SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter ended September 30, 1994 Commission File Number 1-10521 CITY NATIONAL CORPORATION - - - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 95-2568550 - - - ------------------------------------------------------------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 North Roxbury Drive, Beverly Hills, California 90210 - - - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (310) 888-6000 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 SOCH subject to such filing requirements for the past 90 days. YES X NO -------- -------- Number of shares of common stock outstanding at October 31, 1994: 45,142,206 This Form 10-Q contains 29 pages. CITY NATIONAL CORPORATION Consolidated Balance Sheet (Unaudited) ASSETS September 30, December 31, September 30, 1994 1993 1993 ----------- ------------ ------------ (Dollars in thousands) Cash and due from banks ................................... $ 227,630 $ 234,504 $ 200,792 Interest-bearing deposits in other banks................... 673 649 621 Federal funds sold and securities purchased under resale agreements ....................................... 183,000 265,000 520,800 Investment securities (market values $700,073, $902,738 and $576,798 at September 30, 1994, December 31, 1993 and September 30, 1993, respectively) 726,374 902,481 569,721 Securities available for sale (cost $197,596 and $2,000 at September 30, 1994 and December 31, 1993, respectively).. 192,164 2,000 - Trading account securities ................................ 41,781 39,765 22,410 Loans...................................................... 1,534,454 1,620,556 1,610,189 Less allowance for credit losses .......................... 112,308 110,499 123,353 ----------- ------------ ------------ Net loans ............................................... 1,422,146 1,510,057 1,486,836 Leveraged leases .......................................... 9,756 13,852 13,474 Premises and equipment, net ............................... 18,282 20,359 20,927 Customers' acceptance liability ........................... 6,177 5,150 4,851 Other real estate ......................................... 8,269 5,559 5,114 Deferred tax asset ........................................ 26,300 18,050 30,120 Assets held for accelerated disposition.................... - 17,450 51,222 Other assets .............................................. 35,299 65,750 58,799 ----------- ------------ ------------ Total assets ............................................ $ 2,897,851 $ 3,100,626 $ 2,985,687 =========== ============ ============ LIABILITIES Demand deposits ........................................... $ 948,374 $ 1,088,026 $ 973,551 Interest checking deposits ................................ 279,267 324,034 284,901 Money market accounts ..................................... 704,466 742,381 805,937 Savings deposits .......................................... 87,623 107,221 98,893 Time deposits - under $100,000 ............................ 82,764 96,672 102,745 Time deposits - $100,000 and over ......................... 137,453 168,433 189,313 ----------- ----------- ----------- Total deposits .......................................... 2,239,947 2,526,767 2,455,340 Federal funds purchased and securities sold under repurchase agreements ............................. 250,969 202,459 205,091 Other short-term borrowings ............................... 46,002 15,000 15,000 Mortgages payable ......................................... - 26,319 - Other liabilities ......................................... 32,130 26,857 11,884 Acceptances outstanding ................................... 6,177 5,150 4,851 ----------- ----------- ----------- Total liabilities ....................................... 2,575,225 2,802,552 2,692,166 ----------- ----------- ----------- Commitments and contingencies SHAREHOLDERS' EQUITY Preferred Stock, authorized-5,000,000 shares none outstanding Common stock- par value- $1.00 Authorized-75,000,000 shares Outstanding-45,127,214, 45,027,417 and 45,021,360 at September 30, 1994, December 31, 1993 and September 30, 1993, respectively......................... 45,127 45,027 45,021 Additional paid-in capital ................................ 263,151 262,471 262,507 Unrealized losses on securities available for sale......... (3,529) - - Accumulated earnings (deficit)............................. 17,877 (9,424) (14,007) ----------- ----------- ----------- Total shareholders' equity .............................. 322,626 298,074 293,521 ----------- ----------- ----------- Total liabilities and shareholders' equity............... $ 2,897,851 $ 3,100,626 $ 2,985,687 =========== =========== =========== See accompanying Notes to the Unaudited Consolidated Financial Statements -2- Consolidated Statement of Operations (Unaudited) For the three months For the nine months ended September 30, ended September 30, ----------------------------- --------------------------- 1994 1993 1994 1993 ------------- ------------- ------------- ------------- (Dollars in thousands except per share data) Interest income: Interest and fees on loans ............................... $32,988 $30,528 $94,143 $99,135 Interest on federal funds sold and securities purchased under resale agreements ............................... 1,841 2,892 5,194 6,792 Interest on investment securities: U.S. Treasury and federal agency securities............ 7,869 6,489 24,856 17,631 Municipal securities .................................. 240 - 587 - Other securities ...................................... 443 216 1,131 555 Interest on securities available for sale................. 3,266 216 5,913 1,001 Interest on trading account securities.................... 394 258 823 754 -------------- ------------- ------------- ------------- Total ................................................. 47,041 40,599 132,647 125,868 -------------- ------------- ------------- ------------- Interest expense: Interest on deposits ..................................... 7,377 8,202 21,774 26,104 Interest on federal funds purchased and securities sold under repurchase agreements ........................... 2,248 1,643 5,754 5,959 Interest on other short-term borrowings................... 268 119 557 343 -------------- ------------- ------------- ------------- Total ................................................. 9,893 9,964 28,085 32,406 -------------- ------------- ------------- ------------- Net interest income ...................................... 37,148 30,635 104,562 93,462 Provision for credit losses .............................. - 5,500 6,000 24,500 -------------- -------------- ------------- ------------- Net interest income after provision for credit losses..... 37,148 25,135 98,562 68,962 -------------- -------------- ------------- ------------- Noninterest income: Service charges on deposit accounts ...................... 2,186 3,184 7,352 8,577 Trust fees ............................................... 1,677 1,875 5,195 5,708 Customer trading account income .......................... 1,919 1,475 5,128 4,808 Gain on sale of Equity Line of Credit loans............... - - - 4,460 Gain on sale of leverage leases .......................... - - 1,331 - Gain on sale of merchant draft business................... - - - 1,941 Gain (loss) on sale of securities ........................ (647) - (647) - All other income ......................................... 3,003 3,773 8,974 11,051 -------------- -------------- ------------- ------------- Total noninterest income............................... 8,138 10,307 27,333 36,545 -------------- -------------- ------------- ------------- Noninterest expense: Salaries and other employee benefits ..................... 16,124 17,966 48,580 54,076 Net occupancy of premises ................................ 2,386 2,959 7,769 8,537 Data processing .......................................... 1,672 1,903 5,250 5,887 Professional ............................................. 2,184 1,981 5,579 5,236 FDIC insurance ........................................... 1,387 1,580 4,387 5,622 Office supplies .......................................... 1,140 1,146 3,481 3,688 Depreciation ............................................. 1,031 1,098 3,124 3,322 Promotion ................................................ 649 522 2,195 1,352 Equipment ................................................ 