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, 1999 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.) City National Center 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 subject to such filing requirements for the past 90 days. YES X NO ------- -------- Number of shares of common stock outstanding at October 31, 1999: 45,403,936 PART 1 - FINANCIAL INFORMATON ITEM 1. FINANCIAL STATEMENTS CITY NATIONAL CORPORATION CONSOLIDATED BALANCE SHEET (UNAUDITED) SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS 1999 1998 1998 - ------------------------------------------ ------------- ------------ ------------- ASSETS Cash and due from banks ................................................... $ 307,549 $ 285,843 $ 326,313 Federal funds sold ........................................................ 60,000 405,000 122,000 Investment securities (fair value $195,844 at September 30, 1998) ......... -- -- 192,771 Securities available-for-sale (cost $1,090,607; $990,152 and $715,707 at September 30, 1999, December 31, 1998 and September 30, 1998, respectively) ......................................................... 1,060,431 1,012,526 734,391 Trading account securities ................................................ 55,082 35,015 49,055 Loans ..................................................................... 5,171,924 4,530,427 4,343,796 Less allowance for credit losses .......................................... 139,015 135,339 135,486 ------------- ------------ ------------- Net loans .......................................................... 5,032,909 4,395,088 4,208,310 Premises and equipment, net ............................................ 62,674 55,766 52,659 Customers' acceptance liability ........................................ 2,779 1,759 2,101 Deferred tax asset ..................................................... 59,968 45,738 43,005 Goodwill and core deposit intangibles .................................. 130,152 73,706 63,867 Bank owned life insurance .............................................. 49,367 42,545 41,989 Affordable housing investments ......................................... 45,769 13,262 11,748 Other assets ........................................................... 68,936 61,533 59,099 ------------- ------------ ------------- Total assets ....................................................... $ 6,935,616 $ 6,427,781 $ 5,907,308 ============= ============ ============= LIABILITIES Demand deposits ........................................................ $ 2,296,288 $ 2,382,724 $ 2,016,327 Interest checking deposits ............................................. 419,888 452,249 351,817 Money market deposits .................................................. 1,014,675 927,651 926,592 Savings deposits ....................................................... 218,335 183,353 170,338 Time deposits-under $100,000 ........................................... 254,537 187,710 190,580 Time deposits-$100,000 and over ........................................ 1,107,014 753,715 793,018 ------------- ------------ ------------- Total deposits ..................................................... 5,310,737 4,887,402 4,448,672 Federal funds purchased and securities sold under repurchase agreements.............................................................. 347,498 276,311 459,466 Other short-term borrowings ............................................ 341,725 317,001 77,059 Subordinated debt ...................................................... 123,405 123,265 123,217 Long-term debt ......................................................... 180,000 200,000 200,000 Other liabilities ...................................................... 69,084 60,240 55,160 Acceptances outstanding ................................................ 2,779 1,759 2,101 ------------- ------------ ------------- Total liabilities .................................................. 6,375,228 5,865,978 5,365,675 ------------- ------------ ------------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Preferred Stock authorized - 5,000,000 : none outstanding ................... -- -- -- Common Stock-par value-$1.00; authorized - 75,000,000; issued - 46,885,182...................................................... 46,885 46,885 46,885 Additional paid-in capital .................................................. 276,979 287,363 289,508 Accumulated other comprehensive income (loss) ............................... (17,398) 12,901 10,772 Retained earnings ........................................................... 300,744 243,275 224,932 Treasury shares, at cost - 1,467,816; 877,945 and 896,907 shares at September 30, 1999, December 31, 1998 and September 30, 1998, respectively ........................................................... (46,822) (28,621) (30,464) ------------- ------------ ------------- Total shareholders' equity .............................................. 560,388 561,803 541,633 ------------- ------------ ------------- Total liabilities and shareholders' equity .............................. $ 6,935,616 $ 6,427,781 $ 5,907,308 ============= ============ ============= See accompanying Notes to the Unaudited Consolidated Financial Statements. 2 CITY NATIONAL CORPORATION CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED) FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ---------------------- ---------------------- IN THOUSANDS, EXCEPT PER SHARE AMOUNTS 1999 1998 1999 1998 - -------------------------------------- --------- --------- --------- --------- INTEREST INCOME Loans ...................................................................... $ 101,835 $ 93,490 $ 289,502 $ 273,195 Securities ................................................................. 16,094 12,576 47,967 36,857 Trading account securities ................................................. 