UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| (Mark One) | ||
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
| For the fiscal year ended December 31, 2019 | ||
| 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
MUFG Americas Holdings Corporation
(Exact name of registrant as specified in its charter)
| Delaware | 94-1234979 | |
| (State of Incorporation) | (I.R.S. Employer Identification No.) | |
| 1251 Avenue of the Americas, New York, NY | 10020 | |
| (Address of principal executive offices) | (Zip Code) | |
Registrant's telephone number, including area code: (212) 782-5911
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading symbol(s) | Name of each exchange on which registered | ||||
| None | Not Applicable | Not Applicable | ||||
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1.00 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer x (Do not check if a smaller reporting company) | Smaller reporting company o | Emerging growth company o | ||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant: Not applicable; all of the voting stock of the registrant is owned by its parent, MUFG Bank, Ltd. and its ultimate parent, Mitsubishi UFJ Financial Group, Inc.
As of January 31, 2020, the number of shares outstanding of the registrant's Common Stock was 132,076,912.
DOCUMENTS INCORPORATED BY REFERENCE
None.
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION (I) (1) (a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.
MUFG Americas Holdings Corporation and Subsidiaries
Table of Contents
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Glossary of Defined Terms
The following acronyms and abbreviations are used throughout this report, particularly in Part I, Item 1. “Business," Item 1A. “Risk Factors,” Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” and Item 8. “Financial Statements and Supplementary Data.”
| ABS | Asset-backed securities |
| ACR | Americas Credit Review |
| ADR | American depositary receipt |
| Agency Securities | Securities guaranteed by a U.S. government agency |
| ALCO | Asset Liability Management Committee |
| ALM | Asset Liability Management |
| AML | Anti-money laundering |
| AMT | Alternative minimum tax |
| AOCI | Accumulated other comprehensive income |
| ARC | Americas Risk Committee |
| ARM | Americas Risk Management |
| ASU | Accounting Standards Update |
| BCBS | Basel Committee on Banking Supervision |
| BHC | U.S. Bank Holding Company |
| BHCA | Bank Holding Company Act |
| BSA | Bank Secrecy Act |
| CCAR | Comprehensive Capital Analysis and Review |
| CCPA | California Consumer Privacy Act of 2018 |
| CD | Certificate of deposit |
| CECL | Current Expected Credit Loss |
| CFPB | Consumer Financial Protection Bureau |
| CLO | Collateralized loan obligation |
| CMBS | Commercial mortgage-backed security |
| COSO | Committee of Sponsoring Organizations of the Treadway Commission |
| CRA | Community Reinvestment Act |
| CRO | Chief Risk Officer |
| Dodd-Frank Act | Dodd-Frank Wall Street Reform and Consumer Protection Act |
| ECA | Executive Committee for the Americas |
| EGRRCPA | Economic Growth, Regulatory Relief and Consumer Protection Act |
| ESBP | Executive Supplemental Benefit Plan |
| EURIBOR | Euro Interbank Offered Rate |
| Exchange Act | U.S. Securities Exchange Act of 1934 |
| FASB | Financial Accounting Standards Board |
| FBO | Foreign banking organization |
| FDIA | Federal Deposit Insurance Act |
| FDIC | Federal Deposit Insurance Corporation |
| Federal Reserve | Board of Governors of the Federal Reserve System |
| FHLB | Federal Home Loan Bank |
| FICO | Fair Isaac Corporation |
| FINRA | Financial Industry Regulatory Authority |
| GAAP | Accounting principles generally accepted in the United States of America |
| GLBA | Gramm-Leach-Bliley Act |
| GSE | Government-sponsored enterprise |
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| GSIB | Global systemically important bank |
| HLBV | Hypothetical liquidation at book value |
| HQLA | High quality liquid assets |
| HRA Plan | MUFG Union Bank, N.A. Retiree Health Reimbursement Plan |
| IAA | Internal Audit for the Americas |
| IBOR | Interbank Offered Rate |
| IDI | Insured deposit institution |
| IHC | Intermediate Holding Company |
| IRC | Internal revenue code |
| IRS | Internal Revenue Service |
| LCR | Liquidity Coverage Ratio |
| LIBOR | London Interbank Offered Rate |
| LIHC | Low income housing tax credit |
| LLC | Limited Liability Company |
| LTV | Loan-to-value |
| MBS | Mortgage-backed securities |
| MRM | Market Risk Management |
| MRMC | Market Risk Management Committee |
| MSRB | Municipal Securities Rulemaking Board |
| MUAH | MUFG Americas Holdings Corporation |
| MUAH Plan | MUFG Americas Holdings Corporation Stock Bonus Plan |
| MUB | MUFG Union Bank, N.A. |
| MUFG | Mitsubishi UFJ Financial Group, Inc. |
| MUSA | MUFG Securities Americas Inc. |
| NAFTA | North American Free Trade Agreement |
| NAV | Net asset value |
| n/a | Not available |
| nm | Not meaningful |
| NY DFS | New York State Department of Financial Services |
| OCC | Office of the Comptroller of the Currency |
| OCI | Other comprehensive income |
| OFAC | U.S. Treasury's Office of Foreign Assets Control |
| OREO | Other real estate owned |
| ORMD | Operational Risk Management Department |
| PCAOB | Public Company Accounting Oversight Board |
| RMBS | Residential mortgage-backed security |
| S&P | Standard & Poor's Ratings Services |
| SEC | Securities and Exchange Commission |
| SOFR | Secured Overnight Financing Rate |
| SRO | Self-regulatory organization |
| TCJA | Tax Cuts and Jobs Act |
| TDR | Troubled debt restructuring |
| TLAC | Total Loss Absorbing Capacity |
| U.S. Basel lll Rules | Basel lll capitalization rules of the Basel Committee on Banking Supervision |
| USMCA | United States Mexico Canada Agreement |
| VaR | Value-at-risk |
| VIE | Variable interest entity |
| Volcker Rule | Section 619 of the Dodd-Frank Act |
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NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements, which include expectations for our operations and business and our assumptions for those expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly compared to our expectations. See Part I, 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.
Forward-looking statements 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 SEC filings, press releases, news articles and when we are speaking on behalf of MUFG Americas Holdings Corporation and its subsidiaries. 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," "forecast," "outlook," 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 known to our management 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 any forward-looking statements are made.
In this document and other reports to the SEC, for example, we make forward-looking statements, which discuss our expectations about:
| • | Our business objectives, strategies and initiatives, organizational structure, business growth, competitive position and prospects, and the effect of competition on our business and strategies |
| • | Our assessment of significant factors and developments that have affected or may affect our results |
| • | Our assessment of economic conditions and trends, economic and credit cycles and their impact on our business |
| • | The economic outlook for the U.S. in general, West Coast states and global economies |
| • | The impact of changes in interest rates resulting from changes in Federal Reserve policy or for other reasons, our strategy to manage our interest rate risk profile and other market risks, our outlook for short-term and long-term interest rates and their effect on our net interest margin, our investment portfolio, our balance sheet composition, our borrowers’ ability to service their loans and residential mortgage loans and refinancings |
| • | Pending and recent legislative and regulatory actions, and future legislative and regulatory developments, including the effects of legislation and other governmental measures, including the monetary policies of the Federal Reserve introduced in response to the financial crisis, and the ensuing recession affecting the banking system, financial markets and the U.S. economy, the Dodd-Frank Act, the EGRRCPA, changes to the deposit insurance assessment policies of the FDIC, the effect on and application of foreign and other laws and regulations to our business and operations, and anticipated fees, costs or other impacts on our business and operations as a result of these developments |
| • | Our strategies and expectations regarding capital levels and liquidity, our funding base, deposits, long-term debt, issuance of additional notes under the Bank's unsecured bank note program, our expectations regarding the capital, liquidity and enhanced prudential standards adopted by the U.S. bank regulators as a result of or under the Dodd-Frank Act and the BCBS capital and liquidity standards including the Federal banking agencies' TLAC regulation, and other recently adopted and proposed regulations by the U.S. federal banking agencies, and the effect of the foregoing on our business and expectations regarding compliance |
| • | Regulatory and compliance controls and processes and their impact on our business, including our operating costs and revenues |
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| • | The costs and effects of legal actions, investigations, regulatory actions, criminal proceedings or similar matters, our anticipated litigation strategies, our assessment of the timing and ultimate outcome of legal actions, or adverse facts and developments related thereto |
| • | Our allowance for credit losses, including the conditions we consider in determining the unallocated allowance and our portfolio credit quality, probability of default and credit migration trends, and severity of loss upon default, and the expected impact of the adoption of the current expected credit loss model regarding the allowance |
| • | Loan portfolio composition and risk rating trends, residential loan delinquency rates compared to the industry average, portfolio credit quality, our strategy regarding TDRs, and our intent to sell or hold loans we originate |
| • | Our intent to sell or hold, and the likelihood that we would be required to sell, or expectations regarding recovery of the amortized cost basis of, various investment securities |
| • | Our hedging strategies, positions, expectations regarding reclassifications of gains or losses on hedging instruments into earnings; and the sensitivity of our net income to various factors, including customer behavior relating to mortgage prepayments and deposit repricing |
| • | Expected rates of return, maturities, yields, loss exposure, growth rates, pension plan strategies, contributions and benefit payments, forecasted balance sheet activity and projected results |
| • | Tax rates and taxes, the possible effect of changes in taxable profits of the U.S. operations of MUFG on our state tax obligations and of expected tax credits or benefits |
| • | Critical accounting policies and estimates, the impact or anticipated impact of recent accounting pronouncements, guidance or changes in accounting principles and future recognition of impairments for the fair value of assets, including goodwill, financial instruments, intangible assets and other assets |
| • | Decisions to downsize, sell or close units, dissolve subsidiaries, expand our branch network, pursue acquisitions, purchase banking facilities and equipment, realign our business model or otherwise restructure, reorganize or change our business mix, or the transfer to MUAH by MUFG of its interests in U.S. subsidiaries, and their timing and impact on our business |
| • | Our expectations regarding the impact of acquisitions on our business and results of operations |
| • | The impact of changes in our credit ratings including methodology changes adopted by rating agencies |
| • | Maintenance of casualty and liability insurance coverage appropriate for our operations |
| • | The relationship between our business and that of MUFG Bank, Ltd. and MUFG, the impact of their credit ratings, operations or prospects on our credit ratings and actions that may or may not be taken by MUFG Bank, Ltd. and MUFG |
| • | Threats to the banking sector and our business due to cyber-security issues and attacks on financial institutions and other businesses, such as large retailers, and regulatory expectations relating to cyber-security |
| • | Technological challenges and our Transformation and Rewiring Programs and our other technology-related programs and initiatives and our expectations regarding their implementation and performance |
| • | Our understanding that MUFG Bank, Ltd. will continue to limit its participation in transactions with Iranian entities and individuals to certain types of transactions |
| • | The possible risks resulting from the replacement of LIBOR, the Company's exposure to IBOR-based rates, and the Company's LIBOR transition program and expectations regarding its effectiveness |
| • | The impact and timing of completion of our initiatives known as the "Transformation Program" and the "Rewiring Program" |
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| • | The effect of a possible return of the California drought on its economy and related governmental actions and the potential consequences of recent California wildfires and related electrical power outages or other natural disasters |
| • | Descriptions of assumptions underlying or relating to any of the foregoing |
Readers of this document should not rely unduly on any forward-looking statements, which reflect only our management’s belief as of the date of this report. There are numerous risks and uncertainties that could cause actual outcomes and results to differ materially from those discussed in our forward-looking statements. Many of these factors are beyond our ability to control or predict and could have a material adverse effect on our financial condition, results of operations or prospects. Such risks and uncertainties include, but are not limited to, those described or referred to in Part I, Item 1. "Business" under the captions "Competition" and "Supervision and Regulation", Item 1A. "Risk Factors" and Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K and in our other reports to the SEC.
Any factor described in this report or in our other reports could by itself, or together with one or more other factors, adversely affect our business, prospects, results of operations or financial condition.
PART I
ITEM 1. BUSINESS
General
We are a financial holding company, bank holding company and intermediate holding company whose principal subsidiaries are MUFG Union Bank, N.A. (MUB or the Bank) and MUSA. We are owned by MUFG Bank, Ltd. and MUFG. MUFG Bank, Ltd. is a wholly-owned subsidiary of MUFG. As used in this Form 10-K, terms such as "the Company," "we," "us" and "our" refer to MUFG Americas Holdings Corporation (MUAH), one or more of its consolidated subsidiaries, or to all of them together.
We provide a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, both nationally and internationally. The Company also provides various business, banking, financial, administrative and support services, and facilities for MUFG Bank, Ltd. in connection with the operation and administration of MUFG Bank, Ltd.'s business in the U.S. (including MUFG Bank, Ltd.'s U.S. branches). The Bank and MUFG Bank, Ltd. are parties to a master services agreement whereby the Bank earns fee income in exchange for services and facilities provided.
The Company has four reportable segments: Regional Bank, Global Corporate & Investment Banking - U.S. (previously U.S. Wholesale & Investment Banking), Transaction Banking and MUSA. We service Global Corporate & Investment Banking - U.S., certain Transaction Banking, and MUSA customers through the MUFG brand and serve Regional Bank and Transaction Banking customers through the Union Bank brand. The Company’s leadership team is bicoastal with Regional Bank and Transaction Banking leaders on the West Coast while Global Corporate & Investment Banking - U.S. and MUSA leaders are based in New York City. The corporate headquarters (principal executive office) for MUB, MUSA and MUAH is in New York City. MUB's main banking office is in San Francisco. The Company had consolidated assets of $170.8 billion at December 31, 2019.
On July 1, 2016, MUFG designated MUAH as its U.S. Intermediate Holding Company and transferred substantially all its U.S. subsidiaries to the IHC in accordance with the requirements of the Federal Reserve's final rules for Enhanced Prudential Standards. MUFG's remaining U.S. subsidiaries were transferred to MUAH on July 1, 2017.
All reports that we file or furnish electronically with the SEC, including the Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and current reports on Form 8-K, as well as any amendments to those reports, are accessible at no cost at www.unionbank.com as soon as reasonably practicable after we electronically file such reports with, or furnish them to, the SEC. These filings are also accessible on the SEC's website at www.sec.gov.
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Lines of Business
Our operations are organized into four reportable segments: Regional Bank, Global Corporate & Investment Banking - U.S., Transaction Banking and MUSA. These segments and their financial information are described more fully in Note 22 to our Consolidated Financial Statements included in this Form 10-K.
Employees
At December 31, 2019, we had approximately 13,240 full-time equivalent employees.
Competition
Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business both nationally and internationally. Our competitors include a large number of state and national banks, thrift institutions, credit unions, finance companies, mortgage banks and major foreign-affiliated or foreign banks, as well as many financial and nonfinancial firms that offer services similar to those offered by us, including many large securities firms, financial services subsidiaries of commercial and manufacturing companies and marketplace lenders. Many of these competitors enjoy fewer regulatory restraints and some may have lower cost structures. Some of our competitors are community or regional banks that have strong local market positions, while others include large financial institutions that have substantial capital, technology and marketing resources.
The financial services industry is also becoming more competitive as further technological advances enable more companies to provide financial services. These technological advances increasingly allow parties to complete financial transactions electronically and may diminish the importance of depository institutions and other financial intermediaries.
Current federal law has made it easier for out-of-state banks to enter and compete in the states in which we operate. Competition in our principal markets may further intensify as a result of the Dodd-Frank Act which, among other things, permits out-of-state de novo branching by national banks, state banks, and foreign banks from other states.
The primary factors in competing for business include pricing, convenience of office locations and other delivery methods, range of products offered, customer relationships, and level of services offered.
Supervision and Regulation
BHCs, banks and securities broker-dealers are extensively regulated under federal and state law. This regulation is intended primarily for the safety and soundness of banks, the protection of bank depositors, brokerage and other customers, the Federal Deposit Insurance Fund, the Securities Investors Protection Fund and the U.S. banking and financial system as a whole, and not for the benefit of investors in securities issued by a BHC or bank or creditors other than depositors. Set forth below is a summary description of significant laws and regulations and other legal authorities that relate to our operations and those of our subsidiaries, including MUB and MUSA. This summary description of applicable legal authorities is not complete and is qualified by reference to such legal authorities and does not address every legal authority. Financial statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies, and a change in them, including changes in how they are interpreted, implemented or applied in a specific instance, could have a material effect on our business and operations.
Principal Federal Banking Laws
BHCA and the GLBA. The Company, MUFG and MUFG Bank, Ltd. are subject to regulation under the BHCA, which subjects us to Federal Reserve reporting, supervision and examination and other requirements. Generally, the BHCA restricts our ability to invest in non-banking entities, and we may not acquire more than five percent of the voting shares of any domestic bank without the prior approval of the Federal Reserve. Our activities are limited, with some exceptions, to the business of banking, managing or controlling banks, and other activities that the Federal Reserve deems to be so closely related to banking as to be a proper incident thereto.
The GLBA allows “financial holding companies” to offer banking, insurance, securities and other financial products. Among other things, the GLBA provides a framework for BHCs to engage in new financial activities
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under certain conditions. MUAH, MUFG Bank, Ltd. and MUFG are financial holding companies under the BHCA. A financial holding company is authorized to engage in activities beyond those permissible for a BHC that are deemed to be financial in nature or incidental to such financial activity as well as certain specified non-banking activities deemed to be closely related to banking. In order to maintain its status as a financial holding company, a BHC must continue to meet certain standards established by the Federal Reserve. Those standards require that a financial holding company exceed the minimum standards applicable to BHCs that have not elected to become financial holding companies. These higher standards include meeting the “well capitalized” and “well managed” standards for financial holding companies as defined in the regulations of the Federal Reserve. The Federal Reserve has the authority to limit the ability of a financial holding company (or any of its affiliates) to conduct otherwise permissible activities if the financial holding company or any of its depository institution subsidiaries ceases to meet these standards. If the deficiencies are not corrected, the Federal Reserve may require that the financial holding company either terminate any activity that is not permissible for a BHC or divest control of a deficient depository institution subsidiary. Failure to comply can also result in the assessment of civil money penalties against the financial holding company. In addition, a financial holding company must ensure that its U.S. banking subsidiaries meet certain minimum standards under the Community Reinvestment Act of 1977.
National Bank Act. MUB, our principal U.S. banking subsidiary, is chartered under and subject to the National Bank Act which, together with the regulations of the OCC, governs many aspects of the corporate activities and banking operations of national banks, including the powers and duties of national banks, the payment of dividends on capital stock, conduct of loan, investment and fiduciary activities, minimum capital ratios, the opening and closing of branches, the acquisition of other banking entities or financial companies and many other matters.
Principal Federal Banking Regulatory Agencies
Federal Reserve. As a BHC and financial holding company, we are subject to the extensive regulation, supervision and examination authority of the Federal Reserve. The Federal Reserve also has extensive enforcement authority over all BHCs. Such authority includes the power to assess civil monetary penalties against any BHC violating any provision of the BHCA or any regulation or order of the Federal Reserve under the BHCA. The Federal Reserve also has the power to order termination of activities or ownership of non-bank subsidiaries of the holding company if it determines there is reasonable cause to believe that the activities or ownership of the non-bank subsidiaries constitutes a serious risk to the financial safety, soundness or stability of banks owned by the BHC. Willful violations of the BHCA or regulations or orders of the Federal Reserve can also result in criminal penalties for the BHC and any individuals participating in such conduct.
Comptroller of the Currency. MUB, as a national banking association, is subject to broad regulation and oversight of all its operations by the OCC, its primary federal banking regulator, and also by the Federal Reserve and the FDIC. MUB is required to file periodic reports with the OCC and is subject to ongoing supervision and examination by the OCC.
The OCC has extensive enforcement authority over national banks. If, during an examination of a bank or otherwise, the OCC determines that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, interest rate sensitivity, or other aspects of the bank’s operations are unsatisfactory or that the bank or its management is violating or has violated any laws or regulations, various remedies are available to the OCC, including the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced to increase capital, to restrict the growth of the bank, to assess civil monetary penalties, to remove officers and directors and/or ultimately to terminate the bank’s charter. The OCC also has broad authority to address bank activity it deems to constitute an unsafe or unsound practice.
The OCC has adopted guidelines that establish minimum standards for the design and implementation of a risk governance framework for large national banks with average total consolidated assets of $50 billion or more, such as MUB. The guidelines establish specific risk management-related roles and responsibilities for three designated functions: a bank’s “front line” public-facing business; independent risk management; and internal audit.
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The OCC has also provided additional guidance to national banks for assessing and managing risks associated with third-party relationships, including any business relationship between a bank and another entity, by contract or otherwise. The guidance includes regulatory expectations for planning, due diligence, third-party selection, contract negotiation and ongoing monitoring of third-party relationships that banks should consider when outsourcing bank functions. The guidance could have an impact on MUB’s selection of vendors to which it outsources certain functions and on MUB’s contract negotiations, particularly with respect to representations and warranties and indemnification by the vendors it may select.
In November 2017, MUFG Bank, Ltd. applied to the OCC to convert its state-licensed branches and agencies in the U.S. to federal branches and agencies; the OCC approved the conversion applications and issued federal licenses to such branches and agencies in November 2017. For additional information, see “MUFG Bank, Ltd.'s and Mitsubishi UFJ Financial Group’s credit ratings and financial or regulatory condition could adversely affect our operations” in Part I, Item 1A. "Risk Factors" in this Report on Form 10-K.
Consumer Financial Protection Bureau. The CFPB has direct supervision and examination authority over banks with more than $10 billion in assets, including MUB. The CFPB’s responsibilities include implementing and enforcing federal consumer financial protection laws, reviewing the business practices of financial services providers for legal compliance, monitoring the marketplace for transparency on behalf of consumers and responding to complaints and questions from consumers about consumer financial products and services. The Dodd-Frank Act added prohibitions on unfair, deceptive or abusive acts and practices to the scope of consumer protection regulations overseen and enforced by the CFPB. In various public pronouncements and enforcement actions, the CFPB has focused on a variety of practices it deems to be unfair, deceptive or abusive, including the following: credit-card add-on products, including billing of consumers for credit-monitoring services without prior consent; failing to accept or timely post payments; failure to honor loan modifications after the loan servicing is transferred; various debt collection practices, including sending foreclosure notices to borrowers who were current on their loans; and various practices relating to debts owed by service members, such as threatening to contact the members’ commanding officers about loan arrears or burying the contractual authorization for this practice in the lending contract. The CFPB has also focused on automobile dealer discretionary interest rate markups and on holding banks and other purchasers of such contracts responsible for unlawful disparities in markups charged by dealers to borrowers of different races or ethnicities. The CFPB also has finalized rules that impact many aspects of residential mortgage loans and lending practices, including a requirement that banks develop and implement procedures to ensure compliance with a borrower’s “reasonable ability to repay” test, make new or revised disclosures and revise policies and procedures for originating and servicing residential mortgage loans.
California Governor Gavin Newsom’s proposed 2020-2021 state budget includes a new California Consumer Financial Protection Law which, if adopted, would reorganize the existing California Department of Business Oversight as the Department of Financial Protection and Innovation. The new agency would be charged with protecting financial consumers from predatory business practices and would extend state supervision to important financial services providers not currently subject to state supervision. If this proposal becomes law in California, it could subject the California banking industry, including the Bank, to additional regulation and oversight by the new agency.
Financial Stability Oversight Council. The Financial Stability Oversight Council (consisting of the Secretary of the Treasury, heads of the federal banking regulatory agencies and the SEC, and certain other officials) provides oversight of all risks created within the U.S. economy from the activities of financial services companies and supports enhanced prudential regulation. It also has the authority to recommend stricter standards for the largest, most interconnected financial services and other firms. Where it determines that certain practices or activities pose a threat to financial stability, it may make recommendations to the primary financial regulatory agencies for new or heightened regulatory standards. The Financial Stability Oversight Council must determine which BHCs and non-bank financial companies pose risks to U.S. financial stability, and subject those companies to the supervision and regulation of the Federal Reserve. The Dodd-Frank Act automatically subjected all bank holding companies and foreign banks with $50 billion or more in total consolidated assets designated by the Financial Stability Oversight Council as “systemically important” to enhanced prudential regulation. The Company falls within this category, and therefore, is subject to heightened prudential standards including enhanced capital, leverage, and liquidity standards, as well as credit exposure reporting, concentration limits, stress testing and resolution plan requirements. In 2018, the President signed into law the EGRRCPA, which
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created a more “tiered” and “tailored” enhanced prudential standards regime for banks. See “Dodd-Frank Act and Related Regulations” below, for additional information.
Dodd-Frank Act and Related Regulations
The Dodd-Frank Act, enacted in 2010, has resulted in sweeping changes to the U.S. financial system. Many provisions of the law have been implemented by rules and regulations of the federal banking agencies. The Dodd-Frank Act also provides authority to the FDIC to serve as receiver in the liquidation of systemically important non-bank financial companies, including BHCs. Liquidation proceedings for such companies will be funded by borrowings from the U.S. Treasury and risk-based assessments on covered financial companies. In circumstances where there is a shortfall after assessments on creditors of a failed company, there may be assessments on BHCs with consolidated assets of $10 billion or more, such as the Company.
As required by the Dodd-Frank Act, the Federal Reserve adopted rules regarding stress testing requirements for large BHCs such as the Company. The OCC also adopted similar rules for large national banks such as MUB. The stress testing rules govern the timing and type of stress testing activities required of large BHCs and banks as well as rules governing testing controls, oversight and disclosure requirements. The stress testing rules limit the ability of a BHC to make capital distributions to the extent that its actual capital issuances are less than the amount indicated in its capital plan, measured on a quarterly basis.
As also required by the Dodd-Frank Act, the Federal Reserve adopted final rules regarding enhanced prudential standards for both large U.S. BHCs, such as the Company, and FBOs operating in the U.S., such as MUFG Bank, Ltd. These integrated rules included the Federal Reserve’s resolution plan, capital plan and stress testing rules, as well as a final rule regarding enhanced prudential standards. The final enhanced prudential standards rule, inclusive of subsequent amendments including Tailoring Rules amendments discussed below, address a diverse array of regulatory subjects, each of which is highly complex. In some instances, the rule requires new financial regulatory requirements and in other instances it overlapped other regulatory reforms already in existence (such as the Basel III capital and liquidity reforms and stress testing requirements discussed elsewhere in this report). For large domestic BHCs, such as the Company, and FBO’s operating in the U.S., such as MUFG Bank, Ltd., the final enhanced prudential standards rule formalized governance and oversight processes with respect to various prudential standards already in place through the Federal Reserve’s other rule-makings, as described in this section, but also imposed certain additional requirements such as an internal liquidity stress testing regime (intended to be complementary to the Federal Reserve’s liquidity coverage ratio proposal discussed below) and maintenance of a related liquidity buffer.
In May 2018, the President signed into law the EGRRCPA, which amended various provisions of the Dodd-Frank Act as well as other federal banking statutes. Among other things, the EGRRCPA raised the threshold for designation as a systemically important financial institution from $50 billion to $250 billion in assets, removed BHCs with less than $100 billion in assets from the application of enhanced prudential standards and eliminated the applicability of enhanced prudential standards to BHCs with between $100 billion and $250 billion in assets 18 months after enactment unless the Federal Reserve by order or rule determines to apply enhanced prudential standards to any such institution.
In October 2019, the federal banking agencies issued two final rules related to the implementation of the EGRRCPA (the “Tailoring Rules”). The final rules assign banks with $100 billion or more in total assets, including U.S. intermediate holding companies of certain foreign banking organizations, such as MUAH, to one of four risk-based categories that increase in stringency based on risk-based indicators, such as measures of size, cross-jurisdictional activity, weighted short-term wholesale funding, nonbank assets, and off-balance sheet exposure, with each category assigned its own tailored requirements based on the risk profile of its combined U.S. operations or its bank or intermediate holding company-level assets. These rules became effective on December 31, 2019. The Tailoring Rules introduce significant regulatory reporting requirements for liquidity-related regulatory reporting on a U.S. operations basis but do not have an impact on MUAH from a capital planning, capital management and liquidity perspective.
Based on MUAH’s analysis of the Tailoring Rules’ capital and liquidity requirements as measured on a bank and intermediate holding company basis (excluding additional U.S. operations), which are based, in part, on the size and complexity of an FBO’s activities in the U.S., MUAH believes that it falls within the least restrictive
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of those risk-based categories (“Category IV”). Under the Tailoring Rules, Category IV institutions generally have lower risk profiles than those subject to Category I, II, or III standards.
In one of the Tailoring Rules, the federal banking agencies amended certain elements of their regulatory capital rules and standardized liquidity requirements to apply tailored capital and liquidity requirements to large banking organizations in each of the four risk-based categories of institutions described in the Tailoring Rules. Under the final rules, the capital requirements applicable to U.S. intermediate holding companies, such as MUAH, are generally consistent with those applicable to U.S. bank holding companies and savings and loan holding companies of a similar size and risk profile. The final Tailoring Rules determine the applicability of liquidity standards with respect to a U.S. intermediate holding company, such as MUAH, based on its risk profile, rather than the combined U.S. operations of the FBO. Under this rule, Category IV firms (such as MUAH) will be required to conduct internal liquidity stress tests quarterly rather than monthly and will be subject to simplified liquidity risk management requirements. Category IV firms will still be required to maintain a liquidity buffer that is sufficient to meet the projected net stressed cash-flow need over a 30-day planning horizon under the firm’s internal liquidity stress test and will remain subject to monthly tailored liquidity reporting requirements. Also, under this Tailoring Rule, Category IV firms (like MUAH) will no longer be required to conduct and publicly disclose the results of company-run capital stress tests and will be subject to a supervisory capital stress test conducted by the Federal Reserve every other year rather than every year.
The final Tailoring Rules adopted by the federal banking agencies also provide that Category IV firms will not be subject to the countercyclical capital buffer or the supplementary leverage ratio and will be allowed to opt out of including most elements of accumulated other comprehensive income (“AOCI”) in regulatory capital. The Tailoring Rules also eliminate or apply a reduced LCR requirement to banking organizations subject to Category IV standards. See “Regulatory Capital and Liquidity Standards - Liquidity Coverage Ratio” below, for additional information.
Effective October 2018, the Federal Reserve adopted a final rule to establish single-counterparty credit limits for BHCs and foreign banking organizations with $250 billion or more in total consolidated assets, including any U.S. intermediate holding company of such a foreign banking organization with $50 billion or more in total consolidated assets, such as MUAH (together, “covered foreign entities”), and any BHC identified as a GSIB under the Federal Reserve’s capital rules. The single-counterparty credit limit for U.S. intermediate holding companies that are covered foreign entities, such as MUAH, fall into three tailored tiers. For U.S. intermediate holding companies that have total consolidated assets of at least $50 billion but less than $250 billion, such as MUAH, the aggregate net credit exposure to a counterparty cannot exceed 25% of the intermediate holding company’s total regulatory capital, plus the balance of its allowance for loan and lease losses not included in tier 2 capital under the applicable capital adequacy guidelines. Stricter restrictions apply to U.S. intermediate holding companies that have $250 billion or more in total consolidated assets but are not major U.S. intermediate holding companies, which are subject to a general limit on the aggregate net credit exposure to a counterparty of 25% of the intermediate holding company’s tier 1 capital, and U.S. intermediate holding companies that have $500 billion or more in total consolidated assets and are considered major U.S. intermediate holding companies, which are subject to a limit on the aggregate net credit exposure to a major counterparty of 15% of the intermediate holding company’s tier 1 capital and a limit on the aggregate net credit exposure to any other counterparty of 25% of the intermediate holding company’s tier 1 capital.
The Federal Reserve's enhanced prudential standards rules relating to FBOs are similar in various respects to those adopted for large domestic BHCs, such as enhanced requirements relating to risk management, including liquidity risk management and capital adequacy and liquidity stress testing. However, the final FBO rules differ in various respects from the domestic BHC rules. For example, a large FBO must certify to the Federal Reserve that it meets capital adequacy standards established by its home country supervisor that are consistent with the BCBS framework. If the FBO does not satisfy such requirements, the Federal Reserve may impose requirements, conditions or restrictions on its U.S. activities.
In addition, the final FBO rules require that an FBO with $50 billion or more of non-branch assets in the U.S. (such as MUFG Bank, Ltd.) operate in the U.S. through an IHC structure. The FBO is required to hold its interest in any U.S. subsidiary through the IHC, which will be its top-tier U.S. subsidiary. U.S. branches of FBOs, such as those of MUFG Bank, Ltd., are excluded from this requirement. MUAH became the IHC for the U.S. operations of MUFG and MUFG Bank, Ltd. on July 1, 2016.
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In December 2016, the Federal Reserve finalized rules imposing new TLAC requirements on GSIBs with operations in the U.S., such as MUFG. The Company, which serves as MUFG’s designated IHC in the U.S., is required to maintain a minimum amount of total loss-absorbing capacity, which must be met with a combination of Tier 1 regulatory capital and long-term debt. Due to MUFG’s single point of entry resolution approach, the Company is subject to a minimum level of internal TLAC, which must be issued either to a foreign company that controls the Company (in this case MUFG Bank, Ltd. or MUFG) or to another directly or indirectly wholly-owned foreign subsidiary of MUFG. TLAC Tier 1 regulatory capital is intended to absorb ongoing losses, while the conversion of TLAC eligible long-term debt into common equity is intended to recapitalize the Company prior to any bankruptcy or insolvency proceedings. The Company became subject to these new rules on January 1, 2019.
Under the Dodd-Frank Act and Federal Reserve regulations, a BHC is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. Under these requirements, a BHC may be required to contribute additional capital to an undercapitalized subsidiary bank. However, this additional capital may be required at times when the BHC may not have the resources to provide such support, or may not be inclined to provide such support under the then existing circumstances.
The federal financial regulatory agencies adopted final rules implementing Section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule. The final rule generally prohibits banking entities from engaging in short-term proprietary trading of securities, derivatives, commodity futures and associated options for their own account. The final rule provides exemptions for certain activities, including certain types of market making, underwriting, hedging of specific, identifiable risks of individual or aggregated positions and trading in U.S. government, agency, state and municipal obligations. These exemptions are limited if they involve a material conflict of interest, a material exposure to high-risk assets or trading strategies or a threat to the institution’s safety and soundness or to that of the U.S. financial system. The rules also exempt trading for customers in a fiduciary capacity or in riskless principal trades, subject to certain requirements.
The Volcker Rule also prohibits banking entities from owning or sponsoring hedge funds and private equity funds (covered funds), subject to certain exclusions. MUB sold the vast majority of its non-conforming private equity fund interests after the Volcker Rule was proposed.
The Volcker Rule also provides compliance requirements generally requiring banking entities to establish an internal compliance program reasonably designed to ensure and monitor compliance with the final rules. As a larger banking entity, the Company was required to establish a more detailed compliance program.
Although we have incurred increased compliance costs as a result of the Volcker Rule, we do not anticipate a material adverse impact to our financial results as revenue from prohibited proprietary trading and covered fund investment activities does not contribute significantly to our financial results.
The Dodd-Frank Act also changed the previous standard for the federal preemption of state consumer financial laws to allow a court or the OCC to preempt a state consumer financial law only if it discriminates against national banks, prevents or significantly interferes with the exercise by the national bank of its powers or the state law is preempted by another federal law. This change was intended to allow greater regulation of national banks under state law and may result in increased consumer protection requirements being imposed on national banks. The Dodd-Frank Act also eliminated the extension of federal preemption under the National Bank Act to operating subsidiaries of national banks negating certain OCC regulations and court decisions. The Act also authorized state law enforcement authorities to bring lawsuits under state law against national banks, thus subjecting national banks to varying and potentially conflicting interpretation of law by state attorneys general and state agencies. This could result in increased compliance costs for national banks. The Act also required the OCC to make preemption determinations on particular state consumer financial laws on a case-by-case basis, rather than making preemption determinations on broad categories of laws.
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Regulatory Capital and Liquidity Standards
The federal banking regulatory agencies have adopted risk-based capital standards under which a banking organization’s capital is compared to the risks associated with assets reflected on its balance sheet as well as its off-balance sheet exposures, such as letters of credit.
Regulatory Capital Rules. The Federal Reserve and the other U.S. federal banking agencies have adopted rules to implement the Basel III capitalization rules of the BCBS for banking organizations located in the United States (U.S. Basel III Rules). The U.S. Basel III Rules replace the U.S. federal banking agencies’ general risk-based capital rules, advanced approaches rule, market-risk rule, and leverage rules, in accordance with certain transition provisions. The U.S. Basel III Rules generally establish more restrictive capital definitions, create additional categories and higher risk-weightings for certain asset classes and off-balance sheet exposures, and higher leverage ratios and capital conservation buffers that are added to the minimum capital requirements and must be satisfied for banking organizations to avoid becoming subject to certain limitations on dividends and discretionary bonus payments to executive officers. The U.S. Basel III Rules also implement higher minimum capital requirements. Under the Tailoring Rules, MUAH as a Category IV firm, retains the ability to exclude certain components of AOCI from its regulatory capital calculations. The Tailoring Rules enacted capital simplification rules amending aspects of the U.S. Basel III Rules which take effect April 1, 2020 for banks not subject to advanced approaches risk-based capital rules.
The U.S. Basel III Rules also provide for various adjustments and deductions to the definitions of regulatory capital that became fully effective on December 31, 2017. Under these rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer above its minimum risk-based capital requirements (equal to 2.50% of its total risk-weighted assets). The capital conservation buffer is designed to absorb losses during periods of economic stress.
In January 2014, the BCBS issued an updated version of its leverage ratio and disclosure guidance (the “Basel III leverage ratio”). The BCBS guidance continues to set a minimum Basel III leverage ratio of 3%. In April 2016, the BCBS proposed, among other things, that for purposes of calculating the denominator of the leverage ratio, off-balance sheet exposures of banks to securitization transactions should be treated the same as such exposures are treated under the BCBS revisions to its securitization framework for risk-based capital. The BCBS further amended the leverage ratio, among other revisions to its Basel III capital framework, in December 2017 (“Basel IV”). The Basel IV revisions refined the definition of the leverage ratio “exposure measure” (the Basel III term for total non-risk-weighted assets), and introduced a leverage ratio buffer applicable to GSIBs, requiring GSIBs to maintain a higher leverage ratio. Beginning January 1, 2022, the updates to the leverage ratio will be implemented and the BCBS leverage ratio buffer will apply to GSIBs.
Prompt Corrective Action. Under the OCC’s prompt corrective action regulations (established pursuant to Section 38 of the Federal Deposit Insurance Act), a bank is assigned to one of five capital categories ranging from “well-capitalized” to “critically under- capitalized.” Institutions that are “under-capitalized” or lower are subject to increasingly more restrictive mandatory supervisory corrective actions. At each successively lower capital category, an insured bank is subject to increased restrictions on its operations. Failure to meet regulatory capital guidelines can result in a bank being required to raise additional capital. An “under-capitalized” bank must develop a capital restoration plan and its parent holding company must generally guarantee the bank’s compliance with the plan. The OCC has amended its prompt corrective action regulations to reflect the changes made to the regulatory capital requirements by the U.S. Basel III Rules.
For additional information regarding the regulatory capital positions of MUAH and MUB, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital Management” in Part II, Item 7 of this Report on Form 10-K and Note 18 to our Consolidated Financial Statements in this Report on Form 10-K.
Capital Planning and Comprehensive Capital Analysis and Review Program. MUAH is subject to regulatory requirements to develop and maintain a capital plan which must be reviewed and approved by its Board of Directors (or designated subcommittee thereof) and which must include internal enterprise-wide stress testing evaluations and assessments of capital adequacy levels under baseline and economic stressed scenarios.
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Under the Tailoring Rules, as a Category IV firm, MUAH is subject to supervisory stress testing and CCAR every other year in even years (e.g. MUAH will be subject to the CCAR process in 2020). CCAR evaluates capital planning processes and assesses capital adequacy levels under various scenarios to determine if BHCs and IHCs would have sufficient capital to continue operations throughout times of economic and financial market stress. Depending on the circumstances, failure to attain a non-objection of a BHC’s or IHC's annual capital plan submission as part of the CCAR process from the Federal Reserve could have a variety of adverse consequences for the institution, including a requirement to augment capital, restrain growth or other adverse consequences. The Federal Reserve’s capital plan and stress testing rules for bank holding companies provide that the Federal Reserve may only issue an objection to a capital plan on the basis of qualitative deficiencies in the BHC’s or IHC's capital planning process if a firm subject to CCAR has not yet had their capital plans evaluated on qualitative grounds for four consecutive years. After December 31, 2020, the Federal Reserve will cease objecting to capital plans on qualitative grounds entirely, other than for firms receiving a qualitative objection in 2020. MUAH continues not to be subject to the CCAR qualitative objection. Under these rules, such bank holding companies’ capital planning processes will be evaluated during the Federal Reserve’s regular ongoing supervisory activities.
Liquidity Coverage Ratio. The U.S. banking agencies adopted a rule implementing a standardized quantitative liquidity requirement generally consistent with the LCR standard, which was included in the Basel III framework of the BCBS. This LCR rule was designed to ensure that covered banking organizations maintain an adequate level of cash and HQLA, such as central bank reserves and government and corporate debt, to meet estimated net liquidity needs in a short-term stress scenario using specified liquidity inflow and outflow assumptions (that produce net cash outflow). An institution’s LCR is the amount of its HQLA, as defined and calculated in accordance with the reductions and limitations in the rules, divided by its net cash outflow, with the quotient expressed as a percentage. While the LCR standard generally applies to all internationally active banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposures, the rule also applied a less stringent, reduced LCR to BHCs that are not internationally active, and have $50 billion or more in total assets (such as the Company). The Tailoring Rules, discussed above, apply a reduced LCR requirement to a banking organization subject to Category IV standards with weighted short-term wholesale funding of at least $50 billion, but less than $75 billion, calibrated at 70% of the full LCR requirement. The reduced LCR requirement does not apply to a depository institution subsidiary of a banking organization subject to Category IV standards. Further, the LCR rule does not apply to banking organizations subject to Category IV standards with less than $50 billion in weighted short-term wholesale funding. In the Tailoring Rules, the Federal Reserve noted that it is still considering whether to develop and propose for implementation a standardized liquidity requirement with respect to the U.S. branches and agencies of foreign banking organizations as part of a separate rulemaking process. MUAH’s most recent short-term wholesale funding amount as reported in form FR Y-15 does not meet the $50 billion threshold and, therefore, the Company is not subject to the LCR requirement.
Other Federal Laws and Regulations Affecting Banks
There are additional requirements and restrictions in the laws of the U.S. and states in which MUB and its subsidiaries conduct operations. The consumer lending and other banking activities of MUB are subject to extensive regulation under various state laws as well as the federal laws discussed above. Furthermore, due to MUFG Bank, Ltd.’s controlling ownership of the Company, regulatory requirements adopted or enforced by the Government of Japan may have an impact on the activities and investments of the Company in the future.
Deposit Insurance. Customer deposits maintained by MUB are insured up to statutory limits (currently $250,000 per depositor, subject to certain exceptions) by the FDIC and, accordingly, are subject to deposit insurance assessments. Deposit insurance assessment rates are subject to change by the FDIC and can be impacted by the overall economy and the stability of the banking industry as a whole.
As required by the Dodd-Frank Act, the FDIC adopted a comprehensive, long-range restoration plan for the FDIC's deposit insurance fund to increase the fund’s reserves relative to total insured deposits in the U.S. The ultimate effect on our business of legislative, regulatory and economic developments on the deposit insurance fund cannot be predicted with certainty.
The FDIA provides that, in the event of the liquidation or other resolution of an insured depository institution, the claims of its depositors (including claims by the FDIC as subrogee of insured depositors) and
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certain claims for administrative expenses of the FDIC as receiver would be afforded a priority over other general unsecured claims against such an institution. If an insured depository institution fails, claims of insured and uninsured depositors and the FDIC will be placed ahead of unsecured, non-deposit creditors, in order of priority of payment.
If any insured depository institution becomes insolvent and the FDIC is appointed its conservator or receiver, the FDIC may, in most cases, disaffirm or repudiate any contract to which such institution is a party if the FDIC determines that performance of the contract would be burdensome and that disaffirmance or repudiation of the contract would promote the orderly administration of the institution’s affairs. In addition, the FDIC as conservator or receiver may enforce most contracts entered into by the institution notwithstanding any provision providing for termination, default, acceleration or exercise of rights upon or solely by reason of insolvency of the institution, appointment of a conservator or receiver for the institution, or exercise of rights or powers by a conservator or receiver for the institution.
Under provisions of the FDIA, an FDIC-insured bank under common control with another FDIC-insured bank is generally liable for any loss incurred or reasonably expected to be incurred, by the FDIC upon the actual or reasonably likely failure of such other bank. Thus, MUB could incur liability to the FDIC under these provisions in the event of failure of another bank controlled by the Company or MUFG. This liability would be subordinated to deposit liabilities and certain other senior liabilities. At present, neither the Company nor MUFG have such other bank subsidiaries.
Pursuant to the Dodd-Frank Act and related regulations, BHCs and insured depository institutions with $50 billion or more in assets were required to develop and annually file with the bank regulators resolution plans or so-called “living wills” to facilitate the FDIC’s ability to liquidate such banks in a prompt and orderly fashion upon a failure. MUFG's U.S. operations are covered under the Federal Reserve and FDIC's joint Section 165(d) of the Dodd-Frank Act, and MUB as an insured depository institution is subject to the FDIC's insured depository institution rule, which requires certain insured depository institutions to submit resolution plans, with respect to specification of supervisory requirements for maintaining compliance with "living will" regulations. If the bank regulators determine that the resolution plan is not credible or would not facilitate the orderly resolution of the institution, they may require the institution to submit a revised resolution plan that addresses the deficiencies identified by the regulators. If the regulators determine that the revised plan remains deficient, they may decide to subject the institution to more stringent capital, leverage, or liquidity requirements or restrictions on growth, activities or operations and may impose other sanctions. The Tailoring Rules, discussed above, amend and restate the 165(d) resolution planning rule, and extend the deadline for submission of 165(d) resolution plans to either July 1, 2021 or July 1, 2022 (based on category of firm). Generally, GSIB’s, foreign firms and larger domestic institutions will file resolution plans every two or three years, alternating between full plans and targeted plans focused on core areas like capital and liquidity, as well as material changes in other areas. MUFG's U.S. operations are included within required filings alternating full and targeted resolution plans on a three-year cycle, with transition to the new rule beginning with the filing of a targeted resolution plan on July 1, 2021.
In September of 2016, the OCC adopted guidelines establishing standards for recovery planning by national banks with total consolidated assets of $50 billion or more, such as MUB. The guidelines required such larger banks to undertake recovery planning to be able to respond quickly to and recover from the financial effects of severe stress on the bank. Banks with total assets of more than $100 billion but less than $750 billion, such as MUB, were required to comply with these new requirements on or before January 1, 2018. Effective January 28, 2019, the OCC amended its recovery planning guidelines and standards for insured national banks, increasing the average total consolidated assets threshold for applicability from $50 billion to $250 billion. Under the revised guidelines, MUB is no longer subject to recovery planning requirements.
Community Reinvestment Act. MUB is subject to the CRA. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the needs of local communities, including low- and moderate-income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and the CRA into account when regulating and supervising other activities and in evaluating whether to approve applications for permission to engage in new activities or to acquire other banks or companies or de novo branching. An unsatisfactory CRA rating may be the basis for denying the application. On January 9, 2020, the OCC and the FDIC published a notice of proposed rule-making intended to modernize and strengthen
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the CRA regulations to better achieve their underlying statutory purpose by clarifying which activities qualify for CRA credit, updating where activities count for CRA credit, creating a more transparent and objective method for measuring CRA performance, and providing for more transparent, consistent, and timely CRA-related data collection, recordkeeping, and reporting. This rule, if enacted, is likely to have a significant impact on the CRA implementation framework; however, the final form of this rule and its impact on the financial services industry in general, and on MUB in particular, cannot be predicted at this time.
Fair Lending and Other Related Laws. MUB is subject to the Equal Credit Opportunity Act of 1974 and the implementing regulations thereunder. The statute requires financial institutions and other firms engaged in the extension of credit to make credit equally available to all creditworthy customers and makes it unlawful for any creditor to discriminate against any applicant with respect to any aspect of a credit transaction: (1) on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract); (2) because all or part of the applicant’s income derives from any public assistance program; or (3) because the applicant has in good faith exercised any right under the Consumer Credit Protection Act. In addition, a creditor may not make any oral or written statement, in advertising or otherwise, to customers or prospective customers that would discourage on a prohibited basis an application for credit.
MUB is also subject to the Federal Housing Act, which makes discrimination in home lending illegal, as well as the Americans with Disabilities Act, which requires banks to reasonably accommodate individuals with disabilities.
Banks are periodically examined for compliance with these fair lending laws and other related laws. The banking regulators are required to refer matters relating to these fair lending laws to the Department of Justice for possible investigation and further appropriate action under civil penalty statutes whenever the regulator has reason to believe that a creditor has engaged in a pattern or practice of conduct that may violate these laws.
Bank Secrecy Act and Office of Foreign Assets Control Regulations. The banking industry is subject to extensive regulatory controls and processes under the Bank Secrecy Act and related anti-money laundering laws. Under the USA PATRIOT Act, federal banking regulators must consider the effectiveness of a financial institution’s anti-money laundering program prior to approving an application for a merger, acquisition or other activities requiring regulatory approval. The U.S. also imposes economic sanctions that affect transactions with designated foreign countries, nationals and others. These rules are administered by OFAC. Included among OFAC restrictions are limitations or prohibitions on engaging in financial transactions involving a sanctioned country, entity or person and prohibitions on transfers of blocked property and bank deposits subject to U.S. jurisdiction. Failure to comply with these requirements may adversely affect the Company’s ability to obtain regulatory approvals for future initiatives requiring regulatory approval, including acquisitions, and additionally could result in substantial monetary fines, penalties and other sanctions.
Affiliate Transactions. MUB and its affiliates are subject to certain restrictions under the Federal Reserve Act and related regulations, including restrictions on loans by MUB to, and other transactions with, its affiliates (including requirements that such transactions with MUB be collateralized and on arm’s-length terms). Dividends payable by MUB to MUAH are subject to restrictions under a formula imposed by the OCC unless express approval is given by the OCC to exceed these limitations.
Customer Information Security. The federal bank regulatory agencies have adopted guidelines for safeguarding confidential, personal customer information. The guidelines require each financial institution to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. MUB has adopted a customer information security program. In addition, each agency has published its standards and expectations for banks to protect their own data, information technology and other assets and operations from unauthorized intrusion and vulnerability to malicious cyber-attack to the greatest degree possible.
Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, the
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statute requires explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the banks’ policies and procedures and applicable law. These regulations also allow consumers to opt-out of the sharing of certain information among non-affiliates, and impose other requirements. MUB implemented its privacy policy, which provides that all of its existing and new customers will be notified of MUB’s privacy policies. Federal financial regulators have issued regulations under the Fair and Accurate Credit Transactions Act, which increased the length of the waiting period, after privacy disclosures are provided to new customers, before information can be shared among affiliated companies for the purpose of cross-marketing products and services between those affiliated companies. Certain state laws and regulations designed to protect the privacy and security of customer information also apply to us and our other subsidiaries, including laws requiring notification to affected individuals and regulators of data security breaches. For additional discussion, see “Increasing regulation of data privacy could adversely affect our business" in Part I, Item 1A. "Risk Factors" in this Report on Form 10-K.
Overdraft and Interchange Fees; Interest on Demand Deposits. Regulation E restricts a bank's ability to charge overdraft services and fees. The rule prohibits financial institutions from charging fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to an overdraft service for those types of transactions. The Dodd-Frank Act's "Durbin Amendment" also required the Federal Reserve to establish standards for interchange fees that are “reasonable and proportional” to the cost of processing the debit card transaction and imposes other requirements on card networks.
Regulation of MUSA
MUSA is a registered broker-dealer with the SEC and is a member of FINRA. MUSA is also registered with the MSRB as a broker-dealer.
Much of the regulation of broker-dealers has been delegated to self-regulatory organizations such as FINRA of which MUSA is a member. The principal purpose of regulating broker-dealers is the protection of clients and the securities markets. The regulations cover many aspects of the securities business, including, among other things, sales and trading practices, publication of research, margin lending, uses and safekeeping of clients’ funds and securities, capital adequacy, recordkeeping and reporting, fee arrangements, disclosure to clients, fiduciary duties owed to advisory clients, and the conduct of directors, officers and employees.
MUSA is subject to Rule 15c3-1 under the Exchange Act (the Uniform Net Capital Rule), Rule 15c3-3 (Customer Protection Rule) and related SRO requirements. The Uniform Net Capital Rule specifies minimum capital requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. The Customer Protection Rule provides requirements for customer cash reserves and the custody of customer securities.
The Uniform Net Capital Rule prohibits a broker-dealer subsidiary from paying cash dividends, or making unsecured advances or loans to its parent company or repaying subordinated loans to its parent company if such payment would result in a net capital amount of less than 5% of aggregate debit balances or less than 120% of its minimum dollar requirement of $1,000,000.
In addition to the net capital requirements as a self-clearing broker-dealer, MUSA is subject to cash deposit and collateral requirements with clearing houses, such as the Depository Trust & Clearing Corporation, Options Clearing Corporation and Fixed Income Clearing Corporation, which may fluctuate significantly from time to time based upon the nature and size of clients’ trading activity and market volatility.
Future Legislation or Regulatory Initiatives
The economic and political environment of the past several years has led to a number of proposed legislative, governmental and regulatory initiatives, at both the federal and state levels, certain of which are described above, that may significantly impact our industry. These and other initiatives could significantly change the competitive and operating environment in which we and our subsidiaries operate. We cannot predict whether these or any other proposals will be enacted or the ultimate impact of any such initiatives on our operations, competitive situation, financial condition or results of operations.
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On January 30, 2020, the Federal Reserve adopted a final rule, effective on April 1, 2020, revising the Federal Reserve’s regulations relating to determinations of whether a company has the ability to exercise a controlling influence over a banking organization or other entity for purposes of the BHCA. This rule outlines a tiered framework that is designed to incorporate the major factors and thresholds, or combinations of factors, that the Federal Reserve will use to determine if a company has control over a bank or other entity, including a company's total voting and non-voting equity investment in the entity; director, officer and employee interlocks between a company and the entity; and the scope of business relationships between a company and the entity. This rule, while generally consistent with the Federal Reserve’s historical practice, in some respects expands on or adds additional rebuttable presumptions of control. This rule could impact the manner in which MUFG makes investments in companies, in particular those that have a presence in the United States. To what extent MUAH and MUB may be affected by this final rule cannot be predicted at this time.
Disclosure of Iranian Activities under Section 13(r) of the Securities Exchange Act of 1934
We are disclosing the following information pursuant to Section 13(r) of the Exchange Act, which requires an issuer to disclose whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with natural persons or entities designated by the U.S. government under specified Executive Orders. The scope of activities that must be reported includes activities not prohibited by U.S. law and conducted outside the United States in compliance with applicable local law. Because we are indirectly wholly-owned by MUFG, a Japanese corporation, our disclosure is required to include, in addition to our activities, transactions or dealings, those conducted outside the United States by non-U.S. affiliates of MUFG which are not controlled by us. We have requested that MUFG provide us a description of reportable activity under Section 13(r) and have received the following information:
During the fiscal year ended December 31, 2019, a non-U.S. subsidiary of MUFG engaged in business activities with entities in, or affiliated with, Iran, including counterparties owned or controlled by the Iranian government. Specifically, MUFG’s non-U.S. banking subsidiary, MUFG Bank, issued letters of credit and guarantees and provided remittance and other settlement services mainly in connection with customer transactions related to the purchase and exportation of Iranian crude oil to Japan prior to the expiration of the Significant Reduction Exception granted to Japan, and in some cases, in connection with other petroleum-related transactions with Iran by its customers that are exempt from applicable Iran-related sanctions or otherwise permitted by OFAC. The remittance and other settlement services did not involve U.S. dollars nor clearing services of U.S. banks. For the fiscal year ended December 31, 2019, the aggregate interest and fee income relating to these transactions was less than ¥50 million, representing less than 0.005 percent of MUFG’s total interest and fee income. Some of these transactions were conducted through the use of non-U.S. dollar correspondent accounts and other similar settlement accounts maintained with MUFG Bank outside the United States by Iranian financial institutions and other entities in, or affiliated with, Iran. In addition to such accounts, MUFG Bank receives deposits in Japan from, and provides settlement services in Japan to, fewer than 10 Iranian government-related entities and fewer than 100 Iranian government-related individuals such as Iranian diplomats, and maintains settlement accounts outside the United States for certain other financial institutions specified in Executive Order 13382, which settlement accounts were frozen in accordance with applicable laws and regulations. For the fiscal year ended December 31, 2019, the average aggregate balance of deposits held in these accounts represented less than 0.1 percent of the average balance of MUFG’s total deposits. The fee income from the transactions attributable to these account holders was less than ¥5 million, representing less than 0.005 percent of MUFG’s total fee income.
