2008. The Scheduling Order also stays and suspends all proceedings in VIGERS (including the derivative claim) other than those necessary to carry out the settlement, and enjoins the purported class members, including the plaintiff, from asserting claims in connection with the Offer and the Merger, except as set forth in the Stipulation of Settlement. The dismissals of the VIGERS and Jaroslawicz actions contemplated by the Stipulation of Settlement require court approval, as do the anticipated request of plaintiffs' counsel to be
82
awarded their attorneys' fees and costs. We agreed not to oppose such a request, provided that the attorneys' fees and costs requested do not exceed $1.25 million, and to pay such attorneys' fees and costs as are awarded by the Delaware Chancery Court, again provided that those fees and costs do not exceed $1.25 million.
On September 23, 2008, plaintiffs Kahn and Pires made an ex parte application to the San Francisco County Superior Court to issue a temporary restraining order enjoining the consummation of the Merger. The Court, after oral argument on September 24, 2008, orally denied the application; there is no written order.
On October 7, 2008, all counsel in the Kahn, Jaroslawicz and Pires actions submitted a stipulation to the San Francisco County Superior Court asking the court to consolidate and stay all three actions without prejudice to the right of plaintiffs Kahn and Pires to object to the settlement to be presented to the Delaware court. On October 15, 2008, the Superior Court agreed to declare all three cases complex, to coordinate all three cases before one judge and to stay all three cases pending the settlement approval hearing in the Delaware court. The Superior Court set a further case management conference for January 9, 2009.
We are subject to various other 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. In addition, we believe the disposition of all claims currently pending will not have a material adverse effect on our consolidated financial condition, operating results or liquidity.
For a discussion of risk factors relating to our business, please refer to Item 1A of Part I of our 2007 Form 10-K, which is incorporated by reference herein, in addition to the following information.
Industry Factors
The U.S. and global economies have experienced a slowing of economic growth, unprecedented volatility in the financial markets, and significant deterioration in sectors of the U.S. residential real estate markets, all of which present challenges for the banking and financial services industry and for UnionBanCal Corporation
Commencing in 2007 and continuing throughout 2008, certain adverse financial developments have impacted the U.S. and global economies and financial markets and present challenges for the banking and financial services industry and for UnionBanCal Corporation. These developments include a general slowing of economic growth both globally and in the U.S. which prompted the Congress to adopt an economic stimulus bill which President Bush signed into law on February 13, 2008, and which prompted the Federal Reserve Board to decrease its discount rate and the federal funds rate numerous times during 2008. These developments have contributed to substantial volatility in the equity securities markets, as well as volatility and a tightening of liquidity in the credit markets. In addition, financial and credit conditions in the domestic residential real estate markets have deteriorated significantly, particularly in the subprime sector. These conditions in turn have led to significant deterioration in certain financial markets, particularly the markets for subprime residential mortgage-backed securities and for collateralized debt obligations backed by residential mortgage-backed securities. In addition, these conditions have rendered it more difficult for financial institutions and others to obtain transparent valuations for various portfolio debt securities, especially in the case of collateralized debt obligations backed by residential mortgage-backed securities or other collateral, including corporate obligations, as well as contributing to a widening of credit spreads and a general lack of liquidity in the marketplace, all of which can result in decreases in fair value of portfolio securities of these types. On July 30, 2008, President Bush signed into law a housing bill which grants the Treasury Department broad authority to safeguard Fannie Mae and Freddie Mac and authorizes the Federal Housing Administration to insure up to $300 billion in refinanced mortgages.
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In the third quarter of 2008, the volatility and disruption in the capital and credit markets reached unprecedented levels. On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the EESA) in response to the recent financial crises affecting the banking system and financial markets. The EESA was the result of a proposal by Treasury Secretary Henry Paulson to the U.S. Congress on September 20, 2008, in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. Pursuant to the EESA, the U.S. Treasury will have the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Further, pursuant to the EESA, on October 14, 2008, the U.S. Treasury announced a voluntary Capital Purchase Program pursuant to which the Treasury will purchase up to $250 billion in senior preferred stock of qualifying U.S. financial institutions. On October 13, 2008, the U.S. Treasury announced that it had agreed, under the authority of the new law, with the nine largest banks in the U.S. to purchase an aggregate of $125 billion in senior preferred stock in such banks and that it would allocate an additional $125 billion to the purchase of senior preferred stock in other banking institutions. The purpose of the program is to provide substantial new capital to the U.S. banking industry. It is expected that many banks and bank holding companies will participate in such program. UnionBanCal Corporation, as a wholly-owned subsidiary of a foreign bank, will not be eligible to participate in such program.