724 421 1,845 1,475 Other operating .......................................... 2,620 2,874 7,742 7,887 Other real estate expense (income)........................ (203) (2,020) (5,503) 38,244 -------------- -------------- ------------- ------------- Total noninterest expense............................... 29,714 30,430 84,449 135,326 -------------- -------------- ------------- ------------- Income (loss) before taxes.................................. 15,572 5,012 41,446 (29,819) Income taxes (benefit) ..................................... 5,160 1,537 14,145 (11,202) -------------- -------------- ------------- ------------- Net income (loss) from continuing operations................ 10,412 3,475 27,301 (18,617) Net income from gain on sale of discontinued operations..... - - - 7,128 -------------- -------------- ------------- ------------- Net income (loss) .......................................... $10.412 $3,475 $27,301 $(11,489) ============== ============== ============= ============= Income (loss) per share from continuing operations.......... $0.23 $0.08 $0.60 ($0.49) Income (loss) per share .................................... $0.23 $0.08 $0.60 (0.30) ============== ============== ============= ============= Shares used to compute earnings (loss) per share............ 45,726 45.021 45,608 34,746 ============== ============== ============= ============= See accompanying Notes to the Unaudited Consolidated Financial Statements. -3- City National Corporation Consolidated Statement of Cash Flows (Unaudited) For the nine months ended September 30, --------------------------- 1994 1993 ----------- ----------- (Dollars in thousands) Operating Activities Net income (loss) ................................................ $ 27,301 $ (11,489) Adjustment to net income (loss): Provision for credit losses .................................. 6,000 24,500 Writedowns of ORE ............................................ - 40,327 Gain on sales of ORE and Disposition Program assets........... (5,361) - Gain on sale of leveraged leases.............................. (1,331) - Depreciation ................................................. 3,124 3,322 Net (increase) in trading securities ........................ (2,016) (12,152) Net (increase) decrease in deferred tax benefits ............. (8,250) 7,000 Tax refunds................................................... 24,955 - Other, net ................................................... 26,255 4,136 ---------- ---------- Net cash provided by operating activities................. 70,677 55,644 ---------- ---------- Investing Activities Net decrease (increase)in short term investments ................. (24) 14,335 Purchases of securities available for sale ....................... (253,836) - Sales and maturities of securities available for sale............. 53,904 - Maturities of investment securities .............................. 484,556 183,509 Purchases of investment securities................................ (305,205) (310,834) Loan originations and principal collections, net ................. 173,842 333,222 Purchase of residential mortgage loans............................ (122,257) - Proceeds from sales of loans ..................................... - 73,699 Proceeds from sales of ORE and Disposition Program assets ........ 7,861 17,117 Proceeds from sale of leveraged lease............................. 5,141 - Other, net ....................................................... 6,524 8,438 ---------- ---------- Net cash provided by investing activities .................... 50,506 319,486 ---------- ---------- Financing Activities Net increase (decrease) in federal funds purchased and securities sold under repurchase agreements ............................. 48,510 (134,058) Net decrease in deposits ......................................... (286,820) (455,936) Net increase in short term borrowings............................. 31,002 - Proceeds from issuance of stock................................... 685 77,017 Other, net ....................................................... (3,434) (378) ---------- ---------- Net cash used in financing activities ........................ (210,057) (513,355) ---------- ---------- Net decrease in cash and cash equivalents ........................ (88,874) (138,225) Cash and cash equivalents at beginning of period ................. 499,504 859,817 ---------- --------- Cash and cash equivalents at end of period ....................... $ 410,630 $ 721,592 ========== ========= Supplemental disclosures of cash flow information Cash paid (received) during the period for: Interest................................................... $ 28,131 $ 33,099 Income taxes............................................... (6,986) (30,023) Non-Cash Investing activities: Transfer from loans to OREO and Disposition Program........ 3,784 78,560 See accompanying Notes to the Unaudited Consolidated Financial Statements -4- CITY NATIONAL CORPORATION STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited) For the nine months ended September 30, ---------------------------------- 1994 1993 -------------- --------------- (Dollars in thousands) Common Stock Balance, beginning of period .................. $45,027 $32,240 Stock options exercised ........................ 100 64 Proceeds from Rights Offering................... - 12,717 ------------- -------------- Balance, end of period ......................... 45,127 45,021 ------------- -------------- Additional paid in capital Balance, beginning of period .................. 262,471 198,222 Stock options exercised ........................ 585 383 Tax benefit from stock options ................. 95 49 Proceeds from Rights Offering................... - 63,853 ------------- -------------- Balance, end of period ......................... 263,151 262,507 ------------- ------------- Unrealized net losses on securities available for sale Balance, beginning of period .................. - - Change during period ........................... (3,529) - ------------- ------------- Balance, end of period ......................... (3,529) - ------------- ------------- Accumulated earnings (deficit) Balance, beginning of period ................. (9,424) (2,518) Net income (loss) .............................. 27,301 (11,489) ------------- -------------- Balance, end of period ......................... 17,877 (14,007) ------------- ------------- Total shareholders' equity ....................... $322,626 $293,521 ============= ============= See accompanying Notes to the Unaudited Consolidated Financial Statements -5- NOTES TO THE FINANCIAL STATEMENTS OF THE REGISTRANT 1. The results of operations reflect the interim adjustments, all of which are of a normal recurring nature and which, in the opinion of management, are necessary for a fair presentation of the results for such interim periods. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1993. 2. In March of 1993, the Company adopted a program (the Disposition Program) to accelerate the disposition of certain assets, consisting of other real estate owned (ORE), including in-substance foreclosures, and certain nonaccrual loans. The assets included in the Disposition Program were segregated as "assets held for accelerated disposition" on the consolidated balance sheet. The book value of these assets prior to the adoption of the Disposition Program was $88.9 million of ORE and $30.6 million of nonaccrual loans. A credit loss provision of $4.0 million and additional ORE writedowns and expense accruals of $36.5 million and certain charge offs in the amount of $12.4 million were recorded during the first quarter of 1993 to record the assets at their estimated liquidation values. The Bank signed a definitive agreement to sell, as of November 1, 1993, all six asset pools in the Disposition Program. The sale of the loans contained in the Disposition Program for $48.3 million closed concurrently with the signing of the definitive agreement and a gain of $12.8 million was recognized at that time. During the first and second quarters of 1994, the Company completed the sale of the ORE contained in the Disposition Program. Gains of $3.5 million and $0.7 million, respectively, from the Disposition Program were recognized in the first and second quarters of 1994, respectively. 