We understand that MUFG Bank recognizes that following the withdrawal in May 2018 by the United States from the Joint Comprehensive Plan of Action, the United States has imposed secondary sanctions against non-U.S. persons who engage in or facilitate a broad range of transactions and activities involving Iran. We understand that MUFG Bank has taken the recent sanctions related developments into account and will monitor any future transactions relating to Iran in order to comply with applicable U.S. and Japanese regulations as well as U.S., Japanese and other international sanctions.
Financial Information
See our Consolidated Financial Statements beginning on page 76 of this Form 10-K for financial information about MUAH and its subsidiaries.
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ITEM 1A. RISK FACTORS
The following discussion sets forth material risk factors that could affect our financial condition and operations:
Industry Factors
Commencing in 2008 and continuing for several years thereafter, the U.S. and global economies experienced a serious recession, slow economic recovery, persistent financial market volatility, and significant U.S. and global consumer and business economic deterioration which presented challenges for the banking and financial services industry and for MUAH. For the past several years, the U.S. economy has experienced a period of significant expansion; however, this expansion is not likely to continue indefinitely and, at some point, economic conditions in the U.S. are likely to soften or become recessionary with resultant adverse consequences for the U.S. financial services industry and for MUAH.
Following the financial crisis of 2008, adverse financial and economic developments impacted U.S. and global economies and financial markets and presented challenges for the banking and financial services industry and for MUAH. These developments included a general recession both globally and in the U.S. followed by a slow economic recovery accompanied by unprecedented volatility in the financial markets.
In response, various significant economic and monetary stimulus measures were implemented by the U.S. government. The Federal Reserve pursued a highly accommodative monetary policy aimed at keeping interest rates at historically low levels although the Federal Reserve has more recently modified certain aspects of this policy by gradually increasing short-term interest rates and reducing its balance sheet. The U.S. economy has experienced a period of significant expansion in recent years; however, this expansion is not likely to continue indefinitely and, at some point, economic conditions in the U.S. are likely to soften or become recessionary. We, and other financial services companies, are impacted to a significant degree by current economic conditions.
The U.S. government continues to face significant fiscal and budgetary challenges which, if not resolved, could result in renewed adverse U.S. economic conditions. These challenges may be intensified over time if federal budget deficits were to increase and Congress and the Administration cannot effectively work to address them.
Indeed, the overall level of the federal government's debt, the extensive political disagreements regarding the government's statutory debt limit and the continuing substantial federal budget deficits led to a downgrade from “AAA” to “AA+” of the long-term sovereign credit rating of United States debt by one credit rating agency, although other credit rating agencies did not take such action. This risk, and other risks associated with the divided control of the federal government, could be exacerbated over time. If substantial federal budget deficits were to continue in the years ahead, further downgrades by the credit rating agencies with respect to the obligations of the U.S. federal government could occur. Any such further downgrades could increase over time the U.S. federal government’s cost of borrowing, which may worsen its fiscal challenges, as well as generate upward pressure on interest rates generally in the U.S. which could, in turn, have adverse consequences for borrowers and the level of business activity. Any such developments could also have adverse consequences for the securities business conducted by MUSA, which relies upon both the credit quality of bonds issued by the U.S. federal government and the smooth functioning of the markets using such bonds as collateral. It is also possible that the federal government’s fiscal and budgetary challenges could be intensified over time as a result of the federal tax legislation signed into law in December of 2017 if the reductions in tax rates along with greater government spending result in increased federal budget deficits.
Difficult market conditions have adversely affected the U.S. banking industry in the past and may do so again
The resulting economic pressure on consumers and lack of confidence in the financial markets following the 2008 recession adversely affected our business, financial condition and results of operations for several years after the recession. Although the economic conditions in our markets, including California in particular and in the U.S. in general, have significantly improved in recent years, there can be no assurance that these conditions will continue to improve, especially given the fact that the U.S. economic expansion is becoming extended in its duration. In addition, turbulent political and economic conditions in foreign countries and trade policy differences
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with major U.S. trading partners may negatively impact the U.S. financial markets and economy in general. If these conditions worsen, market conditions could be adversely affected. In particular, we may face the following risks in connection with these events:
| • | Our ability to assess the creditworthiness of our customers and counterparties may be impaired if the methods and approaches we use to select, manage, and underwrite our customers and counterparties become less predictive of future behaviors. |
| • | We may not be able to accurately estimate credit exposure losses because the process we use to estimate these losses requires difficult, subjective, and complex judgments which may not be amenable to precise estimates, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans. |
| • | Our ability to borrow from other financial institutions 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. |
| • | Downgrades in the credit ratings of major U.S. or foreign banks or other financial difficulties affecting such major banks could have adverse consequences for the financial markets generally, including possible negative effects on the available sources of market liquidity and increased pricing pressures in such markets which, in turn, could make it more difficult or expensive for banks generally and for us in particular to access such markets to satisfy liquidity needs. |
| • | Significant fluctuations in the prices of equity and fixed income securities could adversely impact the revenues of our broker-dealer and asset management and trust businesses. MUSA is exposed to the price risk of such securities where it holds inventory to meet expected customer demand. MUSA's debt capital markets fee income would also be detrimentally impacted from sustained periods of fixed income price volatility. MUB's fee income may also decline since its asset management and trust business fees are primarily based upon the values of assets it manages, and declines in the values of those assets proportionately reduce the amount of its fees charged. |
| • | We may incur goodwill impairment losses in future periods. See “Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates - Goodwill Impairment Analysis” in Part II, Item 7. and Note 5 to our Consolidated Financial Statements included in this Form 10-K. |
| • | The United States, Mexico and Canada have come to an agreement to replace NAFTA with USMCA. Early in 2020, the U.S. Congress approved legislation implementing the USMCA and the President signed this legislation into law. Mexico had previously ratified the USMCA and Canada is expected to do so in the near future. The effect of this agreement and future proposals on international trade between the U.S. and other countries and on the level of economic activity in the U.S., as well as possible volatility in the financial markets generally, remains uncertain. |
| • | Changes and uncertainties about U.S. and international trade relationships, agreements, policies, treaties and restrictive actions, as well as the possibility of significant increases in tariffs on imported goods and other restrictive actions, could have a material adverse impact on U.S., global and regional economic conditions and could result in volatility in the financial markets generally, among other impacts. |
| • | Given the inter-connectivity of the global economy, pandemic disease and health events, such as the recent outbreak of coronavirus infections originating in the Far East, have the potential to negatively impact economic activities in many countries, including the U.S., with consequent adverse effects on our customers and business. |
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The effects of changes or increases in, or supervisory enforcement of, banking, securities, competition or other laws and regulations or governmental fiscal, monetary, or tax policies could adversely affect us or make strategic planning more difficult
We are subject to significant banking and federal and state securities regulation and supervision, which is primarily for the benefit and protection of our depositors and other customers and the Federal Deposit Insurance Fund and the banking system as a whole and less so for the benefit of investors in our securities. In the past, our business has been materially affected by these regulations. This can be expected to continue in the future. Laws, regulations or policies, including accounting standards and interpretations, currently affecting us and our subsidiaries may change over time. Regulatory authorities may also change their interpretation of, and intensify their examination of compliance with, 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 perceived noncompliance, which could result in the imposition of significant penalties or fines. Changes in laws and regulations may also increase our expenses by imposing additional supervision, fees, taxes or restrictions on our operations. Compliance with laws and regulations, especially new laws and regulations, increases our operating expenses and may require additional management time and attention. To the extent state and local laws and regulations are not preempted by federal laws or regulations, our regulatory compliance could become more challenging.
The Dodd-Frank Act was enacted in 2010 in response to the financial crisis that culminated in the severe economic disruptions during and after 2008. The Dodd-Frank Act, among other things, established the CFPB with broad powers to regulate consumer financial products such as credit cards and mortgages, established the Financial Stability Oversight Council comprised of the heads of various regulatory agencies, led to new capital requirements from U.S. federal banking agencies, placed new limits on electronic debit card interchange fees, and required the SEC and national stock exchanges to adopt significant new corporate governance and executive compensation reforms. While the CFPB's regulatory powers have not changed under the current Administration, the number of publicly announced enforcement actions it has chosen to pursue has significantly declined.
This important legislation has affected U.S. financial institutions, including MUAH and MUB, in many ways, some of which have increased, or may increase in the future, the cost of doing business and present other challenges to the financial services industry. For additional information regarding the impact on our business of the Dodd-Frank Act and related regulations, see "Supervision and Regulation – Principal Federal Banking Laws - Dodd-Frank Act and Related Regulations" in Part I, Item 1. "Business" in this Form 10-K.
Following the 2008 financial crisis and again during the past year, the Federal Reserve and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for banking organizations operating in the U.S., including our Company. For additional information, see "Supervision and Regulation – Regulatory Capital and Liquidity Standards" in Part I, Item I. "Business" and "Regulatory Capital" in Part II, Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K.
The EGRRCPA, signed into law in May 2018, amended various provisions of the Dodd-Frank Act as well as other federal banking statutes as described more fully in "Supervision and Regulation – Dodd Frank Act and Related Regulations" in Part I, Item I. "Business" in this Form 10-K.
The need to maintain more and higher quality capital and greater liquidity under applicable bank regulatory agency rules could limit the Company’s lending and other business activities and its ability to expand, either organically or through acquisitions. It could also result in the Company taking steps to increase its capital or being limited in its ability to pay dividends or otherwise return capital to its shareholders, or selling or refraining from acquiring assets. In addition, the regulatory liquidity standards could limit the Company’s ability to invest in longer-term or less liquid assets even if more desirable from a balance sheet management perspective.
The capital rules of the U.S. federal banking agencies as well as the various other regulations referred to herein, along with other regulations which may be adopted in the future, may also generally increase our cost of doing business or lead us to stop, reduce or modify our products and services.
Proposals to reform the housing finance market in the U.S. could also significantly affect our business. These proposals, among other things, include reducing or eliminating over time the role of the GSEs (Fannie Mae and Freddie Mac) in guaranteeing mortgages and providing funding for mortgage loans, as well as the
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implementation of reforms relating to borrowers, lenders, and investors in the mortgage market, including reducing the maximum size of a loan that the GSEs can guarantee, phasing in a minimum down payment requirement for borrowers, improving underwriting standards, and increasing accountability and transparency in the securitization process. While the specific nature of these reforms and their impact on the financial services industry in general, and on MUB in particular, is uncertain at this time, such reforms, if enacted, are likely to have a substantial impact on the mortgage market and could potentially reduce our income from mortgage originations by increasing mortgage costs and/or lowering originations. The GSE reforms could also reduce real estate prices, which could reduce the value of collateral securing outstanding mortgage loans. This reduction of collateral value could negatively impact the value or perceived collectability of these mortgage loans and cause an increase in our allowance for loan losses. Such reforms may also include changes to the Federal Home Loan Bank System, which could adversely affect a significant source of funding for lending activities by the banking industry, including the Bank. These reforms may also result in higher interest rates on residential mortgage loans, thereby reducing demand, which could have an adverse impact on the Bank’s residential mortgage lending business. In addition, any impact of such changes upon the credit quality of GSE’s and therefore upon agency MBS securities held by MUAH could result in material reductions in valuations, as well as adverse impacts upon MUSA’s agency MBS trading business.
Several cities in the United States (including New York, Los Angeles, San Diego, San Francisco, San Jose and Seattle) have adopted responsible banking ordinances and other cities are considering the adoption of similar ordinances. These ordinances generally require banks that hold city government deposits to provide detailed accounts of their lending practices in low-income communities, as well as their participation in foreclosure prevention and home loan principal reduction programs. Performance under these ordinances is used as a basis for awarding the city’s financial services contracts. The adoption of these ordinances by municipalities for which the Bank is a provider of cash management or other banking services could result in increased regulatory and compliance costs and other operational costs and expenses, making this business less desirable to the Bank and potentially resulting in reduced opportunities for the Bank to provide these services. In August of 2015, New York City's ordinance was found to be invalid because it was pre-empted by federal and state banking laws and that case was dismissed. Whether and to what extent other responsible banking ordinances will be challenged and invalidated cannot be predicted.
International laws, regulations and policies affecting us, our subsidiaries and the business we conduct may change over time and affect our business opportunities and competitiveness in these jurisdictions. Due to our ownership by MUFG and MUFG Bank, Ltd., laws, regulations, policies, fines and other supervisory actions adopted or enforced by the Government of Japan, the Federal Reserve and other regulators 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. Some legal and 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 reasonably designed 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. Legal or regulatory compliance failure may also adversely affect our ability to obtain regulatory approvals for future strategic initiatives. Furthermore, failure to take necessary corrective action or the discovery of other violations of laws in the process of implementing any corrective measures could result in further regulatory enforcement action.
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, which regulates the supply of money and credit in the U.S. Under the Dodd-Frank Act and a long-standing policy of the Federal Reserve, a BHC 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 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 deposits accepted by banks and 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 can be expected to have a material effect on our business, prospects, results of operations and financial condition. For additional information regarding the impact of the Federal Reserve’s monetary policies on interest rates and
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our net interest margin, see “Fluctuations in interest rates on deposits or other funding sources could adversely affect our net interest margin” below in this Risk Factors section.
Refer to "Supervision and Regulation" in Part I, Item 1. "Business" in this Form 10-K for discussion of certain additional existing and proposed laws and regulations that may affect our business.
Increased regulation of the financial services industry has required and can be expected to continue to require significant investments in technology, personnel or other resources. Our competitors may be subject to different or reduced regulation due to their asset size or types of products offered and may also be able to more efficiently utilize resources to comply with regulations and to more efficiently absorb increased regulatory compliance costs into their cost structures.
The December 2017 reform of the U.S. tax laws that included a substantial reduction in corporate and personal tax rates also changed the tax laws relevant to our business. While such reform has had and could continue to have positive effects on corporate profitability which could benefit the Company and its customers, there could be other potential adverse consequences such as a decrease in the value of tax credits on certain investments we may make. There could also be possible adverse consequences for the economy and the business climate, such as a large increase in the federal deficits and increasing interest rates generally, including for the federal government’s borrowing costs. The potential long-run impact of these possible developments remains uncertain. For additional information regarding the possible effects of these changes on our business, see “The changes in the U.S. tax laws, the majority of which were effective January 1, 2018, will impact our business and results of operations in a variety of ways, some of which are expected to be positive and others which may be negative” below in this "Risk Factors" section.
Higher credit losses could require us to increase our allowance for credit losses resulting in 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 of 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 believe 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 rate increase could reduce our borrowers’ ability to repay their loans, resulting in our increasing the allowance. We might also increase the allowance because of the occurrence of events previously unexpected. Any increase in our credit allowance would result in a charge to earnings.
The need to account for assets at market prices may adversely affect our results of operations
We report certain assets, including securities, at fair value. Generally, for assets that are reported at fair value, we use quoted market prices or valuation models that utilize market data inputs and assumptions to estimate that value. Because generally accepted accounting principles in the U.S. require fair value measurements to reflect appropriate adjustments for risks related to liquidity and the use of unobservable assumptions, we may recognize unrealized losses even if we believe that the asset in question presents minimal credit risk. During periods of adverse conditions in the capital markets, we may be required to recognize other-than-temporary impairments with respect to securities in our investment portfolio and such conditions could also result in mark-to-market losses in our trading portfolios at MUSA.
Fluctuations in interest rates on loans could adversely affect our business
Significant increases in market interest rates on loans or other fixed income investments, or the perception that an increase may occur, could adversely affect our current loan and investment portfolios, our ability to originate new loans and our ability to grow. An increase in market interest rates could adversely affect the ability of our floating-rate borrowers to meet their higher payment obligations. If this occurred, it could cause an increase in nonperforming assets and charge-offs, which could adversely affect our business. Conversely, decreases in
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interest rates could result in an acceleration of loan prepayments that could negatively affect our profitability. Increases in interest rates could also diminish the flow of corporate debt offerings in the securities markets generally and this could adversely impact the investment banking business of MUSA which is dependent on the sales of debt securities issued by its customers.
Fluctuations in interest rates on deposits or other funding sources could adversely affect our net interest margin
Changes in market interest rates on deposits or other funding sources, including changes in the relationship between short-term and long-term market interest rates or between different interest rate indices, can impact, and has in past years impacted, our net interest margin (that is, the difference between the interest rates we charge on interest earning assets, such as loans, and the interest rates we pay on interest-bearing liabilities, such as deposits or other borrowings). This impact could result in a decrease in our interest income relative to interest expense. Following the 2008 recession, the Federal Reserve’s highly accommodative monetary policies (including a very low federal funds rate and substantial purchases of long-term U.S. Treasury and agency securities) placed downward pressure on the net interest margins of U.S. banks, including MUB. The Federal Reserve continued to gradually raise interest rates from late 2016 through 2018 and gradually reduce its historically high $4.5 trillion balance sheet until the third quarter of 2019 when the Federal Reserve again began to lower interest rates. The long-term impact of these measures on the U.S. economy and financial markets cannot be predicted with certainty at this time. For additional information, see “The effects of changes or increases in, or supervisory enforcement of, banking, securities, competition or other laws and regulations or governmental fiscal, monetary, or tax policies could adversely affect us or make strategic planning more difficult” above in this Risk Factors section. For additional information, see Part I, Item 1. "Business - Supervision and Regulation - Principal Federal Banking Regulatory Agencies" in this Form 10-K.
Our deposit customers may pursue alternatives to bank deposits or seek higher yielding deposits, which may increase our funding costs and adversely affect our liquidity position
Checking and savings account balances and other forms of deposits can decrease when our deposit customers perceive alternative investments, such as the stock market, other non-depository investments or higher yielding deposits, as providing superior expected returns. Technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments or other deposit accounts, including products offered by other financial institutions or non-bank service providers. Future increases in short-term interest rates could increase such transfers of deposits to higher yielding deposits or other investments either with us or with other providers. Depositors may withdraw certain deposits from MUB and place them in other institutions or invest uninsured funds in investments perceived as being more secure, such as securities issued by the U.S. Treasury or collateralized debt obligations. These consumer preferences may force us to pay higher interest rates or reduce fees to retain certain deposits and may constrain liquidity as we seek to meet funding needs caused by reduced deposit levels.
As interest rates rise from the historically low levels of recent years, our deposits may not be as stable or as interest rate insensitive as similar deposits may have been in the past and, if the expansion of the U.S. economy continues, some existing or prospective deposit customers of banks generally, including MUB, may be inclined to pursue other investment alternatives.
Efforts and initiatives we undertake to retain and increase deposits, including deposit pricing, can increase our costs. When bank customers move money out of bank deposits in favor of alternative investments or into higher yielding deposits, we can lose a relatively inexpensive source of funds, increasing our funding cost. As our assets grow, we may face increasing pressure to seek new deposits through expanded channels from new customers at unfavorable pricing, further increasing our costs.
Substantial competition could adversely affect us
Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business in the West Coast states as well as nationally and internationally. Our competitors include a large number of state, community, regional and national banks, thrift institutions, credit unions, finance companies, mortgage banks and major foreign-affiliated or foreign banks, as well as many nonbank financial and nonfinancial firms that offer services similar to those offered by us, including many large securities firms and financial services subsidiaries of commercial and manufacturing companies. Some of our competitors are insurance companies
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or community or regional banks that have strong local market positions. While we are part of MUFG, one of the largest global financial institutions, MUAH, MUB and MUSA are separate entities from their parent and other affiliates, and our competition includes a number of large financial institutions and securities firms operating in our U.S. markets that have substantial capital, technology and marketing resources, which may be well in excess of ours. Competition in our industry may further intensify as a result of the recent and increasing level of consolidation of financial services companies, particularly in our principal markets resulting from various economic and market conditions. Larger financial institutions may have greater access to capital at a lower cost than ours, which may adversely affect our ability to compete effectively. In addition, some of our current commercial banking customers may seek alternative banking sources if they develop credit needs larger than we may be able to accommodate. Many of our non-bank competitors are not subject to the same extensive regulations that govern our activities and may have greater flexibility in competing for business. Additionally, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and payment systems. We also experience competition, especially for deposits, from internet-based banking institutions and other financial companies, which do not always have a physical presence in our market footprint and have grown rapidly in recent years. Competition in our principal markets may further intensify as a result of provisions of the Dodd-Frank Act which permit the establishment of new branches in states other than their home state by national banks, state banks and foreign banks to the same extent as banks located in the other states.
There are an increasing number of non-bank competitors providing financial services
Technology and other changes increasingly allow parties to complete financial transactions electronically, and in many cases, without banks. For example, consumers can pay bills and transfer funds over the internet and by telephone or mobile devices without banks. In addition, so-called “marketplace lenders” have been expanding their market share of consumer, mortgage and small business loans. Many non-bank financial service providers have lower overhead costs and are subject to fewer regulatory constraints and burdens. If consumers and small businesses do not use banks for their borrowings or to complete their financial transactions, we could potentially lose interest and fee income, deposits and income generated from those deposits and other financial transactions.
Changes in accounting standards could materially impact our financial statements
From time to time, the FASB and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements or new interpretations of existing standards emerge as standard industry practice. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, resulting in our restating prior period financial statements. For information regarding the change in accounting standards relating to the allowance for expected credit losses, see Note 1 to our Consolidated Financial Statements in this Form 10-K.
The continuing war on terrorism, overseas military conflicts, unrest and political developments in other countries and the U.S. could adversely affect U.S. and global economic conditions
Acts or threats of terrorism and actions taken by the U.S. or other governments as a result of such acts or threats and other international hostilities, as well as political unrest in various regions, including the Middle East, may result in a disruption of U.S. and global economic and financial conditions and increases in energy costs and could adversely affect business, economic and financial conditions in the U.S. and globally and in our principal markets. In addition, continuing global tensions may result in new and enhanced U.S. economic sanctions against other governments or entities which may increase our compliance costs under the regulations of OFAC and other federal or state agencies. Although to date we have not experienced an adverse impact on our business from the United Kingdom's exit from the European Union (known as "Brexit"), potential changes in the European Union may have negative consequences for the global and U.S. economies and for our customers.
The Far East, including the Korean peninsula, China and Japan, continues to be subject to political tensions and potential volatility. In the event these conditions were to worsen, there could be material adverse economic consequences for the region, including for Japan, where our parents, MUFG and MUFG Bank, Ltd., have a substantial portion of their assets and business. If MUFG Bank, Ltd.’s business were to sustain seriously
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adverse conditions from such circumstances, this could adversely impact the ability of MUFG and MUFG Bank, Ltd. to support MUAH’s business in the U.S.
The replacement of LIBOR could adversely impact our business and results of operations, and the value of certain financial instruments
In July 2017, the Chief Executive of the U.K. Financial Conduct Authority, which regulates the process of setting LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. There are ongoing global efforts to establish alternatives to interbank offered rates (such as LIBOR). However, there is uncertainty regarding the scope of the ultimate acceptance of alternative reference rates, and the potential impact on rates and pricing and assets, liabilities and results of operations. If another reference rate does not achieve widespread acceptance as an alternative to LIBOR, there likely will be disruption in the financial markets which rely on the availability of a broadly accepted reference rate, and volatility in the pricing of securities, derivatives and other instruments, which could adversely affect the Company’s businesses and results of operations.
The replacement of LIBOR creates a broad range of risks and challenges (including financial, operational, legal, reputational, compliance and market risks) for the banking industry and could adversely impact our businesses and results of operations, and the value of certain financial instruments originated or held by the Company that use LIBOR as a reference rate. LIBOR is used as a reference rate for many of our transactions, including interest rate swap agreements and other contracts used for hedging and trading account purposes, loans to commercial customers and consumers (including mortgage loans and other loans), and long term borrowings, which means that it is the base on which relevant interest rates are determined. The risks and challenges that may be created by the replacement of LIBOR will become clearer as replacement alternatives are developed. For additional information, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk Management - LIBOR Transition” in Part II, Item 7. in this Form 10-K.
There are ongoing efforts to establish an alternative reference rate. The Secured Overnight Financing Rate (or SOFR) published by the Federal Reserve Bank of New York is considered the most likely alternative reference rate suitable for replacing LIBOR, but issues remain with respect to its implementation. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. As a result, the scope of its ultimate acceptance and the impact on rates, pricing and the ability to manage risk, including through derivatives, remain uncertain. No other alternative rate is currently under wide consideration.
Even if SOFR or another reference rate ultimately replaces LIBOR, risks and challenges will remain for us with respect to outstanding loans, derivatives or other instruments using LIBOR, which will need to be transitioned to a new reference rate that is unlikely to exactly mimic, or produce the economic equivalent of, LIBOR. Risks related to transitioning instruments to a new reference rate or to how LIBOR is calculated and its availability are likely to vary by asset class and contract and will require considerable effort and expense to renegotiate contracts for outstanding financial assets and liabilities and include impacts on the yield on loans or securities held by us, amounts paid on securities we have issued, or amounts received and paid on derivative instruments we have entered into, and increase the risk of litigation.
In addition, prior to LIBOR’s cessation, instruments that continue to refer to LIBOR may be impacted if there is a change in the availability or calculation of LIBOR. While we expect LIBOR to continue to be available in substantially its current form until the end of 2021, it is possible that LIBOR quotes will become unavailable prior to that point and that it may be discontinued. This could result, for example, if sufficient LIBOR panel banks decline to make submissions to the LIBOR administrator. Discontinuation of LIBOR prior to that time may cause significant disruption to financial markets and have adverse consequences for market participants.
The value of loans, securities, or derivative instruments tied to LIBOR, the trading market for LIBOR-based securities and the Company’s risk exposures could also be impacted upon LIBOR’s discontinuance or if it is limited. If LIBOR becomes unavailable earlier than the end of 2021, the risks and consequences associated with transitioning to an alternative reference rate are likely to be accelerated and magnified due, in part, to the shorter time available for preparing for the transition.
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The replacement of LIBOR may adversely affect the Company’s revenue and expenses associated with financial instruments tied to LIBOR, and the value of those financial instruments, and may have adverse tax or accounting impacts, and result in compliance, legal, operational and systems costs and risks, which, in turn, could adversely impact our businesses and results of operations.
Company Factors
Adverse economic factors affecting certain industries we serve could adversely affect our business
We provide financing to businesses in a number of industries that may be particularly vulnerable to industry-specific economic factors that can adversely impact the performance of our commercial real estate and commercial and industrial credit portfolios. The commercial real estate industry in the U.S., and in California in particular, was adversely impacted by the post-2008 recessionary environment and lack of liquidity in the financial markets. The home building and mortgage industries in California also were especially adversely impacted by the deterioration in residential real estate markets. Our commercial and industrial credit portfolio, and the communications and media industry, the retail industry, and the energy industry in particular, were also adversely impacted by recessionary market conditions and other emerging developments that are disruptive to their customary business models. Volatility in fuel prices and energy costs could adversely affect businesses in several of these industries, while a prolonged slump in oil, natural gas and coal prices could have adverse consequences for some of our borrowers in the energy sector. Poor economic conditions and financial access for commercial real estate developers and homebuilders could adversely affect property values, resulting in higher nonperforming assets and charge-offs in this sector. MUSA provides financing through repurchase transactions to mortgage real estate investment trusts (REITs) collateralized by U.S. agency-backed mortgages held by such trusts. MUSA also has established a trading business in U.S. agency mortgage-backed securities. A down-turn in the real estate sector in the U.S. could adversely impact the creditworthiness of these mortgage REITs, and could adversely impact MUSA’s business and results of operations. Conditions remain uncertain in various industries and could produce elevated levels of charge-offs.
Starting in 2018, federal tax legislation imposes various new limits on the ability of taxpayers to deduct on their federal income tax returns the interest they pay on residential mortgage loans, as well as their state and local property taxes. These changes could have negative consequences for residential market values in the states in which we operate which could, in turn, have adverse impacts on MUB’s existing residential mortgage loan portfolio and on the volume of newly-originated residential mortgage loans in the future.
A significant portion of our 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, and could negatively impact our title and escrow deposit levels. California markets have experienced a strong recovery in home prices since the post-2008 housing market crisis; however, home price growth has begun to moderate and some fundamentals of the housing market have remained soft through the recovery. A renewed downturn could have an adverse effect on our operations and the quality of our real estate loan portfolio. These factors could adversely impact the quality of our residential construction and residential mortgage portfolios 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.
Changes to the operating framework or functioning of the market in mortgage securities sponsored by the GSE’s could also have an adverse impact on our exposure to mortgage-backed assets in both our banking and securities businesses. For additional information, see “The effects of changes or increases in, or supervisory enforcement of, bank, securities, competition or other laws and regulations or governmental fiscal, monetary, or tax policies could adversely affect us or make strategic planning more difficult” above in these Risk Factors.
Industry-specific risks are beyond our control and could adversely affect our loan portfolio, 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
A substantial majority of our assets, deposits and interest and fee income is 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.
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At times in past years, economic conditions in California have been subject to various challenges, including significant deterioration in the residential real estate sector and the California state government’s budgetary and fiscal difficulties. While California home prices and the California economy in general have experienced a recovery in recent years, there can be no assurance that the recovery will continue. Recent growth in home prices in some California markets may be unsustainable relative to market fundamentals and home price declines may occur.
In addition, although the State of California has historically experienced budget shortfalls or deficits, during the past several years, California’s budgetary situation has improved considerably (with a budget surplus being forecast for the coming year by the nonpartisan legislative analyst). However, there can be no assurance that the state’s fiscal and budgetary challenges will not recur. Also, municipalities and other governmental units within California have experienced budgetary difficulties and several California municipalities have filed for protection under the Bankruptcy Code. As a result, concerns also have arisen regarding the outlook for the governmental obligations of California municipalities and other governmental units. If the budgetary and fiscal difficulties of the California state government and California municipalities and other governmental units were to recur or economic conditions in California decline, we expect that our level of problem assets could increase and our prospects for growth could be impaired.
For a number of years in the past decade, California has experienced severe drought, wildfires or other natural disasters. It can be expected that these events will continue to occur from time to time in the areas served by the Bank, and that the consequences of these natural disasters, including programs of public utility public safety power outages when weather conditions and fire danger warrant, may adversely affect the Bank’s business and that of its customers. It is also possible that climate change may be increasing the severity or frequency of adverse weather conditions, thus increasing the impact of these types of natural disasters on our business and that of our customers.
Our stockholder votes are controlled by MUFG Bank, Ltd. and Mitsubishi UFJ Financial Group, Inc.
MUFG Bank, Ltd., a wholly-owned subsidiary of MUFG, and MUFG own all of the outstanding shares of our common stock. As a result, MUFG Bank, Ltd. and MUFG 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 or debt securities; incurring 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 MUFG Bank, Ltd. or MUFG.
A majority of our directors are independent of MUFG and MUFG Bank, Ltd. and are not officers or employees of MUAH or any of our affiliates, including MUFG or MUFG Bank, Ltd. However, because of MUFG’s and MUFG Bank, Ltd.’s control over the election of our directors, they could at any time change the composition of our Board of Directors so that the Board would not have a majority of independent directors.
MUFG Bank, Ltd.'s and Mitsubishi UFJ Financial Group’s credit ratings and financial or regulatory condition could adversely affect our operations
A substantial part of our operations has been historically funded independently of MUFG Bank, Ltd. and MUFG, and we believe our business is not necessarily closely related to the business or outlook of MUFG Bank, Ltd. or MUFG. Although we make an effort to diversify our sources of liquidity, we are required to maintain a minimum of TLAC-eligible debt because of our affiliation with MUFG Bank, Ltd. If MUFG Bank, Ltd. and MUFG’s credit ratings, financial condition or business prospects were to decline, this could adversely affect our credit rating or harm our reputation or perceived creditworthiness. For additional information, see Part II, Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Liquidity Risk Management” in this Form 10-K.
MUFG Bank, Ltd. and MUFG are also subject to regulatory oversight, review and supervisory action (which can include fines or penalties) by Japanese, U.S. and other regulatory authorities. Our business operations and expansion plans could be negatively affected by regulatory concerns or supervisory action any such authority might take against MUFG Bank, Ltd. or MUFG. For example, in connection with its annual BSA/AML and OFAC examination of MUFG Bank, Ltd.’s U.S. based branches, in February 2019, the OCC imposed a public enforcement action upon MUFG Bank Ltd.’s New York, Los Angeles, and Chicago branches. The enforcement
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action relates to the BSA/AML portion of the examination, is in the form of a consent order and requires MUFG Bank Ltd. and its U.S. branches to implement various remedial measures to address the deficiencies found in the examination, including the adoption of a comprehensive action plan satisfactory to the OCC, implementation of measures to ensure effective compliance management and qualified staffing, the adoption of comprehensive BSA/AML risk assessment policies and procedures and other remedial actions. MUB is not a party to the consent order.
In November 2017, MUFG Bank, Ltd. applied to the OCC to convert its state-licensed branches and agencies in the U.S. to federal branches and agencies and the OCC approved those conversion applications. As a result, these branches and agencies are now supervised by the OCC and are no longer supervised by state regulatory authorities. As a condition of the OCC’s approval of the conversion applications, the OCC required MUFG Bank, Ltd.’s primary New York branch to enter into a consent order with the OCC that supersedes and contains nearly identical substantive requirements as the historic 2013 and 2014 consent agreements with the NY DFS pertaining to compliance with OFAC sanctions. MUFG Bank, Ltd.’s remediation efforts under the OCC consent orders are ongoing. The OCC and MUFG Bank, Ltd. have established an ongoing regulatory relationship and the nature of that relationship will continue to evolve over time.
Immediately following the OCC’s approval of the conversion applications, the NY DFS issued an order which, among other things, asserted that the NY DFS continued to have regulatory authority over MUFG Bank, Ltd. MUFG Bank filed suit on November 8, 2017, captioned The Bank of Tokyo-Mitsubishi UFJ, Ltd. v. Maria Vullo, 17-cv-08691, in the United States District Court for the Southern District of New York, seeking a declaration that the NY DFS had no such continuing authority over MUFG Bank, Ltd. In response, DFS filed counterclaims against MUFG Bank, Ltd. In June 2019, MUFG Bank, Ltd. entered into a settlement with the NY DFS to resolve this litigation. Under the terms of the settlement, the NY DFS has released all of its claims against MUFG Bank, Ltd. and will not challenge the validity of the licenses issued by the OCC to MUFG Bank Ltd. In return, and in consideration of the impact of prolonged litigation, MUFG Bank Ltd. has released all of its claims against the NY DFS and agreed to make a $33 million settlement payment. This settlement resolves the pending federal civil litigation in its entirety and does not constitute a regulatory order or involve a monetary penalty.
MUFG Bank, Ltd. and other inter-bank offered rate (IBOR) panel member banks have been named as defendants in a number of putative class and other legal proceedings in the United States relating to their actions as such and in some proceedings to their trading of financial instruments the prices of which can be affected by IBORs. Other somewhat similar proceedings have also named MUFG and MUSA along with MUFG Bank, Ltd. as defendants. MUFG Bank, Ltd. has also been named as a defendant in a number of civil lawsuits including putative class actions in the United States and Canada alleging foreign exchange market misconduct. While certain of these lawsuits have been settled without any admission of wrongdoing and there have been procedural and substantive developments favorable to MUFG affiliated defendants in others, it is currently not possible for us to predict the scope and ultimate outcome of these legal actions, including any possible effect on us as an affiliate of MUFG.
Potential conflicts of interest with MUFG Bank, Ltd. and MUFG could adversely affect us
The views of MUFG Bank, Ltd. and MUFG regarding customer relationships, possible new businesses, strategies, acquisitions, divestitures or other initiatives, including compliance and risk management processes, may differ from ours. This may prevent, delay or hinder us from pursuing individual initiatives or cause us to incur additional costs and subject us to additional oversight. Our securities broker-dealer subsidiary, MUSA, receives a significant portion of its investment banking business from referrals from MUFG Bank, Ltd. and MUFG and their affiliated entities. If such referrals were to diminish, this could have a materially adverse impact on the business of MUSA.
Also, as part of MUFG Bank, Ltd.’s risk management processes, MUFG Bank, Ltd. manages global credit and other types of exposures and concentrations on an aggregate basis, including exposures and concentrations at MUAH or its subsidiaries. Therefore, at certain levels or in certain circumstances, our ability to approve certain credits or other banking transactions and categories of customers is subject to the concurrence of MUFG Bank, Ltd. We may wish to extend credit or furnish other banking services to the same customers as MUFG Bank, Ltd. Our ability to do so may be limited for various reasons, including MUFG Bank, Ltd.’s aggregate exposure and marketing policies.
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Since MUB, MUSA, MUAH and MUFG Bank, Ltd. all compete in U.S. banking or investment banking markets, ownership interests in MUFG’s common stock held by certain of our directors or officers, or services provided by those individuals as a director or officer or other employee of MUFG Bank, Ltd., could create or appear to create potential conflicts of interest. In addition, a number of the executive officers of MUAH and MUB also serve as executive officers of MUFG Bank, Ltd.’s U.S. branch operations, which could increase or appear to increase the risks of potential conflicts of interests with MUFG and MUFG Bank, Ltd. While the corporate governance policies adopted by MUAH, MUB, MUSA, MUFG and MUFG Bank, Ltd. address such potential conflicts of interest, there can be no assurance that these policies will prevent conflicts of interest which may have an adverse impact on our business.
Restrictions on dividends and other distributions could limit amounts payable to us
As a holding company, a portion of our cash flow may come from dividends our bank and non-bank subsidiaries pay to us. Various statutory provisions restrict the amount of dividends our subsidiaries can pay to us without prior regulatory approval. Our securities broker-dealer subsidiary, MUSA, is also subject to regulatory net capital rules which limit its ability to pay dividends. In addition, if any of our subsidiaries were to liquidate, that subsidiary’s creditors will be entitled to receive distributions from the assets of that subsidiary to satisfy their claims against it before we, as a holder of an equity interest in the subsidiary, will be entitled to receive any of the assets of the subsidiary.
Risks associated with potential acquisitions, divestitures, integrations or restructurings may adversely affect us
We have in the past sought, and may in the future seek, to expand our business by acquiring other businesses which we believe will enhance our business. We cannot predict the frequency, size or timing of our acquisitions, as this will depend on the availability of otherwise suitable prospective target opportunities at valuation levels we find attractive and the competition for such opportunities from other parties. There can be no assurance that our acquisitions will have the anticipated positive results, including results related to: the total cost of integration; the retention of key personnel; the time required to complete the integration; the amount of longer-term cost savings; continued growth; or the overall performance of the acquired company or combined entity. We also may encounter difficulties in obtaining required regulatory approvals due to operational limitations, regulatory restrictions on our own activities, or other reasons. Unexpected contingent liabilities can arise from the businesses we acquire. Acquisitions may also lead us to enter geographic and product markets in which we have limited or no direct experience. Further, the asset quality or other financial characteristics of a business or assets we may acquire may deteriorate after an acquisition closes, which could result in impairment or other expenses and charges which would reduce our operating results.
In addition, we continue to evaluate the performance of all of our businesses and may sell or restructure one or more of them. Any divestitures or restructurings may result in significant expenses and write-offs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our business, results of operations and financial condition and may involve additional risks, including difficulties in obtaining any required regulatory approvals, the diversion of management’s attention from other business concerns, the disruption of our business and the potential loss of key employees.
We may not be successful in addressing these or any other significant risks encountered in connection with any acquisition, divestiture, integration or restructuring we might make.
Increasing regulation of data privacy could adversely affect our business
Laws and regulations related to data privacy and data security are increasing, as Federal, state and foreign governments continue to adopt new laws and regulations addressing the collection, processing, storage, use, and security of personal and confidential information. Further, these laws and regulations are aimed at the use of personal information for marketing purposes in some cases. Laws and regulations designed to protect the privacy and security of customer information apply to us and our subsidiaries. These laws limit the handling and sharing of data. Our business model relies, in part, upon cross-marketing the products and services offered by us and our subsidiaries to our customers. Laws that restrict our ability to share information about customers between our affiliated companies or impose additional compliance costs could adversely affect our business, results of operations and financial condition. For additional discussion, see “Supervision and Regulation” in Part I, Item 1. "Business" in this Form 10-K.
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The California Consumer Privacy Act of 2018 or other such laws could result in increased operating expenses as well as additional exposure to the risk of litigation by or on behalf of customers
In June of 2018, the Governor of California signed into law The California Consumer Privacy Act of 2018 (the “CCPA”). This new law became effective on January 1, 2020 and provides consumers with expansive rights and control over their personal information which is obtained by or shared with “covered businesses” (which includes MUB and most other banking institutions subject to California law). The CCPA gives consumers the right to request disclosure of information collected about them and whether that information has been sold or shared with others, the right to request deletion of personal information subject to certain exceptions, the right to opt out of the sale of the consumer’s personal information and the right not to be discriminated against because of choices regarding the consumer’s personal information.
The CCPA provides for certain monetary penalties and for its enforcement by the California Attorney General or consumers whose rights under the law are not observed. It also provides for damages as well as injunctive or declaratory relief if there has been unauthorized access, theft or disclosure of personal information due to failure to implement reasonable security procedures. The CCPA contains several exemptions, including a provision to the effect that the CCPA does not apply where the information is collected, processed, sold or disclosed pursuant to the GLBA if the GLBA is in conflict with the CCPA. The impact of the CCPA on the business of MUB is yet to be determined, but it could result in increased operating expenses as well as additional exposure to the risk of litigation by or on behalf of consumers. It is possible that other states where we have customers could enact similar laws. For additional information, see “Supervision and Regulation – Other Federal Laws and Regulations Affecting Banks – Privacy” in Part I, Item 1. "Business" in this Form 10-K.
Our business could suffer if we fail to attract, develop, retain and successfully integrate skilled personnel
Our success depends, in large part, on our ability to attract, develop and retain key personnel, including executives. Any of our current employees, including our senior management, may terminate their employment with us at any time. Competition for qualified personnel in our industry can be intense. We may not be successful in attracting, developing and retaining sufficient qualified personnel. We may also incur increased expenses and be required to divert the attention of other senior executives to recruit replacements for the loss of any key or other personnel.
From time to time, we experience turnover among members of management, often due to retirement or rotation to other assignments within the MUFG group. We must successfully integrate any new management personnel that we bring into the organization in order to achieve our operating objectives as new management becomes familiar with our business.
We regularly encounter the need to effectively deal with technological change to maintain and enhance our competitive position; our current technological and other operational initiatives may strain our available resources
The financial services industry is undergoing rapid technological change which regularly involves the introduction of new products and services based on new or enhanced technologies. Examples include cloud computing, artificial intelligence and machine learning, biometric authentication and data protection enhancements, as well as increased online and mobile device interaction with customers. We have been investing in technology to facilitate the ability of our customers to engage in financial transactions and for many other purposes, including our Transformation Program (see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Overview” in Part II, Item 7. in this Form 10-K). Our continued success and the maintenance of our competitive position depends, in part, upon our ability to meet the needs of our customers through the application of new technologies. If we fail to maintain or enhance our competitive position with regard to technology, whether because we fail to anticipate customer needs and expectations or because our technological initiatives fail to perform as desired or are not timely implemented, we may lose market share or incur additional expense.
In addition to our technology-related programs and initiatives, there are a number of other operational and other initiatives which require our attention and resources. These include implementation of our Rewiring Program (see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Overview” in Part II, Item 7. in this Form 10-K), adoption of amendments to U.S. Basel III capital and liquidity rules, impacts of CECL GAAP accounting standard change on regulatory reporting, and other enhanced
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capital and liquidity guidelines, including the reforms to the Basel III agreement on bank capital standards finalized by the BCBS in December 2017 (“Basel IV”) but not yet applied by the U.S. federal banking agencies, various other regulatory initiatives, various strategic initiatives, and integration of new employees, including key members of management. Our ability to execute our core operations and to implement technology and other important initiatives may be adversely affected if our resources are insufficient or if we are unable to allocate available resources effectively.
Significant legal or regulatory proceedings could subject us to significant financial and reputational risks
We are from time to time subject to claims and proceedings related to our present or previous operations including claims by customers, our current or former employees and our contractual counterparties. These claims, which could include supervisory or enforcement actions by bank regulatory and other authorities, or criminal proceedings by prosecutorial authorities, could involve demands for large monetary amounts, including civil money penalties or fines imposed by government authorities, and significant defense costs. Such claims also can divert the attention of senior management. We may be exposed to substantial liabilities which could adversely affect our business, prospects, results of operations, reputation and financial condition. In the past several years, federal and state regulators have announced regulatory enforcement actions against a number of large BHCs and banks arising from deficiencies in processes, procedures and controls involving anti-money laundering measures and compliance with the economic sanctions that affect transactions with designated foreign countries, nationals and others as provided for in the regulations of the OFAC of the U.S. Treasury Department. These actions evidence an intensification of U.S. federal and state governments’ expectations for compliance with these regulatory frameworks on the part of banks operating in the U.S., including MUB, and may result in increased compliance costs and increased risks of regulatory sanctions.
The changes in the U.S. tax laws, the majority of which were effective January 1, 2018, will impact our business and results of operations in a variety of ways, some of which are expected to be positive and others which may be negative
The Tax Cuts and Jobs Act signed into law on December 22, 2017, enacted sweeping changes to the U.S. tax laws effective January 1, 2018. These changes can be expected to impact our business and results of operations in a variety of ways, some of which are expected to be positive and others which may be negative. Among changes which are expected to affect MUAH and its subsidiaries are the following.
| • | A reduction in the federal corporate tax rate to 21 percent from 35 percent, effective January 1, 2018. In general, we expect that this will result in a net reduction in annual income tax expense; however, our ability to currently utilize tax credits may be constrained by the lower tax rate. For example, we have invested in low-income housing and alternative energy investments that generate tax benefits and credits. The reduction of income tax expense reduces our ability to currently realize the tax credits generated by these investments. |
| • | A new incremental base erosion and anti-abuse tax (“BEAT”) which is intended to tax certain outbound deductible payments made to related foreign affiliates. To the extent that the taxpayer’s deductible payments to foreign affiliates exceed a specified threshold, the taxpayer will be subject to the BEAT minimum tax calculation. This minimum tax could apply to payments we make to our parent or other affiliates both within and outside of the U.S. We are presently analyzing the possible impact of this new tax on payments we may make to our affiliates. |
We are continuing to monitor the full impact of these changes in the tax law on our tax positions which may not be fully known until interpretive guidance is issued by the IRS.
For additional information regarding the possible effects of the new federal tax laws on our business, see “The effects of changes or increases in, or supervisory enforcement of, banking, securities, competition, or other laws and regulations or governmental fiscal, monetary or tax policies could adversely affect us or make strategic planning more difficult” and “Adverse economic factors affecting certain industries we serve could adversely affect our business” above in this Risk Factors section.
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Our effective tax rates and our future results can also be affected by our participation for state income tax purposes as a member of MUFG’s unitary group in the U.S. and by other factors
Under a tax election we have made, we are required to file our California franchise tax returns as a member of a unitary group that includes MUFG’s U.S. operations, including its U.S. branches and other affiliates. Increases or decreases in the taxable profits of MUFG’s U.S. operations could increase or decrease our effective tax rate for California state income tax purposes. We review MUFG’s financial information on a quarterly basis to determine the rate at which to recognize our California income taxes. However, all of the information relevant to determining the effective California tax rate may not be available until after the end of the period to which the tax relates, primarily due to MUFG’s March 31 fiscal year-end. Our California effective tax rate can change during the calendar year or between calendar years as additional information becomes available. We could be subject to penalties and interest if we understate our tax obligations. Our effective tax rates for both federal and state income tax purposes also could be affected by valuation changes in our deferred tax assets and liabilities, changes in tax laws or their interpretations and by the outcomes of examinations of our income tax returns by tax authorities.
Our credit ratings are important in order to maintain liquidity
Major credit rating agencies regularly evaluate and provide credit ratings of the securities of MUAH and the securities and deposits of MUB and also provide entity ratings for MUAH, MUB and MUSA. Their ratings of our long-term and short-term debt obligations and of our deposits and our entity ratings are based on a number of factors including our financial strength, ability to generate earnings, and other factors, some of which are not entirely within our control, such as conditions affecting the financial services industry and the economy. In light of the continually evolving conditions in the financial services industry, the financial markets and the economy, changes to credit rating methodologies and the ongoing assessment of our current and expected satisfaction of various rating criteria, no assurance can be given that we will maintain our current ratings. If our long-term or short-term credit ratings suffer substantial downgrades, particularly if lowered below investment grade, such downgrades could adversely affect access to liquidity and could significantly increase our cost of funds (especially our wholesale funding), trigger additional collateral or funding requirements and decrease the number of commercial depositors, investors and counterparties willing or permitted to lend to us, thereby curtailing our business operations and reducing our ability to generate income. For additional information, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Liquidity Risk Management” in Part II, Item 7. of this Form 10-K.
Certain of our derivative instruments contain provisions that require us to maintain a specified credit rating. If our credit rating were to fall below the specified rating, the counterparties to these derivative instruments could terminate the contract and demand immediate payment or demand immediate and ongoing full overnight collateralization for those derivative instruments in net liability positions.
Adverse changes in the credit ratings, operations or prospects of our parent companies, MUFG Bank, Ltd. and MUFG, could also adversely impact our credit ratings. For additional information, refer to the discussion above in these Risk Factors under the caption “MUFG Bank Ltd.’s and Mitsubishi UFJ Financial Group’s credit ratings and financial or regulatory condition could adversely affect our operations”.
We rely on third parties for important products and services
Third-party vendors provide key components of our business infrastructure such as internet connections, network access and mutual fund distribution and, although we monitor their performance, we do not control their actions. Among other services provided by these vendors, third-party vendors have played and will continue to play a key role in the implementation of our technology enhancement and replacement projects, including our Transformation and Rewiring Programs. The federal banking agencies have issued enhanced guidance and are examining with increasing scrutiny financial institutions’ diligence conducted on and oversight of their third-party vendors. Any problems caused by these third parties, including those as a result of their not providing us their services for any reason or their performing their services poorly or failing to meet legal and regulatory requirements, could adversely affect our ability to deliver products and services to our customers, implement our technology enhancement and replacement projects or otherwise conduct our business and also could result in disputes with such vendors over the performance of their services to us, as well as adverse regulatory consequences for us. Replacing these third-party vendors on economically feasible terms may not always be possible or within our control and could also entail significant delay and expense.
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We are subject to a wide array of operational risks, including, but not limited to, cyber-security risks
We are subject to many types of operational risks throughout our organization. Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events, that do not fall into the market risk or credit risk categories described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Risk Management” in Part II, Item 7. of this Form 10-K. Operational risk includes execution risk related to operational initiatives, such as implementation of our technology enhancement and replacement projects, including our Transformation and Rewiring Programs, increased reliance on internally developed models for risk and finance management and compliance, including models associated with regulatory capital requirements, the pricing of various products, grading loans, measuring interest rate and other market risks, predicting losses, and other activities and risks; risks from cyber-security breaches or attacks; the risk of fraud or theft by employees, customers or outsiders; unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems; and operational risks related to use of third party service providers. To the extent that any such models which we use are not correctly designed or are poorly implemented, our business could be at risk and information we furnish to the public or regulators could be rendered inaccurate or misleading, which, in turn, could have adverse consequences for our regulatory relations and public perceptions of our Company. A discussion of risks associated with regulatory compliance appears above in these Risk Factors under the caption “The effects of changes or increases in, or supervisory enforcement of, banking, securities, competition or other laws and regulations or governmental fiscal, monetary, or tax policies could adversely affect us or make strategic planning more difficult.”
Our operations rely on the secure processing, storage, transmission and reporting of personal, confidential and other sensitive information or data in our computer systems, networks and business applications. Although we take protective measures, our computer systems, as well as the systems of our third-party service providers, may be vulnerable to breaches, unauthorized access, misuse, computer viruses or other malicious code and other events that could have significant negative consequences to us. Such events could result in interruptions or malfunctions in our operations or our customers’ operations; interception, misuse or mishandling of personal, confidential or proprietary information and data; or processing of unauthorized transactions or loss of funds. These events could result in litigation, regulatory enforcement actions, and financial losses that are either not insured against or not fully covered by our insurance or result in regulatory consequences or reputational harm, any of which could harm our competitive position, operating results and financial condition. We maintain cyber insurance, but this insurance may not cover all costs associated with cyber incidents or the consequences of personal or confidential information being compromised. These types of incidents can remain undetected for extended periods of time, thereby increasing the associated risks. We may also be required to expend significant resources to modify our protective measures or to investigate and remediate vulnerabilities or exposures arising from cyber-security risks. We may also be required to expend significant resources to cover costs imposed on us as a result of breaches of bank card information occurring at retail merchants and other businesses.
We depend on the continued efficacy of our data management and governance policies, technical systems, operational infrastructure, relationships with third parties and our employees in our day-to-day and ongoing operations. Our increasing dependence upon automated systems to record and process transactions may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect or data which are not reliable. We are also exposed to the risk that, notwithstanding our data management and governance policies, data in our system may become corrupted, inaccurate or out-of-date, any of which can impair the integrity of our decision-making processes. With regard to the physical infrastructure that supports our operations, we have taken measures to implement backup systems and other safeguards, but our ability to conduct business may be adversely affected by any disruption to that infrastructure, including disruptions from natural disasters or other causes. Failures in our internal control or operational systems, security breaches or service interruptions, or those of our third-party service providers could impair our ability to operate our business and result in potential liability to customers, reputational damage and regulatory intervention, any of which could harm our operating results and financial condition. Although we carefully review the risk management standards and processes of our important third-party service providers, there can be no assurance that the risk management efforts of our providers will be successful in preventing all cyber incidents.
MUB, and reportedly other financial institutions, have been the target of various denial-of-service or other cyber-attacks (including attempts to inject malicious code and viruses into computer systems) as part of
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what appears to be a coordinated effort to disrupt the operations of financial institutions and potentially test their cyber-security in advance of future and more advanced cyber-attacks. These cyber-attacks originate from a variety of sophisticated sources who may be involved with organized crime, linked to terrorist organizations or hostile countries and have extensive resources to disrupt the operations of MUB or the financial system more generally. The potential for denial-of-service and other attacks requires substantial resources to defend and may affect customer satisfaction and behavior. To date we have not experienced any material losses relating to cyber-attacks or other information security breaches, but there can be no assurance that we will not suffer such losses or information security breaches in the future. A successful cyber-attack could result in a material disruption of MUB’s operations, exposure of confidential information and financial loss to MUB, its clients, customers and counterparties and could lead to significant exposure to litigation and regulatory fines, penalties and other sanctions as well as reputational damage. While we have a variety of cyber-security measures in place, the consequences to our business of such attacks cannot be predicted with any certainty.
In addition, there have been increasing efforts on the part of third parties to breach data security at financial institutions as well as at other types of companies, such as large retailers, or with respect to financial transactions, including through the use of social engineering schemes such as “phishing.” The ability of our customers to bank remotely, including online and through mobile devices, requires secure transmissions of confidential information and increases the risk of data security breaches which would expose us to financial claims by customers or others and which could adversely affect our reputation and could lead to a material loss. Even if cyber-attacks and similar tactics are not directed specifically at MUB or our third-party service providers, such attacks on other large financial institutions could disrupt the overall functioning of the financial system and undermine consumer confidence in banks generally, to the detriment of other financial institutions, including MUB. For additional information regarding our obligations to provide for the security of our customers' data, see "Supervision and Regulation - Other Federal Laws and Regulations Affecting Banks - Customer Information Security" in this Form 10-K.
We, and other banking institutions, are also at risk of increased losses from fraudulent conduct of criminals using increasingly sophisticated techniques which, in some cases, are part of larger criminal organizations which allow them to be more effective. This criminal activity is taking many forms, including information theft, debit/credit card fraud, check fraud, mechanical devices affixed to ATM’s, social engineering, phishing attacks to obtain personal information, or impersonation of customers through falsified or stolen credentials, business email compromise, and other criminal endeavors. We, and other banking institutions are also at risk of fraudulent or criminal activities by employees, contractors, vendors and others with whom we do business. There is also the risk of errors by our employees and others responsible for the systems and controls on which we depend and any resulting failures of these systems and controls could significantly harm our Company, including customer remediation costs, regulatory fines and penalties, litigation or enforcement actions, or limitations on our business activities.