It cannot be predicted whether this recent governmental action will result in significant improvement in financial and economic conditions affecting the banking industry. If, notwithstanding the federal government's recent fiscal and monetary measures, the U.S. economy were to remain in a recessionary condition for an extended period, this would present additional significant challenges for the U.S. banking and financial services industry and for our company. While it is difficult to predict how long these conditions will exist and which markets and businesses of our company may be affected, these factors could continue to present risks for some time for the industry and our company.
Current levels of market volatility are unprecedented
The capital and credit markets have been experiencing volatility and disruption for more than 12 months. In recent weeks, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers' underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations. As a result of these volatile and disrupted credit markets, our customers' ability to raise capital and refinance maturing obligations could be adversely affected, and this could result in a further adverse impact on our business, financial condition and results of operations.
There can be no assurance that recently enacted legislation authorizing the U.S. government to purchase large amounts of illiquid mortgages and mortgage-backed securities from financial institutions and the Treasury's Capital Purchase Program will help stabilize the U.S. financial system
There can be no assurance as to the actual impact that the EESA and the Treasury's Capital Purchase Program will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA and the Treasury's Capital Purchase Program to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations or access to credit.
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Difficult market conditions have adversely affected our industry
Dramatic declines in the housing market in the U.S. in general, and in California in particular, over the past year, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities as well as major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative and cash securities, in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected our business, financial condition and results of operations. We can not predicate whether the difficult conditions in the financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events:
- •
- We expect to face increased regulation of our industry, including as a result of the EESA. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.
- •
- Our ability to assess the creditworthiness of our customers and counterparties may be impaired if the models and approaches we use to select, manage, and underwrite our customers and counterparties become less predictive of future behaviors.
- •
- The process we use to estimate losses inherent in our credit exposure requires difficult, subjective, and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans, which may no longer be capable of accurate estimation, which may, in turn, impact the reliability of the process.
- •
- Our ability to borrow from other financial institutions or to engage in securitization funding transactions on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations.
- •
- Competition in our industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions.
- •
- Under an Federal Deposit Insurance Corporation (FDIC) proposal announced on October 7, 2008, we may be required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.
Changes in the premiums payable to the Federal Deposit Insurance Corporation will increase our costs and could adversely affect our business
Deposits of Union Bank of California are insured up to statutory limits by the FDIC, and, accordingly, are subjected to deposit insurance assessments to maintain the Deposit Insurance Fund. In November 2006, the FDIC issued a final rule, effective January 1, 2007, that created a new assessment system designed to more closely tie what banks pay for deposit insurance to the risks they pose and adopted a new base schedule of rates that the FDIC can adjust up or down, depending on the revenue needs of the insurance fund. This new assessment system has resulted in annual assessments on deposits of Union Bank of California of approximately 5 basis points. Prior to this change, Union Bank of California was not paying any insurance assessments on deposits under the FDIC's risk-related assessment system. An FDIC credit for prior
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contributions offset the assessment for 2007. Since this credit was exceeded in the second quarter of 2008, the deposit insurance assessments Union Bank of California pays have increased our costs. In addition, an increase in the deposit insurance assessments that Union Bank of California pays could result from the recent increases in bank closures by the federal banking agencies, as well as FDIC action that may be taken in connection with other troubled financial institutions. Currently, the Deposit Insurance Fund's ratio of reserves to insured deposits is below the statutory minimum. On October 7, 2008, the FDIC announced an increase in the deposit insurance premiums payable by banks beginning in 2009, pending final approval of the plan after a comment period. For the first quarter of 2009, the average premium under the proposal would increase to 13.5 cents on every $100 in deposits, from 6.3 cents currently, and the assessment rate schedule would be raised uniformly by seven basis points (annualized) beginning on January 1, 2009. Any increases in the deposit insurance assessments Union Bank of California pays would further increase our costs.
The soundness of other financial institutions could adversely affect us
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
The effects of changes in, or supervisory enforcement of, 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 the Deposit Insurance Fund and not for the benefit of investors in our stock or other securities. 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 changes in laws, regulations, policies or interpretations or regulatory approaches to compliance and enforcement, as well as by supervisory action or criminal proceedings taken as a result of noncompliance which could result in the imposition of significant civil money penalties or fines. 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 UFJ's controlling ownership of us, laws, regulations, policies, fines and other supervisory actions 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.
We maintain systems and procedures designed to comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of criminal or civil penalties (which can be substantial) for noncompliance. In some cases, liability may attach even if the noncompliance was inadvertent or unintentional and even if compliance systems and procedures were in place at the time. There may be other negative consequences from a finding of noncompliance, including restrictions on certain activities and damage to our reputation.