788 1,024 2,126 2,438 Federal funds sold and securities purchased under resale agreements ........ 432 420 1,416 1,827 --------- --------- --------- --------- Total interest income .................................................. 119,149 107,510 341,011 314,317 --------- --------- --------- --------- INTEREST EXPENSE Deposits ................................................................... 23,588 22,786 64,412 65,111 Federal funds purchased and securities sold under repurchase agreements .... 7,003 5,713 20,952 15,280 Other short-term borrowings ................................................ 2,770 690 5,488 4,027 Subordinated debt .......................................................... 1,707 2,081 5,712 5,873 Other long-term debt ....................................................... 2,779 2,559 9,353 5,249 --------- --------- --------- --------- Total interest expense ................................................. 37,847 33,829 105,917 95,540 --------- --------- --------- --------- Net interest income ........................................................ 81,302 73,681 235,094 218,777 Provision for credit losses ................................................ -- -- -- -- --------- --------- --------- --------- Net interest income after provision for credit losses ...................... 81,302 73,681 235,094 218,777 --------- --------- --------- --------- NONINTEREST INCOME Service charges on deposit accounts ........................................ 4,531 3,821 12,696 13,031 Investment services ........................................................ 5,474 4,482 14,413 11,900 Trust fees ................................................................. 4,442 2,282 13,307 6,735 International services ..................................................... 2,479 2,206 6,865 5,929 Bank owned life insurance .................................................. 574 546 1,654 1,589 Gain on sale of assets ..................................................... 545 223 1,724 1,881 Gain on sale of securities ................................................. 1,570 1,120 4,015 2,329 Other ...................................................................... 3,550 2,118 9,323 7,115 --------- --------- --------- --------- Total noninterest income ............................................... 23,165 16,798 63,997 50,509 --------- --------- --------- --------- NONINTEREST EXPENSE Salaries and other employee benefits ....................................... 34,191 29,489 99,017 87,072 Professional ............................................................... 5,107 4,886 14,818 16,560 Net occupancy of premises .................................................. 4,753 3,843 12,725 10,178 Information services ....................................................... 3,204 2,082 8,663 6,780 Marketing and advertising .................................................. 2,428 1,784 7,573 7,138 Depreciation ............................................................... 3,005 2,290 8,154 6,369 Office services ............................................................ 2,118 1,703 5,983 5,686 Equipment .................................................................. 422 607 1,546 1,616 Amortization of goodwill and core deposit intangibles ...................... 2,286 1,737 6,257 5,119 Acquisition integration .................................................... 1,083 9 1,109 409 Other operating ............................................................ 3,039 2,601 9,438 11,528 Other real estate income ................................................... (267) (172) (179) (257) --------- --------- --------- --------- Total noninterest expense .............................................. 61,369 50,859 175,104 158,198 --------- --------- --------- --------- Income before income taxes ................................................. 43,098 39,620 123,987 111,088 Income taxes ............................................................... 15,015 14,231 43,797 39,594 --------- --------- --------- --------- NET INCOME ................................................................. 28,083 25,389 80,190 71,494 --------- --------- --------- --------- Other comprehensive income Unrealized gains (loss) on securities available-for-sale ............... (9,253) 5,693 (49,312) 11,735 Reclassification adjustment for gains (losses) included in noninterest income ................................................. (2,204) (1,120) (3,239) (2,329) Income taxes (benefits) ................................................ (4,852) 2,163 (22,252) 3,983 --------- --------- --------- --------- Other comprehensive income (loss) .......................................... (6,605) 2,410 (30,299) 5,423 --------- --------- --------- --------- Comprehensive income ....................................................... $ 21,478 $ 27,799 $ 49,891 $ 76,917 ========= ========= ========= ========= Net income per share, basic ............................................... $ 0.61 $ 0.55 $ 1.75 $ 1.54 ========= ========= ========= ========= Net income per share, diluted ............................................. $ 0.60 $ 0.53 $ 1.70 $ 1.48 ========= ========= ========= ========= Shares used to compute income per share, basic ............................. 45,664 46,230 45,767 46,504 ========= ========= ========= ========= Shares used to compute income per share, diluted ........................... 46,690 47,842 47,049 48,352 ========= ========= ========= ========= 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, ---------------------------- DOLLARS IN THOUSANDS 1999 1998 - -------------------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income ...................................................... $ 80,190 $ 71,494 Adjustments to net income: Gain on sales of ORE ....................................... 179 446 Depreciation ............................................... 