Under the applicable Federal regulatory guidance, financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate the identity of customers accessing internet-based services of the financial institution. In addition, the financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive or other malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. A financial institution which fails to observe this regulatory guidance could be subject to various regulatory sanctions, including financial penalties.
The Federal bank regulators have also issued a cyber-security assessment tool, the output of which can assist a financial institution’s senior management and board of directors in assessing the institution’s cyber-security risk and preparedness. The first part of the assessment tool generates an inherent risk profile, which assists management in determining an institution’s level of cyber-security risk. The second part of the assessment tool evaluates cyber-security maturity, which is designed to help management assess whether their controls provide the desired level of preparedness. The Federal bank regulators utilize the assessment tool as part of their examination process when evaluating financial institutions’ cyber-security preparedness in information technology and safety and soundness examinations and inspections. Failure to effectively utilize this tool could result in regulatory criticism. Significant resources are required to adequately implement the tool and address
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any assessment concerns regarding preparedness. Management performs an annual cyber-security assessment using this tool to facilitate the identification and remediation of any concerns regarding our cyber-security preparedness.
We may also be subject to disruptions of our operating systems arising from other events that are wholly or partially beyond our control, such as outages related to electrical, internet or telecommunications or other key supporting third party service providers, natural disasters (such as major seismic events or wildfires), terrorist attacks or unexpected difficulties with the implementation of our technology enhancement and replacement projects, which may give rise to disruption of service to customers and to financial loss or liability in ways which cannot be predicted with any certainty. Our business recovery plan may not work as intended or may not prevent significant interruptions of our operations.
The risks associated with cyber-security are also increasing due to the proliferation of new technologies and the use of the Internet and telecommunications technologies to conduct financial transactions.
Negative public opinion could damage our reputation and adversely impact our business and revenues
As a financial institution, our business and revenues are subject to risks associated with negative public opinion. The reputation of the financial services industry in general has been damaged as a result of the financial crisis and other matters affecting the financial services industry, including mortgage foreclosure issues. Negative public opinion about us could result from our actual or alleged conduct in any number of activities, including our lending practices, the failure of any product or service we provide to meet our customers’ expectations or applicable regulatory requirements, governmental enforcement actions, corporate governance deficiencies, business acquisitions, use of social media, cyber-security breaches or from actions taken by regulators and community organizations in response to those activities. Negative public opinion could also result from regulatory concerns or supervisory or other governmental actions in the U.S. or Japan with respect to MUB, MUSA, MUFG Bank, Ltd. or MUFG. Negative public opinion can adversely affect our ability to keep, attract and retain lending, deposit and other customers and employees and can expose us to claims and litigation and regulatory actions and increased liquidity risk. Actual or alleged misconduct by one of our businesses can result in negative public opinion about our other businesses.
Our framework for managing risks may not be effective in mitigating risk and loss to the Company
Our risk management framework is made up of various processes and strategies to manage and mitigate our risk exposure. Types of risk to which we are subject include liquidity risk, credit risk, market and investment risk, interest rate risk, operational risk (including, but not limited to, information and model risk), legal risk, compliance risk, reputation risk, fiduciary risk, counterparty risk and strategic risk (including risks to our financial position and resilience arising from adverse business decisions or poorly implemented decisions or lack of responsiveness to industry changes and the operating environment), among others. Our framework to manage risk, including the framework’s underlying assumptions, such as our modeling methodologies, may not be effective under all conditions and circumstances. In the banking industry’s complex and rapidly evolving operating environment, certain risks, especially operational risk and strategic risk, can present significant challenges to our risk management framework. If our risk management framework proves ineffective, we could suffer unexpected losses and our business, financial condition, results of operations or prospects could be materially adversely affected and there also could be consequent adverse regulatory implications in any such event.
Effective July 1, 2016, MUAH became the IHC for MUFG Bank, Ltd.’s operations in the U.S. (other than its branches, agencies and other offices) and became subject to enhanced risk management and governance standards. These enhanced prudential standards, as well as the addition of the securities business of MUSA and other businesses to the Company, could continue to pose challenges for our risk management and governance oversight functions, including new customer relationships and lines of business, structural and operational changes, and enhanced governance and risk management standards to which we are subject.
Our disclosure controls and procedures may not prevent or detect all errors or acts of fraud
Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is accumulated and communicated to management and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Any disclosure controls and procedures or internal controls and
37
procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected.
We may be adversely affected by the poor condition of other financial institutions
As a result of trading, clearing or other relationships, we have exposure to many different counterparties and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers, dealers and investment banks. Many of these transactions expose us to credit risk in the event of a default by such a counterparty. In addition, our credit risk may be exacerbated when the collateral we hold cannot be readily liquidated or can only be liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure owed to us. Any such losses could have a material adverse effect on our business, results of operations, financial condition or prospects.
Our financial results depend on management’s selection of accounting methods and certain assumptions and estimates
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect management’s judgment of the most appropriate manner to report our financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in our reporting materially different results than would have been reported under a different alternative.
Certain accounting policies are critical to presenting our financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include allowance for credit losses, transfer pricing, goodwill impairment analysis and income taxes. Because of the uncertainty of estimates involved in deciding these matters, we may be required to do one or more of the following: significantly increase or decrease the allowance for credit losses; sustain loan losses that are significantly different than the reserve provided; recognize significant impairment on goodwill; or significantly increase or decrease our accrued tax liability. Any one or more of these actions could adversely affect our business, results of operations and financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
MUAH's headquarters is located at 1251 Avenue of the Americas, in New York, New York. The Company leases approximately 362,000 square feet of building space at this location. The Company also owns or leases significant administrative or operational facilities in the San Francisco, Los Angeles, New York and Phoenix areas and owns or leases 349 branches, primarily located in California.
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ITEM 3. LEGAL PROCEEDINGS
We are subject to various pending and threatened legal actions that arise in the normal course of business. We maintain liabilities for losses from legal actions that are recorded when they are determined to be both probable in their occurrence and can be reasonably estimated. In addition, we believe the disposition of all claims currently pending, including potential losses from claims that may exceed the liabilities recorded, and claims for loss contingencies that are considered reasonably possible to occur, will not have a material effect, either individually or in the aggregate, on our consolidated financial condition, operating results or liquidity.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
On November 4, 2008, the Company became a wholly-owned subsidiary of MUFG Bank, Ltd. and the Company's common stock was delisted from the New York Stock Exchange. All of the Company's issued and outstanding shares of common stock are now held by MUFG Bank, Ltd. and MUFG, and there is presently no established public trading market for the Company's common stock.
ITEM 6. SELECTED FINANCIAL DATA
The information called for by this item has been omitted pursuant to General Instruction I(2) of Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 7. to this Form 10-K begins on page 44 of this report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. to this Form 10-K begins on page 67 of this report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. to this Form 10-K begins on page 76 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company's management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that these disclosure controls and procedures were effective.
Internal Control Over Financial Reporting. Management's Report on Internal Control Over Financial Reporting is presented on page 147. The Report of Independent Registered Public Accounting Firm is presented on page 149. During the quarter ended December 31, 2019, 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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ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Certain information called for by this item has been omitted pursuant to General Instruction I(2) of Form 10-K.
Code of Ethics
We have adopted a Code of Ethics applicable to senior financial officers, including our Chief Executive Officer, Chief Financial Officer and Controller & Chief Accounting Officer. A copy of this Code of Ethics is posted on our website. To the extent required by SEC rules, we intend to disclose promptly any amendment to, or waiver from any provision of, the Code of Ethics applicable to senior financial officers on our website. Our website address is www.unionbank.com.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this item has been omitted pursuant to General Instruction I(2) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information called for by this item has been omitted pursuant to General Instruction I(2) of Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information called for by this item has been omitted pursuant to General Instruction I(2) of Form 10-K.
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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
The following is a description of the fees billed to MUAH by Deloitte & Touche LLP for 2019 and 2018. All fees were pre-approved by our Audit & Finance Committee.
| (Dollars in thousands) | 2019 | 2018 | ||||||
Audit Fees(1) | $ | 7,271 | $ | 8,365 | ||||
Audit-Related Fees(2) | 2,704 | 2,561 | ||||||
Tax Fees(3) | 410 | 698 | ||||||
| Total | $ | 10,385 | $ | 11,624 | ||||
| (1) | Audit fees relate to services rendered in connection with the annual audit of MUAH's consolidated financial statements, quarterly reviews of financial statements included in MUAH's quarterly reports on Form 10-Q, fees for consultation on new accounting and reporting requirements and SEC registration statement services, and the attestation assessment related to the effectiveness of MUAH's financial reporting controls, as required by Section 404 of the Sarbanes-Oxley Act. |
| (2) | Audit-related fees consist of assurance and other such services that are reasonably related to the performance of the audit or review of MUAH's financial statements and are not included in Audit Fees. Amounts include fees for services provided in connection with service auditors reports and audits of employee benefit plans, Statement on Standards for Attestation Engagements 18 and ASU 2016-13 (CECL) reviews. 2019 includes increased cost for the CECL review, as well as work related to Statement on Standards for Attestation Engagements 18 scope changes. |
| (3) | Tax fees include fees for tax compliance, advice and planning services. Fees related to tax compliance and preparation for 2019 and 2018 were $24,000 and $209,000, respectively. For 2019 and 2018, fees related to tax advice and planning were $386,000 and $489,000, respectively. |
The Audit & Finance Committee also considered whether the provision of the services other than audit services is compatible with maintaining Deloitte & Touche LLP's independence. All of the services described above were approved by the Audit & Finance Committee in accordance with the following policy.
Pre-approval of Services by Deloitte & Touche LLP
The Audit & Finance Committee has adopted a policy for pre-approval of audit and permitted non-audit services by Deloitte & Touche LLP. The Audit & Finance Committee will periodically consider and, if appropriate, approve, the provision of audit services by its independent registered public accounting firm and consider and, if appropriate, pre-approve, the provision of certain defined audit and non-audit services. The policy provides that:
| • | the pre-approval request must be detailed as to the particular services to be provided; |
| • | the pre-approval may not result in a delegation of the Audit & Finance Committee's responsibilities to the management of MUAH; and |
| • | the pre-approved services must be commenced within twelve months of the Audit & Finance Committee's pre-approval decision. |
Any proposed engagement may be presented to the Audit & Finance Committee for consideration at its next regular meeting or, if earlier consideration is required, to the Audit & Finance Committee Chair. The Chair reports any specific approval of services at the Audit & Finance Committee's next regular meeting. The Audit & Finance Committee regularly reviews summary reports detailing all services being provided by its independent registered public accounting firm.
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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
Our Consolidated Financial Statements, Management's Report on Internal Control Over Financial Reporting and Reports of Independent Registered Public Accounting Firm are set forth beginning on page 76 of this Form 10-K.
(a)(2) Financial Statement Schedules
All schedules to our Consolidated Financial Statements are omitted because of the absence of the conditions under which they are required or because the required information is included in our Consolidated Financial Statements or accompanying notes.
(a)(3) Exhibits
A list of exhibits to this Form 10-K is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated into this item by reference.
ITEM 16. FORM 10-K SUMMARY
Not applicable.
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MUFG Americas Holdings Corporation and Subsidiaries
Table of Contents
| Supplementary Information: | |
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MUFG Americas Holdings Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition and Results of Operations
This report includes forward-looking statements, which include expectations for our operations and business, and our assumptions for those expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly from our expectations. Please also refer to "Note Regarding Forward-Looking Statements" and Part I, Item 1A. "Risk Factors" in this Form 10-K for a discussion of some factors that may cause results to differ from our expectations.
The following discussion and analysis of our consolidated financial position and results of our operations for the years ended December 31, 2019, 2018 and 2017 should be read together with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included in this Form 10-K. Averages, as presented in the following tables, are substantially all based upon daily average balances.
As used in this Form 10-K, terms such as "the Company," "we," "us" and "our" refer to MUFG Americas Holdings Corporation (MUAH), one or more of its consolidated subsidiaries, or to all of them together. As permitted by General Instruction I(2) of Form 10-K, we have abbreviated Management's Discussion and Analysis into a management's narrative analysis of the results of operations.
MUFG Americas Holdings Corporation and Subsidiaries
Consolidated Financial Highlights
| For the Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Results of operations: | ||||||||||||
| Net interest income | $ | 3,093 | $ | 3,307 | $ | 3,204 | ||||||
| Noninterest income | 2,705 | 2,177 | 2,010 | |||||||||
| Total revenue | 5,798 | 5,484 | 5,214 | |||||||||
| Noninterest expense | 6,215 | 4,277 | 3,984 | |||||||||
Pre-tax, pre-provision (loss) income(1) | (417 | ) | 1,207 | 1,230 | ||||||||
| (Reversal of) provision for credit losses | 252 | 106 | (103 | ) | ||||||||
| (Loss) income before income taxes and including noncontrolling interests | (669 | ) | 1,101 | 1,333 | ||||||||
| Income tax expense (benefit) | 82 | 52 | 299 | |||||||||
| Net (loss) income including noncontrolling interests | (751 | ) | 1,049 | 1,034 | ||||||||
| Deduct: Net loss from noncontrolling interests | 17 | 24 | 43 | |||||||||
| Net (loss) income attributable to MUAH | $ | (734 | ) | $ | 1,073 | $ | 1,077 | |||||
| Balance sheet (period average): | ||||||||||||
| Total assets | $ | 170,324 | $ | 160,529 | $ | 152,544 | ||||||
| Total securities | 26,695 | 27,395 | 26,315 | |||||||||
| Securities borrowed or purchased under resale agreements | 22,721 | 20,486 | 20,901 | |||||||||
| Total loans held for investment | 88,288 | 82,746 | 78,770 | |||||||||
| Earning assets | 156,578 | 147,136 | 139,389 | |||||||||
| Total deposits | 94,210 | 86,478 | 86,395 | |||||||||
| Securities loaned or sold under repurchase agreements | 27,902 | 26,906 | 26,291 | |||||||||
| MUAH stockholders' equity | 16,866 | 18,400 | 17,926 | |||||||||
| Performance ratios: | ||||||||||||
Return on average assets(2) | (0.43 | )% | 0.67 | % | 0.71 | % | ||||||
Return on average MUAH stockholders' equity(2) | (4.35 | ) | 5.83 | 6.01 | ||||||||
Return on average MUAH tangible common equity(2)(3) | 6.29 | 7.35 | 7.57 | |||||||||
Efficiency ratio(4) | 107.18 | 77.98 | 76.42 | |||||||||
Adjusted efficiency ratio(5) | 74.69 | 72.47 | n/a | |||||||||
Net interest margin(2)(6) | 1.99 | 2.26 | 2.33 | |||||||||
Net loans charged-off to average total loans held for investment (2) | 0.25 | 0.10 | 0.13 | |||||||||
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MUFG Americas Holdings Corporation and Subsidiaries
Consolidated Financial Highlights (Continued)
| As of December 31, | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| Balance sheet (end of period): | ||||||||||||
| Total assets | $ | 170,810 | $ | 168,100 | $ | 154,550 | ||||||
| Total securities | 27,210 | 27,215 | 27,448 | |||||||||
| Securities borrowed or purchased under resale agreements | 23,943 | 22,368 | 20,894 | |||||||||
| Total loans held for investment | 88,213 | 86,507 | 80,014 | |||||||||
| Nonperforming assets | 329 | 422 | 466 | |||||||||
| Total deposits | 95,861 | 90,979 | 84,787 | |||||||||
| Securities loaned or sold under repurchase agreements | 28,866 | 27,285 | 26,437 | |||||||||
| Long-term debt | 17,129 | 17,918 | 12,162 | |||||||||
| MUAH stockholders' equity | 16,280 | 16,508 | 18,255 | |||||||||
| Credit ratios: | ||||||||||||
Allowance for loan losses to total loans held for investment(7) | 0.61 | % | 0.55 | % | 0.59 | % | ||||||
Allowance for loan losses to nonaccrual loans(7) | 164.19 | 112.50 | 102.37 | |||||||||
Allowance for credit losses to total loans held for investment(8) | 0.73 | 0.71 | 0.75 | |||||||||
Allowance for credit losses to nonaccrual loans(8) | 197.34 | 145.61 | 128.75 | |||||||||
| Nonperforming assets to total loans held for investment and OREO | 0.37 | 0.49 | 0.58 | |||||||||
| Nonperforming assets to total assets | 0.19 | 0.25 | 0.30 | |||||||||
| Nonaccrual loans to total loans held for investment | 0.37 | 0.49 | 0.58 | |||||||||
| Capital ratios: | ||||||||||||
Regulatory (9): | ||||||||||||
| Common Equity Tier 1 risk-based capital ratio | 14.10 | % | 13.96 | % | 16.31 | % | ||||||
| Tier 1 risk-based capital ratio | 14.10 | 13.96 | 16.31 | |||||||||
| Total risk-based capital ratio | 14.73 | 14.60 | 17.76 | |||||||||
| Tier 1 leverage ratio | 8.88 | 8.77 | 10.06 | |||||||||
| Other: | ||||||||||||
Tangible common equity ratio(10) | 8.45 | % | 7.89 | % | 9.73 | % | ||||||
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MUFG Americas Holdings Corporation and Subsidiaries
Consolidated Financial Highlights (Continued)
| (1) | Pre-tax, pre-provision income (loss) is total revenue less noninterest expense. Management believes that this is a useful financial measure because it enables investors and others to assess the Company's ability to generate capital to cover credit losses through a credit cycle. |
| (2) | Annualized. |
| (3) | Return on tangible common equity, a non-GAAP financial measure, is net income (loss) excluding intangible asset amortization and goodwill impairment divided by average tangible common equity. Management believes that this ratio provides useful supplemental information regarding the Company's business results. The methodology for determining tangible common equity may differ among companies. Please refer to Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures" in this Form 10-K for further information. |
| (4) | The efficiency ratio is total noninterest expense as a percentage of total revenue (net interest income and noninterest income). |
| (5) | The adjusted efficiency ratio, a non-GAAP financial measure, is adjusted noninterest expense (noninterest expense excluding costs associated with services provided to MUFG Bank, Ltd. branches in the U.S. and goodwill impairment) as a percentage of adjusted total revenue (net interest income and noninterest income excluding fees from affiliates for services provided to MUFG Bank, Ltd.'s branches in the U.S. and the impact of the TCJA). Management believes adjusting the efficiency ratio for the fees and costs associated with services provided to MUFG Bank, Ltd. branches in the U.S. enhances the comparability of MUAH's efficiency ratio when compared with other financial institutions. Management believes adjusting noninterest expense for the impact of goodwill impairment and revenue for the impact of the TCJA enhances comparability between periods. The adjusted efficiency ratio for the year ended December 31, 2017 is not presented because the Company began identifying all costs associated with services provided to MUFG Bank, Ltd. branches in the U.S. in the third quarter of 2017. Previously, the Company was only able to identify a portion of the costs associated with services provided to MUFG Bank, Ltd. branches in the U.S. See "Non-GAAP Financial Measures" in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K for additional information. |
| (6) | Yields, interest income and net interest margin are presented on a taxable-equivalent basis using the federal statutory tax rates of 21% for 2019 and 2018, and 35% for 2017. |
| (7) | The allowance for loan losses ratios are calculated using the allowance for loan losses as a percentage of end of period total loans held for investment or total nonaccrual loans, as appropriate. |
| (8) | The allowance for credit losses ratios include the allowances for loan losses and for losses on unfunded credit commitments as a percentage of end of period total loans held for investment or total nonaccrual loans, as appropriate. |
| (9) | These capital ratios are calculated in accordance with the guidelines set forth in the U.S. federal banking agencies' final U.S. Basel III regulatory capital rules and all applicable amendments. |
| (10) | The tangible common equity ratio, a non-GAAP financial measure, is calculated as tangible common equity divided by tangible assets. The methodology for determining tangible common equity may differ among companies. The tangible common equity ratio facilitates the understanding of the Company's capital structure and is used to assess and compare the quality and composition of the Company's capital structure to other financial institutions. Please refer to Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Management" in this Form 10-K for further information. |
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Introduction
We are a financial holding company, bank holding company and intermediate holding company whose principal subsidiaries are MUFG Union Bank, N.A. (MUB or the Bank) and MUSA. We are owned by MUFG Bank, Ltd. and MUFG. MUFG Bank, Ltd. is a wholly-owned subsidiary of MUFG.
We provide a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, both nationally and internationally. The Company also provides various business, banking, financial, administrative and support services, and facilities for MUFG Bank, Ltd. in connection with the operation and administration of MUFG Bank, Ltd.'s business in the U.S. (including MUFG Bank, Ltd.'s U.S. branches). The Bank and MUFG Bank, Ltd. are parties to a master services agreement whereby the Bank earns fee income in exchange for services and facilities provided. The Company has four reportable segments: Regional Bank, Global Corporate & Investment Banking - U.S. (previously U.S. Wholesale & Investment Banking), Transaction Banking and MUSA. We service Global Corporate & Investment Banking - U.S., certain Transaction Banking, and MUSA customers through the MUFG brand and serve Regional Bank and Transaction Banking customers through the Union Bank brand. See Note 22 to our Consolidated Financial Statements included in this Form 10-K for more information about our reportable segments.
Executive Overview
We are providing you with an overview of what we believe are the most significant factors and developments that affected our 2019 results and that could influence our future results. Further detailed information can be found elsewhere in this Form 10-K. In addition, you should carefully read this entire document and any other reports that we refer to in this Form 10-K for more detailed information to assist your understanding of trends, events and uncertainties that impact us.
Our sources of revenue are net interest income and noninterest income (collectively "total revenue"). Net interest income is generated predominantly from interest earned from loans, investment securities, securities borrowed or purchased under resale agreements, trading account assets and other interest-earning assets, less interest incurred on deposits and borrowings, securities loaned or sold under repurchase agreements and other interest-bearing liabilities. The primary sources of noninterest income are revenues from investment banking and syndication fees, service charges on deposit accounts, trust and investment management fees, trading account activities, credit facility fees, and fees from affiliates. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that affect our revenue sources. In 2019, revenue was comprised of 53% net interest income and 47% noninterest income. A summary of our financial results is discussed below.
Our primary sources of liquidity are core deposits, securities and wholesale funding. Core deposits exclude brokered deposits, foreign time deposits, domestic time deposits greater than $250,000, and certain other deposits not considered to be core customer relationships. Wholesale funding includes unsecured funds raised from MUFG Bank, Ltd. and affiliates, interbank and other sources, both domestic and international, funding secured by certain assets, or by borrowing from the FHLB. We evaluate and monitor the stability and reliability of our various funding sources to help ensure that we have sufficient liquidity when adverse situations arise.
In order to better serve our clients and reduce our cost base, we have launched two multi-year initiatives that we believe are critical to our success: our technology-focused Transformation Program and our continuous improvement, cost-reduction focused Rewiring Program. The Transformation Program is based on three pillars: transformation of our core banking systems, data analytics and functionality, and technology modernization. The Rewiring Program targets four areas: workforce geographic distribution, organizational design, procurement, and process simplification and automation.
47
Performance Highlights
Net loss attributable to MUAH was $734 million in 2019, largely due to a $1.6 billion goodwill impairment charge recorded in the third quarter of 2019. The goodwill impairment charge was primarily due to the impact of declining interest rates and a change in the Company's expectation that interest rates will remain lower than previously assumed, updates to key loan growth and mix assumptions, and a reduction of the expected growth of new initiatives on the Company's cash flow projections for the Consumer Banking reporting unit. See "Goodwill Impairment" in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K for additional information. In addition, net interest income decreased $214 million from 2018, due to a decline in the net interest margin, primarily from higher borrowing costs, partially offset by an increase in earning assets.
The provision for credit losses was $252 million in 2019 compared with $106 million in 2018. The provision for credit losses in 2019 was largely due to growth in unsecured consumer loan balances and the impact of specific reserves for certain impaired loans. The provision for credit losses in 2018 was primarily due to the impact of the specific reserves for credit losses on impaired loans.
Capital Ratios
The Company's capital ratios continued to exceed all well-capitalized and minimum regulatory thresholds for BHCs, as applicable. The U.S. Basel III Common Equity Tier 1, Tier 1 and Total risk-based capital ratios were 14.10%, 14.10% and 14.73%, respectively, at December 31, 2019. The Tier 1 leverage ratio was 8.88% at December 31, 2019.
48
Financial Performance
Net Interest Income
The following table shows the major components of net interest income and net interest margin.
| For the Years Ended | |||||||||||||||||||||||||||||||||
| December 31, 2019 | December 31, 2018 | December 31, 2017 | |||||||||||||||||||||||||||||||
| (Dollars in millions) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | ||||||||||||||||||||||||
| Assets | |||||||||||||||||||||||||||||||||
Loans held for investment(3): | |||||||||||||||||||||||||||||||||
| Commercial and industrial | $ | 25,721 | $ | 1,090 | 4.24 | % | $ | 23,667 | $ | 989 | 4.18 | % | $ | 24,786 | $ | 899 | 3.63 | % | |||||||||||||||
| Commercial mortgage | 15,805 | 640 | 4.05 | 14,704 | 614 | 4.18 | 14,304 | 581 | 4.06 | ||||||||||||||||||||||||
| Construction | 1,587 | 83 | 5.22 | 1,656 | 80 | 4.86 | 1,957 | 85 | 4.35 | ||||||||||||||||||||||||
| Lease financing | 1,241 | 63 | 5.05 | 1,437 | 62 | 4.31 | 1,749 | 41 | 2.37 | ||||||||||||||||||||||||
| Residential mortgage and home equity | 40,077 | 1,427 | 3.56 | 39,585 | 1,421 | 3.59 | 34,994 | 1,204 | 3.44 | ||||||||||||||||||||||||
| Other consumer | 3,857 | 336 | 8.74 | 1,697 | 148 | 8.73 | 980 | 97 | 9.85 | ||||||||||||||||||||||||
| Total loans held for investment | 88,288 | 3,639 | 4.12 | 82,746 | 3,314 | 4.01 | 78,770 | 2,907 | 3.69 | ||||||||||||||||||||||||
| Securities | 26,695 | 629 | 2.36 | 27,395 | 677 | 2.47 | 26,315 | 588 | 2.23 | ||||||||||||||||||||||||
| Securities borrowed or purchased under resale agreements | 22,721 | 765 | 3.37 | 20,486 | 652 | 3.18 | 20,901 | 347 | 1.66 | ||||||||||||||||||||||||
| Interest bearing deposits in banks | 7,477 | 162 | 2.17 | 4,009 | 80 | 1.99 | 3,172 | 39 | 1.24 | ||||||||||||||||||||||||
| Federal funds sold | 2 | — | 6.87 | 5 | — | 2.79 | 2 | — | 1.58 | ||||||||||||||||||||||||
| Trading account assets | 10,610 | 360 | 3.39 | 12,026 | 415 | 3.45 | 9,668 | 326 | 3.37 | ||||||||||||||||||||||||
| Other earning assets | 785 | 18 | 2.29 | 469 | 10 | 2.13 | 561 | 11 | 1.84 | ||||||||||||||||||||||||
| Total earning assets | 156,578 | 5,573 | 3.56 | 147,136 | 5,148 | 3.50 | 139,389 | 4,218 | 3.03 | ||||||||||||||||||||||||
| Allowance for loan losses | (519 | ) | (467 | ) | (571 | ) | |||||||||||||||||||||||||||
| Cash and due from banks | 1,989 | 1,811 | 1,868 | ||||||||||||||||||||||||||||||
Other assets(4) | 12,276 | 12,049 | 11,858 | ||||||||||||||||||||||||||||||
| Total assets | $ | 170,324 | $ | 160,529 | $ | 152,544 | |||||||||||||||||||||||||||
| Liabilities | |||||||||||||||||||||||||||||||||
| Interest bearing deposits: | |||||||||||||||||||||||||||||||||
| Transaction and money market accounts | $ | 37,730 | $ | 370 | 0.98 | % | $ | 36,883 | $ | 238 | 0.65 | % | $ | 39,165 | $ | 153 | 0.39 | % | |||||||||||||||
| Savings | 9,326 | 84 | 0.90 | 9,120 | 65 | 0.71 | 7,683 | 24 | 0.31 | ||||||||||||||||||||||||
| Time | 15,605 | 372 | 2.39 | 7,588 | 138 | 1.81 | 5,430 | 64 | 1.18 | ||||||||||||||||||||||||
| Total interest bearing deposits | 62,661 | 826 | 1.32 | 53,591 | 441 | 0.82 | 52,278 | 241 | 0.46 | ||||||||||||||||||||||||
| Commercial paper and other short-term borrowings | 8,642 | 202 | 2.33 | 8,700 | 168 | 1.93 | 5,047 | 58 | 1.15 | ||||||||||||||||||||||||
| Securities loaned or sold under repurchase agreements | 27,902 | 830 | 2.97 | 26,906 | 734 | 2.73 | 26,291 | 353 | 1.34 | ||||||||||||||||||||||||
| Long-term debt | 16,385 | 497 | 3.04 | 14,062 | 365 | 2.59 | 11,290 | 250 | 2.21 | ||||||||||||||||||||||||
| Total borrowed funds | 52,929 | 1,529 | 2.89 | 49,668 | 1,267 | 2.55 | 42,628 | 661 | 1.55 | ||||||||||||||||||||||||
| Trading account liabilities | 3,502 | 101 | 2.89 | 3,736 | 110 | 2.94 | 2,997 | 73 | 2.45 | ||||||||||||||||||||||||
| Total interest bearing liabilities | 119,092 | 2,456 | 2.06 | 106,995 | 1,818 | 1.70 | 97,903 | 975 | 1.00 | ||||||||||||||||||||||||
| Noninterest bearing deposits | 31,549 | 32,887 | 34,117 | ||||||||||||||||||||||||||||||
Other liabilities(5) | 2,753 | 2,157 | 2,467 | ||||||||||||||||||||||||||||||
| Total liabilities | 153,394 | 142,039 | 134,487 | ||||||||||||||||||||||||||||||
| Equity | |||||||||||||||||||||||||||||||||
| MUAH stockholders' equity | 16,866 | 18,400 | 17,926 | ||||||||||||||||||||||||||||||
| Noncontrolling interests | 64 | 90 | 131 | ||||||||||||||||||||||||||||||
| Total equity | 16,930 | 18,490 | 18,057 | ||||||||||||||||||||||||||||||
| Total liabilities and equity | $ | 170,324 | $ | 160,529 | $ | 152,544 | |||||||||||||||||||||||||||
Net interest income/spread (taxable-equivalent basis) | 3,117 | 1.50 | % | 3,330 | 1.80 | % | 3,243 | 2.03 | % | ||||||||||||||||||||||||
| Impact of noninterest bearing deposits | 0.43 | 0.40 | 0.26 | ||||||||||||||||||||||||||||||
| Impact of other noninterest bearing sources | 0.06 | 0.06 | 0.04 | ||||||||||||||||||||||||||||||
| Net interest margin | 1.99 | 2.26 | 2.33 | ||||||||||||||||||||||||||||||
| Less: taxable-equivalent adjustment | 24 | 23 | 39 | ||||||||||||||||||||||||||||||
| Net interest income | $ | 3,093 | $ | 3,307 | $ | 3,204 | |||||||||||||||||||||||||||
| (1) | Yields, interest income and net interest margin are presented on a taxable-equivalent basis using the federal statutory tax rates of 21% for 2019 and 2018, and 35% for 2017. |
| (2) | Annualized. |
| (3) | Average balances of loans held for investment include nonaccrual loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield. |
| (4) | Other assets include noninterest bearing trading account assets. |
| (5) | Other liabilities include noninterest bearing trading account liabilities. |
49
Net interest income decreased during 2019 compared with 2018 due to a decline in the net interest margin partially offset by an increase in earning assets. The net interest margin decreased 27 basis points, primarily due to an increase in borrowing costs. Earning assets increased largely due to increases in commercial and industrial, commercial mortgage, and other consumer loans, securities borrowed or purchased under resale agreements and interest bearing deposits in banks, partially offset by a decrease in trading assets.
Analysis of Changes in Net Interest Income
The following table shows the changes in the components of net interest income on a taxable-equivalent basis for 2019, 2018 and 2017. The changes in net interest income between periods have been reflected as attributable to either volume or rate changes. For purposes of this table, changes that are not solely due to volume or rate are allocated to these categories in proportion to the absolute dollar amounts of the changes in average volume and average rate. Net loan fees (costs) of $(45) million, $4 million and $7 million for the years ended 2019, 2018 and 2017, respectively, are included in this table.
| For the Years Ended December 31, | ||||||||||||||||||||||||
| 2019 versus 2018 | 2018 versus 2017 | |||||||||||||||||||||||
Increase (Decrease) due to change in | Increase (Decrease) due to change in | |||||||||||||||||||||||
| (Dollars in millions) | Average Volume | Average Rate | Net Change | Average Volume | Average Rate | Net Change | ||||||||||||||||||
Changes in Interest Income (1) | ||||||||||||||||||||||||
| Loans held for investment: | ||||||||||||||||||||||||
| Commercial and industrial | $ | 87 | $ | 14 | $ | 101 | $ | (42 | ) | $ | 132 | $ | 90 | |||||||||||
| Commercial mortgage | 45 | (19 | ) | 26 | 16 | 17 | 33 | |||||||||||||||||
| Construction | (3 | ) | 6 | 3 | (14 | ) | 9 | (5 | ) | |||||||||||||||
| Lease financing | (9 | ) | 10 | 1 | (8 | ) | 29 | 21 | ||||||||||||||||
| Residential mortgage and home equity | 18 | (12 | ) | 6 | 163 | 54 | 217 | |||||||||||||||||
| Other consumer | 188 | — | 188 | 63 | (12 | ) | 51 | |||||||||||||||||
| Total loans held for investment | 325 | 407 | ||||||||||||||||||||||
| Securities | (17 | ) | (31 | ) | (48 | ) | 25 | 64 | 89 | |||||||||||||||
| Securities borrowed or purchased under resale agreements | 73 | 40 | 113 | (7 | ) | 312 | 305 | |||||||||||||||||
| Interest bearing deposits in banks | 74 | 8 | 82 | 12 | 29 | 41 | ||||||||||||||||||
| Trading account assets | (48 | ) | (7 | ) | (55 | ) | 81 | 8 | 89 | |||||||||||||||
| Other earning assets | 7 | 1 | 8 | (3 | ) | 2 | (1 | ) | ||||||||||||||||
| Total earning assets | 425 | 930 | ||||||||||||||||||||||
| Changes in Interest Expense | ||||||||||||||||||||||||
| Interest bearing deposits: | ||||||||||||||||||||||||
| Transaction and money market accounts | 6 | 126 | 132 | (10 | ) | 95 | 85 | |||||||||||||||||
| Savings | 1 | 18 | 19 | 5 | 36 | 41 | ||||||||||||||||||
| Time | 180 | 54 | 234 | 31 | 43 | 74 | ||||||||||||||||||
| Total interest bearing deposits | 385 | 200 | ||||||||||||||||||||||
| Commercial paper and other short-term borrowings | (1 | ) | 35 | 34 | 57 | 53 | 110 | |||||||||||||||||
| Securities loaned or sold under repurchase agreements | 28 | 68 | 96 | 8 | 373 | 381 | ||||||||||||||||||
| Long-term debt | 64 | 68 | 132 | 67 | 48 | 115 | ||||||||||||||||||
| Total borrowed funds | 262 | 606 | ||||||||||||||||||||||
| Trading account liabilities | (7 | ) | (2 | ) | (9 | ) | 20 | 17 | 37 | |||||||||||||||
| Total interest bearing liabilities | 638 | 843 | ||||||||||||||||||||||
| Changes in net interest income | $ | (213 | ) | $ | 87 | |||||||||||||||||||
| (1) | Interest income is presented on a taxable-equivalent basis using the federal statutory tax rates of 21% for 2019 and 2018, and 35% for 2017. |
50
Noninterest Income and Noninterest Expense
The following tables display our noninterest income and noninterest expense for the years ended December 31, 2019, 2018 and 2017.
Noninterest Income
| Increase (Decrease) | ||||||||||||||||||||||||||
| Years Ended December 31, | ||||||||||||||||||||||||||
Years Ended December 31, | 2019 versus 2018 | 2018 versus 2017 | ||||||||||||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | Amount | Percent | Amount | Percent | |||||||||||||||||||
| Service charges on deposit accounts | $ | 166 | $ | 179 | $ | 188 | $ | (13 | ) | (7 | )% | $ | (9 | ) | (5 | )% | ||||||||||
| Trust and investment management fees | 117 | 118 | 121 | (1 | ) | (1 | ) | (3 | ) | (2 | ) | |||||||||||||||
| Trading account activities | 70 | (24 | ) | (5 | ) | 94 | 392 | (19 | ) | (380 | ) | |||||||||||||||
| Securities gains, net | 39 | 8 | 17 | 31 | 388 | (9 | ) | (53 | ) | |||||||||||||||||
| Credit facility fees | 98 | 90 | 98 | 8 | 9 | (8 | ) | (8 | ) | |||||||||||||||||
| Brokerage commissions and fees | 74 | 73 | 69 | 1 | 1 | 4 | 6 | |||||||||||||||||||
| Card processing fees, net | 56 | 50 | 47 | 6 | 12 | 3 | 6 | |||||||||||||||||||
| Investment banking and syndication fees | 433 | 355 | 369 | 78 | 22 | (14 | ) | (4 | ) | |||||||||||||||||
| Fees from affiliates | 1,439 | 1,213 | 866 | 226 | 19 | 347 | 40 | |||||||||||||||||||
| Other, net | 213 | 115 | 240 | 98 | 85 | (125 | ) | (52 | ) | |||||||||||||||||
| Total noninterest income | $ | 2,705 | $ | 2,177 | $ | 2,010 | $ | 528 | 24 | % | $ | 167 | 8 | % | ||||||||||||
Noninterest income increased during 2019 compared with 2018 primarily due to increases in trading account activities, investment banking and syndication fees, and fees from affiliates from services provided to MUFG Bank, Ltd. under the master services agreement, partially offset by a decline in the fair value of mortgage servicing rights (included in other, net). The Company uses derivatives to offset changes in the fair value of mortgage servicing rights. Changes in the fair value of these derivatives are included in trading account activities. In addition, 2018 included the Company's share of losses on certain renewable energy investments of $164 million as a result of the TCJA (included in other, net).
51
Noninterest Expense
| Increase (Decrease) | ||||||||||||||||||||||||||
| Years Ended December 31, | ||||||||||||||||||||||||||
| Years Ended December 31, | 2019 versus 2018 | 2018 versus 2017 | ||||||||||||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | Amount | Percent | Amount | Percent | |||||||||||||||||||
| Salaries and employee benefits | $ | 2,687 | $ | 2,616 | $ | 2,495 | $ | 71 | 3 | % | $ | 121 | 5 | % | ||||||||||||
| Net occupancy and equipment | 431 | 367 | 357 | 64 | 17 | 10 | 3 | |||||||||||||||||||
| Professional and outside services | 651 | 487 | 439 | 164 | 34 | 48 | 11 | |||||||||||||||||||
| Software | 313 | 287 | 192 | 26 | 9 | 95 | 49 | |||||||||||||||||||
| Regulatory assessments | 63 | 85 | 82 | (22 | ) | (26 | ) | 3 | 4 | |||||||||||||||||
| Intangible asset amortization | 34 | 26 | 30 | 8 | 31 | (4 | ) | (13 | ) | |||||||||||||||||
| Goodwill impairment | 1,614 | — | — | 1,614 | 100 | — | — | |||||||||||||||||||
| Other | 422 | 409 | 389 | 13 | 3 | 20 | 5 | |||||||||||||||||||
| Total noninterest expense | $ | 6,215 | $ | 4,277 | $ | 3,984 | $ | 1,938 | 45 | % | $ | 293 | 7 | % | ||||||||||||
Excluding goodwill impairment, the increase in noninterest expense during 2019 compared with 2018 was primarily driven by increases in costs associated with services provided to MUFG Bank, Ltd. under the master services agreement. Expenses related to technology-oriented initiatives to transform certain systems and processes also contributed to the increase in noninterest expense.
Goodwill Impairment
The Company performs goodwill impairment tests on an annual basis as of April 1, and between annual tests if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying amount. The Company adopted Accounting Standards Update No. 2017-04, Simplifying the Test for Goodwill Impairment ("ASU 2017-04") effective July 1, 2019. This standard eliminates Step 2 from the goodwill impairment test. Instead, the Company performs its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognizes an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit.
During the third quarter of 2019, due to the decline in interest rates and slower growth than previously forecasted, cash flow projections for certain reporting units were revised lower. The combination of these events led management to believe that it was more likely than not that the fair values of certain reporting units were below carrying value. As a result, the Company initiated an interim quantitative impairment test of goodwill allocated to three of its reporting units: Consumer Banking, Commercial Banking and Real Estate Industries, and Global Corporate & Investment Banking - U.S.
The Company estimated the fair value of its reporting units using a combination of the income and the market approaches. The income approach estimates the fair value of the reporting units by discounting management’s projections of each reporting unit’s cash flows, including a terminal value to estimate the fair value of cash flows beyond the final year of projected results, using a discount rate derived from the Capital Asset Pricing Model. The market approach incorporates comparable public company price to tangible book value and price to earnings multiples.
Certain projected cash flows used to estimate fair value of the reporting units were revised lower than previous projections due to the combination of the following factors: the decline in interest rates through September 30, 2019 and a change in the Company’s expectation that interest rates will remain lower than previously assumed; updates to key loan growth and loan mix assumptions in the forecast to address the Company’s declining net interest margin; and a reduction of the expected growth and cash flow contribution of new initiatives based on a revised economic outlook. Multiples selected in the market approach to estimate fair values were also revised lower than those used in the most recent annual quantitative impairment test due to lower reporting unit earnings.
52
Upon completing the quantitative impairment test, the Company recorded an impairment charge of $1.6 billion, which represented the entire amount of goodwill allocated to the Consumer Banking reporting unit and a portion of the goodwill allocated to the Global Corporate & Investment Banking - U.S. reporting unit, which has $667 million allocated goodwill remaining after the impairment. The Commercial Banking and Real Estate Industries reporting unit’s estimated fair value exceeded carrying value by 9%. The impairment charge did not result in a cash outflow and did not significantly affect the regulatory capital ratios or the Company’s liquidity position as of September 30, 2019 or December 31, 2019.
Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates, and market factors. Estimating the fair value of individual reporting units requires us to make assumptions and estimates regarding our future plans, as well as industry, economic, and regulatory conditions. These assumptions and estimates include estimated future annual net cash flows, income tax rates, discount rates, growth rates, and other market factors. If current expectations of future growth rates are not met, if market factors outside of our control, such as discount rates and market multiples, change, or if management’s expectations or plans otherwise change, then goodwill allocated to one or more of our reporting units might become impaired in the future.
Income Tax Expense
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Income before income taxes and including noncontrolling interests | $ | (669 | ) | $ | 1,101 | $ | 1,333 | |||||
| Income tax expense | 82 | 52 | 299 | |||||||||
| Effective tax rate | (12 | )% | 5 | % | 22 | % | ||||||
In 2019, income tax expense was $82 million and the effective tax rate was negative 12%, compared with $52 million and an effective tax rate of 5% in 2018. Excluding the goodwill impairment charge in the third quarter of 2019, the majority of which was not deductible for income tax purposes, the effective tax rate would have been 14% in 2019. Income tax expense and the effective tax rate in 2018 included an adjustment to certain prior period state income taxes during the first quarter of 2018. Excluding that adjustment, the effective tax rate for 2018 would have been 10%.
For additional information regarding income tax expense, including a reconciliation between the effective tax rate and the statutory tax rate and changes in unrecognized tax benefits, see Note 17 to our Consolidated Financial Statements included in this Form 10-K.
53
Balance Sheet Analysis
Securities
Our securities portfolio is primarily used for liquidity and interest rate risk management purposes, to invest cash resulting from excess liquidity, and to a lesser extent, to support our business development objectives. We strive to maximize total return while managing this objective within appropriate risk parameters. Securities available for sale are substantially comprised of U.S. Treasury securities, U.S. government-sponsored agency securities, RMBSs, CMBSs, Cash Flow CLOs, and direct bank purchase bonds. Direct bank purchase bonds are instruments that are issued in bond form, accounted for as securities, but underwritten as loans with features that are typically found in commercial loans, and are subject to national bank regulatory lending authority standards. These instruments typically are not issued in bearer form, nor are they registered with the SEC or the Depository Trust Company. Additionally, these instruments generally contain certain transferability restrictions and are not assigned external credit ratings. Securities held to maturity consist of U.S. Treasury securities, U.S. government-sponsored agency securities and U.S. government-sponsored agency RMBSs and CMBSs.
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of securities, and securities pledged as collateral, are detailed in Note 2 to our Consolidated Financial Statements included in this Form 10-K.
The following tables show the remaining contractual maturities and expected yields of the securities based upon amortized cost at December 31, 2019. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
Securities Available for Sale
| December 31, 2019 | |||||||||||||||||||||||||||||||||||
| Maturities | |||||||||||||||||||||||||||||||||||
One Year or Less | Over One Year Through Five Years | Over Five Years Through Ten Years | Over Ten Years | Total Amortized Cost | |||||||||||||||||||||||||||||||
| (Dollars in millions) | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||||||||
| Securities available for sale | |||||||||||||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | — | — | % | $ | 1,243 | 1.50 | % | $ | 4,208 | 1.77 | % | $ | 34 | 1.86 | % | $ | 5,485 | 1.71 | % | |||||||||||||||
| Mortgage-backed: | |||||||||||||||||||||||||||||||||||
| U.S. agencies | — | — | 168 | 2.42 | 1,032 | 2.17 | 4,291 | 2.50 | 5,491 | 2.44 | |||||||||||||||||||||||||
| Residential - non-agency | — | — | — | — | — | — | 759 | 3.44 | 759 | 3.44 | |||||||||||||||||||||||||
| Commercial - non-agency | 32 | 3.10 | — | — | 1,374 | 2.24 | 2,055 | 3.23 | 3,461 | 2.84 | |||||||||||||||||||||||||
| Collateralized loan obligations | — | — | — | — | 432 | 3.38 | 1,067 | 3.31 | 1,499 | 3.33 | |||||||||||||||||||||||||
| Direct bank purchase bonds | 67 | 2.37 | 285 | 3.86 | 460 | 2.95 | 99 | 3.59 | 911 | 3.26 | |||||||||||||||||||||||||
| Other | — | — | 202 | 3.95 | — | — | — | — | 202 | 3.95 | |||||||||||||||||||||||||
| Total securities available for sale | 99 | 2.60 | % | 1,898 | 2.20 | % | 7,506 | 2.08 | % | 8,305 | 2.88 | % | 17,808 | 2.47 | % | ||||||||||||||||||||
54
Securities Held to Maturity
| December 31, 2019 | |||||||||||||||||||||||||||||||||||
| Maturities | |||||||||||||||||||||||||||||||||||
| One Year or Less | Over One Year Through Five Years | Over Five Years Through Ten Years | Over Ten Years | Total Amortized Cost | |||||||||||||||||||||||||||||||
| (Dollars in millions) | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | 9 | 8.62 | % | $ | — | — | % | $ | 1,350 | 2.51 | % | $ | — | — | % | $ | 1,359 | 2.55 | % | |||||||||||||||
| Mortgage-backed: | |||||||||||||||||||||||||||||||||||
| U.S. agencies | — | — | 721 | 2.18 | 892 | 2.32 | 6,553 | 2.59 | 8,166 | 2.52 | |||||||||||||||||||||||||
| Total securities held to maturity | 9 | 8.62 | % | 721 | 2.18 | % | 2,242 | 2.43 | % | 6,553 | 2.59 | % | 9,525 | 2.53 | % | ||||||||||||||||||||
Loans Held for Investment
The following table shows loans held for investment outstanding by loan type at the end of each period presented.
| December 31, | ||||||||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
| Loans held for investment: | ||||||||||||||||||||
| Commercial and industrial | $ | 26,338 | $ | 24,919 | $ | 23,281 | $ | 25,379 | $ | 30,257 | ||||||||||
| Commercial mortgage | 16,895 | 15,354 | 14,320 | 14,625 | 14,030 | |||||||||||||||
| Construction | 1,511 | 1,613 | 1,775 | 2,283 | 2,297 | |||||||||||||||
| Lease financing | 1,001 | 1,249 | 1,533 | 1,819 | 1,911 | |||||||||||||||
| Total commercial portfolio | 45,745 | 43,135 | 40,909 | 44,106 | 48,495 | |||||||||||||||
Residential mortgage and home equity (1) | 38,018 | 40,677 | 38,014 | 32,392 | 30,083 | |||||||||||||||
Other consumer (2) | 4,450 | 2,695 | 1,091 | 1,053 | 679 | |||||||||||||||
| Total consumer portfolio | 42,468 | 43,372 | 39,105 | 33,445 | 30,762 | |||||||||||||||
| Total loans held for investment | $ | 88,213 | $ | 86,507 | $ | 80,014 | $ | 77,551 | $ | 79,257 | ||||||||||
| (1) | Includes home equity loans of $2,049 million and $2,238 million at December 31, 2019 and December 31, 2018, respectively. |
| (2) | Other consumer loans substantially include unsecured consumer loans and consumer credit cards. |
Loans held for investment increased from December 31, 2018 to December 31, 2019, primarily due to growth in the commercial and industrial, commercial mortgage and other consumer loan portfolios, partially offset by a decrease in the residential mortgage and home equity portfolio.
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Loan Maturities
The following table presents our commercial and industrial loans and construction loans held for investment by contractual maturity.
| December 31, 2019 | ||||||||||||||||
| (Dollars in millions) | One Year or Less | Over One Year Through Five Years | Over Five Years | Total | ||||||||||||
| Selected loan maturities: | ||||||||||||||||
| Commercial and industrial | $ | 5,509 | $ | 18,077 | $ | 2,752 | $ | 26,338 | ||||||||
| Construction | 817 | 640 | 54 | 1,511 | ||||||||||||
| Total | $ | 6,326 | $ | 18,717 | $ | 2,806 | $ | 27,849 | ||||||||
| Total fixed rate loans due after one year | $ | 917 | ||||||||||||||
| Total variable rate loans due after one year | 20,606 | |||||||||||||||
| Total due after one year | $ | 21,523 | ||||||||||||||
Cross-Border Outstandings
Our cross-border outstandings reflect certain economic and political risks that differ from or are greater than those reflected in domestic outstandings. These risks include, but are not limited to, exchange rate fluctuations and restrictions on the transfer of funds. Our total cross-border outstandings for Japan exceeded one percent of total assets at December 31, 2019, December 31, 2018 and December 31, 2017 and were $3.2 billion, $3.0 billion and $4.4 billion, respectively. Our total cross-border outstandings for Cayman Islands exceeded one percent of total assets at December 31, 2019 and December 31, 2018 and were $2.3 billion and $2.4 billion, respectively. These cross-border outstandings are based on category and legal residence of ultimate risk and are primarily comprised of securities financing arrangements and commercial loans.
Deposits
The table below presents our deposits as of December 31, 2019 and 2018.
| December 31, 2019 | December 31, 2018 | Increase (Decrease) | |||||||||||||
| (Dollars in millions) | Amount | Percent | |||||||||||||
| Interest checking | $ | 4,725 | $ | 3,598 | $ | 1,127 | 31 | % | |||||||
| Money market | 35,002 | 34,373 | 629 | 2 | |||||||||||
| Total interest bearing transaction and money market accounts | 39,727 | 37,971 | 1,756 | 5 | |||||||||||
| Savings | 8,962 | 9,515 | (553 | ) | (6 | ) | |||||||||
| Time | 15,651 | 11,739 | 3,912 | 33 | |||||||||||
| Total interest bearing deposits | 64,340 | 59,225 | 5,115 | 9 | |||||||||||
| Noninterest bearing deposits | 31,521 | 31,754 | (233 | ) | (1 | ) | |||||||||
| Total deposits | $ | 95,861 | $ | 90,979 | $ | 4,882 | 5 | % | |||||||
Total deposits increased $4.9 billion from December 31, 2018 due substantially to an increase in interest bearing deposits. The increase in interest bearing deposits was largely related to Transaction Banking deposits and Regional Bank deposits, including PurePoint Financial, the direct banking division of the Bank.
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The following table presents domestic time deposits of $100,000 and over by maturity.
| (Dollars in millions) | December 31, 2019 | |||
| Three months or less | $ | 4,075 | ||
| Over three months through six months | 4,453 | |||
| Over six months through twelve months | 2,146 | |||
| Over twelve months | 1,154 | |||
| Total domestic time deposits of $100,000 and over | $ | 11,828 | ||
We offer CDs and other time deposits of $100,000 and over at market rates of interest. A large portion of these deposits are held by customers, both public and private.
Securities Financing Arrangements
The Company enters into securities purchased under agreements to resell, securities sold under agreements to repurchase, and securities borrowing and lending transactions to facilitate customer match-book activity, cover short positions and to fund the Company's trading inventory. These balances are almost entirely attributable to MUSA. See Note 8 to our Consolidated Financial Statements in this Form 10-K for more information.
Securities borrowed or purchased under resale agreements were $23.9 billion and $22.4 billion at December 31, 2019 and December 31, 2018, respectively. The following table provides certain information about securities loaned or sold under repurchase agreements.
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Balance at period end | $ | 28,866 | $ | 27,285 | ||||
| Weighted average interest rate at period end | 1.65 | % | 2.79 | % | ||||
| Maximum outstanding at any month end | $ | 29,581 | $ | 27,884 | ||||
| Average balance during the year | $ | 27,902 | $ | 26,906 | ||||
| Weighted average interest rate during the year | 2.97 | % | 2.73 | % | ||||
Capital Management
Capital Adequacy and Capital Management
A strong capital position is essential to the Company's business strategy. The Company has established a Capital Management Policy, which sets forth, among other things, the principles and guidelines used for capital planning, issuance, usage and distributions, including internal capital goals; the quantitative and qualitative guidelines for dividends and stock repurchases; and the strategies for addressing potential capital shortfalls. The Capital Management Policy sets forth the enterprise-wide capital objectives, which include requirements to maintain capital adequate for the Company's material risks, to maintain access to funding to meet obligations to creditors and counterparties, to provide for effective support of organic growth, and to consider the quality and efficiency of various capital forms while maintaining a strong capital position. Capital is generated principally from the retention of earnings and from capital contributions received from MUFG Bank, Ltd. and MUFG.
Regulatory Capital
Both MUAH and MUB are subject to various capital adequacy regulations issued by the U.S. federal banking agencies, including requirements to complete an annual capital plan and to maintain minimum regulatory capital ratios. As of December 31, 2019, management believes the capital ratios of MUAH and MUB exceeded all regulatory requirements of "well-capitalized" institutions.
MUAH is subject to regulatory requirements to develop and maintain a capital plan which must be reviewed and approved by its Board of Directors (or designated subcommittee thereof). The Board of Directors
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approved the Company's annual capital plan in March 2019. Under the Tailoring Rules, MUAH, as a Category IV firm, is subject to CCAR supervisory capital planning requirements and stress testing submission requirements on an every other year basis in even years (e.g. MUAH will be subject to the 2020 CCAR cycle). See "Supervision and Regulation – Dodd-Frank Act and Related Regulations" and "Supervision and Regulation – Regulatory Capital and Liquidity Standards – Capital Planning and Comprehensive Capital Analysis and Review Program" in Part I, Item 1. "Business" of this Form 10-K.
MUAH and MUB are required to maintain minimum capital ratios under the standardized approach in accordance with the BCBS capital guidelines for U.S. banking organizations issued by the U.S. federal banking agencies (U.S. Basel III Rules). Among other requirements, the U.S. Basel III Rules require a minimum Common Equity Tier 1 capital ratio of 4.5% and a capital conservation buffer of 2.5% (for a total minimum Common Equity Tier 1 capital ratio of 7.0%) and a Tier 1 leverage ratio of 4%.
The following tables summarize the calculation of MUAH’s risk-based capital ratios in accordance with the U.S. Basel III rules as of December 31, 2019 and December 31, 2018.