3. Securities held for investment are classified as investment securities. Because the Company has the ability and management has the intent to hold investment securities until maturity, investment securities are stated at cost, adjusted for amortization of premiums and accretion of discounts. Trading account securities are stated at market value. Investments not classified as trading securities nor as investment securities are classified as securities available for sale and recorded at fair value. Unrealized holding gains or losses for securities available for sale are excluded from earnings -6- and reported as a net amount after taxes, in a separate component of shareholders' equity, until realized. 4. For purposes of reporting cash flows, cash and cash equivalents include cash on hand, non-interest bearing amounts due from banks, federal funds sold and securities purchased under resale agreements, and do not include items with original maturities of over 90 days. 5. On October 26, 1994, the Board of Directors of City National Corporation declared a quarterly dividend of $0.05 per share of common stock, payable on November 18, 1994, to shareholders of record on November 8, 1994. -7- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The following discussion summarizes some of the developments significant to City National Corporation during the third quarter of 1994. However, the Company's consolidated financial statements for the quarter and the entire Management's Discussion and Analysis of Financial Condition and Results of Operations included in this Quarterly Report should be reviewed for a more complete understanding of the Company's financial position and its results of operations. City National Corporation (the Corporation) is the holding company for City National Bank (the Bank). Because the Bank constitutes substantially all of the business of the Company, references to the Company in this Item 2 reflect the consolidated activities of the Company and the Bank. The Company recorded consolidated net income of $10.4 million, or $.23 per share, in the third quarter of 1994, compared to a net income of $3.5 million, or $.08 per share, in the third quarter of 1993, and net income of $8.2 million, or $.18 per share, in the second quarter of 1994. Most of the change between third quarters resulted from an increase in net interest income in the third quarter of 1994 of $6.5 million and a decrease in the provision for credit losses of $5.5 million. Returns on average assets for the third quarter and the first nine months of 1994 were 1.47% and 1.29%, respectively. Returns on average equity for the third quarter and the first nine months of 1994 were 13.04% and 11.80%, respectively. The allowance for credit losses at September 30, 1994 was $112.3 million, or 7.32% of loans outstanding, compared to 7.07% at June 30, 1994 and 7.66% at September 30, 1993. The Company had net recoveries of $6.9 million in the third quarter of 1994, compared to net charge-offs of $6.2 million, or 1.52% of average loans, in the third quarter of 1993, and $9.1 million, or 2.43% of average loans, in the second quarter of 1994. Based on its review of the loan portfolio and the level of the allowance for credit losses, management anticipates that net charge offs for 1994 will decrease from 1993 levels. If credit quality continues to improve and the Southern California economy continues on its recent positive trend, a provision for credit losses may not be required in the last quarter of 1994, and the aggregate provision in 1995 will likely approximate the 1994 provision. -8- Nonaccrual loans totaled $56.1 million at September 30, 1994, or 3.7% of total loans, down from $60.7 million, or 4.1% of total loans, at June 30, 1994, and $97.3 million, or 6.0% of total loans, a year earlier. The reduction in nonaccrual loans between third quarters was principally attributable to payments and charge offs. In April 1994, the Bank implemented a consolidation plan to improve efficiency and operational productivity in its branch network. The streamlining reduced the Bank's total number of branches from 22 to 16, while designating four of the remaining locations as regional commercial lending centers. In addition to providing a full array of regular banking services, the centers house teams of lenders specializing in serving mid-size businesses, as well as the Bank's larger, more complex relationships. The consolidation plan was expected to result in expense savings of approximately $8.0 million per year, before the effect of inflation and other factors. However, this was expected to be partially offset by decreased income resulting from reductions in loans and deposits caused by the consolidation. See "Consolidation Charge Reserve," below. On October 26, 1994, the Board of Directors of City National Corporation declared a quarterly dividend of $.05 per share of common stock, payable on November 18, 1994, to shareholders of record on November 8, 1994. Future dividend amounts will be subject to periodic review by the Board of Directors, with the objective of paying annual dividends equal to approximately one-third of prior year's earnings. The Company last paid a quarterly dividend in the third quarter of 1991, but suspended its dividend as part of the Company's efforts to safeguard its capital position. NET INTEREST INCOME Taxable equivalent net interest income was $37.4 million in the third quarter of 1994, up 21.2% from the year-ago quarter. The increase resulted primarily from the increase in the net interest spread from 3.97% to 4.76%. The net interest spread improved because the increases in the prime interest rates during the last two quarters resulted in higher yields on loans, while rates paid on interest bearing liabilities increased only slightly between quarters. The taxable equivalent net interest margin increased from 4.77% in the third quarter of 1993 to 5.76% in the third quarter of 1994. -9- Net interest income was $105.3 million on a fully-taxable equivalent basis in the first nine months of 1994, up 11.4% from the year-ago period. This increase was primarily due to increases in yields on loans, decreases in rates paid on most deposit accounts and a higher average balance in securities. Management expects interest earning assets to increase slightly from the $2.579 billion average level for the third quarter of 1994. The increases in interest earning assets and the recent increases in the prime interest rate, if sustained, are expected to result in higher net interest income for the fourth quarter of 1994, as compared to the first three quarters of 1994. Average loans declined $160.2 million (9.8%) between third quarters to $1.472 billion at September 30, 1994. The majority of this decrease reflected lower average commercial loans outstanding, down $112.4 million (11.8%). This decline resulted from decreased loan demand because of continued economic weakness in Southern California and strong competition for loans. Average construction loans decreased $55.2 million (77.7%) from the third quarter of 1993, primarily as a continuing result of the Bank's significant cutback in new construction loan commitments, beginning in late 1990 and the transfer of certain construction loans to the real estate mortgage category after completion of construction. Average loans for the first nine months of 1994 declined $274.1 million, or 15.3%, from the first nine months of 1993. Of this decrease, $161.1 million, $70.0 million and $29.9 million were from commercial, real estate construction and real estate mortgage loans, respectively. Average taxable securities increased $371.4 million (71.3%) between third quarters and $420.3 million (97.5%) between the first nine months, as a result of the investment of the Bank's excess liquidity in government, agency and mortgage backed securities during the last twelve months. Average federal funds sold and securities purchased under resale agreements decreased $213.4 million (57.2%) between third quarters and $117.5 million (39.5%) between the first nine months. These decreases resulted from the Bank's decision to invest more of its liquidity in securities offering higher yields. Total deposits decreased $119.8 million (5.1%) between third quarters and $110.2 million (4.7%) between the first nine months. Average time deposits of $100,000 and over -10- decreased $50.3 million (26.0%) between third quarters and $61.5 million (29.1%) between the first nine months. Total average interest bearing core deposits declined $69.0 million (5.5%) between third quarters and $48.0 million (3.8%) between the first nine months. Average federal funds purchased and securities sold under repurchase agreements decreased $21.4 million (9.3%) between third quarters and $69.4 million (24.8%) between the first nine months, due to the Company's reduced requirement for overnight short term funding. -11- Net Interest Income Summary The following table presents the components of net interest income for the quarters ended September 30, 1994 and 1993. 