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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 and managerial 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 the federal funds rate, 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 Item 1 of our 2007 Form 10-K and "Management's Discussion and Analysis of Financial Condition and Results of Operations—Regulatory Matters" in Item 2 of Part I of this Form 10-Q for discussion of other laws and regulations that may affect our business.
Company Factors
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. Increases in residential mortgage loan interest rates could have an adverse effect on our operations by depressing new mortgage loan originations, which in turn could negatively impact our title and escrow deposit levels. Additionally, a further downturn in the residential real estate and housing industries in California could have an adverse effect on our operations and the quality of our real estate loan portfolio. Although we do not engage in subprime or negative amortization lending, effects of recent subprime market challenges, combined with the ongoing deterioration in the U.S. and California real estate markets, could result in further price reductions in single family home prices and a lack of liquidity in refinancing markets. These factors could adversely impact the quality of our residential construction and residential mortgage portfolio in various ways, including by decreasing the value of the collateral for our mortgage loans. These factors could also negatively affect the economy in general and thereby our overall loan portfolio.
We provide financing to businesses in a number of other industries that may be particularly vulnerable to industry-specific economic factors, including the home building industry, the commercial real estate industry, the communications/media industry, the retail industry, the energy industry and the technology industry. The home building industry in California has been especially adversely impacted by the deterioration in residential real estate markets, particularly in the subprime housing sectors, which has lead us to take additional provisions against credit losses in this portfolio as to which we expect an acceleration of charge offs during the rest of 2008. Continued volatility in fuel prices and energy costs could adversely affect 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.
Adverse California economic conditions could adversely affect our business
The State of California currently faces economic and fiscal challenges, the long-term impact of which on the State's economy cannot be predicted with any certainty. 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 significant
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deterioration in the residential real estate sector, especially the subprime housing markets, and the California state government's budgetary and fiscal difficulties. The California state government is currently experiencing budget shortfalls which in January 2008 prompted Governor Schwarzenegger to declare a fiscal emergency. The California state budget enacted in September 2008 projects a deficit of $1.0 billion in 2009-2010 and includes expenditure reductions. It is possible that the legislature response to the state's fiscal difficulties could lead to increased state taxes in California. The financial and economic consequences of this situation cannot be predicted with any certainty at this time. If economic conditions in California decline further, we expect that our level of problem assets could increase and our prospects for growth could be impaired.
Higher credit losses could require us to increase our allowance for credit losses through a charge to earnings
When we loan money or commit to loan money, we incur credit risk, or the risk of losses if our borrowers do not repay their loans. We reserve for credit losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of credit losses inherent in our loan portfolio and our unfunded credit commitments. The process for determining the amount of the allowance is critical to our financial results and condition. It requires difficult, subjective and complex judgments about the future impact from current economic conditions that might impair the ability of our borrowers to repay their loans.
We might underestimate the credit losses inherent in our loan portfolio and have credit losses in excess of the amount reserved. Or, we might increase the allowance because of changing economic conditions, which we conclude have caused losses to be sustained in our portfolio. For example, in a rising interest rate environment, borrowers with adjustable rate loans could see their payments increase. In the absence of offsetting factors such as increased economic activity and higher wages, this could reduce borrowers' ability to repay their loans, resulting in our increasing the allowance. Continued volatility in fuel and energy costs could also adversely impact some borrowers' ability to repay their loans. We might also increase the allowance because of unexpected events. Any increase in the allowance would result in a charge to earnings.
Our stockholder votes are controlled by The Bank of Tokyo-Mitsubishi UFJ
As of November 4, 2008, the Bank of Tokyo-Mitsubishi UFJ, a wholly-owned subsidiary of Mitsubishi UFJ Financial Group, owned all of the outstanding shares of our common stock. As a result, The Bank of Tokyo-Mitsubishi UFJ 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 UFJ or Mitsubishi UFJ Financial Group.
A majority of our directors are independent of The Bank of Tokyo-Mitsubishi UFJ and are not officers or employees of UnionBanCal Corporation or any of our affiliates, including The Bank of Tokyo-Mitsubishi UFJ. However, because of The Bank of Tokyo-Mitsubishi UFJ'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 the Board would not have a majority of independent directors. We have not done so.
Risks associated with potential acquisitions or divestitures or restructurings may adversely affect us
We may seek to acquire or invest in financial and non-financial companies that complement our business.
We may not be successful in completing any 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
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businesses and business lines and may sell or restructure a business or business line. Any acquisitions 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. Any divestures may also result in significant write-offs, including those related to goodwill and other intangible assets.
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, divestitures required by regulatory authorities, the disruption of our business, the potential loss of key employees and unexpected contingent liabilities arising from any business we might acquire. We may not be successful in addressing these or any other significant risks encountered in connection with any acquisition, divesture or restructuring we might make.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Repurchases of Equity Securities
The following table presents repurchases by us of our equity securities during the third quarter of 2008.