MUFG Americas Holdings Corporation
| U.S. Basel III | ||||||||
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Capital Components | ||||||||
| Common Equity Tier 1 capital | $ | 15,086 | $ | 14,256 | ||||
| Tier 1 capital | $ | 15,086 | $ | 14,256 | ||||
| Tier 2 capital | 683 | 648 | ||||||
| Total risk-based capital | $ | 15,769 | $ | 14,904 | ||||
| Risk-weighted assets | $ | 107,023 | $ | 102,088 | ||||
| Average total assets for leverage capital purposes | $ | 169,807 | $ | 162,550 | ||||
| U.S. Basel III | Minimum Capital Requirement with Capital Conservation Buffer(1) | ||||||||||||||||||||||
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | ||||||||||||||||||||
| Capital Ratios | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||
| Common Equity Tier 1 capital (to risk-weighted assets) | $ | 15,086 | 14.10 | % | $ | 14,256 | 13.96 | % | ≥ | $ | 7,492 | 7.00 | % | ||||||||||
| Tier 1 capital (to risk-weighted assets) | 15,086 | 14.10 | 14,256 | 13.96 | ≥ | 9,097 | 8.50 | ||||||||||||||||
| Total capital (to risk-weighted assets) | 15,769 | 14.73 | 14,904 | 14.60 | ≥ | 11,237 | 10.50 | ||||||||||||||||
Tier 1 leverage(2) | 15,086 | 8.88 | 14,256 | 8.77 | ≥ | 6,792 | 4.00 | ||||||||||||||||
| (1) | Beginning January 1, 2019, the minimum capital requirement includes a capital conservation buffer of 2.5%. |
| (2) | Tier 1 capital divided by quarterly average assets (excluding certain disallowed assets, primarily goodwill and other intangibles). |
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The following tables summarize the calculation of MUB’s risk-based capital ratios in accordance with the guidelines set forth in the U.S. Basel III rules as of December 31, 2019 and December 31, 2018.
MUFG Union Bank, N.A.
| U.S. Basel III | ||||||||
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Capital Components | ||||||||
| Common Equity Tier 1 capital | $ | 14,115 | $ | 13,316 | ||||
| Tier 1 capital | $ | 14,115 | $ | 13,316 | ||||
| Tier 2 capital | 631 | 589 | ||||||
| Total risk-based capital | $ | 14,746 | $ | 13,905 | ||||
| Risk-weighted assets | $ | 97,563 | $ | 92,170 | ||||
| Average total assets for leverage capital purposes | $ | 132,590 | $ | 125,461 | ||||
| U.S. Basel III | Minimum Capital Requirement with Capital Conservation Buffer (1) | To Be Well-Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||||||||||||||||
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | |||||||||||||||||||||||||||||
| Capital Ratios | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||||||||
| Common Equity Tier 1 capital (to risk-weighted assets) | $ | 14,115 | 14.47 | % | $ | 13,316 | 14.45 | % | ≥ | $ | 6,829 | 7.00 | % | ≥ | $ | 6,342 | 6.5 | % | ||||||||||||||
| Tier 1 capital (to risk-weighted assets) | 14,115 | 14.47 | 13,316 | 14.45 | ≥ | 8,293 | 8.50 | ≥ | 7,805 | 8.0 | ||||||||||||||||||||||
| Total capital (to risk-weighted assets) | 14,746 | 15.11 | 13,905 | 15.09 | ≥ | 10,244 | 10.50 | ≥ | 9,756 | 10.0 | ||||||||||||||||||||||
Tier 1 leverage(2) | 14,115 | 10.65 | 13,316 | 10.61 | ≥ | 5,304 | 4.00 | ≥ | 6,629 | 5.0 | ||||||||||||||||||||||
| (1) | Beginning January 1, 2019, the minimum capital requirement includes a capital conservation buffer of 2.5%. |
| (2) | Tier 1 capital divided by quarterly average assets (excluding certain disallowed assets, primarily goodwill and other intangibles). |
In addition to capital ratios determined in accordance with regulatory requirements, we consider the tangible common equity ratio when evaluating capital utilization and adequacy. This capital ratio is monitored by management, and presented below, to further facilitate the understanding of our capital structure and for use in assessing and comparing the quality and composition of the Company's capital structure to other financial institutions. This ratio is not codified within GAAP or federal banking regulations in effect at December 31, 2019. Therefore, it is considered a non-GAAP financial measure. Our tangible common equity ratio calculation method may differ from those used by other financial services companies.
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The following table summarizes the calculation of the Company's tangible common equity ratio as of December 31, 2019 and 2018:
| December 31, 2019 | December 31, 2018 | |||||||
| (Dollars in millions) | ||||||||
| Total MUAH stockholders' equity | $ | 16,280 | $ | 16,508 | ||||
| Less: Goodwill | 1,764 | 3,301 | ||||||
| Less: Intangible assets, except mortgage servicing rights | 261 | 285 | ||||||
| Less: Deferred tax liabilities related to goodwill and intangible assets | (17 | ) | (57 | ) | ||||
| Tangible common equity (a) | $ | 14,272 | $ | 12,979 | ||||
| Total assets | $ | 170,810 | $ | 168,100 | ||||
| Less: Goodwill | 1,764 | 3,301 | ||||||
| Less: Intangible assets, except mortgage servicing rights | 261 | 285 | ||||||
| Less: Deferred tax liabilities related to goodwill and intangible assets | (17 | ) | (57 | ) | ||||
| Tangible assets (b) | $ | 168,802 | $ | 164,571 | ||||
| Tangible common equity ratio (a)/(b) | 8.45 | % | 7.89 | % | ||||
Goodwill and related deferred tax liabilities declined due to the impairment recorded in the third quarter of 2019. See "Goodwill Impairment" in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 5 to our Consolidated Financial Statements in this Form 10-K. For additional information regarding our regulatory capital requirements, see "Supervision and Regulation-Regulatory Capital and Liquidity Standards" in Part I, Item 1. "Business" of this Form 10-K.
Risk Management
All financial institutions must manage and control a variety of business risks that can significantly affect their financial condition and performance. Some of the key risks that the Company must manage include credit, market, liquidity, operational, interest rate, compliance, reputation and strategic risks. The Board, directly or through its appropriate committees, provides oversight and approves our various risk management policies. Management has established a risk management structure that is designed to provide a comprehensive approach for identifying, measuring, monitoring, controlling and reporting on the significant risks faced by the Company. Additional information regarding our risk management structure and framework is set forth below.
Risk Management Structure
Board Committees
Risk Committee
The Risk Committee of the Board of Directors is broadly responsible for oversight of (1) risk management, (2) compliance with legal and regulatory requirements, and (3) the credit, operational and other material risks to which the Company may be exposed. The Risk Committee is responsible for risk management oversight in the key areas outlined below, and has the authority to direct corrective and remedial actions.
The Risk Committee generally oversees the Company’s risk management and the enterprise level risk appetite frameworks and establishes guidelines for reporting and escalating risk issues.
The Risk Committee provides oversight of management’s control over the following risk categories: credit, market, interest rate, liquidity, operational (including modeling and information), compliance, reputation and strategic risks. The Risk Committee also reviews and assesses risks from the viewpoint of protecting the overall safety and soundness of the Company.
Human Capital Committee
The Human Capital Committee oversees the Company’s compensation and risk review processes in line with competitive market practice and regulatory guidance associated with responsible risk management
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practices. The Human Capital Committee reviews the Human Capital Risk & Control Committee’s risk assessment of the Company’s annual incentive compensation plan to assure that it is consistent with the Company’s stated risk appetite and regulatory guidance.
Audit & Finance Committee
The Audit & Finance Committee of the Board of Directors is responsible for oversight of liquidity and interest rate risk. The Audit & Finance Committee also oversees IAA and ACR, both of which provide the Audit & Finance Committee with independent assessments of risk.
Management Committees
The ECA provides direction on major corporate policies including strategic, financial, risk management, infrastructure, regulatory and governance policies. The ECA has established and delegated authority to the ARC whose responsibilities include reviewing risk management policies and overseeing the risk management framework and all risks on an integrated basis. The ARC oversees areas of risk with and through its sub-committees, including: Credit Risk Committee; Market Risk Management Committee; Liquidity Risk and Interest Rate Risk Committee; Compliance Risk Committee; Information Risk Committee; Reputation Risk Committee; Operational Risk Management Committee; and Third Party Risk Management Committee.
Americas Risk Management Group
Appointed by the Board of Directors, the Company's CRO is responsible for managing the ARM function which consists of individuals with specialized knowledge to identify, measure, monitor, control and report on the significant risks faced by MUAH and its subsidiaries.
ARM is responsible for maintaining all risk-related policies and procedures, identifying Company-level risks, monitoring emerging risks, and aggregating reporting for review by management, management committees and the Board Risk Committee. ARM is expected to support management's execution of the strategic objectives and overarching goal of maintaining the safety and soundness of the Company and its compliance with U.S. laws, regulations and supervisory guidance.
The following paragraphs discuss the Company’s risk management framework relating to credit, market, interest rate, liquidity, and operational risks.
Credit Risk Management
One of our principal business activities is the extension of credit to individuals and businesses. Our policies and the applicable laws and regulations governing the extension of credit require risk analysis, including an extensive evaluation of the purpose of the request and the borrower's ability and willingness to repay as scheduled. Our process also includes ongoing portfolio and credit management through portfolio diversification, lending limit constraints, credit review and approval policies, and extensive internal monitoring.
Credit risk is defined as the risk to earnings or capital arising from an obligor's failure to meet the financial terms of any contract with the Company in accordance with agreed upon terms. We manage and control credit risk through diversification of the portfolio, including by type of loan, industry concentration, dollar limits on multiple loans to the same borrower, geographic distribution and type of borrower.
In analyzing our loan portfolios, we apply specific monitoring policies and procedures that are tailored according to the risk profile and other characteristics of the loans within the portfolios. Our residential, consumer and certain small commercial loans are homogeneous in nature and are, in general, individually insignificant in terms of size or potential risk of loss. Accordingly, we review these portfolios by analyzing their performance as a pool of loans. In contrast, our monitoring process for larger commercial and industrial, construction, commercial mortgage, lease, and foreign loan portfolios includes a periodic review of individual loans. Loans that are performing, but have shown some signs of weakness, are subjected to more stringent reporting and oversight.
We have a Credit Risk Committee, chaired by the head of the Credit Strategies Group and composed of the Chief Credit Officers responsible for our loan portfolio segments and other executive and senior officers, that establishes our overall risk appetite, portfolio concentration limits, and credit risk rating methodology. This
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committee is supported by the Credit Policy Sub-Committee, composed of Group Senior Credit Officers that have responsibility for establishing credit policy, credit underwriting criteria, and other risk management controls. Credit Administration, under the direction of the Chief Credit Officers and their designated Group Senior Credit Officers, are responsible for administering the credit approval process and related policies. Policies require an evaluation of credit requests and ongoing reviews of existing credits in order to verify that we know with whom we are doing business, that the purpose of the credit is acceptable, and that the borrower is able and willing to repay as agreed. Furthermore, policies require prompt identification and quantification of asset quality deterioration or potential loss.
ACR, which reports to the Audit & Finance Committee of the Board of Directors, provides both the Board and executive management with an independent assessment of the effectiveness of the credit management process. ACR routinely reviews the accuracy and timeliness of risk ratings assigned to individual borrowers with the goal of ensuring that the business unit credit risk identification process is functioning properly. This group also assesses compliance with credit policies and underwriting standards at the business unit level. Additionally, ACR reviews changes to credit policies, practices and underwriting guidelines. ACR summarizes its significant findings on a regular basis and provides recommendations for corrective action when credit management or control deficiencies are identified.
Allowance for Credit Losses
Allowance Policy and Methodology
We maintain an allowance for credit losses (defined as both the allowance for loan losses and the allowance for losses on unfunded credit commitments) to absorb losses inherent in the loan portfolio as well as for unfunded credit commitments. The allowance for credit losses is based on our quarterly assessments of the probable estimated losses inherent in the loan portfolio and unfunded credit commitments. Our methodology for measuring the appropriate level of the allowance relies on several key elements, which include the allowance for loans collectively evaluated for impairment, the allowance for loans individually evaluated for impairment, the unallocated allowance and the allowance for losses on unfunded credit commitments. We develop and document our allowance methodology at the portfolio segment level. Our loan portfolio consists of a commercial portfolio segment and a consumer portfolio segment. Understanding our policies on the allowance for credit losses is fundamental to understanding our consolidated financial condition and consolidated results of operations.
For the commercial portfolio segment, the allowance for loans collectively evaluated for impairment is calculated by utilizing a dual factor internal risk rating system that encompasses both the probability that a credit facility may ultimately default (i.e. probability of default) and an estimate of the severity of the loss that would be realized upon such default (i.e. the loss-given default) and applying these risk ratings to outstanding loans and most unused commitments. The probability of default and loss-given default may be adjusted for qualitative or environmental factors that, in management's judgment, are likely to cause estimated credit losses associated with the existing portfolio to differ from the historical probability of default and loss-given default. While our assessments of these factors are reviewed quarterly with our senior credit officers and executive management, the actual impact from any of these conditions may differ significantly from the estimates used.
For the consumer portfolio segment, loans are generally pooled by product type with similar risk characteristics. We estimate the allowance for loans collectively evaluated for impairment based on forecasted losses, which represent our best estimate of inherent loss.
In addition to the methodologies described above, the allowance for loans collectively evaluated for impairment also includes attributions for certain sectors within the commercial and consumer portfolio segments to account for probable losses that are currently not reflected in the risk ratings or forecasted losses. Segment attributions are calculated based on migration scenarios for the commercial portfolio and specific attributes applicable to the consumer portfolio. Segment considerations are revised periodically as portfolio and credit environment conditions change.
A specific allowance is established for loans that we individually evaluate and determine to be impaired. We individually evaluate for impairment larger nonaccruing commercial and industrial, construction, and commercial mortgage loans. Residential mortgage and consumer loans are not individually evaluated for impairment unless they represent TDRs. The amount of the reserve is based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair
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value of the collateral if the loan is collateral dependent. A loan is collateral dependent if repayment of the loan is expected to be provided solely by the underlying collateral and there are no other reliable sources of repayment.
The unallocated allowance is composed of attributions that are intended to capture probable losses from adverse changes in credit migration and other inherent losses that are not currently reflected in the allowance for loan losses that are ascribed to our portfolio segments. These attributions may be ascribed to portfolio segments in future periods when the loss attributions become more evident.
For additional information on the allowance for credit losses, see the "Critical Accounting Estimates—Allowance for Credit Losses" section within "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7. and Note 1 to our Consolidated Financial Statements included in this Form 10-K.
Allowance and Related Provision for Credit Losses
The allowance for loan losses was $538 million at December 31, 2019 compared with $474 million at December 31, 2018. Our ratio of allowance for loan losses to total loans held for investment was 0.61% as of December 31, 2019 and 0.55% as of December 31, 2018. The provision for loan losses during the year ended December 31, 2019 was $283 million primarily due to growth in our other consumer loan portfolio and the impact of specific reserves for certain impaired loans. Net loans charged off to average total loans held for investment increased to 0.25% for the year ended December 31, 2019, compared with 0.10% for the year ended December 31, 2018.
Nonaccrual loans were $328 million at December 31, 2019 compared with $421 million at December 31, 2018. Our ratio of nonaccrual loans to total loans held for investment decreased to 0.37% at December 31, 2019 from 0.49% at December 31, 2018. Our ratio of allowance for loan losses to nonaccrual loans increased to 164.19% at December 31, 2019 from 112.5% at December 31, 2018. Criticized credits in the commercial segment were $1.6 billion at December 31, 2019 and $1.3 billion at December 31, 2018. Criticized credits are those that have regulatory risk ratings of special mention, substandard or doubtful; classified credits are those that have regulatory risk ratings of substandard or doubtful. Special mention credits are potentially weak, as the borrower has begun to exhibit deteriorating trends, which, if not corrected, may jeopardize repayment of the loan and result in further downgrade. Substandard credits have well-defined weaknesses, which, if not corrected, could jeopardize the full satisfaction of the debt. A credit classified as doubtful has critical weaknesses that make full collection improbable on the basis of currently existing facts and conditions.
The following table reflects the related allowance for loan losses allocated to a loan category at year- end for the indicated years and the percentage of the allocation to the year-end loan balance of that loan category, as set forth in the "Loans Held for Investment" table.
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||||||||||||||||
| Commercial and industrial | $ | 272 | 1.03 | % | $ | 275 | 1.10 | % | $ | 265 | 1.14 | % | $ | 440 | 1.72 | % | $ | 542 | 1.79 | % | |||||||||||||||
| Commercial mortgage | 58 | 0.34 | 56 | 0.37 | 67 | 0.47 | 83 | 0.57 | 89 | 0.64 | |||||||||||||||||||||||||
| Construction | 11 | 0.73 | 10 | 0.63 | 11 | 0.61 | 15 | 0.66 | 14 | 0.59 | |||||||||||||||||||||||||
| Lease financing | 13 | 1.30 | 18 | 1.46 | 17 | 1.15 | 18 | 0.99 | 9 | 0.48 | |||||||||||||||||||||||||
| Total commercial portfolio | 354 | 0.77 | 359 | 0.83 | 360 | 0.88 | 556 | 1.25 | 654 | 1.35 | |||||||||||||||||||||||||
| Residential and home equity | 37 | 0.10 | 37 | 0.09 | 37 | 0.10 | 40 | 0.12 | 37 | 0.12 | |||||||||||||||||||||||||
| Other consumer | 147 | 3.30 | 73 | 2.71 | 49 | 4.49 | 43 | 4.08 | 12 | 1.77 | |||||||||||||||||||||||||
| Total consumer portfolio | 184 | 0.43 | 110 | 0.25 | 86 | 0.22 | 83 | 0.25 | 49 | 0.16 | |||||||||||||||||||||||||
| Total allocated allowance | 538 | 0.61 | 469 | 0.54 | 446 | 0.56 | 639 | 0.82 | 703 | 0.89 | |||||||||||||||||||||||||
| Unallocated | — | 5 | 30 | — | 20 | ||||||||||||||||||||||||||||||
| Total allowance for loan losses | $ | 538 | 0.61 | % | $ | 474 | 0.55 | % | $ | 476 | 0.59 | % | $ | 639 | 0.82 | % | $ | 723 | 0.91 | % | |||||||||||||||
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Change in the Allowance for Loan Losses
The following table sets forth a reconciliation of changes in our allowance for loan losses.
| December 31, | ||||||||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
| Allowance for loan losses, beginning of period | $ | 474 | $ | 476 | $ | 639 | $ | 723 | $ | 540 | ||||||||||
| (Reversal of) provision for loan losses | 283 | 84 | (65 | ) | 158 | 213 | ||||||||||||||
| Other | — | — | 2 | 2 | (2 | ) | ||||||||||||||
| Loans charged-off: | ||||||||||||||||||||
| Commercial and industrial | (73 | ) | (43 | ) | (107 | ) | (146 | ) | (27 | ) | ||||||||||
| Commercial and industrial - transfer to held for sale | (26 | ) | (35 | ) | (8 | ) | (113 | ) | — | |||||||||||
| Commercial mortgage | (1 | ) | (1 | ) | (1 | ) | — | (5 | ) | |||||||||||
| Construction | — | — | — | — | (7 | ) | ||||||||||||||
| Lease financing | (58 | ) | — | — | — | — | ||||||||||||||
| Total commercial portfolio | (158 | ) | (79 | ) | (116 | ) | (259 | ) | (39 | ) | ||||||||||
| Residential mortgage and home equity | 4 | 3 | 5 | 4 | (3 | ) | ||||||||||||||
| Other consumer | (102 | ) | (44 | ) | (44 | ) | (16 | ) | (6 | ) | ||||||||||
| Total consumer portfolio | (98 | ) | (41 | ) | (39 | ) | (12 | ) | (9 | ) | ||||||||||
| Total loans charged-off | (256 | ) | (120 | ) | (155 | ) | (271 | ) | (48 | ) | ||||||||||
| Recoveries of loans previously charged-off: | ||||||||||||||||||||
| Commercial and industrial | 28 | 26 | 49 | 19 | 17 | |||||||||||||||
| Commercial mortgage | 1 | 1 | 1 | 5 | 1 | |||||||||||||||
| Construction | — | — | — | — | — | |||||||||||||||
| Total commercial portfolio | 29 | 27 | 50 | 24 | 18 | |||||||||||||||
| Home equity and other consumer loans | 8 | 7 | 5 | 3 | 2 | |||||||||||||||
| Total consumer portfolio | 8 | 7 | 5 | 3 | 2 | |||||||||||||||
| Total recoveries of loans previously charged-off | 37 | 34 | 55 | 27 | 20 | |||||||||||||||
| Net loans recovered (charged-off) | (219 | ) | (86 | ) | (100 | ) | (244 | ) | (28 | ) | ||||||||||
| Ending balance of allowance for loan losses | 538 | 474 | 476 | 639 | 723 | |||||||||||||||
| Allowance for losses on unfunded credit commitments | 109 | 139 | 123 | 162 | 165 | |||||||||||||||
| Total allowance for credit losses | $ | 647 | $ | 613 | $ | 599 | $ | 801 | $ | 888 | ||||||||||
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Nonperforming Assets
Nonperforming assets consist of nonaccrual loans and OREO. 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. OREO includes property where the Bank acquired title through foreclosure or “deed in lieu” of foreclosure. For a more detailed discussion of the accounting for nonaccrual loans, see Note 1 to our Consolidated Financial Statements included in this Form 10-K.
The following table sets forth the components of nonperforming assets, TDRs, criticized assets and certain credit ratios.
| December 31, | ||||||||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
| Nonaccrual loans: | ||||||||||||||||||||
| Commercial and industrial | $ | 175 | $ | 269 | $ | 319 | $ | 458 | $ | 284 | ||||||||||
| Commercial mortgage | 15 | 12 | 20 | 31 | 37 | |||||||||||||||
| Total commercial portfolio | 190 | 281 | 339 | 489 | 321 | |||||||||||||||
| Residential mortgage and home equity | 137 | 139 | 125 | 199 | 231 | |||||||||||||||
| Other consumer loans | 1 | 1 | 1 | 1 | — | |||||||||||||||
| Total consumer portfolio | 138 | 140 | 126 | 200 | 231 | |||||||||||||||
| Total nonaccrual loans | 328 | 421 | 465 | 689 | 552 | |||||||||||||||
| OREO | 1 | 1 | 1 | 3 | 21 | |||||||||||||||
| Total nonperforming assets | $ | 329 | $ | 422 | $ | 466 | $ | 692 | $ | 573 | ||||||||||
| Troubled debt restructurings: | ||||||||||||||||||||
| Accruing | $ | 392 | $ | 299 | $ | 348 | $ | 215 | $ | 413 | ||||||||||
| Nonaccruing (included in total nonaccrual loans above) | 171 | 136 | 229 | 384 | 409 | |||||||||||||||
| Total troubled debt restructurings | $ | 563 | $ | 435 | $ | 577 | $ | 599 | $ | 822 | ||||||||||
| Criticized credits | $ | 1,567 | $ | 1,264 | $ | 1,564 | $ | 2,427 | $ | 2,545 | ||||||||||
| Allowance for loan losses to nonaccrual loans | 164.19 | % | 112.50 | % | 102.37 | % | 92.69 | % | 130.86 | % | ||||||||||
| Allowance for credit losses to nonaccrual loans | 197.34 | % | 145.61 | % | 128.75 | % | 116.20 | % | 160.74 | % | ||||||||||
| Nonperforming assets to total loans held for investment and OREO | 0.37 | % | 0.49 | % | 0.58 | % | 0.89 | % | 0.72 | % | ||||||||||
| Nonperforming assets to total assets | 0.19 | % | 0.25 | % | 0.30 | % | 0.47 | % | 0.37 | % | ||||||||||
| Nonaccrual loans to total loans held for investment | 0.37 | % | 0.49 | % | 0.58 | % | 0.89 | % | 0.70 | % | ||||||||||
See Note 3 to our Consolidated Financial Statements included in this Form 10-K for a description of criticized credits.
Troubled Debt Restructurings
TDRs are loans where we have granted a concession to a borrower as a result of the borrower experiencing financial difficulty and, consequently, we receive less than the current market-based compensation for loans with similar risk characteristics. Such loans are reviewed for impairment either individually or in pools with similar risk characteristics. Our loss mitigation strategies are designed to minimize economic loss and, at times, may result in changes to the original terms, including interest rate changes, maturity extensions, forbearance, principal paydowns, covenant waivers or changes, payment deferrals, or some combination thereof. We evaluate whether these changes to the terms and conditions of our loans meet the TDR criteria after considering the specific situation of the borrower and all relevant facts and circumstances related to the modification. For our consumer portfolio segment, TDRs are typically initially placed on nonaccrual and a minimum of six consecutive months of sustained performance is required before returning to accrual status. For our commercial portfolio segment, we generally determine accrual status for TDRs by performing an individual assessment of each loan, which may include, among other factors, borrower performance under previous loan terms.
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The following table provides a summary of TDRs by loan type, including nonaccrual loans and loans that have been returned to accrual status, as of December 31, 2019 and 2018. See Note 3 to our Consolidated Financial Statements in this Form 10-K for additional information.
| As a Percentage of Ending Loan Balances | ||||||||||||||
| December 31, | December 31, | |||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2019 | 2018 | ||||||||||
| Commercial and industrial | $ | 140 | $ | 109 | 0.51 | % | 0.42 | % | ||||||
| Commercial mortgage | 168 | 46 | 0.99 | 0.30 | ||||||||||
| Construction | 62 | 63 | 4.10 | 3.91 | ||||||||||
| Total commercial portfolio | 370 | 218 | 0.81 | 0.51 | ||||||||||
| Residential mortgage and home equity | 192 | 216 | 0.51 | 0.53 | ||||||||||
| Other consumer | 1 | 1 | 0.02 | 0.04 | ||||||||||
| Total consumer portfolio | 193 | 217 | 0.45 | 0.50 | ||||||||||
| Total restructured loans | $ | 563 | $ | 435 | 0.64 | % | 0.50 | % | ||||||
Loans 90 Days or More Past Due and Still Accruing Interest
Loans held for investment 90 days or more past due and still accruing interest totaled $20 million and $23 million at December 31, 2019 and 2018, respectively.
Concentration of Risk
Commercial and industrial loans are extended principally to corporations, middle-market businesses and small businesses and are originated primarily through our commercial banking offices. Our commercial and industrial portfolio is comprised primarily of the following industry sectors: finance and insurance, manufacturing, real estate and leasing, power and utilities, and wholesale trade. No individual industry sector exceeded 10% of our total loans held for investment at either December 31, 2019 or December 31, 2018.
Construction and commercial mortgage loans are secured by deeds of trust or mortgages. Construction loans are extended primarily to commercial property developers and to residential builders. At December 31, 2019, 81% of the Company’s construction loan portfolio was concentrated in California, 4% to borrowers in Texas and 4% to borrowers in Colorado. The commercial mortgage loan portfolio consists of loans secured by commercial income properties. At December 31, 2019, 64% of the Company’s commercial mortgage loans were made to borrowers located in California, 7% to borrowers in Washington, and 5% to borrowers in New York.
Residential mortgage loans are originated and secured by one-to-four family residential properties, through our multi-channel network, including branches, private bankers, mortgage brokers, telephone services, and web-based and mobile internet banking applications. We do not have a program for originating or purchasing subprime loan products and we hold the majority of the loans we originate. At December 31, 2019, substantially all our residential mortgage loans were made to borrowers in California.
At December 31, 2019, payment terms on 36% of our residential mortgage loans required a monthly payment that covers the full amount of interest due, but did not reduce the principal balance. At origination, these interest-only loans had strong credit profiles and had weighted average LTV ratios of approximately 64%. The remainder of the portfolio consisted of regularly amortizing loans.
Home equity loans are originated principally through our branch network and private banking offices. Approximately 24% and 26% of these home equity loans and lines were supported by first liens on residential properties at both December 31, 2019 and December 31, 2018, respectively. To manage risk associated with lending commitments, we review all equity-secured lines annually for creditworthiness and may reduce or freeze limits, to the extent permitted by laws and regulations.
Other consumer loans substantially include unsecured consumer loans and consumer credit cards. The Company manages risk associated with these loans by establishing lending criteria similar to other consumer loans originated by the Company.
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See Note 3 to our Consolidated Financial Statements included in this Form 10-K for additional information on refreshed FICO scores and refreshed LTV ratios for our residential mortgage and home equity and other consumer loans at December 31, 2019 and December 31, 2018.
Interest Foregone
If interest that was due on the recorded balances of all nonaccrual and restructured loans (including loans that were, but are no longer, on nonaccrual) had been accrued under their original terms, we would have recognized an additional $40 million of interest income in 2019. For loans that were on nonaccrual status during 2019 and accounted for as cash basis nonaccrual loans, we recognized interest income of $23 million in 2019.
Market Risk Management
The objective of market risk management is to mitigate any adverse impact on earnings and capital arising from changes in interest rates and other market variables. Market risk management supports our broad objective of enhancing shareholder value, which encompasses the achievement of stable earnings growth while promoting capital stability over time. Market risk is defined as the risk of loss arising from an adverse change in the market value of financial instruments caused by fluctuations in market prices or rates. The primary market risk to which we are exposed is interest rate risk. Interest rate risk arises from instruments, positions and transactions entered into for purposes other than trading and for trading. Other than trading interest rate risk arises from loans, securities, deposits, borrowings, securities purchased under agreements to resell, securities sold under agreements to repurchase, securities borrowing and lending transactions, derivative instruments and mortgage servicing rights. Trading interest rate risk primarily arises from trading activities at MUAH's broker-dealer subsidiary, MUSA, and derivative contracts MUB enters into as a financial intermediary for customers.
Market Risk Governance
The MRM Policy, adopted by the Risk Committee of the Board of Directors, governs the Company’s management and oversight of market risk. The MRM Policy establishes the Company’s risk tolerance by outlining standards for measuring market risk, creates Board-level limits for specific market risks, and establishes MRMC responsibilities and oversight of market risk activities.
ARC, composed of selected senior officers of the Company, supports the MRM Policy setting process by striving to ensure that the Company has an effective process to identify, monitor, measure and manage market risk as required by the MRM Policy. ARC provides oversight of the risk management framework and reviews and discusses market risk management reports and trends. MRMC approves the trading policies that govern the Company’s activities. ALCO is responsible for the approval of specific interest rate risk management programs, including those related to interest rate hedging, investment securities and wholesale funding of MUAH, along with approval of capital policies.
The Treasurer is primarily responsible for the implementation of interest rate risk management strategies approved by ALCO and for operational management of market risk, as defined above, through funding, investment and derivative hedging activities. The MRM unit is responsible for monitoring market risk and functions independently of all operating and management units and subsidiaries.
The Company has separate and distinct methods for managing the market risk associated with our asset and liability management activities and our trading activities, as described below.
Interest Rate Risk Management
ALCO monitors interest rate risk from ALM activities on a monthly basis through a variety of modeling techniques that are used to quantify the sensitivity of net interest income to changes in interest rates. Our net interest income sensitivity analysis typically involves a simulation in which we estimate the net interest income impact of gradual parallel shifts in the yield curve of up 200 basis points and down 100 basis points over a 12-month horizon using a forecasted balance sheet.
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Net Interest Income Sensitivity
The table below presents the estimated increase (decrease) in the Company's net interest income given a gradual parallel shift in the yield curve up 200 basis points and down 100 basis points over a 12-month horizon.
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Effect on net interest income: | ||||||||
| Increase 200 basis points | $ | 28.1 | $ | 149.7 | ||||
| as a percentage of base case net interest income | 1.04 | % | 4.59 | % | ||||
| Decrease 100 basis points | $ | (65.6 | ) | $ | (102.4 | ) | ||
| as a percentage of base case net interest income | (2.37 | )% | (3.14 | )% | ||||
An increase in rates increases net interest income. During 2019, the Company’s asset sensitive profile decreased due to changes in balance sheet composition, changes in the ALM derivatives portfolio and forecasted balance sheet activity over the next twelve months. During 2019, the Company added interest rate floors and swaps to hedge floating rate commercial loans given the possibility of declining rates, which contributed to the decrease in the Company's asset sensitivity.
MUSA's securities borrowed or purchased under resale agreements and securities loaned or sold under repurchase agreements are included in the Company's net interest income sensitivity analysis. However, due to the short-term nature of these interest-bearing assets and liabilities, the Company also monitors net interest income sensitivity excluding these balances. Excluding the impact of MUSA, the Company would have a slightly higher asset sensitive risk profile at December 31, 2019.
We believe that our simulation provides management with a comprehensive view of the sensitivity of net interest income to changes in interest rates over the measurement horizon. However, as with any financial model, the underlying assumptions are inherently uncertain and subject to refinement. In particular, two significant models used in interest rate risk measurement address residential mortgage prepayment speeds and non-maturity deposit rate and balance behaviors. The mortgage prepayment model is periodically calibrated to reflect changes in customer behavior. Model performance may be adversely affected by rapid changes in interest rates, home prices and the credit environment. The deposit model uses the Company’s historical deposit pricing to forecast future deposit pricing in its scenarios. Management’s response to future rate scenarios may deviate from historical responses and actual results may differ from those derived in the simulation analysis due to unexpected market events, unanticipated changes in customer behavior, market interest rates, product pricing, and investment, funding and hedging activities.
For additional information on the Company's securities portfolio and derivative instruments used in our ALM hedging strategies, see the "Balance Sheet Analysis—Securities" section within "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7. and Note 2 and Note 12 to our Consolidated Financial Statements included in this Form 10-K.
Trading Activities
Trading activities consist primarily of activities at MUAH's broker-dealer subsidiary, MUSA, and derivative contracts MUB enters into as a financial intermediary for customers. MUSA transacts as principal and agent for a variety of securities and exchange traded derivatives. By acting as a financial intermediary, MUB is able to provide our customers with access to a range of products from the securities, foreign exchange and derivatives markets. We generally take offsetting positions to mitigate our exposure to market risk.
The Company monitors market risk from trading activities by utilizing a combination of position limits, VaR, and stop-loss limits, applied at an aggregated level and to various sub-components within those limits. Positions are controlled and reported both in notional and VaR terms. Our calculation of VaR estimates how high the loss in fair value might be, at a 99% confidence level, due to an adverse shift in market prices over a period of ten business days. VaR at the trading activity level is managed within the maximum limit of $38 million established by Board policy for total trading positions. The VaR model incorporates assumptions on key parameters, including holding period and historical volatility.
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The following table sets forth the average, high and low 10-day 99% confidence level VaR for our trading activities for the years ended December 31, 2019 and 2018:
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||
| (Dollars in millions) | Average VaR | High VaR | Low VaR | Average VaR | High VaR | Low VaR | ||||||||||||||||||
| Interest rate | $ | 12.2 | $ | 17.6 | $ | 8.5 | $ | 12.5 | $ | 15.3 | $ | 9.1 | ||||||||||||
| Debt securities | 7.7 | 12.8 | 3.1 | 6.8 | 12.1 | 2.5 | ||||||||||||||||||
| Equity securities | 1.0 | 1.7 | 0.6 | 0.8 | 1.3 | 0.3 | ||||||||||||||||||
| Foreign exchange | 0.2 | 0.6 | 0.1 | 0.3 | 1.2 | — | ||||||||||||||||||
| Portfolio diversification | (9.4 | ) | (15.2 | ) | (4.2 | ) | (9.7 | ) | (13.1 | ) | (5.5 | ) | ||||||||||||
| Total | $ | 11.7 | $ | 17.5 | $ | 8.1 | $ | 10.7 | $ | 16.8 | $ | 6.4 | ||||||||||||
Consistent with our business strategy of focusing on the sale of capital markets products to customers, we manage our trading risk exposures at relatively low levels. Our foreign exchange business continues to derive the majority of its revenue from customer-related transactions. For additional information on the Company's trading account assets and liabilities and trading derivatives, see Note 11 and Note 12 to our Consolidated Financial Statements included in this Form 10-K.
LIBOR Transition
In July 2017, the Chief Executive of the U.K. Financial Conduct Authority, which regulates the process of setting LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. In the U.S., the Federal Reserve and Federal Reserve Bank of New York convened the Alternative Reference Rates Committee, a group of private-market participants, to help ensure a successful transition from USD LIBOR to a more robust reference rate. The Company recognizes that discontinuance of LIBOR, or any other IBOR-based rate, presents significant risks and challenges that could have an impact on its businesses globally (for information about the risks to the Company from the discontinuation of LIBOR or any other benchmark, see "The replacement of LIBOR could adversely impact our business and results of operations, and the value of certain financial instruments" in Part I, Item 1A. "Risk Factors" in this Form 10-K). We have exposure to IBORs, including in financial instruments and contracts that mature after 2021. Our exposures arise from business loans, derivatives, securities and other financial products (such as residential adjustable rate mortgages).
Accordingly, to facilitate an orderly transition from LIBOR and other benchmark rates to alternative reference rates, the Company has established a firm-wide transition program to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, develop and implement plans to remediate existing products or contracts that reference or rely upon IBORs, develop products and services that use alternative reference rates, achieve systems and operational readiness and engage impacted clients in connection with the transition to alternative reference rates. The Company’s transition program was established by senior management and periodically updates the Company's Board of Directors and ECA. The transition program focuses on:
| • | Identifying and evaluating the scope of existing financial instruments and contracts that may be affected; |
| • | Assessing the impacted financial instruments and contracts to determine if they contain or require appropriate fallback language; |
| • | Amending or otherwise developing action plans to amend existing financial instruments and contracts to incorporate robust fallback language; |
| • | Enhancing infrastructure (e.g., internal framework such as models, technology infrastructure) to prepare for a smooth transition to alternative reference rates; and |
| • | Developing financial instruments and contracts to use alternative reference rates. |
The Company has identified the inherent risks with this transition and continues to monitor the development and usage of alternative reference rates. The Company is also working with regulators, industry working groups and trade associations to develop strategies for an effective transition to alternative reference rates.
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Liquidity Risk Management
Liquidity risk is the risk that an institution's financial condition or overall safety and soundness is adversely affected by an inability, or perceived inability, to meet its contractual, including contingent, obligations. The objective of liquidity risk management is to maintain a sufficient amount of liquidity and diversity of funding sources to allow an institution to meet obligations in both stable and adverse conditions.
The management of liquidity risk is governed by MUAH ALM and Liquidity Risk Management Policies. The MUAH ALM Policy is under the oversight of ALCO, which oversees first line liquidity risk management activities conducted by Treasury. Treasury formulates the funding, liquidity and contingency planning strategies for the Company, the Bank and MUSA, and is responsible for identifying, managing and reporting on liquidity risk. The Liquidity Risk Management Policies for the Company, the Bank and MUSA are under the oversight of the ARC and the Risk Committee of the Board. MRM conducts independent oversight and governance of liquidity risk management activities to establish sound policies and effective risk and independent monitoring controls. We are also subject to a Contingency Funding Plan framework that identifies actions to be taken to help ensure adequate liquidity if an event should occur that disrupts or adversely affects the normal funding activities of the Company, the Bank or MUSA.
Liquidity risk is managed using a total balance sheet perspective that analyzes all sources and uses of liquidity including loans, investments, deposits and borrowings, as well as off-balance sheet exposures. Although we make an effort to diversify our sources of liquidity, as discussed below, we are required to maintain a minimum amount of TLAC-eligible debt due to affiliates beginning January 1, 2019. Various tools are used to measure and monitor liquidity, including forecasting of the sources and uses of cash flows over multiple time horizons and stress testing of the forecasts under various scenarios. Stress testing, which incorporates both institution-specific, and systemic market scenarios, as well as a combination scenario that adversely affects the Company's liquidity position and profile, facilitates the identification of appropriate remedial measures to help ensure that the Company maintains adequate liquidity in adverse conditions. Such measures may include extending the maturity profile of liabilities, optimizing liability levels through pricing strategies, adding new funding sources, altering dependency on certain funding sources, adjusting asset growth and financing or selling assets.
We are subject to the Federal Reserve's rules imposing TLAC requirements on GSIBs with operations in the U.S., such as MUFG. These rules include an Internal TLAC requirement which sets a minimum amount of loss-absorbing instruments, which must be issued by the Company to MUFG or MUFG Bank, Ltd. (or another wholly-owned non-U.S. subsidiary of MUFG) due to MUFG's single point of entry resolution approach. These loss absorbing instruments are comprised of Tier 1 regulatory capital and long-term debt. TLAC Tier 1 regulatory capital is designed to absorb ongoing losses, while the conversion of TLAC-eligible long-term debt into common equity of the Company is intended to recapitalize the Company prior to any bankruptcy or insolvency proceedings. During the fourth quarter of 2018, the Company restructured existing debt issued to MUFG Bank, Ltd. and replaced a portion of its externally-placed debt with the issuance of internal TLAC-eligible debt issued to MUFG Bank, Ltd. in order to comply with the new rules. See "Supervision and Regulation - Dodd-Frank Act and Related Regulations" in Part I, Item 1. "Business" in this Form 10-K.
We maintain a substantial level of available liquidity in the form of on-balance sheet and off-balance sheet funding sources. Sources of liquidity include cash at the Federal Reserve, unencumbered liquid securities, and capacity to borrow on a secured basis at the FHLB of San Francisco and the Federal Reserve Bank’s Discount Window. Total unpledged securities were $25.0 billion at December 31, 2019. Our primary funding sources are customer deposits, secured FHLB advances, and unsecured short-term and long-term debt. Total deposits increased $4.9 billion from $91.0 billion at December 31, 2018 to $95.9 billion at December 31, 2019. As of December 31, 2019, the Bank had $12.7 billion of borrowings outstanding with the FHLB of San Francisco, and the Bank had a remaining unused borrowing capacity from the FHLB of San Francisco of $21.9 billion. The Bank maintains a $12 billion unsecured bank note program. Available funding under the bank note program was $3.6 billion at December 31, 2019. We do not have any firm commitments in place to sell additional notes under this program.
In addition to managing liquidity risk on a consolidated basis and at each of the major subsidiaries (the Bank and MUSA), we assess and monitor liquidity at MUAH and other non-bank subsidiaries. MUAH maintains
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sufficient liquidity to meet expected obligations, without access to the wholesale funding markets or dividends from subsidiaries, for at least 18 months. As of December 31, 2019, the parent company’s liquidity exceeded 18 months.
MUAH and its subsidiaries may borrow on a long-term basis from MUFG Bank, Ltd. and affiliates. As of December 31, 2019, the Company had total long-term debt issued to MUFG Bank, Ltd. and affiliates of $7.3 billion.
The Company’s total wholesale funding at December 31, 2019 included $16.9 billion of long-term debt (excluding nonrecourse debt) and $6.5 billion of short-term debt. For additional information regarding our outstanding debt, see Note 9 and Note 10 to our Consolidated Financial Statements included in this Form 10-K. We evaluate and monitor the stability and reliability of our various funding sources to help ensure that we have sufficient liquidity in adverse circumstances.
Our costs and ability to raise funds in the capital markets are influenced by our credit ratings. The following table provides our credit ratings as of December 31, 2019:
| MUFG Union Bank, N.A. | MUFG Securities Americas Inc. | MUFG Americas Holdings Corporation | ||||||
| Deposits | Senior Debt | Senior Debt | Senior Debt | |||||
| Standard & Poor's | Long-term | Not rated | A | A | A- | |||
| Short-term | Not Rated | A-1 | A-1 | A-2 | ||||
| Moody's | Long-term | Aa2 | A2 | Not rated | A2 | |||
| Short-term | P-1 | P-1 | Not rated | Not rated | ||||
| Fitch | Long-term | A+ | A | A | A | |||
| Short-term | F1 | F1 | F1 | F1 | ||||
For further information, including information about rating agency assessments, see "MUFG Bank, Ltd.'s and Mitsubishi UFJ Financial Group's credit ratings and financial or regulatory condition could adversely affect our operations" and "Our credit ratings are important in order to maintain liquidity" in Part I, Item 1A. "Risk Factors" in this Form 10-K.
Operational Risk Management
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. Operational risk includes legal risk, but excludes strategic and reputation risk. In particular, information security is a significant operational risk element for the Company and includes the risk of losses resulting from cyber-attacks or other related cyber incidents. See "We are subject to a wide array of operational risks including, but not limited to, cyber-security risks" in Part I, Item 1A. "Risk Factors" in this Form 10-K. Operational risk is mitigated through a system of internal controls that are designed to keep these risks at appropriate levels.
Our operational risk management framework was designed to meet industry and regulatory standards. The Operational Risk Management Policies and Procedures establish the core governing principles for operational risk management and provide the framework to identify, assess, measure, manage, monitor, and report on operational risks in a consistent manner across the enterprise.
The Company has established an independent ORMD under the CRO. The operational risk framework provides requirements for the business lines to better manage their operational risk. ORMD and the operational risk management framework are overseen by the Operational Risk Management Committee.
Operational risk is managed through a combination of first and second line of defense functions. The first line of defense is comprised of business line management supported by business unit risk managers. ORMD provides oversight, guidance, tools and support to the business units in assessing and monitoring their operational risk, as well as validation and effective challenge of their operational risk assessments. Specifically, ORMD evaluates and challenges the risk and control self-assessments prepared by the business units and assures their operational risk profiles are within established guidelines and tolerances. ORMD is supported for specific
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categories of operational risk by second line of defense subject matter experts. In addition, ORMD monitors business units to ensure mitigating activities are identified where needed and appropriately addressed.
Critical Accounting Estimates
MUAH's Consolidated Financial Statements are prepared in accordance with GAAP, which includes management estimates and judgments. The financial information contained within our statements is, to a significant extent, financial information that is based on estimates used to measure 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. As discussed in "Allowance for Credit Losses" in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K, we estimate probability of default and the loss severity associated with the default (i.e. the loss-given default) to estimate the credit losses inherent in our loan and lease portfolios held for investment and certain off-balance sheet commitments on the balance sheet date. Actual losses could differ significantly from our loss estimates. Other significant estimates that we use include the assumptions used in measuring our transfer pricing revenue, assumptions used in evaluating our goodwill for impairment, and assumptions regarding our effective tax rates.
Management has reviewed and approved these critical accounting policies and has discussed these policies with the Audit & Finance Committee.
Understanding our accounting policies is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly, both our critical accounting estimates and our significant accounting policies are discussed in Note 1 to our Consolidated Financial Statements included in this Form 10-K. Our most critical accounting policies include the allowance for credit losses, transfer pricing revenue, goodwill impairment analysis and income taxes.
Allowance for Credit Losses
The allowance for credit losses, which consists of the allowances for loan losses and losses on unfunded credit commitments, is an estimate of the losses that are inherent in our loan portfolio as well as for certain unfunded credit commitments such as unfunded loan commitments, standby letters of credit, and commercial lines of credit that are not for sale. Our allowance for credit losses has four components: the allowance for loans collectively evaluated for impairment, the allowance for loans individually evaluated for impairment, the unallocated allowance, and the allowance for losses on unfunded credit commitments which is included in other liabilities. Each of these components is determined based upon estimates that are inherently subjective and our actual losses incurred could differ significantly from those estimates. For the commercial portfolio segment, the allowance for loans collectively evaluated for impairment is calculated by utilizing a dual factor internal risk rating system that encompasses both the probability that a credit facility may ultimately default (i.e. probability of default) and an estimate of the severity of the loss that would be realized upon such default (i.e. the loss-given default) and applying these risk ratings to outstanding loans and most unused commitments. The probability of default and loss-given default may be adjusted for qualitative or environmental factors that, in management's judgment, are likely to cause estimated credit losses associated with the existing portfolio to differ from the historical probability of default and loss-given default. For loans that are homogeneous in nature, such as in our consumer portfolio segment, we estimate the allowance based on forecasted losses based on incurred loss events. The allowance for loans collectively evaluated for impairment also includes attributions for certain sectors within the commercial and consumer portfolio segments to account for probable losses that are currently not reflected in the probability of default and loss-given default. Segment attributions are calculated based on migration scenarios for the commercial portfolio and specific attributes applicable to the consumer portfolio. The unallocated allowance is composed of attributions that are intended to capture probable losses from adverse changes in credit migration and other inherent losses that are not currently reflected in the allowance for loan losses that are ascribed to our portfolio segments. Our allowance for losses on unfunded credit commitments is measured in approximately the same manner as the allowance for loan losses but includes an estimate of expected utilization based upon historical data. For further information regarding our allowance for loan losses, see "Allowance for Loan Losses" in Note 1 and Note 3 to our Consolidated Financial Statements in this Form 10-K.
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Transfer Pricing
Employees of the Company perform management and support services to MUFG Bank, Ltd. in connection with the operation and administration of MUFG Bank, Ltd.’s businesses in the Americas. In consideration for the services provided, MUFG Bank, Ltd. pays the Company fees under a master services agreement, which reflects arm's length market-based pricing for those services. The Company recognizes transfer pricing revenue when delivery (performance) has occurred or services have been rendered. Management applies a facts and circumstances evaluation to determine the most appropriate method to calculate an arm's length market-based price for services performed by the Company for MUFG Bank, Ltd. and other non-consolidated MUFG affiliates.
Goodwill Impairment Analysis
We allocate our goodwill to reporting units and review for impairment at least annually, and whenever events or changes in circumstances indicate the carrying amount may not be recoverable. Goodwill is assessed for impairment at the reporting unit level either qualitatively or quantitatively. If the elected qualitative assessment results indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative impairment test is required. Various valuation methodologies are applied to carry out the first step of the quantitative impairment test by comparing the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is less than its carrying amount, a second step is required to measure the amount of impairment by comparing the implied fair value of the goodwill assigned to the reporting unit with the carrying amount of that goodwill.
Management applies significant judgment when estimating the fair value of its reporting units. This judgment includes developing cash flow projections, selecting appropriate discount rates, incorporating general economic and market conditions, identifying relevant market comparables, and selecting an appropriate control premium. Imprecision in estimating these factors can affect the estimated fair value of the reporting units.
The Company continuously monitors inputs used when performing its annual goodwill impairment such as the cash flow projections developed to estimate the fair value of its reporting units. When a disruption in the Company’s business, unexpected significant declines in operating results, or significant trends become apparent that may negatively affect those projections, the Company may have to assess the need to perform the first step of the quantitative impairment test to conclude whether the fair value of the reporting unit is still above its carrying amount. During the third quarter of 2019, due to the decline in interest rates and slower growth than previously forecasted, cash flow projections for certain reporting units were revised lower and the Company initiated an interim quantitative impairment test of goodwill allocated to three of its reporting units. See "Goodwill Impairment" in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K for additional information.
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Income Taxes
MUAH and its subsidiaries are subject to the income tax laws of the U.S., its states, and municipalities and laws of the other jurisdictions in which we conduct business. Our income tax expense consists of two components; current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period and includes income tax expense for our uncertain tax positions. Uncertain tax positions that meet the "more likely than not" recognition threshold are measured to determine the amount of benefit to recognize. Positions are measured as the largest amount of benefit that management believes has a greater than 50% likelihood of realization upon settlement. Deferred income tax expense results from changes in deferred income tax assets and liabilities between periods, where the deferred tax assets and liabilities are based on the tax effects of the differences between the financial accounting and tax basis of assets and liabilities. Deferred tax assets are recognized subject to management's judgment that realization is "more likely than not" based upon all available positive and negative evidence. Foreign taxes paid are generally applied as a credit to reduce income taxes payable.
The income tax laws of the jurisdictions in which we operate are complex and subject to differing interpretations. In establishing a provision for income tax expense, we make judgments and interpretations about the application of these complex laws and the result is by its nature an estimate. We are routinely subject to audits from tax authorities. To the extent the tax authorities disagree with our conclusions and depending on the final resolution of those disagreements, our effective tax rate may be materially affected in the period of final settlement. We also make estimates about when future certain items will affect taxable income in the jurisdictions in which we conduct business.
We currently have a valid water’s-edge election to include the U.S. operations of MUFG with MUAH and its subsidiaries’ in our combined California tax return. We analyze the alternative California worldwide tax liability annually to determine whether to revoke or retain this voluntary tax election. As a water’s-edge filer, the taxable profits of MUFG’s U.S. operations impact our state effective tax rate. Some affiliates included in our California tax return are fiscal year taxpayers. The inclusion of calendar and fiscal year taxpayers in the same combined return impacts the timing of financial data used in determining our state tax rates. We review MUFG’s U.S. operations quarterly to determine the appropriate rate at which to recognize our California and other state tax expense.
For further information on our income taxes, see Note 17 to our Consolidated Financial Statements included in this Form 10-K.
Non-GAAP Financial Measures
The following table presents a reconciliation between certain GAAP amounts and specific non-GAAP measures used to calculate return on average MUAH tangible common equity for the years ended December 31, 2019, 2018 and 2017. Management believes that this ratio provides useful supplemental information regarding the Company's business results.
| For the Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Net income attributable to MUAH | $ | (734 | ) | $ | 1,073 | $ | 1,077 | |||||
| Add: Intangible asset amortization, net of tax | 25 | 19 | 18 | |||||||||
| Add: Goodwill impairment, net of tax | 1,568 | — | — | |||||||||
| Net income attributable to MUAH, excluding intangible asset amortization and goodwill impairment (a) | $ | 859 | $ | 1,092 | $ | 1,095 | ||||||
| Average MUAH stockholders' equity | $ | 16,866 | $ | 18,400 | $ | 17,926 | ||||||
| Less: Goodwill | 2,963 | 3,301 | 3,263 | |||||||||
| Less: Intangible assets, except mortgage servicing rights | 279 | 299 | 269 | |||||||||
| Less: Deferred tax liabilities related to goodwill and intangible assets | (43 | ) | (57 | ) | (72 | ) | ||||||
| Average MUAH tangible common equity (b) | $ | 13,667 | $ | 14,857 | $ | 14,466 | ||||||
Return on average MUAH tangible common equity (a)/(b) | 6.29 | % | 7.35 | % | 7.57 | % | ||||||
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The following table shows the calculation of the adjusted efficiency ratio for the years ended December 31, 2019 and 2018. Management believes adjusting the efficiency ratio for the fees and costs associated with services provided to MUFG Bank, Ltd. branches in the U.S. enhances the comparability of MUAH's efficiency ratio when compared with other financial institutions. Management believes adjusting noninterest expense for the impact of goodwill impairment and revenue for the impact of the TCJA enhances comparability between periods. The adjusted efficiency ratio for the year ended December 31, 2017 is not presented because the Company began identifying all costs associated with services provided to MUFG Bank, Ltd. branches in the U.S. in the third quarter of 2017. Previously, the Company was only able to identify a portion of the costs associated with services provided to MUFG Bank, Ltd. branches in the U.S.
| For the Years Ended December 31, | ||||||||
| (Dollars in millions) | 2019 | 2018 | ||||||
| Noninterest expense (a) | $ | 6,215 | $ | 4,277 | ||||
| Less: Costs associated with services provided to MUFG Bank, Ltd. branches in the U.S. | 1,295 | 1,001 | ||||||
| Less: Goodwill impairment | 1,614 | — | ||||||
| Noninterest expense, as adjusted (b) | $ | 3,306 | $ | 3,276 | ||||
| Total revenue (c) | $ | 5,798 | $ | 5,484 | ||||
| Less: Fees from affiliates for services provided to MUFG Bank, Ltd.'s branches in the U.S. | 1,373 | 1,128 | ||||||
| Less: Impact of the TCJA | — | (164 | ) | |||||
| Total revenue, as adjusted (d) | $ | 4,425 | $ | 4,520 | ||||
| Efficiency ratio (a)/(c) | 107.18 | % | 77.98 | % | ||||
Adjusted efficiency ratio (b)/(d) | 74.69 | % | 72.47 | % | ||||
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Financial Statements and Supplementary Data
MUFG Americas Holdings Corporation and Subsidiaries
Consolidated Statements of Income
| For the Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Interest Income | ||||||||||||
| Loans | $ | 3,625 | $ | 3,303 | $ | 2,892 | ||||||
| Securities | 619 | 665 | 564 | |||||||||
| Securities borrowed or purchased under resale agreements | 765 | 652 | 347 | |||||||||
| Trading assets | 360 | 415 | 326 | |||||||||
| Other | 180 | 90 | 50 | |||||||||
| Total interest income | 5,549 | 5,125 | 4,179 | |||||||||
| Interest Expense | ||||||||||||
| Deposits | 826 | 441 | 241 | |||||||||
| Commercial paper and other short-term borrowings | 202 | 168 | 58 | |||||||||
| Long-term debt | 497 | 365 | 250 | |||||||||
| Securities loaned or sold under repurchase agreements | 830 | 734 | 353 | |||||||||
| Trading liabilities | 101 | 110 | 73 | |||||||||
| Total interest expense | 2,456 | 1,818 | 975 | |||||||||
| Net Interest Income | 3,093 | 3,307 | 3,204 | |||||||||
| (Reversal of) provision for credit losses | 252 | 106 | (103 | ) | ||||||||
| Net interest income after (reversal of) provision for credit losses | 2,841 | 3,201 | 3,307 | |||||||||
| Noninterest Income | ||||||||||||
| Service charges on deposit accounts | 166 | 179 | 188 | |||||||||
| Trust and investment management fees | 117 | 118 | 121 | |||||||||
| Trading account activities | 70 | (24 | ) | (5 | ) | |||||||
| Securities gains, net | 39 | 8 | 17 | |||||||||
| Credit facility fees | 98 | 90 | 98 | |||||||||
| Brokerage commissions and fees | 74 | 73 | 69 | |||||||||
| Card processing fees, net | 56 | 50 | 47 | |||||||||
| Investment banking and syndication fees | 433 | 355 | 369 | |||||||||
| Fees from affiliates | 1,439 | 1,213 | 866 | |||||||||
| Other, net | 213 | 115 | 240 | |||||||||
| Total noninterest income | 2,705 | 2,177 | 2,010 | |||||||||
| Noninterest Expense | ||||||||||||
| Salaries and employee benefits | 2,687 | 2,616 | 2,495 | |||||||||
| Net occupancy and equipment | 431 | 367 | 357 | |||||||||
| Professional and outside services | 651 | 487 | 439 | |||||||||
| Software | 313 | 287 | 192 | |||||||||
| Regulatory assessments | 63 | 85 | 82 | |||||||||
| Intangible asset amortization | 34 | 26 | 30 | |||||||||
| Goodwill impairment | 1,614 | — | — | |||||||||
| Other | 422 | 409 | 389 | |||||||||
| Total noninterest expense | 6,215 | 4,277 | 3,984 | |||||||||
| Income before income taxes and including noncontrolling interests | (669 | ) | 1,101 | 1,333 | ||||||||
| Income tax expense (benefit) | 82 | 52 | 299 | |||||||||
| Net (Loss) Income Including Noncontrolling Interests | (751 | ) | 1,049 | 1,034 | ||||||||
| Deduct: Net loss (income) from noncontrolling interests | 17 | 24 | 43 | |||||||||
| Net (Loss) Income Attributable to MUAH | $ | (734 | ) | $ | 1,073 | $ | 1,077 | |||||
See accompanying Notes to Consolidated Financial Statements.