8,154 6,369 Amortization of goodwill and core deposit intangibles ...... 6,257 5,119 Net increase in trading securities ......................... (20,067) (18,475) Deferred income tax (benefit) .............................. (11,250) 16,695 Gain on sale of securities ................................. 4,015 2,329 Net increase in other (assets) liabilities ................. (35,852) 56 Other, net ................................................. 24,691 8,286 --------- --------- Net cash provided by operating activities ............... 56,317 92,319 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of securities available-for-sale ....................... (306,541) (397,941) Sales of securities available-for-sale .......................... 203,738 225,649 Maturities of securities available-for-sale ..................... 81,509 64,334 Maturities of investment securities ............................. -- 37,217 Purchase of investment securities ............................... -- (3,971) Purchase of residential mortgage loans .......................... (47,714) (32,396) Sale of residential mortgage loans .............................. 41,357 -- (Loan originations) and principal collections, net .............. (392,709) (351,441) Proceeds from sales of ORE ...................................... 1,897 2,062 Purchase of premises and equipment .............................. (12,846) (13,302) Net cash from acquisitions ...................................... 18,905 43,622 Bank owned life insurance premium paid .......................... (11) (40,399) Other, net ...................................................... 542 668 --------- --------- Net cash used by investing activities ...................... (411,873) (465,898) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net decrease in federal funds purchased and securities sold under repurchase agreements ................................ (138,813) (71,961) Net increase in deposits ........................................ 7,657 14,724 Net increase in short-term borrowings ........................... 234,724 189,484 Net (decrease) increase in other long-term debt ................ (20,000) 150,000 Net proceeds of subordinated debt ............................... -- 124,055 Proceeds from exercise of stock options ......................... 7,136 10,416 Stock repurchases ............................................... (37,932) (55,711) Cash dividends paid ............................................. (22,721) (19,651) Other, net ...................................................... 2,211 3,138 --------- --------- Net cash provided by financing activities .................. 32,262 344,494 --------- --------- Net decrease in cash and cash equivalents ....................... (323,294) (29,085) Cash and cash equivalents at beginning of year .................. 690,843 477,398 --------- --------- Cash and cash equivalents at end of period ...................... $ 367,549 $ 448,313 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest ............................................... $ 105,472 $ 90,294 Income taxes ........................................... 30,050 24,450 Non-cash investing activities: Transfer from loans to foreclosed assets ............... 1,331 2,445 See accompanying Notes to the Unaudited Consolidated Financial Statements. 4 CITY NATIONAL CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) FOR THE NINE MONTHS ENDED SEPTEMBER 30, ----------------------------- DOLLARS IN THOUSANDS 1999 1998 - -------------------- --------- --------- Common Stock Balance, beginning of period ................................. $ 46,885 $ 46,701 Stock issued for acquisitions ................................ -- 131 Stock options exercised ...................................... -- 53 --------- --------- Balance, end of period ....................................... 46,885 46,885 --------- --------- Additional paid-in capital Balance, beginning of period ................................. 287,363 297,654 Tax benefit from stock options ............................... 2,211 3,137 Excess of cost of treasury shares reissued over stock option exercise amounts ...................... (12,595) (18,190) Excess of market value of shares issued for acquisitions over historical cost ................... -- 6,907 --------- --------- Balance, end of period ....................................... 276,979 289,508 --------- --------- Accumulated other comprehensive income Balance, beginning of period ................................. 12,901 5,349 Other comprehensive (loss) income net of income taxes/benefits (30,299) 5,423 --------- --------- Balance, end of period ....................................... (17,398) 10,772 --------- --------- Retained earnings Balance, beginning of period ................................. 243,275 173,089 Net income ................................................... 80,190 71,494 Dividends paid ............................................... (22,721) (19,651) --------- --------- Balance, end of period ....................................... 300,744 224,932 --------- --------- Treasury shares Balance, beginning of period ................................. (28,621) (14,123) Purchase of shares ........................................... (37,932) (55,711) Issuance of shares for acquisitions .......................... -- 10,817 Issuance of shares for stock options ......................... 19,731 28,553 --------- --------- Balance, end of period ....................................... (46,822) (30,464) --------- --------- Total shareholders' equity ......................................... $560,388 $541,633 ========= ========= See accompanying Notes to the Unaudited Consolidated Financial Statements. 5 CITY NATIONAL CORPORATION NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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, 1998. 2. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). This Statement establishes accounting and reporting standards for derivative instruments and for hedging activities. This Statement is effective for fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No.133" (SFAS 137), which extended the effective date to fiscal years beginning after June 15, 2000. The Company uses interest rate swaps to manage interest rate exposure, which are accounted for as hedging activities and does not believe that the implementation will have a significant impact on the Company's financial position, net income or net comprehensive income. 3. Trading account securities are stated at market value. Investments not classified as trading 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 net income and are reported as comprehensive income included as a separate component of shareholders' equity net of taxes. 4. Certain prior periods' data have been reclassified to conform to current period presentation. 5. Under the Company's current one million-share common stock buyback program, which was announced on July 29, 1999, a total of 248,400 shares were repurchased during the third quarter of 1999 at a cost of $8.2 million. As of October 31, 1999, a total of 280,800 shares were repurchased under this program at a cost of $9.3 million. Shares purchased under the buyback program will be reissued for the acquisition of The Pacific Bank, upon the exercise of stock options and for other general corporate purposes. 6. On August 27, 1999 the Company completed its acquisition of American Pacific State Bank (APSB). The total price was $90.4 million in an all cash transaction. This acquisition was accounted for under the purchase method of accounting and resulted in the recording of goodwill and core deposit intangibles of $65.7 million. Included in goodwill as purchase price adjustments were $1.2 million of accrued severance costs, $0.5 million of paid transaction-related expenses and $1.5 million of exit costs of which $0.25 million remain unpaid as of September 30, 1999. The results of APSB's operations are included in those reported by the Company beginning on August 28, 1999. 7. On September 10, 1999, the Bank closed its Fountain Valley branch, a location that was acquired in the Company's acquisition of Harbor Bancorp in 1998. 8. On September 22, 1999, the Company announced the signing of a definitive agreement for the acquisition of the $728.0 million-asset The Pacific Bank in an approximately 50 percent common stock, 50 percent cash transaction valued at $153.0 million. The Pacific Bank's shareholders will receive either cash, City National Corporation common stock or a combination thereof valued at $29.00 per share, subject to certain adjustments. Subject to satisfying the conditions of closing including receiving all required regulatory and shareholders approvals, the transaction is expected to close in the first quarter of 2000. 9. Payments were made in the first half of 1999 for $0.3 million of purchase price adjustments recorded as part of the acquisition of North American Trust Company in 1998. Reserves for excess space of $0.5 million still exist to be used over the remaining 6.5 years of a lease. 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS City National Corporation (the Corporation) is the holding Company for City National Bank (the Bank). Because the Bank comprises substantially all of the business of the Corporation, references to the "Company" in this Item 2 reflect the consolidated activities of the Corporation and the Bank. See "Cautionary Statement for Purposes of the `Safe Harbor' Provision of the Private Securities Litigation Reform Act of 1995", on page 18 in connection with "forward looking" statements included in the Overview section of Results of Operations and in the Loan Portfolio section of the Balance Sheet Analysis. The Company regularly evaluates, and holds discussions with, various potential acquisition candidates. As a general rule, the Company does not publicly announce such acquisitions until after a definitive agreement has been reached, as in the September 22, 1999 announcement of the definitive agreement entered into between the Company and The Pacific Bank in a transaction valued at $153.0 million. Also as a matter of policy, the Company generally does not make any specific projections as to future earnings nor does it endorse any projections regarding future performance which may be made by others. RESULTS OF OPERATIONS OVERVIEW The Company recorded consolidated net income of $28.1 million, or $0.60 per diluted common share, in the third quarter of 1999, compared to $25.4 million, or $0.53 per diluted common share, in the third quarter of 1998. Increased net income was primarily due to $7.6 million in higher net interest income, and $6.4 million higher noninterest income, partially offset by $10.5 million in higher noninterest expense. Net income for the first nine months of 1999 totaled $80.2 million, or $1.70 per diluted common share compared with $71.5 million or $1.48 per diluted common share in the 1998 period. The nine-month increase resulted largely from a $16.3 million increase in net interest income and a $13.5 million increase in noninterest income, partially offset by a $16.9 million increase in noninterest expense. Return on average assets for the third quarter and first nine months of 1999 were 1.72% and 1.71%, respectively, compared with 1.78% and 1.74% for the corresponding periods of 1998. Return on average equity for the third quarter and first nine months of 1999 increased to 19.94% and 19.08% from 18.70% and 17.86% in 1998. Earnings before the amortization of goodwill and core deposits intangibles (net of applicable taxes) ("cash" earnings) for the quarter and nine months ended September 30, 1999 were $29.8 million or $0.64 per diluted common