9-30-94 9-30-93 ------------------------------------ ----------------------------------------- Interest Average Interest Average Average income/ interest Average income/ interest Dollars in thousands Balance expense rate (1) Balance expense rate (1) - - - ---------------------------------------------------------------------------------------------------------------------------- Assets (2) Earning assets Loans: (3) Commercial loans $841,237 $19,102 9.07 % $953,679 $17,385 7.30 % Real estate - construction 15,877 418 10.45 71,088 1,080 6.03 Real estate - mortgage 576,168 12,392 8.53 557,517 10,807 7.69 Installment loans 38,887 1,077 10.99 50,074 1,256 9.95 ---------- --------- -------- ---------- --------- -------- Total loans 1,472,169 32,989 8.93 1,632,358 30,528 7.42 ---------- --------- -------- ---------- --------- -------- State and municipal securities 20,796 240 7.10 12,845 216 Taxable securities 892,491 11,577 5.15 521,062 6,705 5.11 Federal funds sold and securities purchased under resale agreements 159,400 1,841 4.58 372,836 2,892 3.08 Trading account securities 34,264 394 4.91 30,966 258 3.63 ---------- --------- -------- ---------- --------- -------- Total earning assets 2,579,120 47,041 7.28 2,570,067 40,599 6.31 ---------- --------- -------- ---------- --------- -------- Allowance for credit losses (111,600) (127,266) Cash and due from banks 250,208 257,516 Other nonearning assets 93,841 201,073 ----------- ---------- Total assets $2,811,569 $2,901,390 =========== ========== Liabilities and Shareholders' Equity Noninterest - bearing deposits $900,495 - - $900,988 - - Interest-bearing deposits: Interest checking accounts 277,888 676 0.97 277,416 774 1.11 Money market accounts 724,205 4,181 2.29 766,256 4,371 2.26 Savings deposits 92,111 456 1.96 99,547 533 2.12 Time deposits - under $100,000 85,656 792 3.67 105,684 990 3.72 Time deposits - $100,000 and over 142,972 1,272 3.53 193,232 1,534 3.15 ----------- --------- -------- ---------- --------- -------- Total interest - bearing deposits 1,322,832 7,377 2.21 1,442,135 8,202 2.26 ----------- --------- -------- ---------- --------- -------- Total deposits 2,223,327 2,343,123 Federal funds purchased and securities sold under repurchase agreements 209,466 2,248 4.26 230,891 1,643 2.82 Other short - term borrowings 25,954 268 4.10 14,733 119 3.20 ---------- --------- -------- ---------- --------- -------- Total interest - bearing liabilities 1,558,252 9,893 2.52 1,687,759 9,964 2.34 ---------- --------- -------- ---------- --------- -------- Other liabilities 36,072 21,194 Shareholders' equity 316,750 291,449 Total liabilities and shareholders ----------- ---------- equity $2,811,569 $2,901,390 =========== ========== Net interest income/spread $37,148 4.76 % $30,635 3.97 % ========= ======== ========= ======== Fully taxable equivalent net interest income $37,449 $30,899 ========= ========= Net interest margin (4) 5.76 % 4.77 % (1) The average rate data in this table are presented on a taxable equivalent basis. Rates are calculated assuming that interest income exempt from federal income taxes or income taxed at a rate less than the statutory tax rates has been adjusted to a taxable equivalent basis using the federal income tax rates in effect during the years presented. (2) Includes average nonaccrual loans of $57,379 and $100,594 for 1994 and 1993, respectively. (3) Loan income includes loan fees of $2,181 and $1,406 for 1994 and 1993, respectively. (4) Fully taxable net interest income divided by interest-earning assets. -12- Net Interest Income Summary The following table presents the components of net interest income for the nine months ended September 30, 1994 and 1993. 9-30-94 ---------------------------------------------- Interest Average Average income/ interest Dollars in thousands Balance expense rate (1) - - - ------------------------------------------------------------------------------------------------------------------------ Assets (2) Earning assets Loans: (3) Commercial loans $868,444 $54,394 8.43 % Real estate - construction 14,589 974 8.93 Real estate - mortgage 589,363 35,774 8.12 Installment loans 40,874 3,001 9.82 ------------- ----------- -------- Total loans 1,513,270 94,143 8.35 ------------- ----------- -------- State and municipal securities 16,098 587 7.57 Taxable securities 851,528 31,900 5.01 Federal funds sold and securities purchased under resale agreements 179,628 5,194 3.87 Trading account securities 27,235 823 4.36 ------------ ----------- -------- Total earning assets 2,587,759 132,647 6.89 ------------ ----------- -------- Allowance for credit losses (112,553) Cash and due from banks 248,819 Other nonearning assets 110,466 ------------ Total assets $2,834,491 ============ Liabilities and Shareholders' Equity Noninterest - bearing deposits $899,293 - - Interest-bearing deposits: Interest checking accounts 285,583 2,060 0.96 Money market accounts 729,999 12,172 2.23 Savings deposits 97,465 1,430 1.96 Time deposits - under $100,000 90,552 2,450 3.62 Time deposits - $100,000 and over 149,837 3,662 3.27 ------------ ----------- -------- Total interest - bearing deposits 1,353,436 21,774 2.15 ------------ ----------- -------- Total deposits 2,252,729 Federal funds purchased and securities sold under repurchase agreements 210,141 5,754 3.66 Other short - term borrowings 19,583 557 3.80 ------------ ----------- -------- Total interest - bearing liabilities 1,583,160 28,085 2.37 ------------ ----------- -------- Other liabilities 42,771 Shareholders' equity 309,267 Total liabilities and shareholders' ------------ equity $2,834,491 ============ Net interest income/spread $104,562 4.52 % =========== ======== Fully taxable equivalent net interest income $105,326 =========== Net interest margin (4) 5.44 % 9-30-93 ----------------------------------------------- Interest Average Average income/ interest Balance expense rate (1) - - - --------------------------------------------------------------------------------------------------------------------- Assets (2) Earning assets Loans: (3) Commercial loans $1,029,540 $55,809 7.32 % Real estate - construction 84,560 4,264 6.74 Real estate - mortgage 619,232 34,983 7.55 Installment loans 54,046 4,079 10.09 ------------ --------- -------- Total loans 1,787,378 99,135 7.46 ------------ --------- -------- State and municipal securities 20,663 1,001 9.37 Taxable securities 431,270 18,186 5.64 Federal funds sold and securities purchased under resale agreements 297,098 6,792 3.06 Trading account securities 30,706 754 3.62 ------------ --------- -------- Total earning assets 2,567,115 125,868 6.61 ------------ --------- -------- Allowance for credit losses (132,002) Cash and due from banks 274,984 Other nonearning assets 215,887 ------------ Total assets $2,925,984 ============ Liabilities and Shareholders' Equity Noninterest - bearing deposits $900,000 - - Interest-bearing deposits: Interest checking accounts 281,441 2,675 1.27 Money market accounts 756,193 13,485 2.38 Savings deposits 103,273 1,746 2.26 Time deposits - under $100,000 110,672 3,138 3.79 Time deposits - $100,000 and over 211,347 5,060 3.20 ------------ --------- -------- Total interest - bearing deposits 1,462,926 26,104 2.39 ------------ --------- -------- Total deposits 2,362,926 Federal funds purchased and securities sold under repurchase agreements 279,539 5,959 2.85 Other short - term borrowings 14,334 343 3.20 ------------ --------- -------- Total interest - bearing liabilities 1,756,799 32,406 2.47 ------------ --------- -------- Other liabilities 20,573 Shareholders' equity 248,612 Total liabilities and shareholders' ------------ equity $2,925,984 ============ Net interest income/spread $93,462 4.14 % ========= ======== Fully taxable equivalent