76
MUFG Americas Holdings Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Net (Loss) Income Attributable to MUAH | $ | (734 | ) | $ | 1,073 | $ | 1,077 | |||||
| Other Comprehensive Income (Loss), Net of Tax: | ||||||||||||
| Net change in unrealized gains (losses) on cash flow hedges | 105 | (46 | ) | (66 | ) | |||||||
| Net change in unrealized gains (losses) on investment securities | 280 | (140 | ) | 16 | ||||||||
| Foreign currency translation adjustment | — | (2 | ) | 7 | ||||||||
| Pension and other postretirement benefit adjustments | 76 | (130 | ) | 95 | ||||||||
| Other | 1 | (1 | ) | — | ||||||||
| Total other comprehensive income (loss) | 462 | (319 | ) | 52 | ||||||||
| Comprehensive Income (Loss) Attributable to MUAH | (272 | ) | 754 | 1,129 | ||||||||
| Comprehensive income (loss) from noncontrolling interests | (17 | ) | (24 | ) | (43 | ) | ||||||
| Total Comprehensive Income (Loss) | $ | (289 | ) | $ | 730 | $ | 1,086 | |||||
See accompanying Notes to Consolidated Financial Statements.
77
MUFG Americas Holdings Corporation and Subsidiaries
Consolidated Balance Sheets
| (Dollars in millions except per share amount) | December 31, 2019 | December 31, 2018 | ||||||
| Assets | ||||||||
| Cash and due from banks | $ | 2,457 | $ | 2,061 | ||||
| Interest bearing deposits in banks | 7,184 | 6,289 | ||||||
| Total cash and cash equivalents | 9,641 | 8,350 | ||||||
| Securities borrowed or purchased under resale agreements | 23,943 | 22,368 | ||||||
| Trading account assets (includes $887 at December 31, 2019 and $1,239 at December 31, 2018 pledged as collateral that may be repledged) | 10,377 | 11,213 | ||||||
| Securities available for sale (includes $142 at December 31, 2019 and $75 at December 31, 2018 pledged as collateral that may be repledged) | 17,789 | 16,314 | ||||||
| Securities held to maturity (fair value $9,508 at December 31, 2019 and $10,720 at December 31, 2018) | 9,421 | 10,901 | ||||||
| Loans held for investment | 88,213 | 86,507 | ||||||
| Allowance for loan losses | (538 | ) | (474 | ) | ||||
| Loans held for investment, net | 87,675 | 86,033 | ||||||
| Goodwill | 1,764 | 3,301 | ||||||
| Other assets | 10,200 | 9,620 | ||||||
| Total assets | $ | 170,810 | $ | 168,100 | ||||
| Liabilities | ||||||||
| Deposits: | ||||||||
| Noninterest bearing | $ | 31,521 | $ | 31,754 | ||||
| Interest bearing | 64,340 | 59,225 | ||||||
| Total deposits | 95,861 | 90,979 | ||||||
| Securities loaned or sold under repurchase agreements | 28,866 | 27,285 | ||||||
| Commercial paper and other short-term borrowings | 6,484 | 9,263 | ||||||
| Long-term debt | 17,129 | 17,918 | ||||||
| Trading account liabilities | 3,266 | 4,027 | ||||||
| Other liabilities | 2,837 | 2,048 | ||||||
| Total liabilities | 154,443 | 151,520 | ||||||
| Commitments, contingencies and guarantees—See Note 20 | ||||||||
| Equity | ||||||||
| MUAH stockholders' equity: | ||||||||
| Preferred stock: | ||||||||
| Authorized 5,000,000 shares; no shares issued or outstanding | — | — | ||||||
| Common stock, par value $1 per share: | ||||||||
| Authorized 1,700,000,000 shares, 132,076,912 and 131,935,124 shares issued and outstanding at December 31, 2019 and December 31, 2018, respectively | 132 | 132 | ||||||
| Additional paid-in capital | 8,222 | 8,176 | ||||||
| Retained earnings | 8,788 | 9,524 | ||||||
| Accumulated other comprehensive loss | (862 | ) | (1,324 | ) | ||||
| Total MUAH stockholders' equity | 16,280 | 16,508 | ||||||
| Noncontrolling interests | 87 | 72 | ||||||
| Total equity | 16,367 | 16,580 | ||||||
| Total liabilities and equity | $ | 170,810 | $ | 168,100 | ||||
See accompanying Notes to Consolidated Financial Statements.
78
MUFG Americas Holdings Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
| MUAH Stockholders' Equity | ||||||||||||||||||||||||||
| (Dollars in millions) | Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Noncontrolling Interests | Total Equity | ||||||||||||||||||||
| BALANCE DECEMBER 31, 2016 | $ | 144 | $ | 7,884 | $ | 10,101 | $ | (896 | ) | $ | 153 | $ | 17,386 | |||||||||||||
| Net income (loss) | — | — | 1,077 | — | (43 | ) | 1,034 | |||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | 52 | — | 52 | ||||||||||||||||||||
| Compensation—restricted stock units | — | (8 | ) | (2 | ) | — | — | (10 | ) | |||||||||||||||||
| Issuance of Common Stock | 3 | 321 | 78 | — | — | 402 | ||||||||||||||||||||
| Dividends | — | — | — | — | (500 | ) | — | — | (500 | ) | ||||||||||||||||
| TCJA Reclassification | — | — | 182 | (182 | ) | — | — | |||||||||||||||||||
| Other | 1 | — | — | — | (10 | ) | (9 | ) | ||||||||||||||||||
| Net change | 4 | 313 | 835 | (130 | ) | (53 | ) | 969 | ||||||||||||||||||
| BALANCE DECEMBER 31, 2017 | $ | 148 | $ | 8,197 | $ | 10,936 | $ | (1,026 | ) | $ | 100 | $ | 18,355 | |||||||||||||
| Net income (loss) | — | — | 1,073 | — | (24 | ) | 1,049 | |||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | (319 | ) | — | (319 | ) | ||||||||||||||||||
| Compensation—restricted stock units | — | — | (5 | ) | — | — | (5 | ) | ||||||||||||||||||
| Share Repurchase | (16 | ) | — | (2,480 | ) | — | — | (2,496 | ) | |||||||||||||||||
Other(1) | — | (21 | ) | — | 21 | (4 | ) | (4 | ) | |||||||||||||||||
| Net change | (16 | ) | (21 | ) | (1,412 | ) | (298 | ) | (28 | ) | (1,775 | ) | ||||||||||||||
| BALANCE DECEMBER 31, 2018 | $ | 132 | $ | 8,176 | $ | 9,524 | $ | (1,324 | ) | $ | 72 | $ | 16,580 | |||||||||||||
| Net income (loss) | — | — | (734 | ) | — | (17 | ) | (751 | ) | |||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | 462 | — | 462 | ||||||||||||||||||||
| Compensation—restricted stock units | — | 26 | (7 | ) | — | — | 19 | |||||||||||||||||||
Other(2) | — | 20 | 5 | — | 32 | 57 | ||||||||||||||||||||
| Net change | — | 46 | (736 | ) | 462 | 15 | (213 | ) | ||||||||||||||||||
| BALANCE DECEMBER 31, 2019 | $ | 132 | $ | 8,222 | $ | 8,788 | $ | (862 | ) | $ | 87 | $ | 16,367 | |||||||||||||
| (1) | For additional information on other, see Note 13 "Accumulated Other Comprehensive Income" to these Consolidated Financial Statements. |
| (2) | Additional paid-in capital related to the issuance of 141,788 shares of common stock to MUFG in exchange for its contribution of its ownership interest in First State Investments (US) LLC. |
See accompanying Notes to Consolidated Financial Statements.
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MUFG Americas Holdings Corporation and Subsidiaries
Consolidated Statements of Cash Flows
| For the Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Cash Flows from Operating Activities: | ||||||||||||
| Net (loss) income including noncontrolling interests | $ | (751 | ) | $ | 1,049 | $ | 1,034 | |||||
| Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: | ||||||||||||
| (Reversal of) provision for credit losses | 252 | 106 | (103 | ) | ||||||||
| Depreciation, amortization and accretion, net | 563 | 411 | 331 | |||||||||
| Stock-based compensation—restricted stock units | 89 | 77 | 66 | |||||||||
| Deferred income taxes | (264 | ) | (242 | ) | 25 | |||||||
| Net gains on sales of securities | (39 | ) | (8 | ) | (17 | ) | ||||||
| Net decrease (increase) in securities borrowed or purchased under resale agreements | (1,575 | ) | (1,474 | ) | (1,147 | ) | ||||||
| Net decrease (increase) in securities loaned or sold under repurchase agreements | 1,581 | 848 | 1,821 | |||||||||
| Net decrease (increase) in trading account assets | 836 | (646 | ) | (1,625 | ) | |||||||
| Net decrease (increase) in other assets | 216 | 170 | 414 | |||||||||
| Net increase (decrease) in trading account liabilities | (761 | ) | 427 | 695 | ||||||||
| Net increase (decrease) in other liabilities | 219 | 103 | (137 | ) | ||||||||
| Loans originated for sale | (3,238 | ) | (2,339 | ) | (813 | ) | ||||||
| Net proceeds from sale of loans originated for sale | 2,944 | 1,626 | 697 | |||||||||
| Pension and other benefits adjustment | (42 | ) | (50 | ) | (169 | ) | ||||||
| Goodwill impairment | 1,614 | — | — | |||||||||
| Other, net | 59 | (18 | ) | 11 | ||||||||
| Total adjustments | 2,454 | (1,009 | ) | 49 | ||||||||
| Net cash provided by (used in) operating activities | 1,703 | 40 | 1,083 | |||||||||
| Cash Flows from Investing Activities: | ||||||||||||
| Proceeds from sales of securities available for sale | 4,637 | 1,505 | 2,460 | |||||||||
| Proceeds from paydowns and maturities of securities available for sale | 2,566 | 2,822 | 2,809 | |||||||||
| Purchases of securities available for sale | (7,839 | ) | (5,643 | ) | (8,912 | ) | ||||||
| Proceeds from paydowns and maturities of securities held to maturity | 4,454 | 1,682 | 1,782 | |||||||||
| Purchases of securities held to maturity | (3,153 | ) | (772 | ) | (1,360 | ) | ||||||
| Proceeds from sales of loans | 952 | 770 | 926 | |||||||||
| Net decrease (increase) in loans | (2,831 | ) | (6,785 | ) | (2,947 | ) | ||||||
| Purchases of other investments | (143 | ) | (262 | ) | (378 | ) | ||||||
| Other, net | (314 | ) | (57 | ) | (60 | ) | ||||||
| Net cash provided by (used in) investing activities | (1,671 | ) | (6,740 | ) | (5,680 | ) | ||||||
| Cash Flows from Financing Activities: | ||||||||||||
| Net increase (decrease) in deposits | 4,880 | 6,184 | (2,063 | ) | ||||||||
| Net increase (decrease) in commercial paper and other short-term borrowings | (2,778 | ) | 2,198 | 4,709 | ||||||||
| Proceeds from issuance of long-term debt | 5,698 | 15,458 | 5,027 | |||||||||
| Repayment of long-term debt | (6,471 | ) | (9,655 | ) | (4,801 | ) | ||||||
| Dividends paid | — | — | (500 | ) | ||||||||
| Share repurchase | — | (2,496 | ) | — | ||||||||
| Other, net | (96 | ) | (115 | ) | (71 | ) | ||||||
| Change in noncontrolling interests | 32 | (4 | ) | (10 | ) | |||||||
| Net cash provided by (used in) financing activities | 1,265 | 11,570 | 2,291 | |||||||||
| Net change in cash, cash equivalents and restricted cash | 1,297 | 4,870 | (2,306 | ) | ||||||||
| Cash, cash equivalents and restricted cash at beginning of period | 8,398 | 3,528 | 5,834 | |||||||||
| Cash, cash equivalents and restricted cash at end of period | $ | 9,695 | $ | 8,398 | $ | 3,528 | ||||||
| Cash Paid During the Period For: | ||||||||||||
| Interest | $ | 2,417 | $ | 1,761 | $ | 919 | ||||||
| Income taxes, net | 202 | 116 | 178 | |||||||||
| Supplemental Schedule of Noncash Investing and Financing Activities: | ||||||||||||
| Net transfer of loans held for investment to (from) loans held for sale | $ | 718 | $ | 44 | $ | 776 | ||||||
| Securities held to maturity transferred to securities available for sale | 170 | — | — | |||||||||
| Securities available for sale transferred to securities held to maturity | — | 2,006 | — | |||||||||
Transfer of assets and liabilities from MUFG Bank, Ltd. and MUFG (1): | ||||||||||||
| Carrying amount of assets acquired | — | — | 1,003 | |||||||||
| Carrying amount of liabilities assumed | — | — | 601 | |||||||||
| Reconciliation of Cash, Cash Equivalents and Restricted Cash: | ||||||||||||
| Cash and cash equivalents | $ | 9,641 | $ | 8,350 | $ | 3,392 | ||||||
| Restricted cash included in other assets | 54 | 48 | 136 | |||||||||
| Total cash, cash equivalents and restricted cash per consolidated statement of cash flows | $ | 9,695 | $ | 8,398 | $ | 3,528 | ||||||
| (1) | For additional information on the transfer of assets and liabilities from MUFG Bank, Ltd., refer to Note 21 to these Consolidated Financial Statements. |
See accompanying Notes to Consolidated Financial Statements.
80
Notes to Consolidated Financial Statements
Note 1—Summary of Significant Accounting Policies and Nature of Operations
Introduction
MUFG Americas Holdings Corporation (MUAH) is a financial holding company, bank holding company and intermediate holding company whose principal subsidiaries are MUFG Union Bank, N.A. (MUB or the Bank) and MUFG Securities Americas Inc. (MUSA). MUAH is owned by MUFG Bank, Ltd. and MUFG. MUFG Bank, Ltd. is a wholly-owned subsidiary of MUFG. As used in these Consolidated Financial Statements, terms such as "the Company," "we," "us" and "our" refer to MUFG Americas Holdings Corporation (MUAH), one or more of its consolidated subsidiaries, or to all of them together.
MUAH provides a wide range of financial services to consumers, small businesses, middle-market companies and major corporations nationally and internationally. The Company also provides various business, banking, financial, administrative and support services, and facilities for MUFG Bank, Ltd. (formerly The Bank of Tokyo-Mitsubishi UFJ, Ltd.) in connection with the operation and administration of MUFG Bank, Ltd.'s business in the U.S. (including MUFG Bank, Ltd.'s U.S. branches).
Principles of Consolidation and Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of the Company and other entities in which the Company has a controlling financial interest. The Company determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a VIE. The primary beneficiary of a VIE is the entity that has the power to direct the activities of the VIE that most significantly impact the VIE's economic performance and has the obligation to absorb losses or receive benefits from the VIE that could potentially be significant to the VIE. Results of operations from VIEs are included from the dates that the Company became the primary beneficiary. All intercompany transactions and balances with consolidated entities are eliminated in consolidation.
The Company accounts for equity investments over which it exerts significant influence using the equity method of accounting. Non-marketable equity investments where the Company does not exert significant influence are accounted for at cost or using the proportional amortization method. Investments accounted for under the equity method, proportional amortization method, and cost method are included in other assets.
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (GAAP). The policies that materially affect the determination of financial position, results of operations and cash flows are summarized below.
The preparation of financial statements in conformity with GAAP also requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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. Although such estimates contemplate current conditions and management's expectations of how they may change in the future, it is reasonably possible that actual results could differ significantly from those estimates. This could materially affect the Company's results of operations and financial condition in the near term. Critical estimates made by management in the preparation of the Company's financial statements include, but are not limited to, the allowance for credit losses (Note 3 "Loans and Allowance for Loan Losses"), goodwill impairment (Note 5 "Goodwill and Other Intangible Assets"), income taxes (Note 17 "Income Taxes"), and transfer pricing (Note 21 "Related Party Transactions").
Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, interest bearing deposits in banks, and federal funds sold.
Securities Borrowed or Purchased under Agreements to Resell and Securities Loaned or Sold under Agreements to Repurchase
Securities borrowed and securities loaned transactions do not qualify for sale accounting and therefore are not recognized on the transferee's balance sheet. Securities borrowed and securities loaned represent the amount of cash collateral advanced or received, respectively. The Company monitors the market value of the
81
Note 1—Summary of Significant Accounting Policies and Nature of Operations (Continued)
borrowed and loaned securities on a daily basis, with additional collateral obtained or refunded as necessary. Accrued interest associated with securities borrowed and securities loaned is included in other assets and other liabilities, respectively. Interest associated with securities borrowed and securities loaned is recorded as interest income and interest expense, respectively.
Securities purchased under agreements to resell (“reverse repurchase agreements”) and securities sold under agreements to repurchase (“repurchase agreements”) do not qualify for sale accounting and therefore are not recognized on the transferee's balance sheet. Transactions involving these agreements are accounted for as collateralized financings. These agreements are recorded at the amounts at which the securities were acquired or sold and are carried at amortized cost. The Company generally obtains possession of collateral with a market value equal to or in excess of the principal amount financed under reverse repurchase agreements. Collateral is valued daily, and the Company may require counterparties to deposit additional collateral or return collateral pledged, when appropriate. Accrued interest associated with reverse repurchase agreements and repurchase agreements is included in other assets and other liabilities, respectively. Interest associated with reverse repurchase agreements and repurchase agreements is recorded as interest income and interest expense, respectively. The Company generally enters into reverse repurchase and repurchase agreements under legally enforceable master repurchase agreements that give the Company, in the event of counterparty default, the right to liquidate securities held and offset receivables and payables with the same counterparty. The Company offsets reverse repurchase and repurchase agreements with the same counterparty where they have a legally enforceable master netting agreement and the transactions have the same maturity date.
Trading Account Assets and Liabilities
Trading account assets and liabilities are recorded at fair value and include certain securities and derivatives. Securities are classified as trading when management acquires them with the intent to hold for short periods, primarily at MUAH's broker-dealer subsidiary, MUSA, or as an accommodation to customers. Substantially all of the securities have a high degree of liquidity and a readily determinable fair value. Interest on securities classified as trading is included in interest income, and realized gains and losses from sale and unrealized fair value adjustments are recognized in noninterest income. Trading securities that are pledged under an agreement to repurchase and which may be sold or repledged under that agreement are separately identified as pledged as collateral.
Derivatives included in trading account assets and liabilities are entered into for trading purposes or as an accommodation to customers. Contracts primarily include interest rate swaps and options, commodity swaps and options, and foreign exchange contracts. The Company nets derivative assets and liabilities, and the related cash collateral receivables and payables, when a legally enforceable master netting arrangement exists between the Company and the derivative counterparty. Changes in fair values and realized income or expense for trading asset and liability derivatives are included in noninterest income.
Securities
Securities are classified based on management's intent and are recorded on the consolidated balance sheet as of the trade date, when acquired in a regular-way trade. Debt securities for which management has both the positive intent and ability to hold to maturity are classified as held to maturity and are carried at amortized cost. Debt securities with readily determinable fair values that are not classified as trading assets or held to maturity are classified as available for sale and are carried at fair value, with the unrealized gains or losses reported net of taxes as a component of AOCI in stockholders' equity until realized.
Interest income on debt securities classified as either available for sale or held to maturity includes the amortization of premiums and the accretion of discounts using a method that produces a level yield and is included in interest income on securities.
Realized gains and losses on the sale of available for sale securities are included in noninterest income. The specific identification method is used to calculate realized gains and losses on sales.
Securities available for sale that are pledged under an agreement to repurchase and which may be sold or repledged under that agreement are separately identified as pledged as collateral.
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Note 1—Summary of Significant Accounting Policies and Nature of Operations (Continued)
Debt securities available for sale and debt securities held to maturity are subject to impairment testing when a security's fair value is lower than its amortized cost. Debt securities with unrealized losses are considered other-than-temporarily impaired if we intend to sell the debt security, if it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, or if we do not expect to recover the entire amortized cost basis of the security. If we intend to sell the security, or if it is more likely than not that we will be required to sell the security before recovery, an other-than-temporary impairment write-down is recognized in earnings equal to the entire difference between the amortized cost basis and fair value of the debt security. However, even if we do not expect to sell a debt security we must evaluate the expected cash flows to be received and determine if a credit loss exists. In the event of a credit loss, only the amount of impairment associated with the credit loss is recognized in income. Amounts related to factors other than credit losses are recorded in other comprehensive income. For further information on our other-than-temporary impairment analysis, see Note 2 to our Consolidated Financial Statements in this Form 10-K.
Loans Held for Investment, Loans Held for Sale and Leases
Loans held for investment are reported at the principal amounts outstanding, net of charge-offs, unamortized nonrefundable loan fees, direct loan origination costs, and purchase premiums and discounts. Where loans are held for investment, the net basis adjustment excluding charge-offs on the loan is generally recognized in interest income on an effective yield basis over the contractual loan term.
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. Loans are generally placed on nonaccrual when such loans have become contractually past due 90 days with respect to principal or interest. Past due status is determined based on the contractual terms of the loan and the number of payment cycles since the last payment date. Interest accruals are continued past 90 days for certain small business loans and consumer installment loans, which are charged off at 120 days. For the commercial loan portfolio segment, interest accruals are also continued for loans that are both well-secured and in the process of collection.
When a loan is placed on nonaccrual status, all previously accrued but uncollected interest is reversed against current period interest income. When full collection of the outstanding principal balance is in doubt, subsequent payments received are first applied to unpaid principal and then to uncollected interest. A loan may be returned to accrual status at such time as the loan is brought fully current as to both principal and interest, and such loan is considered to be fully collectible on a timely basis. The Company's policy also allows management to continue the recognition of interest income on certain loans placed on nonaccrual status. This portion of the nonaccrual portfolio is referred to as "Cash Basis Nonaccrual" under which the accrual of interest is suspended and interest income is recognized only when collected. This policy applies to consumer portfolio segment loans and commercial portfolio segment loans that are well-secured and in management's judgment are considered to be fully collectible but the timely collection of payments is in doubt.
A TDR is a restructuring of a loan in which the creditor, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider. A loan subject to such a restructuring is accounted for as a TDR. A TDR typically involves a modification of terms such as a reduction of the interest rate below the current market rate for a loan with similar risk characteristics or extending the maturity date of the loan without corresponding compensation or additional support. The Company measures impairment of a TDR using the methodology described for individually impaired loans (see "Allowance for Loan Losses" below). For the consumer portfolio segment, TDRs are initially placed on nonaccrual and typically, a minimum of six consecutive months of sustained performance is required before returning to accrual status. For the commercial portfolio segment, the Company generally determines accrual status for TDRs by performing an individual assessment of each loan, which may include, among other factors, demonstrated performance by the borrower under the previous terms.
Except for certain transactions between entities under common control, loans acquired in a transfer, including business combinations, are recorded at fair value at the acquisition date, factoring in credit losses expected to be incurred over the life of the loan.
Loans held for sale, which are recorded in other assets, are carried at the lower of cost or fair value and measured on an individual basis for commercial loans and on an aggregate basis for residential mortgage loans. Changes in fair value are recognized in other noninterest income. Nonrefundable fees, direct loan origination costs, and purchase premiums and discounts related to loans held for sale are deferred and recognized as a
83
Note 1—Summary of Significant Accounting Policies and Nature of Operations (Continued)
component of the gain or loss on sale. Contractual interest earned on loans held for sale is recognized in interest income.
As lessor, the Company primarily offers two types of leases to customers: 1) direct financing leases where the assets leased are acquired without additional financing from other sources, and 2) leveraged leases where a substantial portion of the financing is provided by debt with no recourse to the Company. Direct financing leases and leveraged leases are recorded based on the amount of minimum lease payments receivable, unguaranteed residual value accruing to the benefit of the lessor, unamortized initial direct costs, and are reduced for any unearned income. Leveraged leases are recorded net of any nonrecourse debt.
Allowance for Loan Losses
The Company maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable estimated losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of charge-offs, net of recoveries. The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include the allowance for loans collectively evaluated for impairment, the allowance for loans individually evaluated for impairment, and the unallocated allowance. Management estimates probable losses inherent in the portfolio based on a loss emergence period. The loss emergence period is the estimated average period of time between a material adverse event that affects the creditworthiness of a borrower and the subsequent recognition of a loss. Updates of the loss emergence period are performed when significant events cause management to reexamine data. Management develops and documents its systematic methodology for determining the allowance for loan losses by first dividing its portfolio into segments—the commercial segment and consumer segment. The Company further divides the portfolio segments into classes based on initial measurement attributes, risk characteristics or its method of monitoring and assessing credit risk. The classes for the Company include commercial and industrial, commercial mortgage, construction, residential mortgage, and home equity and other consumer loans. While the Company's methodology attributes portions of the allowance to specific portfolio segments, the entire allowance is available to absorb credit losses inherent in the total loan portfolio.
For the commercial portfolio segment, the allowance for loans collectively evaluated for impairment is calculated by utilizing a dual factor internal risk rating system that encompasses both the probability that a credit facility may ultimately default (i.e. probability of default) and an estimate of the severity of the loss that would be realized upon such default (i.e. the loss-given default) and applying these risk ratings to outstanding loans and most unused commitments. The probability of default and loss-given default may be adjusted for qualitative or environmental factors that, in management's judgment, are likely to cause estimated credit losses associated with the existing portfolio to differ from the historical probability of default and loss-given default. The Company refined its methodology for estimating the allowance for commercial loans collectively evaluated for impairment and the allowance for losses on unfunded credit commitments during the first quarter of 2018. Previously the Company derived the allowance for these loans by assigning a loss factor based on an internal risk rating that estimated the probability that a credit facility may ultimately default (i.e. probability of default) rather than a dual factor internal risk rating system that encompasses both the probability of default and an estimate of the severity of the loss that would be realized upon such default (i.e. the loss-given default). During the second quarter of 2018, the Company implemented refinements to the qualitative considerations used in our reserve methodology.
For the consumer portfolio segment, loans are generally pooled by product type with similar risk characteristics. The Company estimates the allowance for loans collectively evaluated for impairment based on forecasted losses.
The allowance for loans collectively evaluated for impairment also includes attributions for certain sectors within the commercial and consumer portfolio segments to account for probable losses based on incurred loss events that are currently not reflected in the probability of default and loss-given default. Segment attributions are calculated based on migration scenarios for the commercial portfolio and specific attributes applicable to the consumer portfolio. Segment considerations are revised periodically as portfolio and environmental conditions change.
The Company individually evaluates for impairment larger nonaccruing loans within the commercial portfolio. Residential mortgage and consumer loans are not individually evaluated for impairment unless they represent TDRs. Loans are considered impaired when the evaluation of current information regarding the
84
Note 1—Summary of Significant Accounting Policies and Nature of Operations (Continued)
borrower's financial condition, loan collateral, and cash flows indicates that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including interest payments. The amount of impairment is measured using the present value of expected future cash flows discounted at the loan's effective rate, the loan's observable market price, or the fair value of the collateral, if the loan is collateral dependent.
The unallocated allowance is composed of attributions that are intended to capture probable losses from adverse changes in credit migration and other inherent losses that are not currently reflected in the allowance for loan losses that are ascribed to our portfolio segments.
Significant risk characteristics considered in estimating the allowance for credit losses include the following:
| • | Commercial and industrial—industry specific economic trends and individual borrower financial condition |
| • | Construction and commercial mortgage loans—type of property (i.e., residential, commercial, industrial), geographic concentrations, and risks and individual borrower financial condition |
| • | Residential mortgage and consumer—historical and expected future charge-offs, borrower's credit, property collateral, and loan characteristics |
Loans are charged-off in whole or in part when they are considered to be uncollectible. Loans in the commercial loan portfolio segment are generally considered uncollectible based on an evaluation of borrower financial condition as well as the value of any collateral. Loans in the consumer portfolio segment are generally considered uncollectible based on past due status or the execution of certain TDR modifications such as discharge through Chapter 7 bankruptcy and the value of any collateral. Recoveries of amounts previously charged off are recorded as a recovery to the allowance for loan losses.
Allowance for Losses on Unfunded Credit Commitments
The Company maintains an allowance for losses on unfunded credit commitments to absorb losses inherent in those commitments upon funding. The Company's methodology for assessing the appropriateness of this allowance is the same as that used for the allowance for loan losses (see "Allowance for Loan Losses" above) and incorporates an assumption based upon historical experience of likely utilization of the commitment. The allowance for losses on unfunded credit commitments is classified as other liabilities and the change in this allowance is recognized in the provision for credit losses. Losses on unfunded credit commitments are identified when exposures committed to customers facing difficulty are drawn upon, and subsequently result in charge-offs.
Goodwill and Identifiable Intangible Assets
Intangible assets represent purchased assets that lack physical substance and can be separately distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold, exchanged, or licensed. Intangible assets are recorded at fair value at the date of acquisition.
Intangible assets that have indefinite lives are tested for impairment at least annually, and more frequently in certain circumstances. Intangible assets that have finite lives, which include core deposit intangibles, customer relationships, non-compete agreements and trade names, are amortized either using the straight-line method or a method that patterns the consumption of the economic benefit. Intangible assets are amortized over their estimated periods of benefit, which range from three to forty years. The Company periodically evaluates the recoverability of intangible assets and takes into account events or circumstances that warrant revised estimates of useful lives or that indicate impairment exists.
The Company has elected to account for its residential mortgage servicing rights using the fair value measurement method. Under the fair value measurement method, residential mortgage servicing rights are measured at estimated fair value each period with changes in fair value included in other, net within noninterest income.
Goodwill is assessed for impairment at least annually at the reporting unit level either qualitatively or quantitatively. If the elected qualitative assessment results indicate that it is more likely than not that the fair
85
Note 1—Summary of Significant Accounting Policies and Nature of Operations (Continued)
value of a reporting unit is less than its carrying amount, then the quantitative impairment test is required. Various valuation methodologies are applied to carry out the impairment test by comparing the fair value of the reporting unit to its carrying amount, including goodwill. A goodwill impairment loss is measured as the amount by which a reporting unit’s carrying amount exceeds its fair value; however, the loss recognized cannot exceed the total amount of goodwill allocated to that reporting unit. Goodwill impairment is recognized through noninterest expense as a direct write down to its carrying amount and subsequent reversals of goodwill impairment are prohibited.
Other Investments
The Company invests in limited liability partnerships and other entities operating qualified affordable housing projects. These LIHC investments provide tax benefits to investors in the form of tax deductions from operating losses and tax credits. The LIHC investments are initially recorded at cost, and are subsequently accounted for under the proportional amortization method, when such requirements are met to apply that methodology. Under the proportional amortization method, the Company amortizes the initial investment in proportion to the tax credits and other tax benefits allocated to the Company, with amortization recognized in the statement of income as a component of income tax expense. When the requirements are not met to apply the proportional amortization method, the investment is accounted for under the equity method of accounting with equity method losses recorded in noninterest expense. LIHC investments are reviewed periodically for impairment.
The Company also invests in limited liability entities and trusts that operate renewable energy projects, either directly or indirectly. Tax credits, taxable income and distributions associated with these renewable energy projects may be allocated to investors according to the terms of the partnership agreements. These investments are accounted for under the equity method and are reviewed periodically for impairment, considering projected operating results and realizability of tax credits. For those projects where economic benefits are not allocated based on pro rata ownership percentage, the Company accounts for its investments using the HLBV method. Under the HLBV method, the Company determines its share of an investee’s earnings by comparing the amount it would hypothetically receive at each balance sheet reporting date under the liquidation provisions of the partnership agreements, assuming the investee's net assets were liquidated at amounts determined in accordance with GAAP and distributed to the Company, after taking capital transactions during the period into account.
Derivative Instruments Used in Hedging Relationships
The Company enters into a variety of derivative contracts as a means of managing the Company's interest rate exposure and designates such derivatives under qualifying hedge relationships. All such derivative instruments are recorded at fair value and are included in other assets or other liabilities. The Company offsets derivative assets and liabilities, and the related cash collateral receivables and payables, when a legally enforceable master netting arrangement exists between the Company and the derivative counterparty.
At hedge inception, the Company designates a derivative instrument as a hedge of the fair value of a recognized asset or liability (i.e., fair value hedge), or a hedge of the variability in the expected future cash flows associated with either an existing recognized asset or liability or a probable forecasted transaction (i.e., cash flow hedge).
Where hedge accounting is applied at hedge inception, the Company formally documents its risk management objective and strategy for undertaking the hedge, which includes identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged, and how the hedge's effectiveness will be assessed prospectively and retrospectively. Both at the inception of the hedge and on an ongoing basis, the hedging instrument must be highly effective in offsetting changes in fair values or cash flows of the hedged item in order to qualify for hedge accounting.
For fair value hedges, any ineffectiveness is recognized in noninterest expense in the period in which it arises. For cash flow hedges, only ineffectiveness resulting from over-hedging is recorded in earnings as an adjustment to noninterest expense, with other changes in the fair value of the derivative instrument recognized in other comprehensive income. For cash flow hedges of interest rate risk, the amount in other comprehensive income is subsequently reclassified to net interest income in the period in which the cash flow from the hedged item is recognized in earnings. If a derivative instrument is no longer determined to be highly effective as a
86
Note 1—Summary of Significant Accounting Policies and Nature of Operations (Continued)
designated hedge, hedge accounting is discontinued and subsequent fair value adjustments of the derivative instrument are recorded in earnings.
Transfers of Financial Assets
Transfers of financial assets in which the Company has surrendered control over the transferred assets are accounted for as sales. Control is generally considered to have been surrendered when the transferred assets have been legally isolated from the Company, the transferee has the right to pledge or exchange the assets without any significant constraints, and the Company has not entered into a repurchase agreement, does not hold unconditional call options and has not written put options on the transferred assets. In assessing whether control has been surrendered, the Company considers whether the transferee would be a consolidated affiliate and the impact of all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of transfer.
Revenues from Contracts with Customers
Revenues from contracts with customers include service charges on deposit accounts, trust and investment management fees, brokerage commissions and fees, card processing fees, net, investment banking and syndication fees, and fees from affiliates. The Company recognizes revenue from contracts with customers according to a five-step revenue recognition model: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The Company’s contracts with customers generally contain a single performance obligation or separately identified performance obligations, each with a stated transaction price and generally do not involve a significant timing difference between satisfaction of the performance obligation and customer payment. Revenues are recognized over time or at a point in time as the performance obligations are satisfied. Revenues are generally not variable and do not involve significant estimates or constraints.
Transfer Pricing
Employees of the Company perform management and support services to MUFG Bank, Ltd. in connection with the operation and administration of MUFG Bank, Ltd.’s businesses in the Americas. In consideration for the services provided, MUFG Bank, Ltd. pays the Company fees under a master services agreement, which reflects market-based pricing for those services. The Company recognizes transfer pricing revenue when delivery (performance) has occurred or services have been rendered. Revenue is typically recognized based on the gross amount billed to MUFG Bank, Ltd. without netting the associated costs to perform those services. Gross presentation is typically deemed appropriate in these instances as the Company acts as a principal when providing these services directly to MUFG Bank, Ltd. Transfer pricing revenue is included in fees from affiliates revenue.
Income Taxes
The Company files consolidated U.S. federal income tax returns, foreign tax returns and various combined and separate company state income tax returns.
We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment.
We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Foreign taxes paid are generally applied as credits to reduce U.S. federal income taxes payable.
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Note 1—Summary of Significant Accounting Policies and Nature of Operations (Continued)
Employee Pension and Other Postretirement Benefits
The Company provides a variety of pension and other postretirement benefit plans for eligible employees and retirees. Net periodic pension and other postretirement benefit cost is recognized over the approximate service period of plan participants and includes significant discount rate and plan asset return assumptions.
Stock-Based Compensation
The Company grants restricted stock units settled in ADRs representing shares of common stock of the Company's ultimate parent company, MUFG, to employees. The Company recognizes compensation expense on restricted stock units granted on a straight-line basis over the vesting period for non-retirement eligible employees based on the grant date fair value of MUFG ADRs. Restricted stock units granted to employees who are retirement eligible or will become retirement eligible during the vesting period are expensed as of the grant date or on a straight-line basis over the period from the grant date to the date the employee becomes retirement eligible. Forfeitures are recognized as incurred in earnings.
Business Combinations
The Company accounts for all business combinations using the acquisition method of accounting. Assets and liabilities acquired are recorded at fair value at the acquisition date, with the excess of purchase price over the fair value of the net assets acquired (including identifiable intangibles) recorded as goodwill. Management may further adjust the acquisition date fair values for a period of up to one year from the date of acquisition. The recognition at the acquisition date of an allowance for loan losses is not carried over or recorded as of acquisition date, as credit-related factors are incorporated directly into the fair value measurement of the loans. For combinations between entities under common control, assets and liabilities acquired are recorded at book value at the transfer date.
Recently Issued Accounting Pronouncements
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which provides new guidance on the accounting for credit losses for instruments that are within its scope. This new guidance is commonly referred to as the current expected credit loss (CECL) model. For loans and debt securities accounted for at amortized cost, certain off-balance sheet credit exposures, net investments in leases, and trade receivables, the ASU requires an entity to recognize its estimate of credit losses expected over the life of the financial instrument or exposure by incorporating forward-looking information, such as reasonable and supportable forecasts, in the entity's assessment of the collectability of financial assets. Lifetime expected credit losses on purchased financial assets with credit deterioration will be recognized as an allowance with an offset to the cost basis of the asset. For available for sale debt securities, the new standard will require recognition of expected credit losses by recognizing an allowance for credit losses when the fair value of the security is below amortized cost and the recognition of this allowance is limited to the difference between the security’s amortized cost basis and fair value. The Company adopted the ASU on January 1, 2020, and recorded an increase to the allowance for credit losses of $199 million, primarily due to an increase in the allowance for consumer loans, offset by a $52 million deferred tax asset, and a $147 million cumulative-effect adjustment reduction to retained earnings.
Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement
In August 2018, the FASB issued ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, which modifies disclosure requirements on fair value measurements to improve their effectiveness. The guidance permits entities to consider materiality when evaluating fair value measurement disclosures and, among other modifications, requires certain new disclosures related to Level 3 fair value measurements. The guidance will be effective for MUAH beginning January 1, 2020, with early adoption permitted. The guidance only affects disclosures in the notes to the consolidated financial statements and will not affect the Company’s financial position or results of operations.
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Note 1—Summary of Significant Accounting Policies and Nature of Operations (Continued)
Recently Adopted Accounting Pronouncements
Accounting for Leases
In February 2016, the FASB issued ASU 2016-02, Leases, which requires entities that lease assets (i.e., lessees) to recognize assets and liabilities on their balance sheet for the rights and obligations created by those leases. The accounting by entities that own the assets leased (i.e., lessors) remains largely unchanged; however, leveraged lease accounting is no longer permitted for leases that commence after the effective date. The ASU also requires qualitative and quantitative disclosures about the amount, timing and uncertainty of cash flows arising from leases. The ASU is effective for interim and annual periods beginning on January 1, 2019, and requires a modified retrospective approach, with early adoption permitted. In July 2018, the FASB issued ASU 2018-11, Leases, which allows entities the option to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In December 2018, the FASB issued ASU 2018-20, Leases, which clarified lessor accounting for sales and similar taxes collected by lessors, certain lessor costs, and lease payments with lease and nonlease components. Effective January 1, 2019, the Company adopted this guidance which did not significantly impact the Company's financial position or results of operations.
Premium Amortization on Purchased Callable Debt Securities
In March 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities, which requires premiums on certain purchased callable debt securities to be amortized to the earliest call date. Under current guidance, premiums on callable debt securities are generally amortized over the contractual life of the security. The amortization period for callable debt securities purchased at a discount will not be impacted. Effective January 1, 2019, the Company adopted this guidance which did not significantly impact the Company's financial position or results of operations.
Targeted Improvements to Accounting for Hedging Activities
In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, which will make more hedging strategies eligible for hedge accounting, simplify the application of hedge accounting, and enhance the transparency and understandability of hedge results. The guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. It also amends the disclosure requirements and changes how entities assess effectiveness. Effective January 1, 2019, the Company adopted this guidance which did not significantly impact the Company's financial position or results of operations. As permitted by this guidance, upon adoption the Company transferred securities held to maturity with a carrying amount of $170 million to securities available for sale.
Simplifying the Test for Goodwill Impairment
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. The ASU removes Step 2 of the goodwill impairment test, which measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Under the amendments, a goodwill impairment loss will be measured as the amount by which a reporting unit’s carrying amount exceeds its fair value; however, the loss recognized cannot exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss. Effective July 1, 2019, the Company adopted this guidance in connection with an interim quantitative impairment test of goodwill allocated to three of its reporting units. For additional information related to goodwill, see Note 5 "Goodwill and other Intangible Assets" to these Consolidated Financial Statements.
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Note 2—Securities (Continued)
Note 2—Securities
Securities Available for Sale
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of securities available for sale for December 31, 2019 and 2018 are presented below.
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||||||||||
| (Dollars in millions) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | 5,485 | $ | 6 | $ | 53 | $ | 5,438 | $ | 3,572 | $ | 1 | $ | 144 | $ | 3,429 | ||||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||||||
| U.S. agencies | 5,491 | 13 | 36 | 5,468 | 8,168 | 7 | 168 | 8,007 | ||||||||||||||||||||||||
| Residential - non-agency | 759 | 5 | 2 | 762 | 887 | — | 23 | 864 | ||||||||||||||||||||||||
| Commercial - non-agency | 3,461 | 56 | 28 | 3,489 | 1,198 | 3 | 21 | 1,180 | ||||||||||||||||||||||||
| Collateralized loan obligations | 1,499 | — | 8 | 1,491 | 1,492 | — | 18 | 1,474 | ||||||||||||||||||||||||
| Direct bank purchase bonds | 911 | 43 | 18 | 936 | 1,190 | 30 | 30 | 1,190 | ||||||||||||||||||||||||
| Other | 202 | 3 | — | 205 | 173 | — | 3 | 170 | ||||||||||||||||||||||||
| Total securities available for sale | $ | 17,808 | $ | 126 | $ | 145 | $ | 17,789 | $ | 16,680 | $ | 41 | $ | 407 | $ | 16,314 | ||||||||||||||||
The Company's securities available for sale with a continuous unrealized loss position at December 31, 2019 and 2018 are shown below, identified for periods less than 12 months and 12 months or more.
| December 31, 2019 | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| (Dollars in millions) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||
| U.S. Treasury and government agencies | $ | 4,407 | $ | 48 | $ | 543 | $ | 5 | $ | 4,950 | $ | 53 | ||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||
| U.S. agencies | 914 | 4 | 2,769 | 32 | 3,683 | 36 | ||||||||||||||||||
| Residential - non-agency | 127 | — | 155 | 2 | 282 | 2 | ||||||||||||||||||
| Commercial - non-agency | 1,669 | 28 | 12 | — | 1,681 | 28 | ||||||||||||||||||
| Collateralized loan obligations | 597 | 2 | 790 | 6 | 1,387 | 8 | ||||||||||||||||||
| Direct bank purchase bonds | 118 | 1 | 294 | 17 | 412 | 18 | ||||||||||||||||||
| Other | 25 | — | — | — | 25 | — | ||||||||||||||||||
| Total securities available for sale | $ | 7,857 | $ | 83 | $ | 4,563 | $ | 62 | $ | 12,420 | $ | 145 | ||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| (Dollars in millions) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||
| U.S. Treasury and government agencies | $ | 147 | $ | 1 | $ | 3,182 | $ | 143 | $ | 3,329 | $ | 144 | ||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||
| U.S. agencies | 1,941 | 8 | 4,797 | 160 | 6,738 | 168 | ||||||||||||||||||
| Residential - non-agency | 398 | 7 | 383 | 16 | 781 | 23 | ||||||||||||||||||
| Commercial - non-agency | 380 | 6 | 515 | 15 | 895 | 21 | ||||||||||||||||||
| Collateralized loan obligations | 1,428 | 18 | — | — | 1,428 | 18 | ||||||||||||||||||
| Direct bank purchase bonds | 221 | 6 | 417 | 24 | 638 | 30 | ||||||||||||||||||
| Other | 162 | 3 | 1 | — | 163 | 3 | ||||||||||||||||||
| Total securities available for sale | $ | 4,677 | $ | 49 | $ | 9,295 | $ | 358 | $ | 13,972 | $ | 407 | ||||||||||||
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Note 2—Securities (Continued)
At December 31, 2019, the Company did not have the intent to sell any securities in an unrealized loss position before a recovery of the amortized cost, which may be at maturity. The Company also believes that it is more likely than not that it will not be required to sell the securities prior to recovery of amortized cost.
Agency residential and commercial mortgage-backed securities consist of securities guaranteed by a U.S. government corporation, such as Ginnie Mae, or a government-sponsored agency such as Freddie Mac or Fannie Mae. These securities are collateralized by residential and commercial mortgage loans and may be prepaid at par prior to maturity. The unrealized losses on agency residential mortgage-backed securities resulted from changes in interest rates and not from changes in credit quality. At December 31, 2019, the Company expects to recover the entire amortized cost basis of these securities because the Company determined that the strength of the issuers’ guarantees through direct obligations or support from the U.S. government is sufficient to protect the Company from losses.
Commercial mortgage-backed securities are collateralized by commercial mortgage loans and are generally subject to prepayment penalties. The unrealized losses on commercial mortgage-backed securities resulted from higher market yields since purchase. Cash flow analysis of the underlying collateral provides an estimate of other-than-temporary impairment, which is performed quarterly when the fair value of a security is lower than its amortized cost. Based on the analysis performed as of December 31, 2019, the Company expects to recover the entire amortized cost basis of these securities.
The Company’s CLOs consist of 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. Cash Flow CLOs pay the note holders through the receipt of interest and principal repayments from the underlying loans unlike other types of CLOs that pay note holders through the trading and sale of underlying collateral. Unrealized losses typically arise from widening credit spreads and deteriorating credit quality of the underlying collateral. Cash flow analysis of the underlying collateral provides an estimate of other-than-temporary impairment, which is performed quarterly when the fair value of a security is lower than its amortized cost. Based on the analysis performed as of December 31, 2019, the Company expects to recover the entire amortized cost basis of these securities.
Other debt securities primarily consist of direct bank purchase bonds, which are not rated by external credit rating agencies. The unrealized losses on these bonds resulted from a higher return on capital expected by the secondary market compared with the return on capital required at the time of origination when the bonds were purchased. The Company estimates the unrealized loss for each security by assessing the underlying collateral of each security. The Company estimates the portion of loss attributable to credit based on the expected cash flows of the underlying collateral using estimates of current key assumptions, such as probability of default and loss severity. Cash flow analysis of the underlying collateral provides an estimate of other-than-temporary impairment, which is performed quarterly when the fair value of a security is lower than its amortized cost and potential impairment is identified. Based on the analysis performed as of December 31, 2019, the Company expects to recover the entire amortized cost basis of these securities.
The fair value of debt securities available for sale by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
| December 31, 2019 | ||||||||||||||||||||
| (Dollars in millions) | One Year or Less | Over One Year Through Five Years | Over Five Years Through Ten Years | Over Ten Years | Total Fair Value | |||||||||||||||
| U.S. Treasury and government agencies | $ | — | $ | 1,237 | $ | 4,167 | $ | 34 | $ | 5,438 | ||||||||||
| Mortgage-backed: | ||||||||||||||||||||
| U.S. agencies | — | 167 | 1,021 | 4,280 | 5,468 | |||||||||||||||
| Residential - non-agency | — | — | — | 762 | 762 | |||||||||||||||
| Commercial - non-agency | 32 | — | 1,356 | 2,101 | 3,489 | |||||||||||||||
| Collateralized loan obligations | — | — | 430 | 1,061 | 1,491 | |||||||||||||||
| Direct bank purchase bonds | 67 | 303 | 466 | 100 | 936 | |||||||||||||||
| Other | — | 205 | — | — | 205 | |||||||||||||||
| Total securities available for sale | $ | 99 | $ | 1,912 | $ | 7,440 | $ | 8,338 | $ | 17,789 | ||||||||||
91
Note 2—Securities (Continued)
The gross realized gains and losses from sales of available for sale securities for the years ended December 31, 2019, 2018 and 2017 are shown below. The specific identification method is used to calculate realized gains and losses on sales.
| For the Year Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Gross realized gains | $ | 39 | $ | 8 | $ | 17 | ||||||
| Gross realized losses | — | — | — | |||||||||
Securities Held to Maturity
At December 31, 2019 and 2018, the amortized cost, gross unrealized gains and losses recognized in OCI, carrying amount, gross unrealized gains and losses not recognized in OCI, and fair values of securities held to maturity are presented below. Management has asserted the positive intent and ability to hold these securities to maturity.
| December 31, 2019 | ||||||||||||||||||||||||||||
| Recognized in OCI | Not Recognized in OCI | |||||||||||||||||||||||||||
| (Dollars in millions) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Carrying Amount | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||||
| U.S. Treasury and government agencies | $ | 1,359 | $ | — | $ | — | $ | 1,359 | $ | — | $ | 6 | $ | 1,353 | ||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||
| U.S. agencies | 8,166 | — | 104 | 8,062 | 123 | 30 | 8,155 | |||||||||||||||||||||
| Total securities held to maturity | $ | 9,525 | $ | — | $ | 104 | $ | 9,421 | $ | 123 | $ | 36 | $ | 9,508 | ||||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||||||
| Recognized in OCI | Not Recognized in OCI | |||||||||||||||||||||||||||
| (Dollars in millions) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Carrying Amount | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||||
| U.S. Treasury and government agencies | $ | 1,250 | $ | — | $ | — | $ | 1,250 | $ | 2 | $ | 2 | $ | 1,250 | ||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||
| U.S. agencies | 9,788 | 1 | 138 | 9,651 | 28 | 209 | 9,470 | |||||||||||||||||||||
| Total securities held to maturity | $ | 11,038 | $ | 1 | $ | 138 | $ | 10,901 | $ | 30 | $ | 211 | $ | 10,720 | ||||||||||||||
Amortized cost is defined as the original purchase cost, adjusted for any accretion or amortization of a purchase discount or premium, less principal payments and any impairment previously recognized in earnings. The carrying amount is the difference between the amortized cost and the amount recognized in OCI. The amount recognized in OCI primarily reflects the unrealized gain or loss at date of transfer from available for sale to the held to maturity classification, net of amortization, which is recorded in interest income on securities.
92
Note 2—Securities (Continued)
The Company's securities held to maturity with a continuous unrealized loss position at December 31, 2019 and 2018 are shown below, separately for periods less than 12 months and 12 months or more.
| December 31, 2019 | ||||||||||||||||||||||||||||||||||||
| Less Than 12 months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
| Unrealized Losses | Unrealized Losses | Unrealized Losses | ||||||||||||||||||||||||||||||||||
| (Dollars in millions) | Fair Value | Recognized in OCI | Not Recognized in OCI | Fair Value | Recognized in OCI | Not Recognized in OCI | Fair Value | Recognized in OCI | Not Recognized in OCI | |||||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | 509 | $ | — | $ | 6 | $ | — | $ | — | $ | — | $ | 509 | $ | — | $ | 6 | ||||||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||||||||||
| U.S. agencies | 1,084 | — | 9 | 4,515 | 104 | 21 | 5,599 | 104 | 30 | |||||||||||||||||||||||||||
| Total securities held to maturity | $ | 1,593 | $ | — | $ | 15 | $ | 4,515 | $ | 104 | $ | 21 | $ | 6,108 | $ | 104 | $ | 36 | ||||||||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
| Unrealized Losses | Unrealized Losses | Unrealized Losses | ||||||||||||||||||||||||||||||||||
| (Dollars in millions) | Fair Value | Recognized in OCI | Not Recognized in OCI | Fair Value | Recognized in OCI | Not Recognized in OCI | Fair Value | Recognized in OCI | Not Recognized in OCI | |||||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | — | $ | — | $ | — | $ | 496 | $ | — | $ | 2 | $ | 496 | $ | — | $ | 2 | ||||||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||||||||||
| U.S. agencies | 697 | — | 11 | 8,587 | 138 | 198 | 9,284 | 138 | 209 | |||||||||||||||||||||||||||
| Total securities held to maturity | $ | 697 | $ | — | $ | 11 | $ | 9,083 | $ | 138 | $ | 200 | $ | 9,780 | $ | 138 | $ | 211 | ||||||||||||||||||
The carrying amount and fair value of securities held to maturity by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
| December 31, 2019 | ||||||||||||||||||||||||||||||||||||||||
| Within One Year | Over One Year Through Five Years | Over Five Years Through Ten Years | Over Ten Years | Total | ||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | Carrying Amount | Fair Value | Carrying Amount | Fair Value | Carrying Amount | Fair Value | Carrying Amount | Fair Value | Carrying Amount | Fair Value | ||||||||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | 9 | $ | 9 | $ | — | $ | — | $ | 1,350 | $ | 1,344 | $ | — | $ | — | $ | 1,359 | $ | 1,353 | ||||||||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||||||||||||||
| U.S. agencies | — | — | 704 | 724 | 885 | 890 | 6,473 | 6,541 | 8,062 | 8,155 | ||||||||||||||||||||||||||||||
| Total securities held to maturity | $ | 9 | $ | 9 | $ | 704 | $ | 724 | $ | 2,235 | $ | 2,234 | $ | 6,473 | $ | 6,541 | $ | 9,421 | $ | 9,508 | ||||||||||||||||||||
Securities Pledged and Received as Collateral
At December 31, 2019 and December 31, 2018, the Company pledged $10.5 billion and $11.9 billion of available for sale and trading securities as collateral, respectively, of which $1.0 billion and $1.3 billion, respectively, was permitted to be sold or repledged. These securities were pledged as collateral for derivative liability positions and securities loaned or sold under repurchase agreements, and to secure public and trust department deposits.
At December 31, 2019 and December 31, 2018, the Company received $34.0 billion and $33.1 billion, respectively, of collateral for derivative asset positions and securities borrowed or purchased under resale agreements, of which $34.0 billion and $33.1 billion, respectively, was permitted to be sold or repledged. Of the
93
Note 2—Securities (Continued)
collateral received, the Company sold or repledged $32.5 billion and $32.1 billion at December 31, 2019 and December 31, 2018, respectively, for securities loaned or sold under repurchase agreements.