Period | Total Number of Shares Purchased(1) | 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 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
July 2008 | 642 | $ | 44.01 | — | $ | 509,722,565 | ||||||||
August 2008 | 1,620 | $ | 64.91 | — | $ | 509,617,403 | ||||||||
September 2008 | 2,140 | $ | 73.42 | — | $ | 509,460,291 | (2) | |||||||
Total | 4,402 | $ | 66.00 | — | ||||||||||
- (1)
- All common stock repurchased during July, August and September 2008 were from employees for required personal income tax withholdings on the vesting of restricted stock issued under the Year 2000 UnionBanCal Corporation Management Stock Plan.
- (2)
- In the third quarter of 2008, UnionBanCal Corporation used $0.3 million from the $500 million repurchase program announced on April 26, 2006.
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No. | Description | ||
---|---|---|---|
3.1 | Certificate of Incorporation of the Company(1) | ||
3.2 | Bylaws of the Company(2) | ||
10.1 | Executive Agreement between Union Bank of California N.A. and Timothy H. Wennes, dated as of July 28, 2008(3) | ||
10.2 | UnionBanCal Corporation Bridge Plan dated September 18, 2008(4) | ||
10.3 | Form of UnionBanCal Corporation Bridge Plan Award Agreement(5) | ||
10.4 | Form of UnionBanCal Corporation Bridge Plan Award Agreement with David I. Matson(6) | ||
10.5 | UnionBank of California, N.A. Supplemental Executive Retirement Plan as amended and restated effective September 18, 2008(7) | ||
10.6 | UnionBank of California, N.A. Supplemental Executive Retirement Plan for Policy Making Officers as amended and restated effective September 18, 2008(8) | ||
31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(9) | ||
31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(9) | ||
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(9) | ||
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(9) |
- (1)
- Incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated November 4, 2008.
- (2)
- Incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated November 4, 2008.
- (3)
- Incorporated by reference to Exhibit (e)(42) to the Schedule 14D-9 filed on August 29, 2008.
- (4)
- Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (5)
- Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (6)
- Incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (7)
- Incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (8)
- Incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (9)
- Filed herewith.
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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 6, 2008 | By: | /s/ MASAAKI TANAKA Masaaki Tanaka President and Chief Executive Officer (Principal Executive Officer) | ||
Date: November 6, 2008 | By: | /s/ DAVID I. MATSON David I. Matson Vice Chairman and Chief Financial Officer (Principal Financial Officer) | ||
Date: November 6, 2008 | By: | /s/ DAVID A. ANDERSON David A. Anderson Executive Vice President and Controller (Chief Accounting Officer) |
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No. | Description | ||
---|---|---|---|
3.1 | Certificate of Incorporation of the Company(1) | ||
3.2 | Bylaws of the Company(2) | ||
10.1 | Executive Agreement between Union Bank of California N.A. and Timothy H. Wennes, dated as of July 28, 2008(3) | ||
10.2 | UnionBanCal Corporation Bridge Plan dated September 18, 2008(4) | ||
10.3 | Form of UnionBanCal Corporation Bridge Plan Award Agreement(5) | ||
10.4 | Form of UnionBanCal Corporation Bridge Plan Award Agreement with David I. Matson(6) | ||
10.5 | UnionBank of California, N.A. Supplemental Executive Retirement Plan as amended and restated effective September 18, 2008(7) | ||
10.6 | UnionBank of California, N.A. Supplemental Executive Retirement Plan for Policy Making Officers as amended and restated effective September 18, 2008(8) | ||
31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(9) | ||
31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(9) | ||
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(9) | ||
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(9) |
- (1)
- Incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated November 4, 2008.
- (2)
- Incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated November 4, 2008.
- (3)
- Incorporated by reference to Exhibit (e)(42) to the Schedule 14D-9 filed on August 29, 2008.
- (4)
- Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (5)
- Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (6)
- Incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (7)
- Incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (8)
- Incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated September 19, 2008.
- (9)
- Filed herewith.
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UnionBanCal Corporation and Subsidiaries TABLE OF CONTENTS
NOTE REGARDING FORWARD-LOOKING STATEMENTS
PART I. FINANCIAL INFORMATION
UnionBanCal Corporation and Subsidiaries Condensed Consolidated Statements of Income (Unaudited)
UnionBanCal Corporation and Subsidiaries Condensed Consolidated Balance Sheet
UnionBanCal Corporation and Subsidiaries Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)
UnionBanCal Corporation and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited)
UnionBanCal Corporation and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)
UnionBanCal Corporation and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited)
PART II. OTHER INFORMATION
- Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
EXHIBIT INDEX