net interest income $94,584 ========= Net interest margin (4) 4.93 % (1) Average rate data in this table are presented on a taxable equivalent basis. Rates are calculated assuming that interest income exempt from federal income taxes or income taxed at a rate less than the statutory tax rates has been adjusted to a taxable equivalent basis using the federal income tax rates in effect during the years presented. (2) Includes average nonaccrual loans of $64,203 and $112,492 for 1994 and 1993, respectively. (3) Loan income includes loan fees of $5,085 and $3,899 for 1994 and 1993, respectively. (4) Fully taxable net interest income divided by interest-earning assets. -13- The following tables set forth, for the periods indicated, the changes in interest earned and interest paid resulting from changes in volume and changes in rates. Average balances in all categories in each reported period were used in the volume computations. Average yields and rates in each reported period were used in rate computations. Quarter Ended September 30, Quarter Ended September 30, 1994 vs 1993 1993 vs 1992 --------------------------------------- -------------------------------------------- Increase Increase Dollars in thousands - (decrease) (decrease) Fully taxable equivalent basis (1) due to (2): Net due to (2): Net ------------------------ increase -------------------------- increase Volume Rate (decrease) Volume Rate (decrease) -------- -------- -------- --------- --------- ------------ Interest earned on: Interest-bearing deposits in other banks $ 2 $ (1) $ 1 $ (3) $ 1 $ (2) Loans (3,209) 5,653 2,444 (11,335) 170 (11,165) Taxable securities 4,825 170 4,995 978 (1,492) (514) Non-taxable securities 155 (65) 90 (1,510) (151) (1,661) Federal funds sold and securities purchased under resale agreements (2,091) 1,040 (1,051) (2,392) (337) (2,729) -------- -------- -------- --------- --------- ------------ Total interest-earning assets (318) 6,797 6,479 (14,262) (1,809) (16,071) -------- -------- -------- --------- --------- ------------ Interest paid on: Interest checking 1 (99) (98) (198) (489) (687) Money market deposits (247) 57 (190) (1,788) (1,391) (3,179) Savings deposits (39) (38) (77) (104) (168) (272) Other time deposits (625) 165 (460) (2,831) (766) (3,597) Short-term borrowings (76) 830 754 (2,016) (200) (2,216) -------- -------- -------- --------- --------- ------------ Total interest-bearing liabilities (986) 915 (71) (6,937) (3,014) (9,951) -------- -------- -------- --------- --------- ------------ $ 668 $ 5,882 $ 6,550 $ (7,325) $ 1,205 $ (6,120) ======== ======== ======== ========= ========= ============ Nine Months Ended September 30, Nine Months Ended September 30, 1994 vs 1993 1993 vs 1992 ---------------------------------------- ------------------------------------------- Increase Increase Dollars in thousands - (decrease) (decrease) Fully taxable equivalent basis (1) due to (2): Net due to (2): Net ------------------------ increase ------------------------- increase Volume Rate (decrease) Volume Rate (decrease) -------- -------- -------- -------- --------- ---------- Interest earned on: Interest-bearing deposits in other banks (6) $ (8) $ (14) $ 4 $ 11 $ 15 Loans (7,407) 2,192 (5,215) (33,121) (4,846) (37,967) Taxable securities 14,421 (583) 13,838 (3,085) (3,979) (7,064) Non-taxable securities (298) (292) (590) (4,921) (453) (5,374) Federal funds sold and securities purchased under resale agreements (1,678) 80 (1,598) (7,273) (2,396) (9,669) -------- -------- -------- --------- --------- ------------ Total interest-earning assets 5,032 1,389 6,421 (48,396) (11,663) (60,059) -------- -------- -------- --------- --------- ------------ Interest paid on: Interest checking (10) (605) (615) (766) (1,666) (2,432) Money market deposits (466) (847) (1,313) (6,202) (5,615) (11,817) Savings deposits (95) (221) (316) (112) (632) (744) Other time deposits (2,086) 0 (2,086) (10,459) (4,109) (14,568) Short-term borrowings (512) 521 9 (5,554) (2,087) (7,641) -------- -------- -------- --------- --------- ------------ Total interest-bearing liabilities (3,169) (1,152) (4,321) (23,093) (14,109) (37,202) ------- ------- ------- -------- --------- ------------ $ 8,201 $ 2,541 $ 10,742 $ (25,303) $ 2,446 $ (22,857) ======= ======= ======= ======== ========= ============ (1) The changes in interest income in this table are presented on a fully taxable equivalent basis. Interest income exempt from federal income taxes or income taxed at a rate less than the statutory tax rates has been adjusted to a fully taxable equivalent basis using the federal income tax rates in effect in the periods presented. (2) The change in interest due to both rate and volume has been allocated to change due to volume and rate in proportion to the relationship of the absolute dollar amounts of the change in each. -14- PROVISION FOR CREDIT LOSSES The provision for credit losses was zero and $6.0 million for the quarter and nine months ended September 30, 1994, compared with $5.5 million and $24.5 million for the corresponding periods in 1993. Loans charged off in the third quarter of 1994 were $4.5 million, compared to $16.4 million in the third quarter of 1993 and $17.4 million in the second quarter of 1994. Recoveries were $11.4 million in the third quarter of 1994, compared to $10.2 million in the third quarter of 1993 and $8.3 million in the second quarter of 1994. The provision for credit losses charged to operations reflects management's judgment of the adequacy of the allowance for credit losses, and is determined through periodic analysis of the loan portfolio. This analysis includes a detailed review of the classification and categorization of problem and potential problem loans and loans to be charged off, an assessment of the overall quality and collectability of the portfolio, and consideration of the loan loss experience, trends in problem loans and concentrations of credit risk, as well as current and expected future economic conditions, particularly in Southern California. The Bank has an internal risk analysis and review staff that reports to the Board of Directors and continuously reviews loan quality. Such reviews also assist management in establishing the level of the allowance for credit losses. If credit quality continues to improve and the Southern California economy continues on its recent positive trend, management anticipates, based on its review of the loan portfolio and the level of the allowance for credit losses, that a provision for credit losses may not be necessary in the fourth quarter of 1994, and the aggregate provision in 1995 will likely approximate the 1994 provision. NON-INTEREST INCOME Non-interest income for the third quarter of 1994 totaled $8.1 million, down $2.2 million (21.0%) from a year earlier. Non-interest income for the first nine months of 1994 was $27.3 million, a decrease of $9.2 million (25.2%) from the first nine months of 1993. Service charges on deposit accounts decreased $1.0 million (31.3%) and $1.2 million (14.3%), respectively, for the quarter and nine months ended September 30, 1994. Due to the effect of increases in interest rates utilized for purposes of account analysis, future -15- service charge income on deposit accounts may be less than third quarter 1994 levels. Trust fees decreased $.2 million (10.6%) and $.5 million (9.0%) for the quarter and nine months ended September 30, 1994 due to lower volumes. Customer trading income increased $.4 million (30.1%) and $.3 million (6.6%) for the quarter and nine months ended September 30, 1994, respectively. Other income in 1994 included a pre-tax gain of $1.3 million from the sale of two leveraged leases in the first quarter, while other income in 1993 included $1.9 million from sale of the Bank's merchant credit card business in the first quarter and $4.5 million from the Bank's sale of $73.7 million in ELC loans in the second quarter. All other income decreased $.8 million (20.4%) and $2.1 million (18.8%) for the quarter and nine months ended September 30, 1994, because of lower escrow, foreign exchange, letter of credit and proof of deposit fees. A securities loss of $.6 million was recorded in the third quarter of 1994, compared to none in the prior periods. Management does not expect a significant increase in non-interest income from third quarter 1994 levels during the remainder of 