For additional information related to the Company's significant accounting policies on securities pledged as collateral, see Note 1 "Summary of Significant Accounting Policies and Nature of Operations" to our Consolidated Financial Statements in Part II, Item 8. "Financial Statements and Supplementary Data" of this Form 10-K.
Note 3—Loans and Allowance for Loan Losses
The following table provides the outstanding balances of loans held for investment at December 31, 2019 and 2018.
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Loans held for investment: | ||||||||
| Commercial and industrial | $ | 26,338 | $ | 24,919 | ||||
| Commercial mortgage | 16,895 | 15,354 | ||||||
| Construction | 1,511 | 1,613 | ||||||
| Lease financing | 1,001 | 1,249 | ||||||
| Total commercial portfolio | 45,745 | 43,135 | ||||||
Residential mortgage and home equity(1) | 38,018 | 40,677 | ||||||
Other consumer(2) | 4,450 | 2,695 | ||||||
| Total consumer portfolio | 42,468 | 43,372 | ||||||
Total loans held for investment(3) | 88,213 | 86,507 | ||||||
| Allowance for loan losses | (538 | ) | (474 | ) | ||||
| Loans held for investment, net | $ | 87,675 | $ | 86,033 | ||||
| (1) | Includes home equity loans of $2,049 million and $2,238 million at December 31, 2019 and December 31, 2018, respectively. |
| (2) | Other consumer loans substantially include unsecured consumer loans and consumer credit cards. |
| (3) | Includes $320 million and $340 million at December 31, 2019 and December 31, 2018, respectively, for net unamortized (discounts) and premiums and deferred (fees) and costs. |
Allowance for Loan Losses
The following tables provide a reconciliation of changes in the allowance for loan losses by portfolio segment.
| For the Year Ended December 31, 2019 | ||||||||||||||||
| (Dollars in millions) | Commercial | Consumer | Unallocated | Total | ||||||||||||
| Allowance for loan losses, beginning of period | $ | 359 | $ | 110 | $ | 5 | $ | 474 | ||||||||
| (Reversal of) provision for loan losses | 124 | 164 | (5 | ) | 283 | |||||||||||
| Loans charged-off | (158 | ) | (98 | ) | — | (256 | ) | |||||||||
| Recoveries of loans previously charged-off | 29 | 8 | — | 37 | ||||||||||||
| Allowance for loan losses, end of period | $ | 354 | $ | 184 | $ | — | $ | 538 | ||||||||
| For the Year Ended December 31, 2018 | ||||||||||||||||
| (Dollars in millions) | Commercial | Consumer | Unallocated | Total | ||||||||||||
| Allowance for loan losses, beginning of period | $ | 360 | $ | 86 | $ | 30 | $ | 476 | ||||||||
| (Reversal of) provision for loan losses | 51 | 58 | (25 | ) | 84 | |||||||||||
| Loans charged-off | (79 | ) | (41 | ) | — | (120 | ) | |||||||||
| Recoveries of loans previously charged-off | 27 | 7 | — | 34 | ||||||||||||
| Allowance for loan losses, end of period | $ | 359 | $ | 110 | $ | 5 | $ | 474 | ||||||||
94
Note 3—Loans and Allowance for Loan Losses (Continued)
| For the Year Ended December 31, 2017 | ||||||||||||||||
| (Dollars in millions) | Commercial | Consumer | Unallocated | Total | ||||||||||||
| Allowance for loan losses, beginning of period | $ | 556 | $ | 83 | $ | — | $ | 639 | ||||||||
| (Reversal of) provision for loan losses | (132 | ) | 37 | 30 | (65 | ) | ||||||||||
| Other | 2 | — | — | 2 | ||||||||||||
| Loans charged-off | (116 | ) | (39 | ) | — | (155 | ) | |||||||||
| Recoveries of loans previously charged-off | 50 | 5 | — | 55 | ||||||||||||
| Allowance for loan losses, end of period | $ | 360 | $ | 86 | $ | 30 | $ | 476 | ||||||||
The following tables show the allowance for loan losses and related loan balances by portfolio segment as of December 31, 2019 and 2018.
| December 31, 2019 | ||||||||||||||||
| (Dollars in millions) | Commercial | Consumer | Unallocated | Total | ||||||||||||
| Allowance for loan losses: | ||||||||||||||||
| Individually evaluated for impairment | $ | 43 | $ | 12 | $ | — | $ | 55 | ||||||||
| Collectively evaluated for impairment | 311 | 172 | — | 483 | ||||||||||||
| Total allowance for loan losses | $ | 354 | $ | 184 | $ | — | $ | 538 | ||||||||
| Loans held for investment: | ||||||||||||||||
| Individually evaluated for impairment | $ | 436 | $ | 246 | $ | — | $ | 682 | ||||||||
| Collectively evaluated for impairment | 45,309 | 42,222 | — | 87,531 | ||||||||||||
| Total loans held for investment | $ | 45,745 | $ | 42,468 | $ | — | $ | 88,213 | ||||||||
| December 31, 2018 | ||||||||||||||||
| (Dollars in millions) | Commercial | Consumer | Unallocated | Total | ||||||||||||
| Allowance for loan losses: | ||||||||||||||||
| Individually evaluated for impairment | $ | 62 | $ | 13 | $ | — | $ | 75 | ||||||||
| Collectively evaluated for impairment | 297 | 97 | 5 | 399 | ||||||||||||
| Total allowance for loan losses | $ | 359 | $ | 110 | $ | 5 | $ | 474 | ||||||||
| Loans held for investment: | ||||||||||||||||
| Individually evaluated for impairment | $ | 450 | $ | 280 | $ | — | $ | 730 | ||||||||
| Collectively evaluated for impairment | 42,685 | 43,092 | — | 85,777 | ||||||||||||
| Total loans held for investment | $ | 43,135 | $ | 43,372 | $ | — | $ | 86,507 | ||||||||
95
Note 3—Loans and Allowance for Loan Losses (Continued)
Nonaccrual and Past Due Loans
The following table presents nonaccrual loans as of December 31, 2019 and 2018.
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Commercial and industrial | $ | 175 | $ | 269 | ||||
| Commercial mortgage | 15 | 12 | ||||||
| Total commercial portfolio | 190 | 281 | ||||||
| Residential mortgage and home equity | 137 | 139 | ||||||
| Other consumer | 1 | 1 | ||||||
| Total consumer portfolio | 138 | 140 | ||||||
| Total nonaccrual loans | $ | 328 | $ | 421 | ||||
| Troubled debt restructured loans that continue to accrue interest | $ | 392 | $ | 299 | ||||
| Troubled debt restructured nonaccrual loans (included in total nonaccrual loans above) | $ | 171 | $ | 136 | ||||
The following tables show the aging of the balance of loans held for investment by class as of December 31, 2019 and 2018.
| December 31, 2019 | ||||||||||||||||||||
| Aging Analysis of Loans | ||||||||||||||||||||
| (Dollars in millions) | Current | 30 to 89 Days Past Due | 90 Days or More Past Due | Total Past Due | Total | |||||||||||||||
| Commercial and industrial | $ | 27,241 | $ | 37 | $ | 61 | $ | 98 | $ | 27,339 | ||||||||||
| Commercial mortgage | 16,858 | 34 | 3 | 37 | 16,895 | |||||||||||||||
| Construction | 1,511 | — | — | — | 1,511 | |||||||||||||||
| Total commercial portfolio | 45,610 | 71 | 64 | 135 | 45,745 | |||||||||||||||
| Residential mortgage and home equity | 37,788 | 179 | 51 | 230 | 38,018 | |||||||||||||||
| Other consumer | 4,400 | 33 | 17 | 50 | 4,450 | |||||||||||||||
| Total consumer portfolio | 42,188 | 212 | 68 | 280 | 42,468 | |||||||||||||||
| Total loans held for investment | $ | 87,798 | $ | 283 | $ | 132 | $ | 415 | $ | 88,213 | ||||||||||
| December 31, 2018 | ||||||||||||||||||||
| Aging Analysis of Loans | ||||||||||||||||||||
| (Dollars in millions) | Current | 30 to 89 Days Past Due | 90 Days or More Past Due | Total Past Due | Total | |||||||||||||||
| Commercial and industrial | $ | 26,114 | $ | 18 | $ | 36 | $ | 54 | $ | 26,168 | ||||||||||
| Commercial mortgage | 15,333 | 17 | 4 | 21 | 15,354 | |||||||||||||||
| Construction | 1,593 | 20 | — | 20 | 1,613 | |||||||||||||||
| Total commercial portfolio | 43,040 | 55 | 40 | 95 | 43,135 | |||||||||||||||
| Residential mortgage and home equity | 40,440 | 188 | 49 | 237 | 40,677 | |||||||||||||||
| Other consumer | 2,671 | 15 | 9 | 24 | 2,695 | |||||||||||||||
| Total consumer portfolio | 43,111 | 203 | 58 | 261 | 43,372 | |||||||||||||||
| Total loans held for investment | $ | 86,151 | $ | 258 | $ | 98 | $ | 356 | $ | 86,507 | ||||||||||
Loans held for investment 90 days or more past due and still accruing interest totaled $20 million and $23 million at December 31, 2019 and 2018, respectively.
96
Note 3—Loans and Allowance for Loan Losses (Continued)
Credit Quality Indicators
Management analyzes the Company's loan portfolios by applying specific monitoring policies and procedures that vary according to the relative risk profile and other characteristics within the various loan portfolios. Loans within the commercial portfolio segment are classified as either pass or criticized. Criticized credits are those that have regulatory risk ratings of special mention, substandard or doubtful; classified credits are those that have regulatory risk ratings of substandard or doubtful. Special mention credits are potentially weak, as the borrower has begun to exhibit deteriorating trends, which, if not corrected, may jeopardize repayment of the loan and result in further downgrade. Substandard credits have well-defined weaknesses, which, if not corrected, could jeopardize the full satisfaction of the debt. A credit classified as doubtful has critical weaknesses that make full collection improbable on the basis of currently existing facts and conditions.
The following tables summarize the loans in the commercial portfolio segment monitored for credit quality based on regulatory risk ratings.
| December 31, 2019 | ||||||||||||||||
| Criticized | ||||||||||||||||
| (Dollars in millions) | Pass | Special Mention | Classified | Total | ||||||||||||
| Commercial and industrial | $ | 26,210 | $ | 636 | $ | 493 | $ | 27,339 | ||||||||
| Commercial mortgage | 16,569 | 114 | 212 | 16,895 | ||||||||||||
| Construction | 1,399 | 50 | 62 | 1,511 | ||||||||||||
| Total commercial portfolio | $ | 44,178 | $ | 800 | $ | 767 | $ | 45,745 | ||||||||
| December 31, 2018 | ||||||||||||||||
| Criticized | ||||||||||||||||
| (Dollars in millions) | Pass | Special Mention | Classified | Total | ||||||||||||
| Commercial and industrial | $ | 25,191 | $ | 355 | $ | 622 | $ | 26,168 | ||||||||
| Commercial mortgage | 15,138 | 105 | 111 | 15,354 | ||||||||||||
| Construction | 1,542 | 8 | 63 | 1,613 | ||||||||||||
| Total commercial portfolio | $ | 41,871 | $ | 468 | $ | 796 | $ | 43,135 | ||||||||
The Company monitors the credit quality of its consumer portfolio segment based primarily on payment status. The following tables summarize the loans in the consumer portfolio segment, which exclude $3 million and $6 million of loans covered by FDIC loss share agreements, at December 31, 2019 and 2018, respectively.
| December 31, 2019 | ||||||||||||
| (Dollars in millions) | Accrual | Nonaccrual | Total | |||||||||
| Residential mortgage and home equity | $ | 37,878 | $ | 137 | $ | 38,015 | ||||||
| Other consumer | 4,449 | 1 | 4,450 | |||||||||
| Total consumer portfolio | $ | 42,327 | $ | 138 | $ | 42,465 | ||||||
| December 31, 2018 | ||||||||||||
| (Dollars in millions) | Accrual | Nonaccrual | Total | |||||||||
| Residential mortgage and home equity | $ | 40,532 | $ | 139 | $ | 40,671 | ||||||
| Other consumer | 2,694 | 1 | 2,695 | |||||||||
| Total consumer portfolio | $ | 43,226 | $ | 140 | $ | 43,366 | ||||||
97
Note 3—Loans and Allowance for Loan Losses (Continued)
The Company also monitors the credit quality for substantially all of its consumer portfolio segment using credit scores provided by FICO and refreshed LTV ratios. FICO credit scores are refreshed at least quarterly to monitor the quality of the portfolio. Refreshed LTV measures the principal balance of the loan as a percentage of the estimated current value of the property securing the loan. Home equity loans are evaluated using combined LTV, which measures the principal balance of the combined loans that have liens against the property (including unused credit lines for home equity products) as a percentage of the estimated current value of the property securing the loans. The LTV ratios are refreshed on a quarterly basis, using the most recent home pricing index data available for the property location.
The following tables summarize the loans in the consumer portfolio segment based on refreshed FICO scores and refreshed LTV ratios at December 31, 2019 and 2018. These tables exclude loans covered by FDIC loss share agreements, as discussed above. The amounts presented reflect unpaid principal balances less partial charge-offs.
| December 31, 2019 | ||||||||||||||||
| FICO scores | ||||||||||||||||
| (Dollars in millions) | 720 and Above | Below 720 | No FICO Available(1) | Total | ||||||||||||
| Residential mortgage and home equity | $ | 31,441 | $ | 5,742 | $ | 454 | $ | 37,637 | ||||||||
| Other consumer | 2,567 | 1,841 | 3 | 4,411 | ||||||||||||
| Total consumer portfolio | $ | 34,008 | $ | 7,583 | $ | 457 | $ | 42,048 | ||||||||
| Percentage of total | 81 | % | 18 | % | 1 | % | 100 | % | ||||||||
| (1) | Represents loans for which management was not able to obtain an updated FICO score (e.g., due to recent profile changes). |
| December 31, 2018 | ||||||||||||||||
| FICO scores | ||||||||||||||||
| (Dollars in millions) | 720 and Above | Below 720 | No FICO Available(1) | Total | ||||||||||||
| Residential mortgage and home equity | $ | 33,313 | $ | 6,470 | $ | 484 | $ | 40,267 | ||||||||
| Other consumer | 1,625 | 1,000 | 2 | 2,627 | ||||||||||||
| Total consumer portfolio | $ | 34,938 | $ | 7,470 | $ | 486 | $ | 42,894 | ||||||||
| Percentage of total | 82 | % | 17 | % | 1 | % | 100 | % | ||||||||
| (1) | Represents loans for which management was not able to obtain an updated FICO score (e.g., due to recent profile changes). |
| December 31, 2019 | ||||||||||||||||||||
| LTV ratios | ||||||||||||||||||||
| (Dollars in millions) | Less than or Equal to 80 Percent | Greater than 80 and Less than 100 Percent | Greater than or Equal to 100 Percent | No LTV Available(1) | Total | |||||||||||||||
| Residential mortgage and home equity | $ | 35,893 | $ | 1,689 | $ | 12 | $ | 43 | $ | 37,637 | ||||||||||
| Total consumer portfolio | $ | 35,893 | $ | 1,689 | $ | 12 | $ | 43 | $ | 37,637 | ||||||||||
| Percentage of total | 95 | % | 5 | % | — | % | — | % | 100 | % | ||||||||||
| (1) | Represents loans for which management was not able to obtain refreshed property values. |
98
Note 3—Loans and Allowance for Loan Losses (Continued)
| December 31, 2018 | ||||||||||||||||||||
| LTV ratios | ||||||||||||||||||||
| (Dollars in millions) | Less than or Equal to 80 Percent | Greater than 80 and Less than 100 Percent | Greater than or Equal to 100 Percent | No LTV Available(1) | Total | |||||||||||||||
| Residential mortgage and home equity | $ | 38,570 | $ | 1,582 | $ | 16 | $ | 99 | $ | 40,267 | ||||||||||
| Total consumer portfolio | $ | 38,570 | $ | 1,582 | $ | 16 | $ | 99 | $ | 40,267 | ||||||||||
| Percentage of total | 96 | % | 4 | % | — | % | — | % | 100 | % | ||||||||||
| (1) | Represents loans for which management was not able to obtain refreshed property values. |
Troubled Debt Restructurings
The following table provides a summary of the Company's recorded investment in TDRs as of December 31, 2019 and 2018. The summary includes those TDRs that are on nonaccrual status and those that continue to accrue interest. The Company had $61 million and $49 million in commitments to lend additional funds to borrowers with loan modifications classified as TDRs as of December 31, 2019 and 2018, respectively.
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Commercial and industrial | $ | 140 | $ | 109 | ||||
| Commercial mortgage | 168 | 46 | ||||||
| Construction | 62 | 63 | ||||||
| Total commercial portfolio | 370 | 218 | ||||||
| Residential mortgage and home equity | 192 | 216 | ||||||
| Other consumer | 1 | 1 | ||||||
| Total consumer portfolio | 193 | 217 | ||||||
| Total restructured loans | $ | 563 | $ | 435 | ||||
In 2019, TDR modifications in the commercial portfolio segment were substantially composed of maturity extensions, forbearance and reduction of spread. In the consumer portfolio segment, modifications were largely composed of maturity extensions and interest rate reductions. There were no charge-offs related to TDR modifications for the 2019 or 2018. For the commercial and consumer portfolio segments, the allowance for loan losses for TDRs was measured on an individual loan basis or in pools with similar risk characteristics.
The following tables provide the pre- and post-modification outstanding recorded investment amounts of TDRs as of the date of the restructuring that occurred during the years ended December 31, 2019 and 2018.
| For the Year Ended December 31, 2019 | For the Year Ended December 31, 2018 | ||||||||||||||
| (Dollars in millions) | Pre-Modification Outstanding Recorded Investment(1) | Post-Modification Outstanding Recorded Investment(2) | Pre-Modification Outstanding Recorded Investment(1) | Post-Modification Outstanding Recorded Investment(2) | |||||||||||
| Commercial and industrial | $ | 170 | $ | 172 | $ | 165 | $ | 165 | |||||||
| Commercial mortgage | 129 | 125 | 4 | 4 | |||||||||||
| Total commercial portfolio | 299 | 297 | 169 | 169 | |||||||||||
| Residential mortgage and home equity | 11 | 11 | 11 | 11 | |||||||||||
| Other consumer | — | — | — | — | |||||||||||
| Total consumer portfolio | 11 | 11 | 11 | 11 | |||||||||||
| Total | $ | 310 | $ | 308 | $ | 180 | $ | 180 | |||||||
| (1) | Represents the recorded investment in the loan immediately prior to the restructuring event. |
| (2) | Represents the recorded investment in the loan immediately following the restructuring event. It includes the effect of paydowns that were required as part of the restructuring terms. |
99
Note 3—Loans and Allowance for Loan Losses (Continued)
The following table provides the recorded investment amounts of TDRs at the date of default, for which there was a payment default during the years ended December 31, 2019 and 2018, and where the default occurred within the first twelve months after modification into a TDR. A payment default is defined as the loan being 60 days or more past due.
| (Dollars in millions) | For the Year Ended December 31, 2019 | For the Year Ended December 31, 2018 | ||||||
| Commercial and industrial | $ | 40 | $ | — | ||||
| Commercial mortgage | 1 | — | ||||||
| Total commercial portfolio | 41 | — | ||||||
| Residential mortgage and home equity | $ | 1 | $ | 3 | ||||
| Other consumer | — | — | ||||||
| Total consumer portfolio | 1 | 3 | ||||||
| Total | $ | 42 | $ | 3 | ||||
For loans in the consumer portfolio in which impairment is measured using the present value of expected future cash flows discounted at the loan’s effective interest rate, historical payment defaults and the propensity to redefault are some of the factors considered when determining the allowance for loan losses.
Loan Impairment
Loans that are individually evaluated for impairment include larger nonaccruing loans within the commercial and industrial, construction, and commercial mortgage loan portfolios and loans modified in a TDR. The Company records an impairment allowance when the value of an impaired loan is less than the recorded investment in the loan.
The following tables show information about impaired loans by class as of December 31, 2019 and 2018.
| December 31, 2019 | ||||||||||||||||||||||||
| Recorded Investment | Unpaid Principal Balance | |||||||||||||||||||||||
| (Dollars in millions) | With an Allowance | Without an Allowance | Total | Allowance for Impaired Loans | With an Allowance | Without an Allowance | ||||||||||||||||||
| Commercial and industrial | $ | 186 | $ | 13 | $ | 199 | $ | 43 | $ | 227 | $ | 99 | ||||||||||||
| Commercial mortgage | 7 | 168 | 175 | — | 7 | 168 | ||||||||||||||||||
| Construction | — | 62 | 62 | — | — | 62 | ||||||||||||||||||
| Total commercial portfolio | 193 | 243 | 436 | 43 | 234 | 329 | ||||||||||||||||||
| Residential mortgage and home equity | 178 | 66 | 244 | 12 | 187 | 86 | ||||||||||||||||||
| Other consumer | 2 | — | 2 | — | 2 | — | ||||||||||||||||||
| Total consumer portfolio | 180 | 66 | 246 | 12 | 189 | 86 | ||||||||||||||||||
| Total | $ | 373 | $ | 309 | $ | 682 | $ | 55 | $ | 423 | $ | 415 | ||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||
| Recorded Investment | Unpaid Principal Balance | |||||||||||||||||||||||
| (Dollars in millions) | With an Allowance | Without an Allowance | Total | Allowance for Impaired Loans | With an Allowance | Without an Allowance | ||||||||||||||||||
| Commercial and industrial | $ | 299 | $ | 22 | $ | 321 | $ | 61 | $ | 372 | $ | 39 | ||||||||||||
| Commercial mortgage | 25 | 41 | 66 | 1 | 25 | 41 | ||||||||||||||||||
| Construction | — | 63 | 63 | — | — | 63 | ||||||||||||||||||
| Total commercial portfolio | 324 | 126 | 450 | 62 | 397 | 143 | ||||||||||||||||||
| Residential mortgage and home equity | 196 | 83 | 279 | 13 | 205 | 106 | ||||||||||||||||||
| Other consumer | 1 | — | 1 | — | 1 | — | ||||||||||||||||||
| Total consumer portfolio | 197 | 83 | 280 | 13 | 206 | 106 | ||||||||||||||||||
| Total | $ | 521 | $ | 209 | $ | 730 | $ | 75 | $ | 603 | $ | 249 | ||||||||||||
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Note 3—Loans and Allowance for Loan Losses (Continued)
The following table presents the average recorded investment in impaired loans and the amount of interest income recognized for impaired loans during 2019, 2018 and 2017 for the commercial and consumer loans portfolio segments.
| For the Years Ended December 31, | ||||||||||||||||||||||||
| 2019 | 2018 | 2017 | ||||||||||||||||||||||
| (Dollars in millions) | Average Recorded Investment | Recognized Interest Income | Average Recorded Investment | Recognized Interest Income | Average Recorded Investment | Recognized Interest Income | ||||||||||||||||||
| Commercial and industrial | $ | 399 | $ | 11 | $ | 309 | $ | 12 | $ | 463 | $ | 18 | ||||||||||||
| Commercial mortgage | 119 | 16 | 60 | 27 | 58 | 41 | ||||||||||||||||||
| Construction | 62 | 10 | 95 | 8 | 45 | 5 | ||||||||||||||||||
| Total commercial portfolio | 580 | 37 | 464 | 47 | 566 | 64 | ||||||||||||||||||
| Residential mortgage and home equity | 262 | 16 | 298 | 17 | 355 | 20 | ||||||||||||||||||
| Other consumer | 2 | — | 1 | — | 1 | — | ||||||||||||||||||
| Total consumer portfolio | 264 | 16 | 299 | 17 | 356 | 20 | ||||||||||||||||||
| Total | $ | 844 | $ | 53 | $ | 763 | $ | 64 | $ | 922 | $ | 84 | ||||||||||||
Loans Held for Sale
The following table presents loan transfers from held for investment to held for sale and proceeds from sales of loans during 2019, 2018 and 2017 for the commercial and consumer loans portfolio segments.
| Years Ended December 31, | ||||||||||||||||||||||||
| 2019 | 2018 | 2017 | ||||||||||||||||||||||
| (Dollars in millions) | Transfer of loans from held for investment to held for sale, net | Proceeds from sale | Transfer of loans from held for investment to held for sale, net | Proceeds from sale | Transfer of loans from held for investment to held for sale, net | Proceeds from sale | ||||||||||||||||||
| Commercial portfolio | $ | 723 | $ | 952 | $ | 47 | $ | 638 | $ | 780 | $ | 926 | ||||||||||||
| Consumer portfolio | (5 | ) | — | (3 | ) | — | (4 | ) | — | |||||||||||||||
| Total | $ | 718 | $ | 952 | $ | 44 | $ | 638 | $ | 776 | $ | 926 | ||||||||||||
Loan Concentrations
The Company's most significant concentrations of credit risk within its loan portfolio include residential mortgage loans, commercial real estate loans, and commercial and industrial loans made to the financial and insurance industry, power and utilities industry, manufacturing industry, and business services industry. At December 31, 2019, the Company had $36 billion in residential mortgage loans, substantially all of which were made to borrowers in California. The Company had $18 billion in loans made to the commercial real estate industry and an additional $5 billion in unfunded commitments. At December 31, 2019, the Company had $8 billion in loans made to the financial and insurance industry and an additional $9 billion in unfunded commitments. At December 31, 2019, the Company had $3 billion in loans made to the power and utilities industry and an additional $5 billion in unfunded commitments. At December 31, 2019, the Company had $4 billion in loans made to the manufacturing industry and an additional $3 billion in unfunded commitments. At December 31, 2019, the Company had $3 billion in loans made to the business services industry and an additional $2 billion in unfunded commitments.
101
Note 4—Other Assets
Other Assets
The following table shows the balances of other assets as of December 31, 2019 and 2018.
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Other investments | $ | 3,033 | $ | 3,250 | ||||
| Premises and equipment, net | 656 | 635 | ||||||
| Software | 527 | 445 | ||||||
| Intangible assets | 531 | 444 | ||||||
| OREO | 1 | 1 | ||||||
| Other | 5,452 | 4,845 | ||||||
| Total other assets | $ | 10,200 | $ | 9,620 | ||||
Note 5—Goodwill and Other Intangible Assets
Goodwill
The changes in the carrying amount of goodwill during 2019 are shown in the table below. There were no changes in the carrying amount of goodwill during 2018.
| (Dollars in millions) | Regional Bank | Global Corporate & Investment Banking - U.S. | Transaction Banking | MUFG Fund Services | Total | |||||||||||||||
| Goodwill, December 31, 2018 | $ | 2,134 | $ | 840 | $ | 251 | $ | 76 | $ | 3,301 | ||||||||||
| Goodwill acquired during the year | 59 | 18 | — | — | 77 | |||||||||||||||
| Impairment losses | (1,423 | ) | (191 | ) | — | — | (1,614 | ) | ||||||||||||
| Goodwill, December 31, 2019 | $ | 770 | $ | 667 | $ | 251 | $ | 76 | $ | 1,764 | ||||||||||
| Goodwill | 2,193 | 858 | 251 | 76 | 3,378 | |||||||||||||||
| Accumulated impairment losses | (1,423 | ) | (191 | ) | — | — | (1,614 | ) | ||||||||||||
| Balance at December 31, 2019 | $ | 770 | $ | 667 | $ | 251 | $ | 76 | $ | 1,764 | ||||||||||
The Company performs goodwill impairment tests on an annual basis as of April 1, and between annual tests if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying amount. The Company adopted Accounting Standards Update No. 2017-04, Simplifying the Test for Goodwill Impairment ("ASU 2017-04") effective July 1, 2019. This standard eliminates Step 2 from the goodwill impairment test. Instead, the Company performs its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognizes an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit.
During the third quarter of 2019, due to the decline in interest rates and slower growth than previously forecasted, cash flow projections for certain reporting units were revised lower. The combination of these events led management to believe that it was more likely than not that the fair values of certain reporting units were below carrying value. As a result, the Company initiated an interim quantitative impairment test of goodwill allocated to three of its reporting units: Consumer Banking, Commercial Banking and Real Estate Industries, and Global Corporate & Investment Banking - U.S.
The Company estimated the fair value of its reporting units using a combination of the income and the market approaches. The income approach estimates the fair value of the reporting units by discounting management’s projections of each reporting unit’s cash flows, including a terminal value to estimate the fair value of cash flows beyond the final year of projected results, using a discount rate derived from the Capital
102
Note 5—Goodwill and Other Intangible Assets (Continued)
Asset Pricing Model. The market approach incorporates comparable public company price to tangible book value and price to earnings multiples.
Certain projected cash flows used to estimate fair value of the reporting units were revised lower than previous projections due to the combination of the following factors: the decline in interest rates through September 30, 2019 and a change in the Company’s expectation that interest rates will remain lower than previously assumed; updates to key loan growth and loan mix assumptions in the forecast to address the Company’s declining net interest margin; and a reduction of the expected growth and cash flow contribution of new initiatives based on a revised economic outlook. Multiples selected in the market approach to estimate fair value were also revised lower than those used in the most recent annual quantitative impairment test due to lower reporting unit earnings.
Upon completing the quantitative impairment test, the Company recorded an impairment charge of $1.6 billion in the third quarter of 2019, which represented the entire amount of goodwill allocated to the Consumer Banking reporting unit and a portion of the goodwill allocated to the Global Corporate & Investment Banking - U.S. reporting unit, which had $667 million allocated goodwill remaining after the impairment.
Intangible Assets
The table below reflects the Company's identifiable intangible assets and accumulated amortization at December 31, 2019 and 2018.
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||
| (Dollars in millions) | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||||||||||
| Core deposit intangibles | $ | 565 | $ | (543 | ) | $ | 22 | $ | 565 | $ | (537 | ) | $ | 28 | ||||||||||
| Trade names | 115 | (35 | ) | 80 | 111 | (32 | ) | 79 | ||||||||||||||||
| Customer relationships | 238 | (79 | ) | 159 | 238 | (63 | ) | 175 | ||||||||||||||||
Other(1) | 13 | (13 | ) | — | 18 | (15 | ) | 3 | ||||||||||||||||
| Total intangible assets with a definite useful life | $ | 931 | $ | (670 | ) | $ | 261 | $ | 932 | $ | (647 | ) | $ | 285 | ||||||||||
| (1) | December 31, 2019 and December 31, 2018 exclude $270 million and $159 million, respectively, of mortgage servicing rights accounted for at fair value. |
Total amortization expense for 2019, 2018 and 2017 was $34 million, $26 million and $30 million, respectively.
Estimated future amortization expense at December 31, 2019 is as follows:
| (Dollars in millions) | Core Deposit Intangibles | Trade Name | Customer Relationships | Total Identifiable Intangible Assets | ||||||||||||
| Years ending December 31, : | ||||||||||||||||
| 2020 | $ | 5 | $ | 4 | $ | 16 | $ | 25 | ||||||||
| 2021 | 4 | 3 | 15 | 22 | ||||||||||||
| 2022 | 4 | 3 | 15 | 22 | ||||||||||||
| 2023 | 2 | 3 | 14 | 19 | ||||||||||||
| 2024 | 2 | 3 | 14 | 19 | ||||||||||||
| Thereafter | 5 | 64 | 85 | 154 | ||||||||||||
| Total estimated amortization expense | $ | 22 | $ | 80 | $ | 159 | $ | 261 | ||||||||
103
Note 6—Variable Interest Entities
In the normal course of business, the Company has certain financial interests in entities which have been determined to be VIEs. Generally, a VIE is a corporation, partnership, trust or other legal structure where the equity investors do not have substantive voting rights, an obligation to absorb the entity’s losses or the right to receive the entity’s returns, or the ability to direct the significant activities of the entity. The following discusses the Company’s consolidated and unconsolidated VIEs.
Consolidated VIEs
The following tables present the assets and liabilities of consolidated VIEs recorded on the Company’s consolidated balance sheets at December 31, 2019 and 2018.
| December 31, 2019 | ||||||||||||||||||||||||
| Consolidated Assets | Consolidated Liabilities | |||||||||||||||||||||||
| (Dollars in millions) | Interest Bearing Deposits in Banks | Loans Held for Investment, Net | Other Assets | Total Assets | Other Liabilities | Total Liabilities | ||||||||||||||||||
| LIHC investments | $ | — | $ | — | $ | 96 | $ | 96 | $ | 36 | $ | 36 | ||||||||||||
| Leasing investments | — | 349 | 117 | 466 | 9 | 9 | ||||||||||||||||||
| Total consolidated VIEs | $ | — | $ | 349 | $ | 213 | $ | 562 | $ | 45 | $ | 45 | ||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||
| Consolidated Assets | Consolidated Liabilities | |||||||||||||||||||||||
| (Dollars in millions) | Interest Bearing Deposits in Banks | Loans Held for Investment, Net | Other Assets | Total Assets | Other Liabilities | Total Liabilities | ||||||||||||||||||
| LIHC investments | $ | — | $ | — | $ | 43 | $ | 43 | $ | — | $ | — | ||||||||||||
| Leasing investments | — | 570 | 122 | 692 | 17 | 17 | ||||||||||||||||||
| Total consolidated VIEs | $ | — | $ | 570 | $ | 165 | $ | 735 | $ | 17 | $ | 17 | ||||||||||||
LIHC Investments
The Company sponsors, manages and syndicates two LIHC investment fund structures. These investments are designed to generate a return primarily through the realization of U.S. federal tax credits and deductions. The Company is considered the primary beneficiary and has consolidated these investments because the Company has the power to direct activities that most significantly impact the funds’ economic performances and also has the obligation to absorb losses of the funds that could potentially be significant to the funds. Neither creditors nor equity investors in the LIHC investments have any recourse to the general credit of the Company, and the Company’s creditors do not have any recourse to the assets of the consolidated LIHC investments.
Leasing Investments
The Company has leasing investments primarily in the wind energy, rail and coal industries. The Company is considered the primary beneficiary and has consolidated these investments because the Company has the power to direct the activities of these entities that significantly impact the entities’ economic performances. The Company also has the right to receive potentially significant benefits or the obligation to absorb potentially significant losses of these investments.
Unconsolidated VIEs
The following tables present the Company’s carrying amounts related to the unconsolidated VIEs at December 31, 2019 and 2018. The tables also present the Company’s maximum exposure to loss resulting from its involvement with these VIEs. The maximum exposure to loss represents the carrying amount of the Company’s involvement plus any legally binding unfunded commitments in the unlikely event that all of the assets in the VIEs become worthless. During 2019, 2018, and 2017, the Company had noncash increases in unfunded commitments on LIHC investments of $43 million, $87 million and $55 million, respectively, included within other liabilities.
104
Note 6—Variable Interest Entities (Continued)
| December 31, 2019 | ||||||||||||||||||||||||||||||||
| Unconsolidated Assets | Unconsolidated Liabilities | |||||||||||||||||||||||||||||||
| (Dollars in millions) | Interest Bearing Deposits in Banks | Securities Available for Sale | Loans Held for Investment, Net | Other Assets | Total Assets | Other Liabilities | Total Liabilities | Maximum Exposure to Loss | ||||||||||||||||||||||||
| LIHC investments | $ | — | $ | 27 | $ | 219 | $ | 872 | $ | 1,118 | $ | 148 | $ | 148 | $ | 1,118 | ||||||||||||||||
| Renewable energy investments | — | — | — | 1,256 | 1,256 | — | — | 1,276 | ||||||||||||||||||||||||
| Other investments | — | — | 13 | 69 | 82 | 4 | 4 | 163 | ||||||||||||||||||||||||
| Total unconsolidated VIEs | $ | — | $ | 27 | $ | 232 | $ | 2,197 | $ | 2,456 | $ | 152 | $ | 152 | $ | 2,557 | ||||||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||||||||||
| Unconsolidated Assets | Unconsolidated Liabilities | |||||||||||||||||||||||||||||||
| (Dollars in millions) | Interest Bearing Deposits in Banks | Securities Available for Sale | Loans Held for Investment, Net | Other Assets | Total Assets | Other Liabilities | Total Liabilities | Maximum Exposure to Loss | ||||||||||||||||||||||||
| LIHC investments | $ | — | $ | 28 | $ | 198 | $ | 976 | $ | 1,202 | $ | 165 | $ | 165 | $ | 1,202 | ||||||||||||||||
| Renewable energy investments | 26 | — | 19 | 1,401 | 1,446 | 14 | 14 | 1,467 | ||||||||||||||||||||||||
| Other investments | — | — | — | 35 | 35 | — | — | 79 | ||||||||||||||||||||||||
| Total unconsolidated VIEs | $ | 26 | $ | 28 | $ | 217 | $ | 2,412 | $ | 2,683 | $ | 179 | $ | 179 | $ | 2,748 | ||||||||||||||||
LIHC Investments
The Company makes investments in partnerships and funds formed by third parties. The primary purpose of the partnerships and funds is to invest in low-income housing units and distribute tax credits and tax benefits associated with the underlying properties to investors. The Company is a limited partner investor and is allocated tax credits and deductions, but has no voting or other rights to direct the activities of the funds or partnerships, and therefore is not considered the primary beneficiary and does not consolidate these investments.
The following table presents the impact of the unconsolidated LIHC investments on our consolidated statements of income for the years ended December 31, 2019, 2018 and 2017:
| For the Years Ended December 31, | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| (Dollars in millions) | ||||||||||||
| Losses from LIHC investments included in other noninterest expense | $ | 6 | $ | 7 | $ | 13 | ||||||
| Amortization of LIHC investments included in income tax expense | 130 | 136 | 185 | |||||||||
| Tax credits and other tax benefits from LIHC investments included in income tax expense | 178 | 180 | 193 | |||||||||
Renewable Energy Investments
Through its subsidiaries, the Company makes equity investments in LLCs established by third party sponsors to operate and manage wind, solar, hydroelectric and cogeneration power plant projects. Power generated by the projects is sold to third parties through long-term purchase power agreements. As a limited investor member, the Company is allocated production tax credits and taxable income or losses associated with the projects. The Company has no voting or other rights to direct the significant activities of the LLCs, and therefore is not considered the primary beneficiary and does not consolidate these investments.
Other Investments
The Company has other investments in structures formed by third parties. The Company has no voting or other rights to direct the activities of the investments that would most significantly impact the entities’ performance, and therefore is not considered the primary beneficiary and does not consolidate these investments.
105
Note 7—Deposits
The aggregate amount of time deposits that meet or exceed the FDIC insurance limit was $7.5 billion and $4.2 billion at December 31, 2019 and 2018, respectively.
At December 31, 2019, the Company had $15.7 billion in interest bearing time deposits. Maturity information for all interest bearing time deposits is summarized below.
| (Dollars in millions) | December 31, 2019 | |||
| Due in one year or less | $ | 14,029 | ||
| Due after one year through two years | 1,119 | |||
| Due after two years through three years | 356 | |||
| Due after three years through four years | 70 | |||
| Due after four years through five years | 77 | |||
| Due after five years | — | |||
| Total | $ | 15,651 | ||
Note 8—Securities Financing Arrangements
The Company enters into repurchase agreements and securities lending agreements to facilitate customer match-book activity, cover short positions and fund the Company's trading inventory. The Company manages credit exposure from certain transactions by entering into master netting agreements and collateral arrangements with counterparties. The relevant agreements allow for the efficient closeout of the transaction, liquidation and set-off of collateral against the net amount owed by the counterparty following a default. Under these agreements and transactions, the Company either receives or provides collateral in the form of securities. In many cases, the Company is permitted to sell or repledge these securities held as collateral and use the securities to secure repurchase agreements or enter into securities lending transactions. In certain cases the Company may agree for collateral to be posted to a third party custodian under a tri-party arrangement that enables the Company to take control of such collateral in the event of a counterparty default. Default events generally include, among other things, failure to pay, insolvency or bankruptcy of a counterparty. For additional information related to securities pledged and received as collateral, see Note 2 to these Consolidated Financial Statements.
The following table presents the gross obligations for securities sold under agreements to repurchase and securities loaned by remaining contractual maturity and class of collateral pledged as of December 31, 2019 and December 31, 2018.
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | Overnight and Continuous | Up to 30 Days | 31 - 90 Days | Greater than 90 Days | Total | Overnight and Continuous | Up to 30 Days | 31 - 90 Days | Greater than 90 Days | Total | ||||||||||||||||||||||||||||||
| Securities sold under agreements to repurchase | ||||||||||||||||||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | 12,219 | $ | 2,237 | $ | 385 | $ | 102 | $ | 14,943 | $ | 9,680 | $ | 2,945 | $ | 3,046 | $ | 335 | $ | 16,006 | ||||||||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||||||||||||||
| U.S. agencies | 5,322 | 1,582 | 7,126 | — | 14,030 | 9,803 | 1,640 | 7,569 | — | 19,012 | ||||||||||||||||||||||||||||||
| Corporate debt | 688 | 24 | 1,161 | — | 1,873 | 682 | 130 | 1,227 | — | 2,039 | ||||||||||||||||||||||||||||||
| Other debt | 327 | — | 533 | — | 860 | 115 | 245 | 519 | — | 879 | ||||||||||||||||||||||||||||||
| Equity | 1,400 | 349 | 456 | — | 2,205 | 387 | 220 | 255 | — | 862 | ||||||||||||||||||||||||||||||
| Total | $ | 19,956 | $ | 4,192 | $ | 9,661 | $ | 102 | $ | 33,911 | $ | 20,667 | $ | 5,180 | $ | 12,616 | $ | 335 | $ | 38,798 | ||||||||||||||||||||
| Securities loaned: | ||||||||||||||||||||||||||||||||||||||||
| Corporate bonds | 2 | — | — | — | 2 | 1 | — | — | — | 1 | ||||||||||||||||||||||||||||||
| Equity | 257 | 236 | — | — | 493 | 92 | — | — | — | 92 | ||||||||||||||||||||||||||||||
| Total | $ | 259 | $ | 236 | $ | — | $ | — | $ | 495 | $ | 93 | $ | — | $ | — | $ | — | $ | 93 | ||||||||||||||||||||
106
Offsetting Financial Assets and Liabilities
The Company primarily enters into derivative contracts, repurchase agreements and securities lending agreements with counterparties utilizing standard International Swaps and Derivatives Association Master Agreements and Credit Support Annex Agreements, Master Repurchase Agreements, and Master Securities Lending Agreements, respectively. These agreements generally establish the terms and conditions of the transactions, including a legal right to set-off amounts payable and receivable between the Company and a counterparty, regardless of whether or not such amounts have matured or have contingency features.
The following tables present the offsetting of financial assets and liabilities as of December 31, 2019 and December 31, 2018.
| December 31, 2019 | ||||||||||||||||||||||||
Gross Amounts Not Offset in Balance Sheet | ||||||||||||||||||||||||
| (Dollars in millions) | Gross Amounts of Recognized Assets/Liabilities | Gross Amounts Offset in Balance Sheet | Net Amounts Presented in Balance Sheet | Financial Instruments | Cash Collateral Received/Pledged | Net Amount | ||||||||||||||||||
| Financial Assets: | ||||||||||||||||||||||||
| Derivative assets | $ | 1,233 | $ | 264 | $ | 969 | $ | 26 | $ | — | $ | 943 | ||||||||||||
| Securities borrowed or purchased under resale agreements | 29,483 | 5,540 | 23,943 | 23,844 | — | 99 | ||||||||||||||||||
| Total | $ | 30,716 | $ | 5,804 | $ | 24,912 | $ | 23,870 | $ | — | $ | 1,042 | ||||||||||||
| Financial Liabilities: | ||||||||||||||||||||||||
| Derivative liabilities | $ | 523 | $ | 306 | $ | 217 | $ | 129 | $ | 1 | $ | 87 | ||||||||||||
| Securities loaned or sold under repurchase agreements | 34,406 | 5,540 | 28,866 | 27,957 | — | 909 | ||||||||||||||||||
| Total | $ | 34,929 | $ | 5,846 | $ | 29,083 | $ | 28,086 | $ | 1 | $ | 996 | ||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||
Gross Amounts Not Offset in Balance Sheet | ||||||||||||||||||||||||
| (Dollars in millions) | Gross Amounts of Recognized Assets/Liabilities | Gross Amounts Offset in Balance Sheet | Net Amounts Presented in Balance Sheet | Financial Instruments | Cash Collateral Received/Pledged | Net Amount | ||||||||||||||||||
| Financial Assets: | ||||||||||||||||||||||||
| Derivative assets | $ | 871 | $ | 354 | $ | 517 | $ | 14 | $ | — | $ | 503 | ||||||||||||
| Securities borrowed or purchased under resale agreements | 33,974 | 11,606 | 22,368 | 22,291 | — | 77 | ||||||||||||||||||
| Total | $ | 34,845 | $ | 11,960 | $ | 22,885 | $ | 22,305 | $ | — | $ | 580 | ||||||||||||
| Financial Liabilities: | ||||||||||||||||||||||||
| Derivative liabilities | $ | 804 | $ | 322 | $ | 482 | $ | 69 | $ | — | $ | 413 | ||||||||||||
| Securities loaned or sold under repurchase agreements | 38,891 | 11,606 | 27,285 | 26,434 | — | 851 | ||||||||||||||||||
| Total | $ | 39,695 | $ | 11,928 | $ | 27,767 | $ | 26,503 | $ | — | $ | 1,264 | ||||||||||||
107
Note 9—Commercial Paper and Other Short-Term Borrowings
The following table is a summary of the Company's commercial paper and other short-term borrowings:
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Debt issued by MUB | ||||||||
| Commercial paper, with a weighted average interest rate of 1.98% and 2.39% at December 31, 2019 and December 31, 2018, respectively | $ | 58 | $ | 382 | ||||
| Federal Home Loan Bank advances, with a weighted average interest rate of 1.86% and 2.52% at December 31, 2019 and December 31, 2018, respectively | 6,100 | 7,800 | ||||||
| Total debt issued by MUB | 6,158 | 8,182 | ||||||
| Debt issued by other MUAH subsidiaries | ||||||||
| Short-term debt due to MUFG Bank, Ltd., with weighted average interest rates of 2.27% and 3.01% at December 31, 2019 and December 31, 2018, respectively | 69 | 145 | ||||||
| Short-term debt due to affiliates, with weighted average interest rates of (-0.10)% and (-0.07)% at December 31, 2019 and December 31, 2018, respectively | 257 | 936 | ||||||
| Total debt issued by other MUAH subsidiaries | 326 | 1,081 | ||||||
| Total commercial paper and other short-term borrowings | $ | 6,484 | $ | 9,263 | ||||
At December 31, 2019, Federal Home Loan Bank advances had a weighted average maturity of 160 days. The commercial paper outstanding had a weighted average remaining maturity of 45 days. The short-term debt due to MUFG Bank, Ltd. had a weighted average remaining maturity of 55 days and the short-term debt due to affiliates had a weighted average remaining maturity of 141 days.
Short-term debt due to MUFG Bank, Ltd. consists of both secured and unsecured fixed and floating rate borrowings.
MUSA maintains an uncommitted, unsecured lending facility with Mitsubishi UFJ Securities Holdings Co., Ltd. under which it may borrow up to JPY 160 billion (USD $1.5 billion equivalent). Under the terms of the facility, MUSA can choose to borrow in Japanese Yen or U.S. Dollars. Japanese Yen denominated borrowings include an extension option allowing MUSA to extend the maturity of an individual draw by 100 days at any time prior to its original, stated maturity. At December 31, 2019, MUSA had JPY 28 billion (USD $257 million equivalent) drawn under this facility.
108
Note 10—Long-Term Debt
Long-term debt consists of borrowings having an original maturity of one year or more. The following is a summary of the Company's long-term debt.
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Debt issued by MUAH | ||||||||
| Senior debt: | ||||||||
| Fixed rate 3.50% notes due June 2022 | $ | 399 | $ | 398 | ||||
| Fixed rate 3.00% notes due February 2025 | 397 | 397 | ||||||
| Senior debt due to MUFG Bank, Ltd: | ||||||||
| Floating rate debt due December 2021. This note, which bore interest at 0.81% above 3-month LIBOR, had a rate of 3.58% at December 31, 2018 | — | 1,625 | ||||||
| Floating rate debt due December 2022. This note, which bears interest at 0.90% above 3-month LIBOR, had a rate of 3.03% at December 31, 2019 and 3.67% at December 31, 2018 | 3,250 | 3,250 | ||||||
| Floating rate debt due December 2022. This note, which bears interest at 0.97% above 3-month LIBOR, had a rate of 3.07% at December 31, 2019 | 125 | — | ||||||
| Floating rate debt due December 2023. This note, which bears interest at 0.99% above 3-month LIBOR, had a rate of 3.12% at December 31, 2019 and 3.76% at December 31, 2018 | 1,625 | 1,625 | ||||||
| Floating rate debt due December 2023. This note, which bears interest at 0.94% above 3-month LIBOR, had a rate of 2.82% at December 31, 2019 | 1,765 | — | ||||||
| Floating rate debt due December 2023. This note, which bears interest at 0.76% above 3-month EURIBOR, had a rate of 0.76% at December 31, 2019 and December 31, 2018 | 24 | 24 | ||||||
| Junior subordinated debt payable to trusts: | ||||||||
| Floating rate note due September 2036. This note had an interest rate of 3.59% at December 31, 2019 and 4.49% at December 31, 2018 | 37 | 36 | ||||||
| Total debt issued by MUAH | 7,622 | 7,355 | ||||||
| Debt issued by MUB | ||||||||
| Senior debt: | ||||||||
| Fixed rate 2.10% notes due December 2022. | 698 | — | ||||||
| Floating rate debt due December 2022. These notes which bear interest at 0.71% above the Secured Overnight Financing Rate had a rate of 2.26% at December 31, 2019 | 300 | — | ||||||
| Floating rate debt due March 2022. This note, which bears interest at 0.60% above 3-month LIBOR, had a rate of 2.49% at December 31, 2019 | 300 | — | ||||||
| Variable rate FHLB of San Francisco advances due November 2020. These notes bear a combined weighted average rate of 1.90% at December 31, 2019 | 1,100 | — | ||||||
| Fixed rate 2.25% notes due May 2019 | — | 498 | ||||||
| Fixed rate 3.15% notes due April 2022 | 998 | — | ||||||
| Fixed rate FHLB of San Francisco advances due between February 2020 and December 2023. These notes bear a combined weighted average rate of 2.95% at December 31, 2019 and 2.66% at December 31, 2018 | 5,500 | 9,100 | ||||||
| Other | 13 | 34 | ||||||
| Total debt issued by MUB | 8,909 | 9,632 | ||||||
| Debt issued by other MUAH subsidiaries | ||||||||
| Senior debt due to MUFG Bank, Ltd: | ||||||||
| Various floating rate borrowings due between December 2020 and May 2021. These notes, which bear interest above 3-month LIBOR had a weighted average interest rate of 1.94% at December 31, 2019 and 2.80% at December 31, 2018 | 250 | 250 | ||||||
| Various fixed rate borrowings due between January 2020 and June 2023 with a weighted average interest rate of 2.22% (between1.68% and 2.44%) at December 31, 2019 and 1.82% (between 0.14% and 2.44%) at December 31, 2018 | 137 | 244 | ||||||
| Subordinated debt due to Affiliate: | ||||||||
| Floating rate borrowings due March 2019. These notes, which bore interest above 6-month LIBOR had an interest rate of 4.13% at December 31, 2018 | — | 75 | ||||||
| Non-recourse debt due to MUFG Bank, Ltd: | ||||||||
| Various floating rate non-recourse borrowings due December 2021. These notes, which bear interest above 1- or 3-month LIBOR had a weighted average interest rate of 2.17% at December 31, 2019 and 4.09% (between 2.75% and 4.17%) at December 31, 2018 | 3 | 53 | ||||||
| Fixed rate non-recourse borrowings due between March 2020 and July 2023 which had an interest rate of 3.07% (between 1.96% and 3.72%) at December 31, 2019 and 3.05% at December 31, 2018 | 166 | 187 | ||||||
| Other non-recourse debt: | ||||||||
| Various floating rate non-recourse borrowings due December 2023. These notes, which bear interest above 1- or 3-month LIBOR had a weighted average interest rate of 3.93% at December 31, 2019 and 4.21% (between 4.17% and 4.48%) at December 31, 2018 | 13 | 89 | ||||||
| Fixed rate non-recourse borrowings due December 2026 which had an interest rate of 5.34% at December 31, 2019 and December 31, 2018 | 29 | 33 | ||||||
| Total debt issued by other MUAH subsidiaries | 598 | 931 | ||||||
| Total long-term debt | $ | 17,129 | $ | 17,918 | ||||
109
Note 10—Long-Term Debt (Continued)
A summary of maturities for the Company's long-term debt at December 31, 2019 is presented below.
| (Dollars in millions) | Debt issued by MUAH | Debt issued by MUB | Debt issued by other MUAH subsidiaries | Total | ||||||||||||
| 2020 | $ | — | $ | 2,627 | $ | 212 | $ | 2,839 | ||||||||
| 2021 | — | 1,925 | 179 | 2,104 | ||||||||||||
| 2022 | 3,774 | 2,794 | 41 | 6,609 | ||||||||||||
| 2023 | 3,414 | 1,550 | 137 | 5,101 | ||||||||||||
| Thereafter | 434 | 13 | 29 | 476 | ||||||||||||
| Total long-term debt | $ | 7,622 | $ | 8,909 | $ | 598 | $ | 17,129 | ||||||||
Senior Debt
Certain of the debt issuances are repayable prior to maturity at the Company’s option at a redemption price equal to 100% of par plus accrued interest, plus a make-whole premium. MUAH senior debt was issued under a shelf registration statement with the SEC, which expired as of January 29, 2018.
In December 2019, MUB issued $300 million of floating rate senior bank notes and $700 million of 2.10% senior bank notes. In March 2019, MUB issued $300 million of floating rate senior bank notes and $1.0 billion of 3.15% senior bank notes. These notes were issued as part of MUB's $12 billion bank note program under which MUB may issue, from time to time, senior and subordinated unsecured debt obligations. At December 31, 2019, there was $3.6 billion available for issuance under the program. MUB does not have any firm commitments in place to sell notes under this program.
MUAH Senior Debt due to MUFG Bank, Ltd.
In December 2018, MUAH entered into a Master Internal Total Loss Absorbing Capacity Loan Agreement with MUFG Bank, Ltd., under which MUAH initially borrowed an aggregate of $6.5 billion to comply with the Federal Reserve’s TLAC rule (12 CFR Section 252.165). MUAH may prepay the notes, in whole or in part, two years prior to the stated maturities. The outstanding principal of the notes can be declared due and payable immediately, together with any accrued and unpaid interest, in the event of liquidation, insolvency or similar proceeding with respect to MUAH or all or substantially all of its property. As the TLAC long-term debt is repaid and refinanced from time to time, it is expected that such debt will be replaced by new TLAC long-term debt of similar terms. Under certain circumstances, the Federal Reserve may issue a conversion order pursuant to the TLAC rule (12 CFR Section 252.163) that would result in the conversion of any then-outstanding note, in whole or in part, to MUAH equity issued to MUFG Bank, Ltd.
Senior Debt due to MUFG Bank, Ltd. by other MUAH subsidiaries
MUAH’s subsidiaries also borrow on a long-term basis from MUFG Bank, Ltd. At December 31, 2019, $250 million of senior debt issued to MUFG Bank, Ltd. was floating rate and linked to customer deposits maintained at MUFG Bank, Ltd.’s New York Branch. An additional $137 million was fixed rate, amortizing funding tied to specific assets owned by MUAH’s subsidiaries.
FHLB Senior Debt
The Bank borrows periodically from the FHLB on a medium-term basis. The advances are secured by certain of the Bank's assets and bear either a fixed or a floating interest rate. The floating rates are tied to the three-month LIBOR plus a spread, reset every 90 days. As of December 31, 2019 and December 31, 2018, the Bank had $45.3 billion and $44.3 billion of pledged loans, respectively, as collateral for short-term and medium-term advances from the FHLB and the Federal Reserve Bank.
Subordinated Debt due to Affiliate
MUSA maintains subordinated funding provided by an affiliate. This subordinated debt is a junior obligation to MUSA’s existing and future outstanding senior indebtedness.
110
Note 10—Long-Term Debt (Continued)
Non-recourse Debt
Non-recourse debt serves as funding for certain lease financings offered to customers. The lenders are secured by an interest in the underlying leased assets and have no recourse to the Company or its subsidiaries. Interest and principal on this debt is serviced entirely by the underlying assets and is not supported by the Company.