1994. NON-INTEREST EXPENSE Excluding net ORE results, non-interest expense totaled $29.9 million in the third quarter of 1994, a decrease of $2.5 million (7.8%) from the third quarter of 1993, and $90.0 million for the first nine months of 1994, a decrease of $7.1 million (7.3%) from the first nine months of 1993. Salaries and other employee benefits decreased $1.8 million (10.3%) and $5.5 million (10.2%) for the quarter and nine months ended September 30, 1994, respectively, from comparable periods in 1993. This decrease was net of $2.4 million profit sharing expense in 1994, compared to none in 1993. Full-time equivalent staff levels, which had declined from approximately 1,650 at December 31, 1992 to 1,220 at September 30, 1994, stabilized in the second and third quarters of 1994. The remaining expense categories other than staff decreased $.7 million (4.8%) and $1.6 million (3.8%) for the quarter and nine months ended September 30, 1994, respectively, from the comparable periods in 1993. These decreases resulted from the continued realization of savings from the Company's expense management efforts and from the implementation of the branch consolidation program. See "Consolidation Charge Reserve," below. The increases in promotion expenses resulted from the Company's increased -16- advertising program. The increases in professional expenses were due to higher legal fees for defense and collection matters. Net ORE result in the third quarter of 1994 was a credit of $.2 million, compared to a credit of $2.0 million in the prior year. For the first nine months of 1994, net ORE result was a credit of $5.5 million, of which $4.2 million represented gains on the sale of assets in the Disposition Program, compared to expense of $38.2 million in the first nine months of 1993, $36.5 million of which resulted from the initiation of the Disposition Program in March 1993. INCOME TAXES The third quarter 1994 effective tax rate was 33.1%, compared to 30.7% for the third quarter of 1993. The effective tax expense (benefit) rates for the first nine months of 1994 and 1993 were 34.1% and (37.6%), respectively. The effective rates differed from the statutory federal tax rates of 35% due primarily to tax exempt income. As a result of the Company's net operating loss carry-forwards, no regular California franchise tax provision has been recorded in 1994. No California tax benefit was taken in 1993. At September 30, 1994, the Company had fully utilized its California net operating loss carry-forwards and had unrecognized California tax benefits of $13.7 million, all of which relate to deductible temporary differences. Realization of these tax benefits is dependent on having sufficient taxable income during the years when these deductible temporary differences are expected to reverse. The Company's improved profitability may allow it to recognize in the fourth quarter of 1994 the benefit of deductible timing differences anticipated to reverse in the next calendar year. -17- BALANCE SHEET ANALYSIS LOAN PORTFOLIO A comparative period-end loan table is presented below: Sept. 30, June 30, Dec. 31, Sept. 30, 1994 1994 1993 1993 --------- -------- -------- --------- (Dollars in thousands) Commercial and financial(1) $ 823,341 $ 868,346 $ 939,719 $ 949,471 Real estate - construction 19,351 14,622 11,699 66,255 Real estate - mortgage(2) 506,715 529,793 617,067 542,701 Residential first mortgage 147,552 38,135 6,586 2,777 Installment 37,495 39,546 45,485 48,985 ---------- ---------- ---------- ---------- Total loans, gross 1,534,454 1,490,442 1,620,556 1,610,189 Less: Allowance for credit losses (112,308) (105,380) (110,499) (123,353) ---------- ---------- ---------- ---------- Total loans, net $1,422,146 $1,385,062 $1,510,057 $1,486,836 ========== ========== ========== ========== (1) Commercial and financial loans include unsecured loans to real estate developers and customers involved in real estate investments, as well as commercial loans where real estate partially secures the borrowing. (2) Does not include first mortgages on residential properties. Gross loans at September, 30, 1994 amounted to $1,534 million, down $76 million (4.7%) from September 30, 1993. The decrease in loans resulted from decreased loan demand because of continued economic weakness in Southern California. Commercial loans continue to constitute the major portion of the Bank's lending activity, 53.7% at September 30, 1994 and 59.0% at September 30, 1993. Real estate construction loans decreased $46.9 million, or 70.8%, between September 30, 1993 and September 30, 1994, because new construction lending was curtailed beginning in late 1990, and certain construction loans were transferred to the real estate mortgage category after completion of construction. Real estate mortgage loans decreased $36.0 million, or 6.6%, between September 30, 1993 and 1994, due to paydowns. However, residential first mortgage loans increased $144.8 million between September 30, 1993 and 1994, primarily as a result of purchases of residential mortgages originated by third parties, which supplemented mortgages originated by the Bank beginning in late 1993. Substantially all of the Bank's loans are in Southern California. At September 30, 1994, real estate construction and mortgage loans constituted 34.3% of the Bank's loan portfolio. No other industry comprised 10% or more of the portfolio. -18- REAL ESTATE CONSTRUCTION LOANS BY TYPE Sept. 30, June 30, Dec. 31, Sept. 30, 1994 1994 1993 1993 --------- -------- -------- -------- (Dollars in thousands) Office building $ 8,195 $ 7,997 $ 7,282 $25,497 Condominium and apartment - - - 13,777 Shopping center 1,723 - - 4,019 1-4 family 3,837 1,482 594 4,790 Industrial 600 - - 6,133 Other 4,996 5,143 3,823 12,039 ------- ------- ------- ------- $19,351 $14,622 $11,699 $66,255 ======= ======= ======= ======= REAL ESTATE MORTGAGE LOANS BY TYPE Sept. 30, June 30, Dec. 31, Sept.30, 1994 1994 1993 1993 --------- --------- --------- --------- (Dollars in thousands) Equity lines of credit $ 27,931 $ 30,323 $ 47,279 $ 59,360 Industrial 107,031 113,942 123,594 125,430 Office building 97,688 103,613 110,183 98,841 Shopping center 67,015 63,964 68,236 66,363 Land, residential 14,258 22,486 30,761 30,878 Condominium and apartment 39,227 43,208 54,040 36,498 Land, non-residential 9,472 10,114 32,885 26,209 Other 144,093 142,143 150,089 99,122 -------- -------- -------- -------- $506,715 $529,793 $617,067 $542,701 ======== ======== ======== ======== -19- RISK ELEMENTS NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS The following table presents information concerning nonaccrual loans, ORE, accruing loans which are contractually past due 90 days or more as to interest or principal payments and still accruing, and restructured loans. Sept. 30, June 30, Dec. 31, Sept. 30, 1994 1994 1993 1993 --------- -------- -------- -------- (Dollars in thousands) Nonaccrual loans: Real estate - construction $ - $ - $ - $16,831 Real estate - mortgage 45,670 46,179 48,016 43,057 Commercial 10,443 14,509 23,040 37,388 Installment - - - - ------ ------ ------ ------ Total 56,113 60,688 71,056 97,276 ORE 8,269 7,564 5,559 5,114 ------- ------- ------- -------- Total nonaccrual loans and ORE $64,382 $ 68,252 $ 76,615 $102,390 ======= ======= ======= ======== Assets held for accelerated disposition - - $ 17,450 $ 51,222 ====== ====== ====== ======= In-substance foreclosures intangible assets $ 3,889 $ 4,097 $ 4,740 $ 4,791 ======= ====== ======= ====== Ratio of nonaccrual loans to total loans 3.66% 4.07% 4.38% 6.04% Ratio of nonaccrual loans and ORE to total loans and ORE 4.17 4.56 4.71 6.34 Ratio of allowance for credit losses to nonaccrual loans 200.07 173.64 155.51 126.81 Accruing loans past due 90 days or more: Real estate $19,744 $ 19,125 $17,412 $ 20,363 Commercial 2,018 10,599 11,382 5,185 Installment 139 137 155 9 ------- ------- ------- -------- Total $21,901 $ 29,861 $ 28,949 $ 25,557 ======= ======= ======= ======== Restructured loans; all on accrual status except for $6,230 at Sept. 30, 1994 $ 8,349 $ 2,125 $ 958 $ 1,014 ======= ======= ======= ======== -20- NONACCRUAL LOANS The table below summarizes the approximate changes in nonaccrual loans for the quarters ended September 30, 1994, June 30, 1994, and September 30, 1993, and for the nine month periods ended September 30, 1994 and 1993. Quarter ended Nine months ended -------------------------------------- ----------------------- Sept. 30, June 30, Sept.30, Sept.30, Sept.30, 1994 1994 1993 1994 1993 ---------- ---------- --------- --------- ------ (Dollars in millions) Balance, beginning of period $ 60.7 $ 65.1 $105.0 $ 71.1 $160.3 Loans placed on nonaccrual 6.4 30.5 12.7 55.9 86.2 Charge offs (3.8) (12.3) (11.3) (22.6) (47.5) Loans returned to accrual (1.0) (6.0) (1.1) (13.4) (30.6) Repayments (including interest applied to principal) (5.3) (15.9) (14.4) (33.3) (44.6) Transfer to ORE (.9) (.7) (.2) (1.6) (11.8) Transfer from (to) Disposition Program, net - - 6.6 - (14.7) ----- ------ ------ ------ ------ Balance, end of period $ 56.1 $ 60.7 $ 97.3 $ 56.1 $ 97.3 ===== ====== ====== ====== ====== The additional interest income that would have been recorded from nonaccrual loans (including restructured loans on nonaccrual status), if the loans had not been on nonaccrual status, was $1.4 million and $2.7 million for the quarters and $3.4 million and $8.5 million for the nine-month periods ended September 30, 1994 and 1993, respectively. Interest payments received on nonaccrual loans are generally applied to principal, unless there is no doubt as to the ultimate full repayment of principal, in which case the interest payment is recognized as interest income. Interest income included $.6 million and $.2 million for the quarters and $2.7 million and $1.3 million for the nine-month periods ended September 30, 1994 and 1993, respectively, from the collection of interest related to nonaccrual loans, including loans paid off during the quarter. Interest income not recognized on nonaccrual loans reduced the net interest margin by 21 and 42 basis points for the quarters and 17 and 44 basis points for the nine-month periods ended September 30, 1994 and 1993, respectively. POTENTIAL PROBLEM LOANS At September 30, 1994, in addition to loans disclosed above as past due, nonaccrual or restructured, management had also identified $28 million of loans about which it had serious doubts as to the ability of the borrowers to comply with the present loan payment -21- terms in the future. This amount was determined based on analysis of information known to management about the borrowers' financial conditions and current and expected economic conditions. If economic conditions change, or if additional information relating to borrowers' financial conditions comes to light, then the amount of such potential problem loans may change significantly. Currently estimated potential losses from these potential problem loans have been considered in determining the adequacy of the allowance for credit losses. OTHER REAL ESTATE The following tables summarize the changes in the Company's ORE balances. Quarter ended Nine months ended -------------------------------------- ------------------------ Sept. 30, June 30, Sept.30, Sept.30, Sept.30, 1994 1994 1993 1994 1993 ---------- ---------- --------- --------- -------- (Dollars in millions) Balance, beginning of period $7,564 $3,677 $ 9,581 $ 5,559 $ 94,065 Additions 1,286 2,498 301 3,784 12,541 Sales (493) (195) (322) (2,505) (4,843) Writedowns (41) - (622) (41) (40,327) Payments and other reductions (47) (118) (1,798) (230) (5,407) Transfer from (to) Disposition Program - 1,702 (2,026) 1,702 (50,915) ----- ------- ------- ------ -------- Balance, end of period $ 8,269 $ 7,564 $ 5,114 $ 8,269 $ 5,114 ====== ======= ======= ======= ======== -22- ALLOWANCE FOR CREDIT LOSSES The following table summarizes average loans outstanding and changes in the allowance for credit losses for the periods presented: Quarter ended Nine months ended -------------------------------------- ------------------------ Sept. 30, June 30, Sept.30, Sept.30, Sept.30, 1994 1994 1993 1994 1993 ---------- -------- -------- -------- -------- (Dollars in millions) Average amount of loans outstanding $ 1,472.2 $ 1,496.8 $ 1,632.4 $ 1,513.3 $ 1,787.4 ======== ======== ======== ======== ======== Balance of allowance for credit losses, beginning of period $ 105.4 $ 111.5 $ 124.1 $ 110.5 $ 136.1 ------- ------- ------- ------- ------- Loans charged off: Commercial 1.9 10.2 10.7 17.4 31.7 Real estate loans - construction - - .6 - 3.4 Real estate loans - mortgage 2.6 7.0 5.0 13.0 22.0 Installment - .2 .1 .4 .8 -------- -------- -------- -------- -------- Total loans charged off 4.5 17.4 16.4 30.8 57.9 -------- -------- -------- -------- -------- Less recoveries of loans previously charged off: Commercial 11.1 7.9 9.8 25.7 21.5 Real estate loans - construction - - - .1 - Real estate loans - mortgage .1 .1 .2 .2 .3 Installment .2 .3 .2 .6 .4 -------- -------- -------- -------- -------- Total recoveries 11.4 8.3 10.2 26.6 22.2 -------- -------- -------- -------- -------- Net loans charged off(recovered) (6.9) 9.1 6.2 4.2 35.7 Provisions charged to operating expense - 3.0 5.5 6.0 24.5 Other/1/ - - - - (1.5) -------- -------- -------- -------- -------- Balance, end of period $ 112.3 $ 105.4 $ 123.4 $ 112.3 $ 123.4 ======== ======== ======== ======== ======== Ratio of net charge-offs to average loans NM 2.43% 1.52% 0.38% 2.66% == ==== ==== ==== ==== (1) Credit loss allowance allocated to $73.7 million of equity line of credit loans sold in April 1993. At September 30, 1994, the allowance for credit losses was 7.32% of gross loans, compared to 7.66% at September 30, 1993. The allowance at September 30, 1994 was equal to 200.1% of total nonaccrual loans, as compared to 126.8% at September 30, 1993. Management believes that the adoption of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures," upon their January 1, 1995, effective date -23- will not have a material impact on the Company's results of operations or shareholders' equity. INVESTMENT SECURITIES A comparative period-end table is presented below: September 30, June 30, September 30, 1994 1994 1993 -------------- ---------- ------------- (Dollars in thousands) Investment securities: Cost $726,374 $705,392 $569,721 ======== ======== ======== Market $700,073 $681,973 $576,798 ======== ======== ======== Market in excess of (below) cost $(26,301) $(23,419) $ 7,077 ======== ======== ======== The Company has the ability and management has the intent to hold its investment securities until maturity. Due to the rise in interest rates in 1994, the market value of the Company's investment securities portfolio is $26.3 million (3.6%) lower than its carrying value. Under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," unrealized gains or losses on investment securities do not affect shareholders' equity until realized. SECURITIES AVAILABLE FOR SALE Securities available for sale amounted to $192.2 million at market (cost of $197.6 million) at September 30, 1994, compared to $2.0 million (both cost and market) at December 31, 1993 and none at September 30, 1993. The unrealized gains or losses on available for sale securities is included, net of tax effect, in shareholders' equity. During the first nine months of 1994, in order to provide flexibility with respect to future loan funding, the Company designated certain securities at the time of purchase as securities available for sale. DEFERRED TAX ASSETS Deferred tax assets amounted to $26.3 million at September 30, 1994 and $30.1 million at September 30, 1993. These deferred tax assets were primarily due to the inability of the Bank to take loan loss deductions for income tax purposes with respect to anticipated -24- loan losses for which an allowance had been established on its financial accounting records. It is more likely than not that the reversing deductible temporary differences, net of the recorded valuation allowances, at September 30, 1994 will be realized by the availability of reversing taxable temporary differences, recovery of taxes paid in applicable carry-back years, and projected taxable income. CONSOLIDATION CHARGE RESERVE In November 1993, the Bank announced a consolidation plan to improve efficiency and operational productivity in its branch network. To cover the costs associated with this action, the Bank recorded a consolidation charge of $12.0 million in the fourth quarter of 1993, consisting of $7.5 million for the disposition of lease commitments, $1.5 million for the disposition of fixed assets and $3.0 million for severance costs and other costs directly related to the consolidation. At September 30, 1994, the