Note 11—Fair Value Measurement and Fair Value of Financial Instruments
Valuation Methodologies
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., an exit price) in an orderly transaction between willing market participants at the measurement date. The Company has an established and documented process for determining fair value for financial assets and liabilities that are measured at fair value on either a recurring or nonrecurring basis. 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 yield curves, foreign exchange rates, credit spreads, commodity prices and implied volatilities. 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 that consider the Company's own creditworthiness in determining the fair value of its trading assets and liabilities.
Fair Value Hierarchy
In determining fair value, the Company maximizes the use of observable market inputs and minimizes 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 significant inputs used, the Company classifies its fair value measurements in accordance with the three-level hierarchy as defined by GAAP. This hierarchy is based on the quality, observability, and reliability of the information used to determine fair value. The Company’s policy is to recognize transfers in and out of Level 1, 2 and 3 as of the end of a reporting period.
Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities. Since the valuations are based on quoted prices that are readily available in an active market, they do 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 at least one significant unobservable input that is supported by little or no market activity and is significant to the fair value measurement. Values are determined using pricing models and discounted cash flow models that include management judgment and estimation, which may be significant.
In assigning the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are measured at fair value. In certain cases, the inputs used to measure fair value 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 many significant inputs that are readily observable.
111
Note 11—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
Valuation Processes
The Company has established a valuation committee to oversee its valuation framework for measuring fair value and to establish valuation policies and procedures. The valuation committee's responsibilities include reviewing fair value measurements and categorizations within the fair value hierarchy and monitoring the use of pricing sources, mark-to-model valuations, dealer quotes and other valuation processes. The valuation committee reports to the Company's Disclosure & Accounting Committee and meets at least quarterly.
Independent price verification is performed periodically by the Company to test the market data and valuations of substantially all instruments measured at fair value on a recurring basis. As part of its independent price verification procedures, the Company compares pricing sources, tests data variances within certain thresholds and performs variance analysis, utilizing third party valuations and both internal and external models. Results are formally reported on a quarterly basis to the valuation committee.
A description of the valuation methodologies used for certain financial assets and liabilities measured at fair value is as follows:
Recurring Fair Value Measurements:
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.
Securities Available for Sale: Securities available for sale are recorded at fair value based on readily available quoted market prices, if available. When available, these securities are classified as Level 1 and include exchange traded equities. If such quoted market prices are not available, management utilizes third-party pricing services and broker quotations from dealers in the specific instruments. These securities are classified as Level 2 and include U.S. Treasuries, U.S. government-sponsored agencies, RMBS and CMBS, CLOs, and certain other debt securities. If no market prices or broker quotes are available, internal pricing models are used. To the extent possible, these pricing model valuations utilize observable market inputs obtained for similar securities. Typical inputs include LIBOR and U.S. Treasury yield curves, benchmark yields, consensus prepayment estimates and credit spreads. When pricing model valuations use significant unobservable inputs, the securities are classified as Level 3. These other debt securities primarily include direct bank purchase bonds. The valuation of these securities is based upon a return on equity method, which incorporates a market-required return on capital, probability of default and loss severity.
Other Assets: Other assets included mortgage servicing rights, loans held for sale and derivative contracts. The fair value of the Company's mortgage servicing rights asset is determined using a discounted cash flow model with significant unobservable inputs, primarily influenced by forecasted future servicing revenues and prepayment speed assumptions. The fair value of the Company's loans held for sale is based on secondary market offerings for loans with similar characteristics. Mortgage servicing rights and loans held for sale are classified as Level 3. See discussion below on derivatives.
Derivatives: The Company's derivatives are primarily 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. These derivatives, which are included in trading account assets, trading account liabilities, other assets and other liabilities are generally classified as Level 2. Trading account assets and trading account liabilities include Level 3 derivatives comprised of embedded derivatives contained in market-linked CDs and matched over-the-counter options, whose fair value is obtained through unadjusted third party broker quotes, which incorporate significant unobservable inputs.
Trading Account Liabilities: Trading account liabilities are recorded at fair value and primarily consist of securities sold, not yet purchased and derivatives. See discussion above on derivatives valuation. Securities sold, not yet purchased consist of U.S. Treasury, U.S. government-sponsored agencies, state and municipal,
112
Note 11—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
sovereign government obligations, corporate bonds, ABS and equities and are classified as Level 2, which utilize the same valuation methodology as securities available for sale.
Other Liabilities: Other liabilities included the FDIC clawback liability and derivative contracts. The fair value of the Company's FDIC clawback liability is determined using a discounted cash flow model with significant unobservable inputs, which include probability of default and loss severity. The FDIC clawback liability is classified as Level 3. See discussion above on derivatives.
Nonrecurring Fair Value Measurements:
Individually Impaired Loans: Individually impaired loans are valued at the time the loan is identified as impaired based on the present value of the remaining expected cash flows. Because the discount factor applied is based on the loan's original effective yield rather than a current market rate, that present value does not represent fair value. However, as a practical expedient, an impaired loan may be measured based on a loan's observable market price or the underlying collateral securing the loan (provided the loan is collateral dependent), which does approximate fair value. 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. The loan's market price is determined using market pricing for similar assets, adjusted for management judgment. Impaired loans are reviewed and evaluated at least quarterly for additional impairment and adjusted accordingly. Impaired loans that are adjusted to fair value based on underlying collateral or the loan's market price are classified as Level 3.
113
Note 11—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
Fair Value Measurements on a Recurring Basis
The following tables present financial assets and financial liabilities measured at fair value on a recurring basis at December 31, 2019 and 2018, by major category and by valuation hierarchy level.
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | Level 1 | Level 2 | Level 3 | Netting(1) | Fair Value | Level 1 | Level 2 | Level 3 | Netting(1) | Fair Value | ||||||||||||||||||||||||||||||
| Assets | ||||||||||||||||||||||||||||||||||||||||
| Trading account assets: | ||||||||||||||||||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | — | $ | 2,393 | $ | — | $ | — | $ | 2,393 | $ | — | $ | 3,071 | $ | — | $ | — | $ | 3,071 | ||||||||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||||||||||||||
| U.S. agencies | — | 5,376 | — | — | 5,376 | — | 5,785 | — | — | 5,785 | ||||||||||||||||||||||||||||||
| Corporate debt | — | 1,212 | — | — | 1,212 | — | 1,367 | — | — | 1,367 | ||||||||||||||||||||||||||||||
| Other debt | — | 306 | — | — | 306 | — | 360 | — | — | 360 | ||||||||||||||||||||||||||||||
| Equity | 127 | — | — | — | 127 | 127 | — | — | — | 127 | ||||||||||||||||||||||||||||||
| Derivative contracts | 16 | 1,195 | 8 | (256 | ) | 963 | 19 | 806 | 13 | (335 | ) | 503 | ||||||||||||||||||||||||||||
| Total trading account assets | 143 | 10,482 | 8 | (256 | ) | 10,377 | 146 | 11,389 | 13 | (335 | ) | 11,213 | ||||||||||||||||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||||||||||||||||||
| U.S. Treasury and government agencies | — | 5,438 | — | — | 5,438 | — | 3,429 | — | — | 3,429 | ||||||||||||||||||||||||||||||
| Mortgage-backed: | ||||||||||||||||||||||||||||||||||||||||
| U.S. agencies | — | 5,468 | — | — | 5,468 | — | 8,007 | — | — | 8,007 | ||||||||||||||||||||||||||||||
| Residential - non-agency | — | 762 | — | — | 762 | — | 864 | — | — | 864 | ||||||||||||||||||||||||||||||
| Commercial - non-agency | — | 3,471 | 18 | — | 3,489 | — | 1,180 | — | — | 1,180 | ||||||||||||||||||||||||||||||
| Collateralized loan obligations | — | 1,491 | — | — | 1,491 | — | 1,474 | — | — | 1,474 | ||||||||||||||||||||||||||||||
| Direct bank purchase bonds | — | — | 936 | — | 936 | — | — | 1,190 | — | 1,190 | ||||||||||||||||||||||||||||||
| Other | — | 28 | 177 | — | 205 | — | 29 | 141 | — | 170 | ||||||||||||||||||||||||||||||
| Total securities available for sale | — | 16,658 | 1,131 | — | 17,789 | — | 14,983 | 1,331 | — | 16,314 | ||||||||||||||||||||||||||||||
| Other assets: | ||||||||||||||||||||||||||||||||||||||||
| Mortgage servicing rights | — | — | 270 | — | 270 | — | — | 159 | — | 159 | ||||||||||||||||||||||||||||||
| Loans held for sale | — | — | 42 | — | 42 | — | — | 117 | — | 117 | ||||||||||||||||||||||||||||||
| Derivative contracts | — | 10 | 4 | (8 | ) | 6 | — | 32 | 1 | (19 | ) | 14 | ||||||||||||||||||||||||||||
| Equity securities | 10 | — | — | — | 10 | 9 | — | — | — | 9 | ||||||||||||||||||||||||||||||
| Total other assets | 10 | 10 | 316 | (8 | ) | 328 | 9 | 32 | 277 | (19 | ) | 299 | ||||||||||||||||||||||||||||
| Total assets | $ | 153 | $ | 27,150 | $ | 1,455 | $ | (264 | ) | $ | 28,494 | $ | 155 | $ | 26,404 | $ | 1,621 | $ | (354 | ) | $ | 27,826 | ||||||||||||||||||
| Percentage of total | 1 | % | 95 | % | 5 | % | (1 | )% | 100 | % | — | % | 95 | % | 6 | % | (1 | )% | 100 | % | ||||||||||||||||||||
| Percentage of total Company assets | — | % | 16 | % | 1 | % | — | % | 17 | % | — | % | 16 | % | 1 | % | — | % | 17 | % | ||||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||||||||||||||||||
| Trading account liabilities: | ||||||||||||||||||||||||||||||||||||||||
| U.S. Treasury and government agencies | $ | — | $ | 2,299 | $ | — | $ | — | $ | 2,299 | $ | — | $ | 2,753 | $ | — | $ | — | $ | 2,753 | ||||||||||||||||||||
| Corporate debt | — | 646 | — | — | 646 | — | 717 | — | — | 717 | ||||||||||||||||||||||||||||||
| Other debt | — | 4 | — | — | 4 | — | 10 | — | — | 10 | ||||||||||||||||||||||||||||||
| Equity | 105 | — | — | — | 105 | 70 | — | — | — | 70 | ||||||||||||||||||||||||||||||
| Derivatives contracts | 11 | 499 | 8 | (306 | ) | 212 | 55 | 731 | 13 | (322 | ) | 477 | ||||||||||||||||||||||||||||
| Total trading account liabilities | 116 | 3,448 | 8 | (306 | ) | 3,266 | 125 | 4,211 | 13 | (322 | ) | 4,027 | ||||||||||||||||||||||||||||
| Other liabilities: | ||||||||||||||||||||||||||||||||||||||||
| FDIC clawback liability | — | — | 121 | — | 121 | — | — | 116 | — | 116 | ||||||||||||||||||||||||||||||
| Derivatives contracts | — | 2 | 3 | — | 5 | — | 3 | 2 | — | 5 | ||||||||||||||||||||||||||||||
| Total other liabilities | — | 2 | 124 | — | 126 | — | 3 | 118 | — | 121 | ||||||||||||||||||||||||||||||
| Total liabilities | $ | 116 | $ | 3,450 | $ | 132 | $ | (306 | ) | $ | 3,392 | $ | 125 | $ | 4,214 | $ | 131 | $ | (322 | ) | $ | 4,148 | ||||||||||||||||||
| Percentage of total | 3 | % | 102 | % | 4 | % | (9 | )% | 100 | % | 3 | % | 102 | % | 3 | % | (8 | )% | 100 | % | ||||||||||||||||||||
| Percentage of total Company liabilities | — | % | 2 | % | — | % | — | % | 2 | % | — | % | 3 | % | — | % | — | % | 3 | % | ||||||||||||||||||||
| (1) | Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts. |
114
Note 11—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
The following tables present a reconciliation of the assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2019 and 2018. Level 3 securities available for sale at December 31, 2019 and 2018 largely consist of direct bank purchase bonds.
| For the Year Ended | ||||||||||||||||||||||||||||||||||||||||
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | Trading Account Assets | Securities Available for Sale | Other Assets | Trading Account Liabilities | Other Liabilities | Trading Account Assets | Securities Available for Sale | Other Assets | Trading Account Liabilities | Other Liabilities | ||||||||||||||||||||||||||||||
| Asset (liability) balance, beginning of period | $ | 13 | $ | 1,331 | $ | 277 | $ | (13 | ) | $ | (118 | ) | $ | 139 | $ | 1,600 | $ | 65 | $ | (138 | ) | $ | (119 | ) | ||||||||||||||||
| Total gains (losses) - (realized/unrealized): | ||||||||||||||||||||||||||||||||||||||||
| Included in income before taxes | 4 | — | (88 | ) | (4 | ) | (6 | ) | (10 | ) | — | (8 | ) | 9 | 1 | |||||||||||||||||||||||||
| Included in other comprehensive income | — | 31 | — | — | — | — | (9 | ) | — | — | — | |||||||||||||||||||||||||||||
| Purchases/additions | — | 57 | 396 | — | — | — | 126 | 220 | — | — | ||||||||||||||||||||||||||||||
| Sales | — | — | (269 | ) | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||
| Settlements | (9 | ) | (288 | ) | — | 9 | — | (116 | ) | (386 | ) | — | 116 | — | ||||||||||||||||||||||||||
| Asset (liability) balance, end of period | $ | 8 | $ | 1,131 | $ | 316 | $ | (8 | ) | $ | (124 | ) | $ | 13 | $ | 1,331 | $ | 277 | $ | (13 | ) | $ | (118 | ) | ||||||||||||||||
| Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period | $ | 4 | $ | — | $ | (103 | ) | $ | (4 | ) | $ | (6 | ) | $ | (10 | ) | $ | — | $ | (8 | ) | $ | 9 | $ | 1 | |||||||||||||||
The following table presents information about significant unobservable inputs related to the Company's significant Level 3 assets and liabilities at December 31, 2019.
| December 31, 2019 | |||||||||||||
| (Dollars in millions) | Level 3 Fair Value | Valuation Technique | Significant Unobservable Input(s) | Range of Inputs | Weighted Average | ||||||||
| Securities available for sale: | |||||||||||||
| Direct bank purchase bonds | $ | 936 | Return on equity | Market-required return on capital | 8.0 - 10.0 | % | 9.4 | % | |||||
| Probability of default | 0.0 - 25.0 | % | 0.3 | % | |||||||||
| Loss severity | 10.0 - 45.0 | % | 20.0 | % | |||||||||
The direct bank purchase bonds generally use a return on equity valuation technique. This technique uses significant unobservable inputs such as market-required return on capital, probability of default and loss severity. Increases (decreases) in any of these inputs in isolation would result in a lower (higher) fair value measurement.
115
Note 11—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
Fair Value Measurement on a Nonrecurring Basis
Certain 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. For assets measured at fair value on a nonrecurring basis during the years ended December 31, 2019 and 2018 that were still held on the consolidated balance sheet as of the respective periods ended, the following tables present the fair value of such assets by the level of valuation assumptions used to determine each fair value adjustment.
| December 31, 2019 | For the Year Ended December 31, 2019 | |||||||||||||||||||
| (Dollars in millions) | Fair Value | Level 1 | Level 2 | Level 3 | Gains (Losses) | |||||||||||||||
| Loans held for investment | $ | 64 | $ | — | $ | — | $ | 64 | $ | (20 | ) | |||||||||
Goodwill (1) | 1,764 | — | — | 1,764 | (1,614 | ) | ||||||||||||||
| Other assets | 301 | — | — | 301 | (36 | ) | ||||||||||||||
| Total | $ | 2,129 | $ | — | $ | — | $ | 2,129 | $ | (1,670 | ) | |||||||||
| (1) | For further information, see Note 5 to these Consolidated Financial Statements. |
| December 31, 2018 | For the Year Ended December 31, 2018 | |||||||||||||||||||
| (Dollars in millions) | Fair Value | Level 1 | Level 2 | Level 3 | Gains (Losses) | |||||||||||||||
| Loans held for investment | $ | 151 | $ | — | $ | — | $ | 151 | $ | (106 | ) | |||||||||
| Other assets | 139 | — | — | 139 | (45 | ) | ||||||||||||||
| Total | $ | 290 | $ | — | $ | — | $ | 290 | $ | (151 | ) | |||||||||
Fair Value of Financial Instruments Disclosures
In addition to financial instruments recorded at fair value in the Company's financial statements, the disclosure of the estimated fair value of financial instruments that are not carried at fair value is also required. Excluded from this disclosure requirement are lease financing arrangements, investments accounted for under the equity method, employee pension and other postretirement obligations and all nonfinancial assets and liabilities, including goodwill and other intangible assets such as long-term customer relationships. The fair values presented are estimates for certain individual financial instruments and do not represent an estimate of the fair value of the Company as a whole.
Certain financial instruments that are not recognized at fair value on the consolidated balance sheet are carried at amounts that approximate fair value due to their short-term nature. These financial instruments include cash and due from banks, interest bearing deposits in banks, federal funds sold and purchased, securities borrowed or purchased under resale agreements, securities loaned or sold under repurchase agreements and commercial paper. In addition, the fair value of deposits with no stated maturity, such as noninterest bearing demand deposits, interest bearing checking, and market rate and other savings are deemed to equal their carrying amounts.
Financial instruments for which their carrying amounts do not approximate fair value include securities held to maturity, loans held for investment, interest bearing deposits with stated maturities, certain other short-term borrowings, long-term debt and off-balance sheet instruments.
Securities Held to Maturity: The fair value of U.S. Treasury, U.S. government agency and government-sponsored agencies securities, including RMBS and CMBS classified as held to maturity are based on unadjusted third party pricing service prices.
Loans Held for Investment: The fair values of mortgage loans were estimated based on quoted market prices for loans with similar credit and interest rate risk characteristics. The fair values of other loans were estimated based upon the type of loan and maturity and were determined by discounting the future expected
116
Note 11—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
cash flows using the current origination rates for similar loans made to borrowers with similar credit ratings and include adjustments for liquidity premiums.
Interest Bearing Deposits: The fair value of fixed maturity CDs was estimated using a discounted cash flow calculation that applies current interest rates being offered on certificates with similar maturities.
Commercial Paper and Other Short-Term Borrowings: The fair values of Federal Reserve Bank term borrowings, FHLB borrowings and term federal funds purchased were estimated using a discounted cash flow calculation that applies current market rates for applicable maturities. The carrying amounts of other short-term borrowed funds were assumed to approximate their fair value due to their limited duration.
Long-Term Debt: The fair value of senior and subordinated debt was estimated using either a discounted cash flow analysis based on current market interest rates for debt with similar maturities and credit quality or estimated using market quotes. The fair value of junior subordinated debt payable to trusts was estimated using market quotes of similar securities.
Off-Balance Sheet Instruments: Commitments to extend credit and issued standby and commercial letters of credit are instruments that generate ongoing fees, which are recognized over the term of the commitment period. The carrying amount of these instruments was the amount of deferred fees and the fair value was estimated using a discounted cash flow calculation and reflected the portion of unused commitments expected to become funded. The Company maintains an allowance for losses on unfunded credit commitments.
117
Note 11—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
The tables below present the carrying amount and estimated fair value of certain financial instruments, all of which are accounted for at amortized cost, classified by valuation hierarchy level as of December 31, 2019 and 2018.
| December 31, 2019 | ||||||||||||||||||||
| (Dollars in millions) | Carrying Amount | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||||
| Assets | ||||||||||||||||||||
| Cash and cash equivalents | $ | 9,641 | $ | 9,641 | $ | 9,641 | $ | — | $ | — | ||||||||||
| Securities borrowed or purchased under resale agreements | 23,943 | 23,946 | — | 23,946 | — | |||||||||||||||
| Securities held to maturity | 9,421 | 9,508 | — | 9,508 | — | |||||||||||||||
Loans held for investment (1) | 86,687 | 87,506 | — | — | 87,506 | |||||||||||||||
| Other assets | 54 | 54 | 54 | — | — | |||||||||||||||
| Liabilities | ||||||||||||||||||||
| Time deposits | $ | 15,651 | $ | 15,691 | $ | — | $ | 15,691 | $ | — | ||||||||||
| Securities loaned or sold under repurchase agreements | 28,866 | 28,866 | — | 28,866 | — | |||||||||||||||
| Commercial paper and other short-term borrowings | 6,484 | 6,484 | — | 6,484 | — | |||||||||||||||
| Long-term debt | 17,129 | 17,344 | — | 17,344 | — | |||||||||||||||
| Off-Balance Sheet Instruments | ||||||||||||||||||||
| Commitments to extend credit and standby and commercial letters of credit | $ | 87 | $ | 280 | $ | — | $ | — | $ | 280 | ||||||||||
| (1) | Excludes lease financing. The carrying amount is net of the allowance for loan losses. |
| December 31, 2018 | ||||||||||||||||||||
| (Dollars in millions) | Carrying Amount | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||||
| Assets | ||||||||||||||||||||
| Cash and cash equivalents | $ | 8,350 | $ | 8,350 | $ | 8,350 | $ | — | $ | — | ||||||||||
| Securities borrowed or purchased under resale agreements | 22,368 | 22,368 | — | 22,368 | — | |||||||||||||||
| Securities held to maturity | 10,901 | 10,720 | — | 10,720 | — | |||||||||||||||
Loans held for investment (1) | 84,805 | 84,729 | — | — | 84,729 | |||||||||||||||
| Other assets | 48 | 48 | 48 | — | — | |||||||||||||||
| Liabilities | ||||||||||||||||||||
| Time deposits | $ | 11,739 | $ | 11,714 | $ | — | $ | 11,714 | $ | — | ||||||||||
| Securities loaned or sold under repurchase agreements | 27,285 | 27,285 | — | 27,285 | — | |||||||||||||||
| Commercial paper and other short-term borrowings | 9,263 | 9,263 | — | 9,263 | — | |||||||||||||||
| Long-term debt | 17,918 | 17,961 | — | 17,961 | — | |||||||||||||||
| Off-Balance Sheet Instruments | ||||||||||||||||||||
| Commitments to extend credit and standby and commercial letters of credit | $ | 120 | $ | 242 | $ | — | $ | — | $ | 242 | ||||||||||
| (1) | Excludes lease financing. The carrying amount is net of the allowance for loan losses. |
118
Note 12—Derivative Instruments and Other Financial Instruments Used For Hedging
The Company enters into certain derivative and other financial instruments primarily to assist customers with their risk management objectives and to manage the Company’s exposure to interest rate risk. When entering into derivatives on behalf of customers, the Company generally acts as a financial intermediary by offsetting a significant portion of the market risk for these derivatives with third parties. The Company may also enter into derivatives for other risk management purposes. All derivative instruments are recognized as assets or liabilities on the consolidated balance sheets at fair value.
Counterparty credit risk is inherent in derivative instruments. In order to reduce its exposure to counterparty credit risk, the Company utilizes credit approvals, limits, monitoring procedures and master netting and credit support annex agreements. Additionally, the Company considers counterparty credit quality and the creditworthiness of the Company in estimating the fair value of derivative instruments.
The table below presents the notional amounts and fair value amounts of the Company's derivative instruments reported on the consolidated balance sheets, segregated between derivative instruments designated and qualifying as hedging instruments and derivative instruments not designated as hedging instruments at December 31, 2019 and December 31, 2018. Asset and liability values are presented gross, excluding the impact of legally enforceable master netting and credit support annex agreements. The fair value of asset and liability derivatives designated and qualifying as hedging instruments and derivatives designated as other risk management are included in other assets and other liabilities, respectively. The fair value of asset and liability trading derivatives are included in trading account assets and trading account liabilities, respectively.
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||
| Fair Value | Fair Value | |||||||||||||||||||||||
| (Dollars in millions) | Notional Amount | Asset Derivatives | Liability Derivatives | Notional Amount | Asset Derivatives | Liability Derivatives | ||||||||||||||||||
| Derivative instruments | ||||||||||||||||||||||||
| Cash flow hedges: | ||||||||||||||||||||||||
| Interest rate contracts | $ | 13,319 | $ | — | $ | — | $ | 674 | $ | 6 | $ | — | ||||||||||||
| Not designated as hedging instruments: | ||||||||||||||||||||||||
| Trading: | ||||||||||||||||||||||||
| Interest rate contracts | 214,805 | 981 | 446 | 189,478 | 531 | 600 | ||||||||||||||||||
| Commodity contracts | 9 | — | — | 336 | 25 | 18 | ||||||||||||||||||
| Foreign exchange contracts | 11,219 | 230 | 64 | 8,475 | 260 | 168 | ||||||||||||||||||
| Equity contracts | 72 | 8 | 8 | 300 | 22 | 13 | ||||||||||||||||||
| Other contracts | 72 | — | — | 127 | — | — | ||||||||||||||||||
| Total Trading | 226,177 | 1,219 | 518 | 198,716 | 838 | 799 | ||||||||||||||||||
| Other risk management | 1,948 | 14 | 5 | 1,704 | 27 | 5 | ||||||||||||||||||
| Total derivative instruments | $ | 241,444 | $ | 1,233 | $ | 523 | $ | 201,094 | $ | 871 | $ | 804 | ||||||||||||
We recognized net gains of $2 million and net losses of $4 million and $17 million on other risk management derivatives for the years ended December 31, 2019, 2018 and 2017, respectively, which are included in other noninterest income.
Derivatives Designated and Qualifying as Hedging Instruments
The Company uses interest rate derivatives to manage the financial impact on the Company from changes in market interest rates. These instruments are used to manage interest rate risk relating to specified groups of assets and liabilities, primarily LIBOR-based commercial loans and debt issuances. Derivatives that qualify for hedge accounting are designated as either fair value or cash flow hedges.
119
Note 12—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)
Cash Flow Hedges
From time to time, the Company uses interest rate derivatives to hedge the risk of changes in cash flows attributable to changes in the designated interest rate on LIBOR indexed loans, and to a lesser extent, to hedge interest rate risk on rollover debt.
The Company used interest rate derivatives with an aggregate notional amount of $13.3 billion at December 31, 2019 to hedge the risk of changes in cash flows attributable to changes in the designated interest rates from variable rate loans. The Company used interest rate derivatives with an aggregate notional amount of $69 million at December 31, 2019 to hedge the risk of changes in cash flows attributable to changes in the designated interest rate on LIBOR indexed short-term borrowings. At December 31, 2019, the weighted average remaining life of the active cash flow hedges was 3.1 years.
For cash flow hedges, changes in the fair value of the hedging instruments is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged cash flows are recognized in net interest income. At December 31, 2019, the Company expects to reclassify approximately $67 million of losses from AOCI as a reduction to net interest income during the twelve months ending December 31, 2020. This amount could differ from amounts actually realized due to changes in interest rates, hedge terminations and the addition of other hedges subsequent to December 31, 2019.
The following table presents the amount and location of the net gains and losses recorded in the Company's consolidated statements of income and changes in stockholders' equity for derivative instruments designated as cash flow hedges for the years ended December 31, 2019, 2018 and 2017:
| Gains (Losses) Recognized in OCI | Gains (Losses) Reclassified from AOCI into Income | Gains (Losses) Recognized in Income (Ineffective Portion) | ||||||||||||||||||||||||||||||||||
| For the Year Ended December 31, | For the Year Ended December 31, | For the Year Ended December 31, | ||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | Location | 2019 | 2018 | 2017 | Location | 2018 | 2017 | ||||||||||||||||||||||||||
| Derivatives in cash flow hedging relationships | ||||||||||||||||||||||||||||||||||||
| Interest income | $ | (91 | ) | $ | (34 | ) | $ | 69 | ||||||||||||||||||||||||||||
| Interest rate contracts | $ | 51 | $ | (96 | ) | $ | (35 | ) | Interest expense | — | — | — | Noninterest expense | $ | (1 | ) | $ | 3 | ||||||||||||||||||
| Total | $ | 51 | $ | (96 | ) | $ | (35 | ) | $ | (91 | ) | $ | (34 | ) | $ | 69 | $ | (1 | ) | $ | 3 | |||||||||||||||
Fair Value Hedges
The Company engaged in an interest rate hedging strategy in which one or more interest rate derivatives were associated with a specified interest bearing liability, in order to convert the liability from a fixed rate to a floating rate instrument. This strategy mitigated the changes in fair value of the hedged liability caused by changes in the designated interest rate, LIBOR.
Prior to 2019, for fair value hedges, any ineffectiveness was recognized in noninterest expense in the period in which it arose. The change in the fair value of the hedged item and the hedging instrument, to the extent completely effective, offset with no impact on earnings.
The following tables present gains (losses) on the Company's fair value hedges and hedged item for the years ended December 31, 2018 and 2017. The Company did not have any fair value hedges during 2019.
| For the Year Ended December 31, 2018 | ||||||||||||||
| (Dollars in millions) | Derivative Instrument | Hedged Item | Hedge Ineffectiveness | |||||||||||
| Interest rate risk on long-term debt | $ | (2 | ) | $ | 2 | $ | — | |||||||
| Total | $ | (2 | ) | $ | 2 | $ | — | |||||||
120
Note 12—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)
| For the Year Ended December 31, 2017 | ||||||||||||||
| (Dollars in millions) | Derivative Instrument | Hedged Item | Hedge Ineffectiveness | |||||||||||
| Interest rate risk on long-term debt | $ | (4 | ) | $ | 3 | $ | (1 | ) | ||||||
| Total | $ | (4 | ) | $ | 3 | $ | (1 | ) | ||||||
Derivatives Not Designated as Hedging Instruments
Trading Derivatives
Derivative instruments classified as trading include derivatives entered into at MUAH's broker-dealer subsidiary, MUSA, and derivatives entered into as an accommodation for customers and for certain economic hedging activities at MUB. Trading derivatives are included in trading assets or trading liabilities with changes in fair value reflected in income from trading account activities.
The following table presents the amount of the net gains and losses for derivative instruments classified as trading reported in the consolidated statements of income under the heading trading account activities for the years ended December 31, 2019, 2018 and 2017:
Gains (Losses) Recognized in Income on Trading Derivatives | ||||||||||||
| For the Years Ended | ||||||||||||
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | December 31, 2017 | |||||||||
| Trading derivatives | ||||||||||||
| Interest rate contracts | $ | (93 | ) | $ | 95 | $ | (49 | ) | ||||
| Equity contracts | 6 | 36 | 12 | |||||||||
| Foreign exchange contracts | 51 | 44 | 43 | |||||||||
| Commodity contracts | — | — | 1 | |||||||||
| Total | $ | (36 | ) | $ | 175 | $ | 7 | |||||
Offsetting Financial Assets and Liabilities
The Company primarily enters into derivative contracts with counterparties utilizing standard International Swaps and Derivatives Association Master Agreements and Credit Support Annex Agreements. These agreements generally establish the terms and conditions of the transactions, including a legal right to set-off amounts payable and receivable between the Company and a counterparty, regardless of whether or not such amounts have matured or have contingency features. For additional information related to offsetting of financial assets and liabilities, refer to Note 8 "Securities Financing Arrangements" to these Consolidated Financial Statements.
121
Note 13—Accumulated Other Comprehensive Income
The following tables present the change in each of the components of accumulated other comprehensive income and the related tax effect of the change allocated to each component.
| (Dollars in millions) | Before Tax Amount | Tax Effect | Net of Tax | |||||||||
| For the Year Ended December 31, 2019 | ||||||||||||
| Cash flow hedge activities: | ||||||||||||
| Unrealized net gains (losses) on hedges arising during the period | $ | 51 | $ | (13 | ) | $ | 38 | |||||
| Reclassification adjustment for net (gains) losses on hedges included in interest income for loans and interest expense on long-term debt | 91 | (24 | ) | 67 | ||||||||
| Net change | 142 | (37 | ) | 105 | ||||||||
| Securities: | ||||||||||||
| Unrealized holding gains (losses) arising during the period on securities available for sale | 385 | (101 | ) | 284 | ||||||||
| Reclassification adjustment for net (gains) losses on securities available for sale included in securities gains, net | (39 | ) | 10 | (29 | ) | |||||||
| Amortization of net unrealized (gains) losses on held to maturity securities | 33 | (8 | ) | 25 | ||||||||
| Net change | 379 | (99 | ) | 280 | ||||||||
| Foreign currency translation adjustment | — | — | — | |||||||||
| Pension and other benefits: | ||||||||||||
Amortization of prior service credit(1) | (40 | ) | 11 | (29 | ) | |||||||
Recognized net actuarial (gain) loss(1) | 74 | (20 | ) | 54 | ||||||||
| Pension and other benefits arising during the year | 70 | (19 | ) | 51 | ||||||||
| Net change | 104 | (28 | ) | 76 | ||||||||
| Other | 1 | — | 1 | |||||||||
| Net change in AOCI | $ | 626 | $ | (164 | ) | $ | 462 | |||||
| (1) | These amounts are included in the computation of net periodic pension cost. For further information, see Note 15 to these Consolidated Financial Statements. |
122
| (Dollars in millions) | Before Tax Amount | Tax Effect | Net of Tax | |||||||||
| For the Year Ended December 31, 2018 | ||||||||||||
| Cash flow hedge activities: | ||||||||||||
| Unrealized net gains (losses) on hedges arising during the period | $ | (96 | ) | $ | 25 | $ | (71 | ) | ||||
| Reclassification adjustment for net (gains) losses on hedges included in interest income for loans and interest expense on long-term debt | 34 | (9 | ) | 25 | ||||||||
| Net change | (62 | ) | 16 | (46 | ) | |||||||
| Securities: | ||||||||||||
| Unrealized holding gains (losses) arising during the period on securities available for sale | (210 | ) | 55 | (155 | ) | |||||||
| Reclassification adjustment for net (gains) losses on securities available for sale included in securities gains, net | (8 | ) | 2 | (6 | ) | |||||||
| Amortization of net unrealized (gains) losses on held to maturity securities | 28 | (7 | ) | 21 | ||||||||
| Net change | (190 | ) | 50 | (140 | ) | |||||||
| Foreign currency translation adjustment | (3 | ) | 1 | (2 | ) | |||||||
| Pension and other benefits: | ||||||||||||
Amortization of prior service credit (1) | (41 | ) | 11 | (30 | ) | |||||||
Recognized net actuarial (gain) loss(1) | 96 | (25 | ) | 71 | ||||||||
| Pension and other benefits arising during the year | (231 | ) | 60 | (171 | ) | |||||||
| Net change | (176 | ) | 46 | (130 | ) | |||||||
| Other | $ | (1 | ) | $ | — | $ | (1 | ) | ||||
| Net change in AOCI | $ | (432 | ) | $ | 113 | $ | (319 | ) | ||||
| (1) | These amounts are included in the computation of net periodic pension cost. For further information, see Note 15 to these Consolidated Financial Statements. |
| (Dollars in millions) | Before Tax Amount | Tax Effect | Net of Tax | |||||||||
| For the Year Ended December 31, 2017 | ||||||||||||
| Cash flow hedge activities: | ||||||||||||
| Unrealized net gains (losses) on hedges arising during the period | $ | (35 | ) | $ | 13 | $ | (22 | ) | ||||
| Reclassification adjustment for net (gains) losses on hedges included in interest income for loans and interest expense on long-term debt | (69 | ) | 25 | (44 | ) | |||||||
| Net change | (104 | ) | 38 | (66 | ) | |||||||
| Securities: | ||||||||||||
| Unrealized holding gains (losses) arising during the period on securities available for sale | 24 | (9 | ) | 15 | ||||||||
| Reclassification adjustment for net (gains) losses on securities available for sale included in securities gains, net | (17 | ) | 7 | (10 | ) | |||||||
| Less: accretion of fair value adjustment on securities available for sale | (1 | ) | — | (1 | ) | |||||||
| Amortization of net unrealized (gains) losses on held to maturity securities | 19 | (7 | ) | 12 | ||||||||
| Net change | 25 | (9 | ) | 16 | ||||||||
| Foreign currency translation adjustment | 11 | (4 | ) | 7 | ||||||||
| Pension and other benefits: | ||||||||||||
Amortization of prior service credit(1) | (48 | ) | 19 | (29 | ) | |||||||
Recognized net actuarial (gain) loss(1) | 91 | (36 | ) | 55 | ||||||||
| Pension and other benefits arising during the year | 116 | (47 | ) | 69 | ||||||||
| Net change | 159 | (64 | ) | 95 | ||||||||
| Net change in AOCI | $ | 91 | $ | (39 | ) | $ | 52 | |||||
| (1) | These amounts are included in the computation of net periodic pension cost. For further information, see Note 15 to these Consolidated Financial Statements. |
123
The following table presents the change in accumulated other comprehensive loss balances.
| For the Year Ended December 31, 2018 and 2019 | ||||||||||||||||||||||||
Net Unrealized Gains (Losses) on Cash Flow Hedges | Net Unrealized Gains (Losses) on Securities | Foreign Currency Translation Adjustment | Pension and Other Postretirement Benefits Adjustment | Other | Accumulated Other Comprehensive Income (Loss) | |||||||||||||||||||
| (Dollars in millions) | ||||||||||||||||||||||||
| Balance, December 31, 2016 | $ | (77 | ) | $ | (208 | ) | $ | (22 | ) | $ | (589 | ) | $ | — | $ | (896 | ) | |||||||
| Other comprehensive income (loss) before reclassifications | (22 | ) | 15 | 7 | 69 | — | 69 | |||||||||||||||||
| Amounts reclassified from AOCI | (44 | ) | 1 | — | 26 | — | (17 | ) | ||||||||||||||||
| Subtotal before TCJA reclass | (143 | ) | (192 | ) | (15 | ) | (494 | ) | — | (844 | ) | |||||||||||||
| TCJA reclass | (31 | ) | (41 | ) | (4 | ) | (106 | ) | — | (182 | ) | |||||||||||||
| Balance, December 31, 2017 | $ | (174 | ) | $ | (233 | ) | $ | (19 | ) | $ | (600 | ) | $ | — | $ | (1,026 | ) | |||||||
| Other comprehensive income (loss) before reclassifications | (71 | ) | (155 | ) | (2 | ) | (171 | ) | (1 | ) | (400 | ) | ||||||||||||
| Amounts reclassified from AOCI | 25 | 15 | — | 41 | — | 81 | ||||||||||||||||||
Transfer to additional paid-in capital(1) | — | — | 21 | — | — | 21 | ||||||||||||||||||
| Balance, December 31, 2018 | $ | (220 | ) | $ | (373 | ) | $ | — | $ | (730 | ) | $ | (1 | ) | $ | (1,324 | ) | |||||||
| Other comprehensive income (loss) before reclassifications | 38 | 284 | — | 51 | 1 | 374 | ||||||||||||||||||
| Amounts reclassified from AOCI | 67 | (4 | ) | — | 25 | — | 88 | |||||||||||||||||
| Balance, December 31, 2019 | $ | (115 | ) | $ | (93 | ) | $ | — | $ | (654 | ) | $ | — | $ | (862 | ) | ||||||||
| (1) | Transfer of accumulated foreign currency translation to additional paid-in capital resulted from the transfer of the Company's investment in a Canadian entity to MUFG Bank, Ltd. during the first quarter of 2018. |
Note 14—Management Stock Plans
The Company adopted the MUAH Plan on June 8, 2015. Under the MUAH Plan, the Company grants restricted stock units settled in ADRs representing shares of common stock of the Company's indirect parent company, MUFG, to key employees at the discretion of the Human Capital Committee of the Board of Directors (the Committee). The Committee determines the number of shares, vesting requirements and other features and conditions of the restricted stock units. Under the MUAH Plan, MUFG ADRs are purchased in the open market upon the vesting of the restricted stock units, through a revocable trust. There is no amount authorized to be issued under the MUAH Plan since all shares are purchased in the open market. These awards generally vest pro-rata on each anniversary of the grant date and become fully vested three years from the grant date, provided that the employee has completed the specified continuous service requirement. Generally, the grants vest earlier if the employee dies, is permanently and totally disabled, retires under certain grant, age and service conditions, or terminates employment under certain conditions. The Company also issues a small number of off-cycle grants each year, primarily for reasons related to recruitment of new employees. The weighted-average service period for grants issued under the MUAH Plan with outstanding restricted stock units as of December 31, 2019 was 3 years.
Participants in the MUAH Plan are entitled to “dividend equivalent credits” on their unvested restricted stock units when MUFG pays dividends to its shareholders. The credit is equal to the dividends that the participants would have received on the shares had the shares been issued to the participants when the restricted stock units were granted. "Dividend equivalent credits" arising from grants under the MUAH Plan are paid to participants in shares on each vesting date for the underlying restricted stock units.
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Note 14—Management Stock Plans (Continued)
The following table is a rollforward of the restricted stock units under the MUAH Plan for the year ended December 31, 2019:
| Restricted Stock Units | |||||||
| 2019 | |||||||
| Number of Units | Weighted-Average Grant Date Fair Value | ||||||
| Units outstanding, beginning of year | 28,443,070 | $ | 5.86 | ||||
| Activity during the year: | |||||||
| Granted | 25,591,407 | 4.67 | |||||
| Vested | (15,013,517 | ) | 5.63 | ||||
| Forfeited | (1,367,274 | ) | 5.41 | ||||
| Units outstanding, end of year | 37,653,686 | 5.16 | |||||
The weighted-average grant date fair value of restricted stock units granted during 2018 and 2017 was 5.89 and 6.53, respectively. The total fair value of restricted stock units that vested during the years ended December 31, 2019, 2018, and 2017 was $70 million, $78 million, and $75 million, respectively.
The following table is a summary of the Company's compensation costs, the corresponding tax benefit, and unrecognized compensation costs:
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Compensation costs | $ | 89 | $ | 77 | $ | 66 | ||||||
| Tax benefit | 23 | 20 | 26 | |||||||||
| Unrecognized compensation costs | 129 | 110 | 111 | |||||||||
At December 31, 2019, approximately $129 million (pretax) of compensation expense related to unvested grants had not yet been charged to net income. Unrecognized compensation costs as of December 31, 2019 are expected to be amortized into compensation expense over a weighted-average period of 1.4 years.
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Note 15—Employee Pension and Other Postretirement Benefits
Retirement Plan
The Company maintains the MUFG Union Bank, N.A. Retirement Plan (the Pension Plan), which is a noncontributory qualified defined benefit pension plan covering substantially all of the domestic employees of the Company. The Pension Plan provides retirement benefits based on a cash balance formula, with annual pay credits based on a participant's eligible pay multiplied by a percentage determined by their age and years of service, with annual interest credits based on 30-year Treasury bond yields. Employees become eligible for the Pension Plan after 1 year of service, and participants become vested upon completing 3 years of vesting service. Prior to 2017, certain participants earned retirement benefits based on years of credited service and the final average earnings amount, as defined in the Pension Plan; such benefits became fixed as of the effective date of certain Plan amendments implementing the cash balance formula.
The Company's funding policy is to make contributions between the minimum required and the maximum deductible amount as allowed by the Internal Revenue Code. Contributions are intended to provide not only benefits attributed to services to date, but also benefits expected to be earned in the future.
Other Postretirement Benefits
The Company maintains the MUFG Union Bank, N.A. Retiree Health Reimbursement Plan (the HRA Plan), the MUFG Union Bank, N.A. Health Benefit Plan (the Health Plan), and the MUFG Union Bank, N.A. Employee Insurance Plan (the Insurance Plan). Under the HRA Plan, eligible post-65 retirees and dependents receive Company-provided financial support to purchase individual health coverage through annual allocations to a Health Reimbursement Account (HRA). Such annual allocations are designed to keep pace with medical inflation. The Health Plan provides certain healthcare benefits for eligible pre-65 retired employees and dependents; costs are shared between the Company and the retiree at a level of approximately 25% to 50%, depending on the retiree's age and length of service with the Company. The Insurance Plan provides life insurance benefits for those eligible employees who retired prior to January 1, 2001 and is noncontributory. Together, the HRA Plan, the Health Plan, and the Insurance Plan are presented as "Other Benefits Plan." The accounting for the Other Benefits Plan anticipates future cost-sharing changes described above that are consistent with the Company's intent. Assets set aside to cover such obligations are primarily invested in mutual funds and insurance contracts. In April 2014, the Health Benefit Plan was amended to discontinue the availability of retiree health benefits for the majority of employees.
The following table sets forth the fair value of the assets in the Company's Pension Plan and Other Benefits Plan as of December 31, 2019 and 2018.
| Pension Plan | Other Benefits Plan | |||||||||||||||
Years Ended December 31, | Years Ended December 31, | |||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2019 | 2018 | ||||||||||||
| Change in Plan Assets: | ||||||||||||||||
| Fair value of plan assets, beginning of year | $ | 3,529 | $ | 3,854 | $ | 255 | $ | 288 | ||||||||
| Actual return on plan assets | 754 | (196 | ) | 52 | (18 | ) | ||||||||||
| Employer contributions | — | — | — | — | ||||||||||||
| Plan participants' contributions | — | — | 4 | 4 | ||||||||||||
| Benefits paid | (143 | ) | (129 | ) | (20 | ) | (19 | ) | ||||||||
| Fair value of plan assets, end of year | $ | 4,140 | $ | 3,529 | $ | 291 | $ | 255 | ||||||||
The investment objective for the Company's Pension Plan and Other Benefits Plan, collectively the Plans, is to maximize total return within reasonable and prudent levels of risk. The Plans' asset allocation strategy is the principal determinant in achieving expected investment returns on the Plans' assets. The Pension Plan asset allocation strategy favors equities, with a target allocation of 53% in equity securities, 35% in debt securities, and 12% in real estate investments as of December 31, 2019. Similarly, the Other Benefits Plan asset allocation strategy favors equities with a target allocation of 70% in equity securities and 30% in debt securities. Additionally, the Other Benefits Plan holds an investment in an insurance contract with Talcott Resolution Life Insurance
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Company, the cash value of which is invested in alignment with the target allocation. Actual asset allocations may fluctuate within acceptable ranges due to market value variability. If market fluctuations cause an asset class to fall outside of its strategic asset allocation range, the portfolio is subject to re-balancing as appropriate. A core equity position of domestic large cap and small cap stocks will be maintained, in conjunction with a diversified portfolio of international equities and fixed income securities. Plan asset performance is compared against established indexes and peer groups to evaluate whether the risk associated with the portfolio is appropriate for the level of return.
The Company periodically reviews the Plans' strategic asset allocation policy and the expected long-term rate of return for plan assets. The investment return volatility of different asset classes and the liability structure of the plans are evaluated to determine whether adjustments are required to the Plans' strategic asset allocation policy, taking into account the principles established in the Company's funding policy. Management periodically reviews and adjusts the long-term rate of return on assets assumption for the Plans based on the expected long-term rate of return for the asset classes and their weightings in the Plans' strategic asset allocation policy and taking into account the prevailing economic and regulatory climate and practices of other companies both within and outside our industry.
The following table provides the fair value by level within the fair value hierarchy of the Company's period-end assets by major asset category for the Pension Plan and Other Benefits Plan. For information about the fair value hierarchy levels, refer to Note 11 to these consolidated financial statements. The Plans do not hold any equity or debt securities issued by the Company or any related parties.
| December 31, 2019 | ||||||||||||||||
| (Dollars in millions) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Pension Plan Investments: | ||||||||||||||||
| Cash and cash equivalents | $ | 9 | $ | 2 | $ | — | $ | 11 | ||||||||
| Collective investment funds | — | 1,089 | — | 1,089 | ||||||||||||
| U.S. government securities | — | 419 | — | 419 | ||||||||||||
| Fixed and variable income securities | — | 882 | — | 882 | ||||||||||||
| Equity securities | 246 | 6 | — | 252 | ||||||||||||
| Mutual funds | 746 | — | — | 746 | ||||||||||||
| Municipal bonds | — | 38 | — | 38 | ||||||||||||
| Other | (4 | ) | 17 | — | 13 | |||||||||||
| Total investments in the fair value hierarchy | $ | 997 | $ | 2,453 | $ | — | $ | 3,450 | ||||||||
Investments measured at net asset value (1) | 680 | |||||||||||||||
| Investments at fair value | 4,130 | |||||||||||||||
| Accrued dividends and interest receivable | 10 | |||||||||||||||
| Net pending trades | — | |||||||||||||||
| Total plan assets | $ | 4,140 | ||||||||||||||
| (1) | In accordance with ASU No. 2015-07, investments in which fair value was measured based on net asset value per share (or its equivalent) using the practical expedient have not been categorized in the fair value hierarchy. The fair value amounts presented in these tables are intended to permit reconciliation of the fair value hierarchy to total plan assets. |
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| December 31, 2018 | ||||||||||||||||
| (Dollars in millions) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Pension Plan Investments: | ||||||||||||||||
| Cash and cash equivalents | $ | — | $ | 25 | $ | — | $ | 25 | ||||||||
| U.S. government securities | — | 382 | — | 382 | ||||||||||||
| Fixed and variable income securities | — | 824 | — | 824 | ||||||||||||
| Equity securities | 185 | 6 | — | 191 | ||||||||||||
| Mutual funds | 620 | — | — | 620 | ||||||||||||
| Municipal bonds | — | 37 | — | 37 | ||||||||||||
| Other | — | 20 | — | 20 | ||||||||||||
| Total investments in the fair value hierarchy | $ | 805 | $ | 1,294 | $ | — | $ | 2,099 | ||||||||
Investments measured at net asset value (1) | 1,420 | |||||||||||||||
| Investments at fair value | 3,519 | |||||||||||||||
| Accrued dividends and interest receivable | 12 | |||||||||||||||
| Net pending trades | (2 | ) | ||||||||||||||
| Total plan assets | $ | 3,529 | ||||||||||||||
| (1) | In accordance with ASU No. 2015-07, investments in which fair value was measured based on net asset value per share (or its equivalent) using the practical expedient have not been categorized in the fair value hierarchy. The fair value amounts presented in these tables are intended to permit reconciliation of the fair value hierarchy to total plan assets. |
| December 31, 2019 | ||||||||||||||||
| (Dollars in millions) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Other Postretirement Benefits Plan Investments: | ||||||||||||||||
| Cash and cash equivalents | $ | — | $ | — | $ | — | $ | — | ||||||||
| Collective investment funds | — | 103 | — | 103 | ||||||||||||
| U.S. government securities | — | 45 | — | 45 | ||||||||||||
| Fixed and variable income securities | — | 27 | — | 27 | ||||||||||||
| Equity securities | — | — | — | — | ||||||||||||
| Mutual funds | 65 | — | — | 65 | ||||||||||||
| Pooled separate account | — | 53 | — | 53 | ||||||||||||
| Total investments in the fair value hierarchy | $ | 65 | $ | 228 | $ | — | $ | 293 | ||||||||
Investments measured at net asset value (1) | — | |||||||||||||||
| Investments at fair value | 293 | |||||||||||||||
| Net pending trades | (2 | ) | ||||||||||||||
| Total plan assets | $ | 291 | ||||||||||||||
| (1) | In accordance with ASU No. 2015-07, investments in which fair value was measured based on net asset value per share (or its equivalent) using the practical expedient have not been categorized in the fair value hierarchy. The fair value amounts presented in these tables are intended to permit reconciliation of the fair value hierarchy to total plan assets. |
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| December 31, 2018 | ||||||||||||||||
| (Dollars in millions) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Other Postretirement Benefits Plan Investments: | ||||||||||||||||
| Cash and cash equivalents | $ | — | $ | 1 | $ | — | $ | 1 | ||||||||
| U.S. government securities | — | 37 | — | 37 | ||||||||||||
| Fixed and variable income securities | — | 32 | — | 32 | ||||||||||||
| Equity securities | — | — | — | — | ||||||||||||
| Mutual funds | 54 | — | — | 54 | ||||||||||||
| Total investments in the fair value hierarchy | $ | 54 | $ | 70 | $ | — | $ | 124 | ||||||||
Investments measured at net asset value (1) | 134 | |||||||||||||||
| Investments at fair value | 258 | |||||||||||||||
| Net pending trades | (3 | ) | ||||||||||||||
| Total plan assets | $ | 255 | ||||||||||||||
| (1) | In accordance with ASU No. 2015-07, investments in which fair value was measured based on net asset value per share (or its equivalent) using the practical expedient have not been categorized in the fair value hierarchy. The fair value amounts presented in these tables are intended to permit reconciliation of the fair value hierarchy to total plan assets. |
The following tables as of December 31, 2019 and 2018 present the Company's Pension Plan and Other Benefits Plan investments in which fair value is measured using net asset value per share (or its equivalent) as a practical expedient.
| December 31, 2019 | ||||||||||||||
| (Dollars in millions) | Fair Value | Unfunded Commitment | Redemption Frequency | Other Redemption Restrictions | Redemption Notice Period | |||||||||
| Pension Plan Investments | ||||||||||||||
| Real estate funds | $ | 480 | $ | 2 | Quarterly | Availability of fund's liquid assets and approval of the board of directors | 45-90 days | |||||||
| Real estate funds | 5 | — | None | Hold until dissolution date | None | |||||||||
| International equity funds | 195 | — | Monthly | None | 15 days | |||||||||
| Total | $ | 680 | $ | 2 | ||||||||||
| December 31, 2018 | ||||||||||||||
| (Dollars in millions) | Fair Value | Unfunded Commitment | Redemption Frequency | Other Redemption Restrictions | Redemption Notice Period | |||||||||
| Pension Plan Investments | ||||||||||||||
| Domestic equity funds | $ | 789 | $ | — | Daily | None | None | |||||||
| Real estate funds | 415 | — | Quarterly | Availability of fund's liquid assets and approval of the board of directors | 45-90 days | |||||||||
| Real estate funds | 7 | 3 | None | Hold until dissolution date | None | |||||||||
| International equity funds | 159 | — | Monthly | None | 15 days | |||||||||
| Money market funds | 50 | — | Immediate | None | None | |||||||||
| Total | $ | 1,420 | $ | 3 | ||||||||||
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| December 31, 2018 | ||||||||||||||
| (Dollars in millions) | Fair Value | Unfunded Commitment | Redemption Frequency | Other Redemption Restrictions | Redemption Notice Period | |||||||||
| Other Postretirement Benefits Plan Investments | ||||||||||||||
| Domestic equity funds | $ | 87 | $ | — | Daily | None | None | |||||||
| Pooled separate account - variable life insurance policies | 46 | — | Quarterly | Proof of death for death claim redemptions | 7 business days | |||||||||
| Money market funds | 1 | — | Immediate | None | None | |||||||||
| Total | $ | 134 | $ | — | ||||||||||
A description of the valuation methodologies used to determine the fair value of the Plans' assets included within the tables above is as follows:
Cash and Cash Equivalents
Cash and cash equivalents include short-term investments of government securities and other debt securities with remaining maturities of less than three months. These short-term investments are classified as Level 2 based on unadjusted prices in active markets for similar securities.
U.S. Government Securities
U.S. government securities include U.S. Treasury securities and U.S. agency mortgage-backed securities. U.S. Treasury securities are fixed income securities that are debt instruments issued by the United States Department of the Treasury. U.S. agency mortgage-backed securities are collateralized by residential mortgage loans and may be prepaid at par prior to maturity. U.S. government securities are classified as Level 2 based on valuations provided by third-party pricing services using quoted market prices in active markets for similar securities.
Fixed and Variable Income Securities
Fixed and variable income securities include a variety of debt instruments, including corporate bonds, private placements and asset-backed securities. These securities are classified as Level 2 based on valuations provided by third-party pricing services using quoted market prices in active markets for similar securities.
Equity Securities
Equity securities are comprised of common stock and preferred securities. The fair value of common stock is recorded based on quoted market prices obtained from an exchange. These securities are classified as Level 1 based on unadjusted prices for identical instruments in active markets. The fair value of preferred securities is based on discounted cash flow models. These securities are classified as Level 2 based on valuations provided by third-party pricing services using observable market data.
Real Estate Funds
Real estate funds invest in real estate property with a focus on apartment, office, industrial and retail properties. These investments were measured at NAV per share and are included in the tables above showing Plan investments that are measured using NAV per share (or its equivalent) as a practical expedient.
International Equity Funds
International equity funds invest in equity securities of foreign companies in developed and emerging markets across diverse industries. These investments were measured at NAV per share and are included in the tables above showing Plan investments that are measured using NAV per share (or its equivalent) as a practical expedient.
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Mutual Funds
Mutual funds invest in equity securities that may be benchmarked to the performance of market indexes including the MSCI EAFE® or MSCI All Country World ex US. These funds are valued using NAV at the end of the period and are classified as Level 1 based on unadjusted prices for identical instruments in active markets.
Collective Investment Funds and Pooled Separate Account
The pooled separate account refers to private placement, variable life insurance policies with Talcott Resolution Life Insurance Company, a successor to Hartford Life Insurance Company. The cash value of the life insurance is invested in four managed divisions that seek to track the S&P 500, NT Russell 2000, MSCI EAFE® and Bloomberg Barclays U.S. Aggregate Bond indexes.
Based on guidance contained in ASU No. 2018-09, Codification Improvements, these investments are reported within the fair value hierarchy as Level 2. Previously, they were reported in accordance with ASU No. 2015-07 and included in the tables showing Plan investments measured using NAV per share (or its equivalent) as a practical expedient. Collective investment funds and the pooled separate account managed divisions are redeemable at NAV, which is determined daily and is the readily determinable fair value. The price per share is quoted on a private market based on the value of the underlying investments. The amount of pension and other postretirement plan investments impacted by the change in reporting was $1.2 billion and $973 million as of December 31, 2019 and 2018, respectively.
The following table sets forth the benefit obligation activity and the funded status for each of the Company's plans at December 31, 2019 and 2018. In addition, the table sets forth the over (under) funded status at December 31, 2019 and 2018. This pension benefits table does not include the obligations for Executive Supplemental Benefit Plans (ESBPs).
| Pension Benefits | Other Postretirement Benefits | |||||||||||||||
Years Ended December 31, | Years Ended December 31, | |||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2019 | 2018 | ||||||||||||
| Accumulated benefit obligation | $ | 3,521 | $ | 3,038 | ||||||||||||
| Change in benefit obligation | ||||||||||||||||
| Benefit obligation, beginning of year | $ | 3,047 | $ | 3,242 | $ | 242 | $ | 265 | ||||||||
| Service cost | 76 | 80 | 3 | 4 | ||||||||||||
| Interest cost | 117 | 100 | 9 | 8 | ||||||||||||
| Plan participants' contributions | — | — | 4 | 4 | ||||||||||||
| Actuarial loss/(gain) | 439 | (246 | ) | 14 | (21 | ) | ||||||||||
| Effect of plan amendments | — | — | — | — | ||||||||||||
| Medicare Part D subsidy | — | — | — | 1 | ||||||||||||
| Benefits paid | (143 | ) | (129 | ) | (21 | ) | (19 | ) | ||||||||
| Benefit obligation, end of year | 3,536 | 3,047 | 251 | 242 | ||||||||||||
| Fair value of plan assets, end of year | 4,140 | 3,529 | 291 | 255 | ||||||||||||
| Over (Under) funded status | $ | 604 | $ | 482 | $ | 40 | $ | 13 | ||||||||
The Pension Plan obligation experienced a net loss of $439 million and a net gain of $246 million during 2019 and 2018, respectively, primarily due to changes in the discount rate. The discount rate increased from 3.48% at December 31, 2017 to 4.12% at December 31, 2018 and decreased to 3.08% at December 31, 2019. The Other Benefits Plan obligation experienced a net loss of $14 million and a net gain of $21 million during 2019 and 2018, respectively, primarily due to changes in the discount rate. The discount rate increased from 3.37% at December 31, 2017 to 4.01% at December 31, 2018 and decreased to 2.93% at December 31, 2019.
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The following table illustrates the changes that were reflected in AOCI during 2019, 2018 and 2017. Pension benefits do not include the ESBPs.
Pension Benefits | Other Postretirement Benefits | |||||||||||||||
| (Dollars in millions) | Net Actuarial (Gain) Loss | Prior Service Credit | Net Actuarial (Gain) Loss | Prior Service Credit | ||||||||||||
| Amounts Recognized in Other Comprehensive Loss: | ||||||||||||||||
| Balance, December 31, 2016 | $ | 1,085 | $ | (179 | ) | $ | 78 | $ | (50 | ) | ||||||
| Arising during the year | (101 | ) | — | (19 | ) | — | ||||||||||
| Recognized in net income during the year | (79 | ) | 27 | (8 | ) | 21 | ||||||||||
| Balance, December 31, 2017 | $ | 905 | $ | (152 | ) | $ | 51 | $ | (29 | ) | ||||||
| Arising during the year | 218 | — | 18 | — | ||||||||||||
| Recognized in net income during the year | (87 | ) | 26 | (5 | ) | 15 | ||||||||||
| Balance, December 31, 2018 | $ | 1,036 | $ | (126 | ) | $ | 64 | $ | (14 | ) | ||||||
| Arising during the year | (59 | ) | — | (22 | ) | — | ||||||||||
| Recognized in net income during the year | (61 | ) | 26 | (9 | ) | 14 | ||||||||||
| Balance, December 31, 2019 | $ | 916 | $ | (100 | ) | $ | 33 | $ | — | |||||||
At December 31, 2019 and 2018, the following amounts were recognized in accumulated other comprehensive loss for pension, including ESBPs, and other benefits.
| December 31, 2019 | ||||||||||||||||||||||||
| Pension Benefits | Other Postretirement Benefits | |||||||||||||||||||||||
| (Dollars in millions) | Gross | Tax | Net of Tax | Gross | Tax | Net of Tax | ||||||||||||||||||
| Net actuarial loss | $ | 916 | $ | 241 | $ | 675 | $ | 33 | $ | 9 | $ | 24 | ||||||||||||
| Prior service credit | (100 | ) | (26 | ) | (74 | ) | — | — | — | |||||||||||||||
| Pension and other postretirement benefits | 816 | 215 | 601 | 33 | 9 | 24 | ||||||||||||||||||
| Executive Supplemental Benefits Plans | ||||||||||||||||||||||||
| Net actuarial loss | 39 | 10 | 29 | — | — | — | ||||||||||||||||||
| Prior service credit | — | — | — | — | — | — | ||||||||||||||||||
| Executive supplemental benefits plans adjustment | 39 | 10 | 29 | — | — | — | ||||||||||||||||||
| Pension and other postretirement benefits, as adjusted | $ | 855 | $ | 225 | $ | 630 | $ | 33 | $ | 9 | $ | 24 | ||||||||||||
| December 31, 2018 | ||||||||||||||||||||||||
| Pension Benefits | Other Postretirement Benefits | |||||||||||||||||||||||
| (Dollars in millions) | Gross | Tax | Net of Tax | Gross | Tax | Net of Tax | ||||||||||||||||||
| Net actuarial loss | $ | 1,036 | $ | 273 | $ | 763 | $ | 64 | $ | 18 | $ | 46 | ||||||||||||
| Prior service credit | (126 | ) | (33 | ) | (93 | ) | (14 | ) | (4 | ) | (10 | ) | ||||||||||||
| Pension and other postretirement benefits | 910 | 240 | 670 | 50 | 14 | 36 | ||||||||||||||||||
| Executive Supplemental Benefits Plans | ||||||||||||||||||||||||
| Net actuarial loss | 32 | 8 | 24 | — | — | — | ||||||||||||||||||
| Prior service credit | — | — | — | — | — | — | ||||||||||||||||||
| Executive supplemental benefits plans adjustment | 32 | 8 | 24 | — | — | — | ||||||||||||||||||
| Pension and other postretirement benefits, as adjusted | $ | 942 | $ | 248 | $ | 694 | $ | 50 | $ | 14 | $ | 36 | ||||||||||||
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Pension Benefits
Our pre-tax net actuarial losses decreased $94 million in 2019 from 2018. At December 31, 2019, the net actuarial loss totaled $816 million, which is net of $100 million in prior service credits. In addition, $264 million, representing the excess of the fair value of plan assets over the market-related value of plan assets, is recognized separately through the asset smoothing method over four years. $792 million of loss is subject to amortization over approximately eight years, and the prior service credits are being amortized until 2022 and 2025. The cumulative net actuarial loss resulted primarily from differences between expected and actual rate of return on plan assets and the discount rate. Included in our 2020 net periodic pension cost will be $107 million of amortization related to net actuarial losses. We estimate that our total 2020 net periodic pension cost will be a credit of approximately $5 million, assuming no contributions in 2020. The 2020 estimate for net periodic pension cost was actuarially determined using the individual spot rates of 3.16% for service cost and 2.72% for interest cost, an expected return on plan assets of 7.0% and an expected compensation increase assumption of 5.1%.
A 50 basis point increase in the discount rate or in the expected return on plan assets would decrease the 2020 periodic pension cost by $28 million and $19 million, respectively, while a 50 basis point increase in the rate of future compensation levels would increase the 2020 periodic pension cost by $2 million. A 50 basis point decrease in the discount rate or in the expected return on plan assets would increase the 2020 periodic pension cost by $31 million and $19 million, respectively, while a 50 basis point decrease in the rate of future compensation levels would decrease the 2020 periodic pension cost by $2 million.
Estimated Future Benefit Payments and Subsidies
The following pension and postretirement benefit payments, which reflect expected future service, as appropriate, are expected to be paid over the next 10 years. This table does not include the ESBPs.
| (Dollars in millions) | Pension Benefits | Postretirement Benefits | ||||||
| Years ending December 31, | ||||||||
| 2020 | $ | 149 | $ | 17 | ||||
| 2021 | 156 | 17 | ||||||
| 2022 | 162 | 18 | ||||||
| 2023 | 169 | 18 | ||||||
| 2024 | 173 | 17 | ||||||
| Years 2024 - 2028 | 939 | 72 | ||||||
The following tables summarize the weighted average assumptions used in computing the present value of the benefit obligations and the net periodic benefit cost.
Pension Benefits | Other Postretirement Benefits | |||||||||||
Years Ended December 31, | Years Ended December 31, | |||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||
| Discount rate in determining net periodic benefit cost | ||||||||||||
| For service cost | 4.19 | % | 3.26 | % | 4.11 | % | 3.49 | % | ||||
| For interest cost | 3.90 | 3.16 | 3.79 | 3.02 | ||||||||
| Discount rate in determining benefit obligations at year end | 3.08 | 4.12 | 2.93 | 4.01 | ||||||||
| Rate of increase in future compensation levels for determining net periodic benefit cost | 5.10 | 4.70 | n/a | n/a | ||||||||
| Rate of increase in future compensation levels for determining benefit obligations at year end | 5.10 | 5.10 | n/a | n/a | ||||||||
| Expected return on plan assets | 7.00 | 7.50 | 7.00 | 7.50 | ||||||||
| Cash balance crediting rate for determining net periodic benefit cost | 3.02 | 2.74 | n/a | n/a | ||||||||
| Cash balance crediting rate for determining benefit obligations at year end | 2.39 | 3.02 | n/a | n/a | ||||||||
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| Pension Benefits | Other Postretirement Benefits | ESBPs | ||||||||||||||||||||||||||||||||||
Years Ended December 31, | Years Ended December 31, | Years Ended December 31, | ||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | 2019 | 2018 | 2017 | |||||||||||||||||||||||||||
| Components of net periodic benefit cost: | ||||||||||||||||||||||||||||||||||||
| Service cost | $ | 76 | $ | 80 | $ | 71 | $ | 3 | $ | 4 | $ | 6 | $ | — | $ | — | $ | — | ||||||||||||||||||
| Interest cost | 117 | 100 | 100 | 9 | 8 | 8 | 3 | 3 | 3 | |||||||||||||||||||||||||||
| Expected return on plan assets | (257 | ) | (268 | ) | (254 | ) | (17 | ) | (21 | ) | (19 | ) | — | — | — | |||||||||||||||||||||
| Amortization of prior service credit | (26 | ) | (26 | ) | (27 | ) | (14 | ) | (15 | ) | (21 | ) | — | — | — | |||||||||||||||||||||
| Recognized net actuarial loss | 61 | 87 | 79 | 9 | 5 | 8 | 4 | 3 | 4 | |||||||||||||||||||||||||||
| Curtailment gain | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||||
| Total net periodic benefit cost | $ | (29 | ) | $ | (27 | ) | $ | (31 | ) | $ | (10 | ) | $ | (19 | ) | $ | (18 | ) | $ | 7 | $ | 6 | $ | 7 | ||||||||||||
The Company's assumed weighted-average healthcare cost trend rates are as follows.
| Years Ended December 31, | |||||||||
| 2019 | 2018 | 2017 | |||||||
| Healthcare cost trend rate assumed for next year | 4.14 | % | 4.44 | % | 4.44 | % | |||
| Rate to which cost trend rate is assumed to decline (the ultimate trend rate) | 3.77 | % | 3.94 | % | 3.94 | % | |||
| Year the rate reaches the ultimate trend rate | 2027 | 2027 | 2026 | ||||||
Executive Supplemental Benefit Plans
The Company has several frozen ESBPs, which provide covered participants with supplemental retirement benefits. The plans are nonqualified defined benefit plans and unfunded. The accrued liability for ESBPs included in other liabilities on the Company's consolidated balance sheets was $94 million and $89 million at December 31, 2019 and 2018, respectively.
Section 401(k) Savings Plans
The Company has a defined contribution plan authorized under Section 401(k) of the Internal Revenue Code. All benefits-eligible employees are eligible to participate in the plan. Employees may contribute up to 75% of their eligible compensation on a pre-tax or Roth basis, or up to 10% of their eligible compensation on an after-tax basis, through payroll deductions, to a combined maximum of 75% of eligible compensation, subject to statutory limits. The Company makes a matching contribution equal to 100% of every pre-tax or Roth dollar an employee contributes on the first 3% of the employee's eligible compensation and 50% of every pre-tax or Roth dollar an employee contributes on the next 2% of the employee's eligible compensation, for a maximum matching opportunity of 4%. Company matching contributions are credited to eligible participants' accounts annually following year-end. Matching contributions are fully vested when credited. All employer contributions are tax deductible by the Company. The Company's combined matching contribution expense was $61 million, $59 million and $55 million for the years ended December 31, 2019, 2018 and 2017, respectively.
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Note 16—Other Noninterest Income and Noninterest Expense
The detail of other noninterest income is as follows.
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Fund administration fees | $ | 94 | $ | 100 | $ | 46 | ||||||
| Losses on renewable energy investments | (85 | ) | (235 | ) | (58 | ) | ||||||
| Other | 204 | 250 | 252 | |||||||||
| Total other noninterest income | $ | 213 | $ | 115 | $ | 240 | ||||||
The detail of other noninterest expense is as follows.
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Fees to affiliates | $ | 94 | $ | 115 | $ | 105 | ||||||
| Net periodic pension cost, excluding service cost | (112 | ) | (124 | ) | (119 | ) | ||||||
| Other | 440 | 418 | 403 | |||||||||
| Total other noninterest expense | $ | 422 | $ | 409 | $ | 389 | ||||||
Note 17—Income Taxes
The following table is an analysis of the effective tax rate:
| Years Ended December 31, | |||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | ||||||
| Federal income tax rate | 21 | % | 21 | % | 35 | % | |||
| Net tax effects of: | |||||||||
| State income taxes, net of federal income tax benefit | (13 | ) | 7 | 5 | |||||
| Goodwill impairment | (45 | ) | — | — | |||||
| Tax-exempt interest income | 2 | (1 | ) | (1 | ) | ||||
| Losses from LIHC investments | 4 | (2 | ) | (3 | ) | ||||
| Amortization of LIHC investments | (20 | ) | 12 | 14 | |||||
| Tax credits | 40 | (25 | ) | (21 | ) | ||||
| FDIC insurance premiums | (2 | ) | 1 | — | |||||
| Valuation allowance release | 1 | — | — | ||||||
| Effects of US tax law change | — | (2 | ) | (8 | ) | ||||
| State tax refunds | — | (5 | ) | — | |||||
| Other | — | (1 | ) | 1 | |||||
| Effective tax rate | (12 | )% | 5 | % | 22 | % | |||
On December 22, 2017, the Tax Cuts & Jobs Act was signed into law reducing the federal corporate income tax rate from 35% to 21% effective January 1, 2018. As a result of the reduction in the corporate income tax rate, the Company revalued its net deferred tax liabilities at December 31, 2017, resulting in a one-time tax benefit of $101 million.
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The components of income tax expense were as follows:
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Current income tax expense: | ||||||||||||
| Federal | $ | 191 | $ | 195 | $ | 257 | ||||||
| State | 154 | 89 | 21 | |||||||||
| Foreign | 1 | 10 | (4 | ) | ||||||||
| Total current expense | 346 | 294 | 274 | |||||||||
| Deferred income tax expense (benefit): | ||||||||||||
| Federal | (202 | ) | (173 | ) | (49 | ) | ||||||
| State | (61 | ) | (64 | ) | 52 | |||||||
| Foreign | (1 | ) | (5 | ) | 22 | |||||||
| Total deferred expense | (264 | ) | (242 | ) | 25 | |||||||
| Total income tax expense | $ | 82 | $ | 52 | $ | 299 | ||||||
The components of the Company's net deferred tax balances as of December 31, 2019 and 2018 were as follows:
| December 31, | ||||||||
| (Dollars in millions) | 2019 | 2018 | ||||||
| Deferred tax assets: | ||||||||
| Tax credits and net operating loss carryforwards | $ | 499 | $ | 448 | ||||
| Allowance for credit losses | 312 | 251 | ||||||
| Accrued expense, net | 143 | 159 | ||||||
| Unrealized losses on pension and postretirement benefits | 233 | 260 | ||||||
| Unrealized net losses on securities available for sale | 32 | 132 | ||||||
| Fair value adjustments for valuation of FDIC covered assets | 40 | 53 | ||||||
| Unrealized gains/losses on cash flow hedges | 41 | 78 | ||||||
| Other | 30 | — | ||||||
| Total deferred tax assets | 1,330 | 1,381 | ||||||
| Deferred tax liabilities: | ||||||||
| Leasing and renewable energy | 515 | 619 | ||||||
| Intangible assets | 17 | 59 | ||||||
| Pension liabilities | 373 | 365 | ||||||
| Other | — | 10 | ||||||
| Total deferred tax liabilities | 905 | 1,053 | ||||||
| Net deferred tax asset (liability) | $ | 425 | $ | 328 | ||||
At December 31, 2019, the U.S. federal tax credit carryforwards were $458 million, and if not utilized, began to expire in 2035. The Company has $77 million of federal net operating loss carryforwards of which $60 million are subject to separate return loss limitation rules and if not utilized begin to expire in tax year 2032. The Company also has $17 million of acquired net operating losses subject to IRC Section 382 limitation rules for which $13 million were generated post-tax reform and can be carried forward indefinitely and $4 million if not utilized begin to expire in 2036. The company has $50 million of apportioned gross state net operating loss carryforwards ($4 million tax effected net of federal benefit), and if not utilized begin to expire in 2030. The state tax credits carryforward net of federal benefit was $33 million and can be carried forward indefinitely. The Company's AMT Credit carryforward was $13 million which can be carried forward indefinitely and is also subject to rules under separate return limitation years. Additionally, as a result of the Tax Cuts and Jobs Act, the AMT credit carryforward can generally be used to offset regular income tax liability in fiscal years 2019 through 2021. Any remaining amount is generally fully refundable by fiscal year 2022.
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Deferred tax assets are evaluated for realization based on the existence of sufficient taxable income of the appropriate character. The Company released $5 million of valuation allowance to recognize the deferred tax assets related to the acquisition of First State Investments (US) LLC. Management determined it was more likely than not that such acquired deferred tax assets would be realized. Management has determined that no valuation allowance is required.
The following table reflects the changes in gross unrecognized tax benefits:
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Balance, beginning of year | $ | 127 | $ | 56 | $ | 11 | ||||||
| Gross increases as a result of tax positions taken during prior periods | 1 | 72 | 45 | |||||||||
| Gross decreases as a result of tax positions taken during prior periods | — | — | — | |||||||||
| Gross increases as a result of tax positions taken during current period | — | — | 2 | |||||||||
| Gross decrease as a result of closed audit years or settlements | (2 | ) | (1 | ) | (2 | ) | ||||||
| Balance, end of year | $ | 126 | $ | 127 | $ | 56 | ||||||
The amount of unrecognized tax positions that would affect the effective tax rate, if recognized, was $99 million, $98 million and $33 million at December 31, 2019, 2018 and 2017, respectively.
The Company recognizes interest and penalties as a component of income tax expense. As of December 31, 2019, we accrued $3 million in interest and $3 million in penalties. It is reasonably possible that certain tax positions will be resolved within the next 12 months, which would decrease the Company's balance of total unrecognized tax benefits by $22 million with 2018 and 2019 filings.
The Company is subject to U.S. federal income tax as well as various state and foreign income taxes. With limited exception, the Company is not open to examination for periods before 2015 by U.S. federal taxing authorities and 2014 by state taxing authorities.
Note 18—Regulatory Capital Requirements
The Company and the Bank are subject to various regulatory capital requirements administered by the U.S. federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the Bank's prompt corrective action classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. Prompt corrective action provisions are not applicable to BHCs such as the Company. The Bank is subject to laws and regulations that limit the amount of dividends it can pay to the Company.
Quantitative measures established by regulation to help ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the tables below) of Total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to quarterly average assets (as defined). As of December 31, 2019, management believes the capital ratios of the Bank met all regulatory requirements of "well-capitalized" institutions, which are 10% for the Total risk-based capital ratio and 8.0% for the Tier 1 risk-based capital ratio. Furthermore, management believes, as of December 31, 2019 and 2018, that the Company and the Bank met all capital adequacy requirements to which they are subject.
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Note 18—Regulatory Capital Requirements (Continued)
The Company's and the Bank's capital amounts and ratios are presented in the following tables.
| U.S. Basel III | Minimum Capital Requirement with Capital Conservation Buffer (1) | |||||||||||||||
| (Dollars in millions) | Amount | Ratio | Amount | Ratio | ||||||||||||
| Capital Ratios for the Company: | ||||||||||||||||
| As of December 31, 2019: | ||||||||||||||||
| Common equity tier 1 capital (to risk-weighted assets) | $ | 15,086 | 14.10 | % | ≥ | $ | 7,492 | 7.000 | % | |||||||
| Tier 1 capital (to risk-weighted assets) | 15,086 | 14.10 | ≥ | 9,097 | 8.500 | |||||||||||
| Total capital (to risk-weighted assets) | 15,769 | 14.73 | ≥ | 11,237 | 10.500 | |||||||||||
Tier 1 leverage(2) | 15,086 | 8.88 | ≥ | 6,792 | 4.000 | |||||||||||
| As of December 31, 2018: | ||||||||||||||||
| Common equity tier 1 capital (to risk-weighted assets) | $ | 14,256 | 13.96 | % | ≥ | $ | 6,508 | 6.375 | % | |||||||
| Tier 1 capital (to risk-weighted assets) | 14,256 | 13.96 | ≥ | 8,039 | 7.875 | |||||||||||
| Total capital (to risk-weighted assets) | 14,904 | 14.60 | ≥ | 10,081 | 9.875 | |||||||||||
Tier 1 leverage(2) | 14,256 | 8.77 | ≥ | 6,502 | 4.000 | |||||||||||
| (1) | Beginning January 1, 2019, the minimum capital requirement includes a capital conservation buffer of 2.5%. |
| (2) | Tier 1 capital divided by quarterly average assets (excluding certain disallowed assets, primarily goodwill and other intangibles). |
| U.S. Basel III | Minimum Capital Requirement with Capital Conservation Buffer (1) | To Be Well-Capitalized Under Prompt Corrective Action Provisions | |||||||||||||||||||||||
| (Dollars in millions) | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
| Capital Ratios for the Bank: | |||||||||||||||||||||||||
| As of December 31, 2019 (U.S. Basel III): | |||||||||||||||||||||||||
| Common equity tier 1 capital (to risk-weighted assets) | $ | 14,115 | 14.47 | % | ≥ | $ | 6,829 | 7.000 | % | ≥ | $ | 6,342 | 6.5 | % | |||||||||||
| Tier 1 capital (to risk-weighted assets) | 14,115 | 14.47 | ≥ | 8,293 | 8.500 | ≥ | 7,805 | 8.0 | |||||||||||||||||
| Total capital (to risk-weighted assets) | 14,746 | 15.11 | ≥ | 10,244 | 10.500 | ≥ | 9,756 | 10.0 | |||||||||||||||||
Tier 1 leverage(2) | 14,115 | 10.65 | ≥ | 5,304 | 4.000 | ≥ | 6,629 | 5.0 | |||||||||||||||||
| As of December 31, 2018 (U.S. Basel III): | |||||||||||||||||||||||||
| Common equity tier 1 capital (to risk-weighted assets) | $ | 13,316 | 14.45 | % | ≥ | $ | 5,876 | 6.375 | % | ≥ | $ | 5,991 | 6.5 | % | |||||||||||
| Tier 1 capital (to risk-weighted assets) | 13,316 | 14.45 | ≥ | 7,258 | 7.875 | ≥ | 7,374 | 8.0 | |||||||||||||||||
| Total capital (to risk-weighted assets) | 13,905 | 15.09 | ≥ | 9,102 | 9.875 | ≥ | 9,217 | 10.0 | |||||||||||||||||
Tier 1 leverage(2) | 13,316 | 10.61 | ≥ | 5,018 | 4.000 | ≥ | 6,273 | 5.0 | |||||||||||||||||
| (1) | Beginning January 1, 2019, the minimum capital requirement includes a capital conservation buffer of 2.5%. |
| (2) | Tier 1 capital divided by quarterly average assets (excluding certain disallowed assets, primarily goodwill and other intangibles). |
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Note 19—Restrictions on Cash and Due from Banks, Securities, Loans and Dividends
Federal Reserve regulations require the Bank to maintain reserve balances based on the types and amounts of deposits received. The required reserve balances were $116 million and $348 million at December 31, 2019 and 2018, respectively.
See Note 2 to these consolidated financial statements for the carrying amounts of securities that were pledged as collateral to secure public and trust deposits and for other transactions as required by contract or law. See Note 10 to these consolidated financial statements for the carrying amounts of loans and securities that were pledged as collateral for borrowings, including those pledged to the Federal Reserve Bank and FHLB.
The Federal Reserve Act restricts the amount of credit transactions and the terms of both credit and non-credit transactions between a bank and its non-bank affiliates. Such transactions may not exceed 10% of the bank's capital and surplus (which for this purpose represents Tier 1 and Tier 2 capital, as calculated under the risk-based capital guidelines, plus the balance of the allowance for loan losses excluded from Tier 2 capital) with any single non-bank affiliate and 20% of the bank's capital and surplus with all its non-bank affiliates. Transactions that are extensions of credit may require collateral to be held to provide added security to the bank. See Note 18 to these consolidated financial statements for further discussion of risk-based capital. At December 31, 2019, $56 million of notes payable remained outstanding from Bankers Commercial Corporation.
The declaration of a dividend by the Bank to the Company is subject to the approval of the OCC if the total of all dividends declared in the current calendar year plus the preceding two years exceeds the Bank's total net income in the current calendar year plus the preceding two years. The payment of dividends is also limited by minimum capital requirements imposed on national banks by the OCC.
At December 31, 2019, MUSA had $35 million of cash segregated in a special reserve account for the exclusive benefit of customers pursuant to Customer Protection Rule 15c3-3 of the Securities and Exchange Act of 1934.
Note 20—Commitments, Contingencies and Guarantees
The following table summarizes the Company's commitments:
| (Dollars in millions) | December 31, 2019 | |||
| Commitments to extend credit | $ | 38,442 | ||
| Issued standby and commercial letters of credit | 4,191 | |||
| Commitments to enter into forward-starting resale agreements | 1,150 | |||
| Other commitments | 556 | |||
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 are generally contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party, while commercial letters of credit are issued specifically to facilitate foreign or domestic trade transactions. The majority of these types of commitments have remaining terms of 1 year or less. At December 31, 2019, the carrying amount of the Company's standby and commercial letters of credit totaled $4 million. Estimated exposure to loss related to these commitments is covered by the allowance for losses on unfunded commitments. The carrying amounts of the standby and commercial letters of credit and the allowance for losses on unfunded credit commitments are included in other liabilities on the consolidated balance sheet.
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
139
Note 20—Commitments, Contingencies and Guarantees (Continued)
amount of these instruments. Collateral may be obtained based on management's credit assessment of the customer.
Other commitments include collateralized financing activities, commitments to fund principal investments, other securities, and residual value guarantees.
Principal investments include direct investments in private and public companies. The Company issues commitments to provide equity and mezzanine capital financing to private and public companies through direct investments. 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 occasionally enters into financial guarantee contracts where a premium is received from another financial institution counterparty to guarantee a portion of the credit risk on interest rate swap contracts entered into between the financial institution and its customer. The Company becomes liable to pay the financial institution only if the financial institution is unable to collect amounts owed to them by their customer. As of December 31, 2019, the current exposure to loss under these contracts totaled $26 million, and the maximum potential exposure to loss in the future was estimated at $43 million.
The Company is subject to various pending and threatened legal actions that arise in the normal course of business. The Company maintains liabilities for losses from legal actions that are recorded when they are determined to be both probable in their occurrence and can be reasonably estimated. Management believes the disposition of all claims currently pending, including potential losses from claims that may exceed the liabilities recorded, and claims for loss contingencies that are considered reasonably possible to occur, will not have a material effect, either individually or in the aggregate, on the Company's consolidated financial condition, results of operations or liquidity.
Note 21—Related Party Transactions
MUAH is a financial holding company, bank holding company and intermediate holding company whose principal subsidiaries are MUFG Union Bank, N.A. and MUFG Securities Americas Inc. It is owned by MUFG Bank, Ltd. and MUFG. MUFG Bank, Ltd. is a wholly-owned subsidiary of MUFG.
On July 1, 2016, MUFG designated MUAH as its IHC in accordance with the requirements of the U.S. Federal Reserve Board’s final rules for Enhanced Prudential Standards and transferred interests in substantially all its U.S. subsidiaries to the IHC. On July 1, 2017, MUFG transferred interests in its remaining U.S. subsidiaries to MUAH. The transferred subsidiaries had assets of $1.0 billion, including goodwill and intangibles of $196 million, and liabilities of $601 million, all of which were transferred at carrying value. In consideration for the transferred assets and liabilities, MUAH issued 3,267,433 shares to MUFG Bank, Ltd. and MUFG.
The Company provides various business, banking, financial, administrative and support services, and facilities for MUFG Bank, Ltd. in connection with the operation and administration of MUFG Bank, Ltd.'s business in the U.S. (including MUFG Bank, Ltd.'s U.S. branches). The Bank and MUFG Bank, Ltd. participate in a master services agreement whereby the Bank earns fee income in exchange for services and facilities provided.
In addition to the above, the Company conducts transactions with affiliates which include MUFG Bank, Ltd., MUFG and other entities which are directly or indirectly owned by MUFG. The transactions include capital market transactions, facilitating securities transactions, secured financing transactions, advisory services, clearing and operational support. Under services level agreements the Company provides services to and receives services from various affiliates. The Company also has referral agreements with its affiliates and pays referral fees from investment banking revenue earned.
Related party transactions reflect market-based pricing. These transactions are subject to federal and state statutory and regulatory restrictions and limitations.
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Note 21—Related Party Transactions (Continued)
The tables and discussion below represent the more significant related party balances and income (expenses) generated by related party transactions.
As of December 31, 2019 and December 31, 2018, assets and liabilities with affiliates consisted of the following:
| (Dollars in millions) | December 31, 2019 | December 31, 2018 | ||||||
| Assets: | ||||||||
| Cash and cash equivalents | $ | 282 | $ | 80 | ||||
| Securities borrowed or purchased under resale agreements | 2,415 | 1,913 | ||||||
| Other assets | 109 | 146 | ||||||
| Liabilities: | ||||||||
| Deposits | $ | 894 | $ | 451 | ||||
| Securities loaned or sold under repurchase agreements | 318 | 148 | ||||||
| Commercial paper and other short-term borrowings | 326 | 1,081 | ||||||
| Long-term debt | 7,345 | 7,333 | ||||||
| Other liabilities | 98 | 69 | ||||||
Revenues and expenses with affiliates for the years ended 2019, 2018, and 2017 were as follows:
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Interest Income | ||||||||||||
| Securities borrowed or purchased under resale agreements | $ | 66 | $ | 66 | $ | 41 | ||||||
| Other | 2 | 2 | 1 | |||||||||
| Interest Expense | ||||||||||||
| Deposits | 13 | 3 | 5 | |||||||||
| Commercial paper and other short-term borrowings | 3 | 2 | 15 | |||||||||
| Long-term debt | 237 | 171 | 114 | |||||||||
| Securities loaned or sold under repurchase agreements | 25 | 18 | 6 | |||||||||
| Noninterest Income | ||||||||||||
| Trading account activities | 34 | — | — | |||||||||
| Fees from affiliates | 1,439 | 1,213 | 866 | |||||||||
| Other, net | (6 | ) | 1 | 13 | ||||||||
| Noninterest Expense | ||||||||||||
| Other | 96 | 115 | 112 | |||||||||
During 2019, the Company sold loans to affiliates for gross proceeds of $280 million, resulting in gains on sale of $0.7 million. During 2019, the Company purchased loans from affiliates for $9 million.
For additional information regarding the debt due to affiliates, see Note 9 and Note 10 to our Consolidated Financial Statements included in this Form 10-K.
At December 31, 2019, the Company had $1.5 billion in uncommitted, unsecured borrowing facilities with affiliates.
At December 31, 2019 and December 31, 2018, the Company had derivative contracts with affiliates totaling $4 billion and $4 billion, respectively, in notional balances, with $68 million and $96 million in net unrealized gains at December 31, 2019 and December 31, 2018, respectively.
An affiliate extends guarantees on liabilities arising out of or in connection with agreements with certain counterparties. There was no amount guaranteed at December 31, 2019 and December 31, 2018.
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Note 22—Business Segments
The Company has four reportable segments: Regional Bank, Global Corporate & Investment Banking - U.S. (previously U.S. Wholesale & Investment Banking), Transaction Banking, and MUSA. The Company uses various management accounting methodologies to measure the performance of its segments. Unlike GAAP, there is no standardized or authoritative guidance for management accounting. Consequently, reported results are not necessarily comparable with those presented by other companies and they are not necessarily indicative of the results that would be reported by the business units if they were separate economic entities.
The management reporting accounting methodologies, which are enhanced from time to time, measure segment profitability by assigning balance sheet and statements of income items to each operating segment. Methodologies that are applied to the measurement of segment profitability, which are enhanced from time to time, include a funds transfer pricing system, an activity-based costing methodology, other indirect costs and a methodology to allocate the provision for credit losses. The funds transfer pricing system assigns a cost of funds or a credit for funds to assets or liabilities based on their type, maturity or repricing characteristics. A segment receives a credit from Corporate Treasury for its funding sources. Conversely, a segment is assigned a charge by Corporate Treasury to fund its assets. Certain indirect costs, such as operations and technology expense, are allocated to the segments based on an activity-based costing methodology. Other indirect costs, such as corporate overhead, are allocated to the segments based on internal surveys and metrics that serve as proxies for estimated usage. During the normal course of business, the Company occasionally changes or updates its management accounting methodologies or organizational structure. Certain non-bank subsidiaries, including MUSA, are reported based on their GAAP results.
Regional Bank
The Regional Bank provides banking products and services to individual and business customers in California, Washington, and Oregon through five major business lines.
Consumer Banking serves consumers and small businesses through 342 full-service branches, digital channels, call centers, ATMs and alliances with other financial institutions. Products and services include checking and other deposit accounts; residential mortgage loans; consumer loans; home equity lines of credit; credit cards; bill and loan payment services; and merchant services.
Commercial Banking provides commercial and asset-based loans to clients across a wide range of industries with annual revenues up to $2 billion. By working with the Company's other segments, Commercial Banking clients also have access to global treasury management and capital markets solutions and foreign exchange, interest rate, and commodity risk management products.
Real Estate Industries serves professional real estate investors and developers with products such as construction loans, commercial mortgages, bridge financing and unsecured financing. Property types supported include apartment, office, retail, industrial and single-family residential on the West Coast and in select metropolitan areas across the country. Real Estate Industries also makes tax credit investments in affordable housing projects through its Community Development Finance unit referenced as LIHC investments. By working with the Company's other segments, Real Estate Industries also offers its clients global treasury management and capital markets solutions and foreign exchange, interest rate, and commodity risk management products.
Wealth Markets serves corporate, institutional, non-profit and individual clients. Capabilities include Wealth Planning and Trust & Estate Services; Investment Management through HighMark Capital Management, Inc., an SEC-registered investment advisory firm wholly-owned by the Bank; Brokerage services through UnionBanc Investment Services, LLC, an SEC-registered broker-dealer/investment advisory firm wholly-owned by the Bank; and Private Wealth Management.
PurePoint Financial is a national online direct bank deposit platform offering consumer savings accounts and CD products with services provided through the online platform and a call center.
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Note 22—Business Segments (Continued)
Global Corporate & Investment Banking - U.S.
Global Corporate & Investment Banking - U.S. delivers the full suite of MUAH products and services to large and mid-corporate customers. The segment employs an industry-focused strategy including dedicated coverage teams in General Industries, Power and Utilities, Oil and Gas, Telecom and Media, Technology, Healthcare and Nonprofit, Public Finance, and Financial Institutions (predominantly Insurance and Asset Managers). Global Corporate & Investment Banking - U.S. provides customers general corporate credit and structured credit services, including project finance, leasing and equipment finance, funds finance and asset-based finance. By working with the Company's other segments, Global Corporate & Investment Banking - U.S. offers its customers a range of noncredit services, which include global treasury management, capital market solutions, and various foreign exchange, interest rate risk and commodity risk management products.
Transaction Banking
Transaction Banking works alongside the Company's other segments to provide working capital management and asset servicing solutions, including deposits and treasury management, trade finance, and institutional trust and custody, to the Company's customers. The client base consists of financial institutions, corporations, government agencies, insurance companies, mutual funds, investment managers and non-profit organizations.
MUFG Securities Americas
MUSA is MUAH's broker-dealer subsidiary which engages in capital markets origination transactions, domestic and foreign debt and equity securities transactions, private placements, collateralized financings, and securities borrowing and lending transactions.
Other
"Other" includes the MUFG Fund Services segment, Markets segment, Japanese Corporate Banking segment and Corporate Treasury. MUFG Fund Services provides comprehensive investment fund administrative solutions. Markets provides risk management solutions, including foreign exchange, interest rate and energy risk management solutions. The Japanese Corporate Banking segment offers a range of credit, deposit, and investment management products and services to companies located primarily in the U.S. that are affiliated with companies headquartered in Japan. Corporate Treasury is responsible for ALM, wholesale funding and the ALM investment and derivatives hedging portfolios. These treasury management activities are carried out to manage the net interest rate and liquidity risks of the Company's balance sheet and to manage those risks within the guidelines established by ALCO. For additional information regarding these risk management activities, see Part II, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-K.
Additionally, "Other" is comprised of certain corporate activities of the Company; the net impact of funds transfer pricing charges and credits allocated to the reportable segments; the residual costs of support groups; fees from affiliates and noninterest expenses associated with MUFG Bank, Ltd. U.S. branch banking operations; the unallocated allowance; goodwill, intangible assets, and the related amortization/accretion associated with the Company's privatization transaction when we became a privately held company in 2008; the goodwill impairment recorded in the third quarter of 2019 (see Note 5 to these Consolidated Financial Statements); the elimination of the fully taxable-equivalent basis amount; the difference between the marginal tax rate and the consolidated effective tax rate; and FDIC covered assets.
143
Note 22—Business Segments (Continued)
As of and for the Twelve Months Ended December 31, 2019:
| (Dollars in millions) | Regional Bank | Global Corporate & Investment Banking - U.S. | Transaction Banking | MUSA | Other (1) | MUFG Americas Holdings Corporation | ||||||||||||||||||
| Results of operations | ||||||||||||||||||||||||
| Net interest income (expense) | $ | 2,294 | $ | 424 | $ | 259 | $ | 167 | $ | (51 | ) | $ | 3,093 | |||||||||||
| Noninterest income | 520 | 353 | 56 | 384 | 1,392 | 2,705 | ||||||||||||||||||
| Total revenue | 2,814 | 777 | 315 | 551 | 1,341 | 5,798 | ||||||||||||||||||
| Noninterest expense | 2,130 | 458 | 244 | 476 | 2,907 | 6,215 | ||||||||||||||||||
| (Reversal of) provision for credit losses | 209 | 51 | (2 | ) | — | (6 | ) | 252 | ||||||||||||||||
| Income (loss) before income taxes and including noncontrolling interests | 475 | 268 | 73 | 75 | (1,560 | ) | (669 | ) | ||||||||||||||||
Income tax expense (benefit) (2) | 93 | 12 | 25 | 18 | (66 | ) | 82 | |||||||||||||||||
| Net income (loss) including noncontrolling interest | 382 | 256 | 48 | 57 | (1,494 | ) | (751 | ) | ||||||||||||||||
| Deduct: net loss from noncontrolling interests | — | — | — | — | 17 | 17 | ||||||||||||||||||
| Net income (loss) attributable to MUAH | $ | 382 | $ | 256 | $ | 48 | $ | 57 | $ | (1,477 | ) | $ | (734 | ) | ||||||||||
| Total assets, end of period | $ | 74,980 | $ | 20,822 | $ | 1,015 | $ | 34,445 | $ | 39,548 | $ | 170,810 | ||||||||||||
| (1) | Other includes goodwill impairment. See Note 5 to these Consolidated Financial Statements. |
| (2) | Income tax expense (benefit) includes certain management accounting classification adjustments. |
As of and for the Twelve Months Ended December 31, 2018:
| (Dollars in millions) | Regional Bank | Global Corporate & Investment Banking - U.S. | Transaction Banking | MUSA | Other | MUFG Americas Holdings Corporation | ||||||||||||||||||
| Results of operations | ||||||||||||||||||||||||
| Net interest income (expense) | $ | 2,195 | $ | 415 | $ | 264 | $ | 200 | $ | 233 | $ | 3,307 | ||||||||||||
| Noninterest income | 451 | 373 | 59 | 300 | 994 | 2,177 | ||||||||||||||||||
| Total revenue | 2,646 | 788 | 323 | 500 | 1,227 | 5,484 | ||||||||||||||||||
| Noninterest expense | 2,058 | 418 | 255 | 443 | 1,103 | 4,277 | ||||||||||||||||||
| (Reversal of) provision for credit losses | 65 | 42 | (3 | ) | — | 2 | 106 | |||||||||||||||||
| Income (loss) before income taxes and including noncontrolling interests | 523 | 328 | 71 | 57 | 122 | 1,101 | ||||||||||||||||||
Income tax expense (benefit) (1) | 105 | 122 | 19 | 17 | (211 | ) | 52 | |||||||||||||||||
| Net income (loss) including noncontrolling interest | 418 | 206 | 52 | 40 | 333 | 1,049 | ||||||||||||||||||
| Deduct: net loss from noncontrolling interests | — | — | — | — | 24 | 24 | ||||||||||||||||||
| Net income (loss) attributable to MUAH | $ | 418 | $ | 206 | $ | 52 | $ | 40 | $ | 357 | $ | 1,073 | ||||||||||||
| Total assets, end of period | $ | 73,554 | $ | 20,933 | $ | 941 | $ | 33,844 | $ | 38,828 | $ | 168,100 | ||||||||||||
| (1) | Income tax expense (benefit) includes certain management accounting classification adjustments. |
144
Note 22—Business Segments (Continued)
As of and for the Twelve Months Ended December 31, 2017:
| (Dollars in millions) | Regional Bank | Global Corporate & Investment Banking - U.S. | Transaction Banking | MUSA | Other | MUFG Americas Holdings Corporation | ||||||||||||||||||
| Results of operations | ||||||||||||||||||||||||
| Net interest income (expense) | $ | 2,051 | $ | 417 | $ | 247 | $ | 234 | $ | 255 | $ | 3,204 | ||||||||||||
| Noninterest income | 442 | 370 | 64 | 351 | 783 | 2,010 | ||||||||||||||||||
| Total revenue | 2,493 | 787 | 311 | 585 | 1,038 | 5,214 | ||||||||||||||||||
| Noninterest expense | 1,961 | 403 | 229 | 445 | 946 | 3,984 | ||||||||||||||||||
| (Reversal of) provision for credit losses | 22 | (104 | ) | 1 | — | (22 | ) | (103 | ) | |||||||||||||||
| Income (loss) before income taxes and including noncontrolling interests | 510 | 488 | 81 | 140 | 114 | 1,333 | ||||||||||||||||||
Income tax expense (benefit) (1) | 178 | (197 | ) | 33 | 59 | 226 | 299 | |||||||||||||||||
| Net income (loss) including noncontrolling interest | 332 | 685 | 48 | 81 | (112 | ) | 1,034 | |||||||||||||||||
| Deduct: net loss from noncontrolling interests | — | — | — | — | 43 | 43 | ||||||||||||||||||
| Net income (loss) attributable to MUAH | $ | 332 | $ | 685 | $ | 48 | $ | 81 | $ | (69 | ) | $ | 1,077 | |||||||||||
| Total assets, end of period | $ | 67,804 | $ | 20,461 | $ | 1,063 | $ | 32,062 | $ | 33,160 | $ | 154,550 | ||||||||||||
| (1) | Income tax expense (benefit) includes certain management accounting classification adjustments. |
Note 23—Condensed MUFG Americas Holdings Corporation Unconsolidated Financial Statements (Parent Company)
Condensed Balance Sheets
| December 31, | ||||||||
| (Dollars in millions) | 2019 | 2018 | ||||||
| Assets | ||||||||
| Cash and cash equivalents | $ | 840 | $ | 739 | ||||
| Investments in and advances to subsidiaries | ||||||||
| Bank subsidiary | 18,103 | 18,493 | ||||||
| Nonbank subsidiaries | 4,770 | 4,618 | ||||||
| Other assets | 407 | 76 | ||||||
| Total assets | $ | 24,120 | $ | 23,926 | ||||
| Liabilities and Stockholders' Equity | ||||||||
| Long-term debt | $ | 7,622 | $ | 7,355 | ||||
| Other liabilities | 218 | 63 | ||||||
| Total liabilities | 7,840 | 7,418 | ||||||
| Stockholders' equity | 16,280 | 16,508 | ||||||
| Total liabilities and stockholders' equity | $ | 24,120 | $ | 23,926 | ||||
145
Note 23—Condensed MUFG Americas Holdings Corporation Unconsolidated Financial Statements (Parent Company) (Continued)
Condensed Statements of Income
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Income: | ||||||||||||
| Dividends from subsidiaries: | ||||||||||||
| Bank subsidiary | $ | — | $ | 1,700 | $ | 320 | ||||||
| Nonbank subsidiaries | 616 | 95 | 51 | |||||||||
| Interest income on advances to subsidiaries and deposits in bank | 161 | 137 | 79 | |||||||||
| Rental Income | 15 | 15 | 15 | |||||||||
| Total income | 792 | 1,947 | 465 | |||||||||
| Expense: | ||||||||||||
| Interest expense | 251 | 194 | 144 | |||||||||
| Other expense | 29 | 17 | 14 | |||||||||
| Total expense | 280 | 211 | 158 | |||||||||
| Income (loss) before income taxes and equity in undistributed net income of subsidiaries | 512 | 1,736 | 307 | |||||||||
| Income tax benefit | (24 | ) | (13 | ) | (20 | ) | ||||||
| Income (loss) before equity in undistributed net income of subsidiaries | 536 | 1,749 | 327 | |||||||||
| Equity in undistributed net income of subsidiaries less dividends received: | ||||||||||||
| Bank subsidiary | (746 | ) | (697 | ) | 366 | |||||||
| Nonbank subsidiaries | (524 | ) | 21 | 384 | ||||||||
| Net Income | $ | (734 | ) | $ | 1,073 | $ | 1,077 | |||||
Condensed Statements of Cash Flows
| Years Ended December 31, | ||||||||||||
| (Dollars in millions) | 2019 | 2018 | 2017 | |||||||||
| Cash Flows from Operating Activities: | ||||||||||||
| Net income | $ | (734 | ) | $ | 1,073 | $ | 1,077 | |||||
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||||||||
| Equity in undistributed net income of subsidiaries less dividends received | 1,270 | 676 | (750 | ) | ||||||||
| Other, net | (743 | ) | (9 | ) | 2 | |||||||
| Net cash provided by (used in) operating activities | (207 | ) | 1,740 | 329 | ||||||||
| Cash Flows from Investing Activities: | ||||||||||||
| Investments in and advances to subsidiaries | (1,585 | ) | (2,612 | ) | (5,050 | ) | ||||||
| Repayment of investments in and advances to subsidiaries | 1,634 | 2,411 | 1,495 | |||||||||
| Net cash used in investing activities | 49 | (201 | ) | (3,555 | ) | |||||||
| Cash Flows from Financing Activities: | ||||||||||||
| Proceeds from advances from subsidiaries | — | — | 200 | |||||||||
| Repayment of advances from subsidiaries | — | — | (200 | ) | ||||||||
| Proceeds from issuance of long-term debt | 1,890 | 6,500 | 3,525 | |||||||||
| Repayment of long-term debt | (1,631 | ) | (6,145 | ) | — | |||||||
| Dividends paid | — | — | (500 | ) | ||||||||
| Share repurchase | — | (2,496 | ) | — | ||||||||
| Net cash provided by (used in) financing activities | 259 | (2,141 | ) | 3,025 | ||||||||
| Net increase (decrease) in cash and cash equivalents | 101 | (602 | ) | (201 | ) | |||||||
| Cash and cash equivalents at beginning of year | 739 | 1,341 | 1,542 | |||||||||
| Cash and cash equivalents at end of year | $ | 840 | $ | 739 | $ | 1,341 | ||||||
146
MUFG Americas Holdings Corporation and Subsidiaries
Management's Report on Internal Control over Financial Reporting
The management of MUFG Americas Holdings Corporation is responsible for establishing and maintaining adequate internal control over financial reporting, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
We maintain a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and transactions are executed in accordance with management's authorization and recorded properly to permit the preparation of consolidated financial statements in accordance with generally accepted accounting principles. Management recognizes that even a highly effective internal control system has inherent risks, including the possibility of human error and the circumvention or overriding of controls, and that the effectiveness of an internal control system can change with circumstances. Management has assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2019. In making this assessment, management used the criteria set out by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework (2013). Based on our assessment, we concluded that the Company's internal control system over financial reporting is effective as of December 31, 2019.
The Company's internal control over financial reporting and the Company's consolidated financial statements have been audited by Deloitte & Touche LLP, Independent Registered Public Accounting Firm.
147
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of MUFG Americas Holdings Corporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of MUFG Americas Holdings Corporation and subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ DELOITTE & TOUCHE LLP
New York, New York
February 26, 2020
We have served as the Company's auditor since 1996.
148
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of MUFG Americas Holdings Corporation
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of MUFG Americas Holdings Corporation and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2019, of the Company and our report dated February 26, 2020 expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
New York, New York
February 26, 2020
149
MUFG Americas Holdings Corporation and Subsidiaries
Supplementary Information
Quarterly Financial Data (Unaudited)
Condensed Consolidated Statements of Income:
| 2019 Quarters Ended | ||||||||||||||||
| (Dollars in millions) | December 31 | September 30 | June 30 | March 31 | ||||||||||||
| Interest income | $ | 1,326 | $ | 1,383 | $ | 1,302 | $ | 1,538 | ||||||||
| Interest expense | 547 | 629 | 525 | 755 | ||||||||||||
| Net interest income | 779 | 754 | 777 | 783 | ||||||||||||
| (Reversal of) provision for credit losses | 63 | 95 | 56 | 38 | ||||||||||||
| Noninterest income | 707 | 717 | 649 | 632 | ||||||||||||
| Noninterest expense | 1,121 | 2,770 | 1,154 | 1,170 | ||||||||||||
| Income before income taxes and including noncontrolling interests | 302 | (1,394 | ) | 216 | 207 | |||||||||||
| Income tax expense | 52 | (18 | ) | 20 | 28 | |||||||||||
| Net income including noncontrolling interests | 250 | (1,376 | ) | 196 | 179 | |||||||||||
| Deduct: Net loss from noncontrolling interests | 5 | 4 | 3 | 5 | ||||||||||||
| Net income | $ | 255 | $ | (1,372 | ) | $ | 199 | $ | 184 | |||||||
| 2018 Quarters Ended | ||||||||||||||||
| (Dollars in millions) | December 31 | September 30 | June 30 | March 31 | ||||||||||||
| Interest income | $ | 1,388 | $ | 1,317 | $ | 1,254 | $ | 1,166 | ||||||||
| Interest expense | 563 | 485 | 429 | 341 | ||||||||||||
| Net interest income | 825 | 832 | 825 | 825 | ||||||||||||
| (Reversal of) provision for credit losses | 63 | 64 | (19 | ) | (2 | ) | ||||||||||
| Noninterest income | 573 | 626 | 596 | 382 | ||||||||||||
| Noninterest expense | 1,051 | 1,059 | 1,083 | 1,084 | ||||||||||||
| Income before income taxes and including noncontrolling interests | 284 | 335 | 357 | 125 | ||||||||||||
| Income tax expense | 31 | 35 | 28 | (42 | ) | |||||||||||
| Net income including noncontrolling interests | 253 | 300 | 329 | 167 | ||||||||||||
| Deduct: Net loss from noncontrolling interests | 4 | 6 | 15 | (1 | ) | |||||||||||
| Net income | $ | 257 | $ | 306 | $ | 344 | $ | 166 | ||||||||
150
Exhibit Index
Exhibit No. | Description | ||
| 2.1 | |||
| 3.1 | |||
| 3.2 | |||
| 4.1 | |||
| 4.2 | The Registrant agrees to furnish upon request to the Commission a copy of each instrument defining the rights of holders of long-term debt of the Registrant. | ||
| 4.3 | |||
| 4.4 | |||
| 4.5 | |||
| 4.6 | |||
| 4.7 | |||
| 10.1 | |||
| 10.2 | Certain exhibits related to compensatory plans, contracts and arrangements have been omitted pursuant to item 601(b)(10)(iii)(C)(6) of Regulation S-K | ||
| 21.1 | Subsidiaries of the Registrant has been omitted pursuant to General Instruction I(2) of Form 10-K | ||
| 24.1 | |||
| 24.2 | |||
| 31.1 | |||
| 31.2 | |||
| 32.1 | |||
| 32.2 | |||
| 101 | Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company's Annual Report on Form 10-K for the year ended December 31, 2019, is formatted in XBRL interactive data files: (i) Consolidated Statements of Income; (ii) Consolidated Balance Sheets; (iii) Consolidated Statements of Changes in Stockholders' Equity; (iv) Consolidated Statements of Cash Flows; and (v) Notes to Financial Statements (7) | ||
| (1) | Incorporated by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K dated July 1, 2016. |
| (2) | Incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated September 11, 2018. |
| (3) | Incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated July 1, 2014. |
| (4) | Incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated December 8, 2003. |
| (5) | Incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated June 18, 2012. |
| (6) | Incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated February 10, 2015. |
| (7) | Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 10-Q for the quarter ended September 30, 2014. |
| (8) | Filed herewith. |
151
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, MUFG Americas Holdings Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| MUFG AMERICAS HOLDINGS CORPORATION (Registrant) | ||||
| By: | /s/ STEPHEN E. CUMMINGS | |||
Stephen E. Cummings President and Chief Executive Officer | ||||
| Date: | February 26, 2020 | |||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of MUFG Americas Holdings Corporation and in the capacities and on the dates indicated.
| Signature | Title | |
| /s/ STEPHEN E. CUMMINGS | Director, President and Chief Executive Officer | |
| Stephen E. Cummings | (Principal Executive Officer) | |
| /s/ JOHANNES WORSOE | Chief Financial Officer | |
| Johannes Worsoe | (Principal Financial Officer) | |
| /s/ NEAL HOLLAND | Controller and Chief Accounting Officer | |
| Neal Holland | (Principal Accounting Officer) | |
| * | ||
| Roberta A. Bienfait | Director | |
| * | ||
| Michael D. Fraizer | Director | |
| * | ||
| Mohan S. Gyani | Director | |
| * | ||
| Ann F. Jaedicke | Director | |
| * | ||
| Suneel Kamlani | Director | |
| * | ||
| Kazuo Koshi | Director | |
| * | ||
| Masato Miyachi | Director | |
| * | ||
| Toby S. Myerson | Director | |
| * | ||
| Barbara L. Rambo | Director | |
| * | ||
| Muneaki Tokunari | Director | |
| * | ||
| Kazuto Uchida | Director | |
| * | ||
| Dean A. Yoost | Director | |
| *By: | /s/ MICHAEL F. COYNE | |||
Michael F. Coyne Attorney-in-Fact | ||||
Dated: February 26, 2020
152