balance remaining in the consolidation reserve was $8.6 million. The Bank is continuing to negotiate settlements of lease commitments and believes the reserve balance at September 30, 1994 is adequate to cover these lease liabilities and the remaining expenses expected to be incurred as part of the consolidation program. CAPITAL ADEQUACY REQUIREMENTS As of September 30, 1994, the Company had a ratio of Tier 1 capital to risk-weighted assets (Tier 1 risk-based capital ratio) of 18.92%, a ratio of total capital to risk weighted assets (total risk-based capital ratio) of 20.23%, and a ratio of Tier 1 capital to average adjusted total assets (Tier 1 leverage ratio) of 11.62%, while the Bank had a Tier 1 risk-based capital ratio of 17.90%, a total risk-based capital ratio of 19.21% and a Tier 1 leverage ratio of 11.00%. Based on the availability of recovery of taxes paid in the current and prior years and projected taxable income for the next twelve months, there is no limitation under OCC guidelines on the amount of recorded deferred tax assets includable in regulatory capital at September 30, 1994. -25- LIQUIDITY A fundamental objective of the asset/liability management strategy of the Company is adequate liquidity -- the ability to meet the requirements of customers for loans and deposit withdrawals in the most timely and economical manner. For most financial institutions, the most manageable sources of liquidity are composed of liabilities, especially core deposits. Average core deposits increased to 84.6% of total funding in the third quarter of 1994, compared to 83.0% in the third quarter of 1993. Liquidity is also provided by assets such as federal funds sold, securities purchased under resale agreements and trading account securities which may be immediately converted into cash at a minimal cost. Liquidity may also be provided by maturing investment securities. At September 30, 1994, investment securities maturing within one year amounted to $137.2 million, and securities available for sale amounted to $192.2 million. Maturing loans also provide liquidity, and $.9 billion of the Bank's loans are scheduled to mature in the next twelve months. City National Corporation has no outstanding debt obligations and limited financial requirements. At September 30, 1994, it had securities of $18.6 million and resale agreements with the Bank of $.5 million. Interest sensitivity is related to liquidity because both are affected by the interrelationships of maturing assets and liabilities. Interest rate sensitivity management, however, is concerned with the timing and magnitude of repricing assets compared to liabilities. It is the objective of interest rate- sensitivity management to control the risks associated with interest rate movement. The interest rate sensitivity gap is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of rising interest rates, a negative gap tends to adversely affect net interest income, while a positive gap tends to result in an increase in net interest income. During a period of falling -26- interest rates, a negative gap tends to result in an increase in net interest income, while a positive gap tends to affect net interest income adversely. The following table shows that the Company's positive interest rate sensitivity gap increased from $824.1 million at September 30, 1993 to $1,033.8 million at September 30, 1994. This increase was due to a $97.3 million increase in rate sensitive assets, especially securities and a $112.4 million decrease in rate sensitive liabilities. The Company's highly asset sensitive position in this period of rising interest rates will have a positive effect on net interest income. However, while the interest rate sensitivity gap is a useful measure and contributes towards effective asset and liability management, it is difficult to predict the net interest margin based solely on that measure. -27- At September 30, 1994 and 1993, the Company's distribution of rate-sensitive assets and liabilities was as follows: Maturing or repricing in ---------------------------------------------------------------------- After 3 After 1 year 3 months months but but within After or less within 1 year 5 years 5 years Total ---------- ------------- ------------ --------- --------- September 30, 1994 (Dollars in millions) Rate-sensitive assets: Interest-bearing deposits in other banks......$ 0.7 $ - $ - $ - $ 0.7 Loans ........................................ 1,061.1 227.2 142.8 47.2 1,478.3 Investment securities ........................ 45.0 90.3 285.1 305.9 726.3 Securities available for sale................. - - 133.1 59.1 192.2 Trading account securities.................... 41.8 - - - 41.8 Federal funds sold and securities purchased under resale agreements........ 183.0 - - - 183.0 --------- -------- -------- --------- --------- Total rate-sensitive assets.............. 1,331.6 317.5 561.0 412.2 2,622.3 --------- -------- -------- --------- --------- Rate-sensitive liabilities: (1) Interest checking ............................ 279.3 - - - 279.3 Money market deposits ........................ 704.5 - - - 704.5 Savings deposits ............................. 87.6 - - - 87.6 Other time deposits .......................... 120.8 64.1 35.3 - 220.2 Short-term borrowings ........................ 296.9 - - - 296.9 --------- -------- -------- -------- --------- Total rate-sensitive liabilities......... 1,489.1 64.1 35.3 - 1,588.5 --------- -------- -------- -------- --------- Interest rate sensitivity gap......................$ (157.5) $ 253.4 $ 525.7 $ 412.2 $ 1,033.8 ========= ======== ======== ========= ========= Cumulative interest rate sensitivity gap...........$ (157.5) $ 95.9 $ 621.6 $ 1,033.8 ========= ======== ======== ========= Cumulative ratio of rate-sensitive assets to rate-sensitive liabilities......................... 89% 106% 139% 165% 165% ========= ======== ======== ========= ========= Maturing or repricing in --------------------------------------------------------------------------- After 3 After 1 year 3 months months but but within After or less within 1 year 5 years 5 years Total ---------- ------------- ------------ --------- --------- September 30, 1993 (Dollars in millions) Rate-sensitive assets: Interest-bearing deposits in other banks......$ 0.6 $ - $ - $ - $ 0.6 Loans ........................................ 1,277.4 49.5 160.3 26.0 1,513.2 Investment securities ........................ 59.3 162.2 268.3 80.0 569.8 Trading account securities.................... 22.4 - - - 22.4 Federal funds sold and securities purchased under resale agreements........ 419.0 - - - 419.0 --------- -------- -------- --------- --------- Total rate-sensitive assets.............. 1,778.7 211.7 428.6 106.0 2,525.0 --------- -------- -------- --------- --------- Rate-sensitive liabilities: (1) Interest checking ............................ 276.1 - - - 276.1 Money market deposits ........................ 775.4 - - - 775.4 Savings deposits ............................. 96.7 - - - 96.7 Other time deposits .......................... 177.9 79.6 35.5 - 293.0 Short-term borrowings ........................ 259.7 - - - 259.7 --------- -------- -------- -------- --------- Total rate-sensitive liabilities......... 1,585.8 79.6 35.5 - 1,700.9 --------- -------- -------- --------- --------- Interest rate sensitivity gap......................$ 192.9 $ 132.1 $ 393.1 $ 106.0 $ 824.1 ========= ======== ======== ========= ========= Cumulative interest rate sensitivity gap...........$ 192.9 $ 325.0 $ 718.1 $ 824.1 ========= ======== ======== ========= Cumulative ratio of rate-sensitive assets to rate-sensitive liabilities......................... 112% 120% 142% 148% 148% ========= ======== ======== ========= ========= (1) Customer deposits which are subject to immediate withdrawal are presented as repricing within 3 months or less. The distribution of other time deposits is based on scheduled maturities. -28- PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS. None ITEM 5. OTHER INFORMATION. None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27. Financial Data Schedule (b) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CITY NATIONAL CORPORATION ------------------------- (Registrant) DATE: November 10, 1994 /s/ Frank P. Pekny ------------------- --------------------------- FRANK P. PEKNY Executive Vice President and Treasurer -29-