share and $84.9 million or $1.81 per diluted common share, respectively, compared to $26.6 million or $0.56 per diluted common share and $75.6 million or $1.56 per diluted common share in the corresponding periods of 1998. On the same basis, the returns on average assets were 1.83% for both the quarter and nine months ended September 30, 1999 compared to 1.88% and 1.86% for the same periods in 1998. Cash return on average common equity was 22.88% and 22.47% for the quarter and nine months ended September 30, 1999, respectively, compared to 21.91% and 20.98% for the year ago periods. "Cash" earnings are presented because they measure the Company's ability to support growth, pay dividends and repurchase stock. The Company's "cash" earnings per share and other ratios are not necessarily comparable to similarly titled measures reported by other companies. Net interest income on a fully taxable-equivalent basis increased 10.0% to $83.9 million in the third quarter of 1999 compared with $76.3 million in the year-ago quarter, and increased 6.6% from $78.7 million in the prior quarter. The year-over-year increase resulted primarily from the 12.5% increase in average loans over the last year. Interest recovered on nonaccrual and charged-off loans was $4.9 million in the first nine months of 1999 compared with $6.0 million for the same period a year ago. The third quarter fully taxable-net interest spread and the net interest margin decreased to 4.14% and 5.57%, respectively, from 4.16% and 5.79%, for the comparable period a year ago. The combination of strong growth in earning assets, which outpaced growth in lower cost core deposits, and the slightly lower prime rate that took effect in the fourth quarter of 1998, contributed to a decrease in net interest margin. 7 Management expects modest growth in net interest income for the remainder of 1999, assuming, among other things, that loan balances will continue to grow. Actual results may vary if the assumption proves to be incorrect. Average loans increased $563.2 million (13.1%) in the third quarter to $4,866.0 million compared to the prior-year quarter and $263.4 million (5.7%) from the second quarter of 1999. This increase includes $85.0 million in average loans from the APSB acquisition. The year-over-year growth was driven primarily by increases in commercial, real estate commercial and construction loans. Commercial loan average balances increased $334.5 million (14.9%) to $2,575.8 million. Real estate commercial mortgage loan averages rose $108.6 million (14.5%) to $859.9 million. Construction loan average balances also increased $81.6 million (36.6%) to $304.8 million. Total loans at September 30, 1999 were $5.2 billion compared with $4.7 billion at June 30, 1999 and $4.5 billion at December 31, 1998. This increase includes $266.9 million from the American Pacific State Bank ("APSB") acquisition. Relationship-originated loans increased $726.1 million in the first nine months of 1999 while non-relationship-syndicated loans, which continue to be less than 10.0% of the portfolio, and purchased residential mortgage loans declined $84.6 million due to repayments and loan sales. Total average deposits increased $488.8 million (11.4%) between third quarters due primarily to increased deposit levels generated by banking offices, the Bank's specialty deposit department and $133.8 million in average deposits from the APSB acquisition. Total average securities increased $192.5 million (21.6%). Total deposits as of September 30, 1999 increased $862.1 million (19.4%) compared to September 30, 1998 and were $626.4 million (13.4%) higher than June 30, 1999. Included in this increase was $403.1 million from the acquisition of APSB. The Company recorded no credit loss provision for the quarters and nine months ended September 30, 1999 and 1998 due to changes in the portfolio and net credit recoveries of $0.3 million in the first nine months of 1999 compared with net credit losses of $5.0 million in the first nine months of 1998. Loans charged off in the third quarter of 1999 were $7.5 million, compared to $3.1 million in the third quarter of 1998. Recoveries were $2.9 million and $2.8 million in the quarters ended September 30, 1999 and 1998, respectively. The allowance for credit losses was 2.69% of total loans at September 30, 1999 compared to 3.12% at September 30, 1998 and 2.79% at June 30, 1999. The provision for credit losses is expected to remain at reduced levels but not necessarily at zero for the remainder of 1999. This assumes that general economic conditions in Southern California will not deteriorate materially during the balance of 1999, and if this assumption proves to be inaccurate, a higher provision for credit losses may be required. The provision levels for the balance of 1999 will depend on numerous factors including the general economic conditions that impact borrowers. Noninterest income of $23.2 million for the third quarter of 1999 continued a sustained growth trend, increasing by $6.4 million (37.9%) over the $16.8 million reported in the same period a year ago. For the first nine months of 1999 noninterest income rose $13.5 million (26.7%) to $64.0 million compared to $50.5 million for the same period in 1998. Investment services and trust fees increased in the third quarter of 1999 compared to the year-earlier quarter as a result of strong, internally generated new business as well as new revenue generated from the North American Trust Company ("NATC") acquisition, which was completed at the end of 1998. Noninterest income is expected to maintain its growth trend over prior-year results for the remainder of 1999. Gains on sale of assets and securities amounted to $2.1 million for the quarter compared with $1.3 million in the year ago quarter. Noninterest expense totaled $61.4 million in the third quarter of 1999, an increase of $10.5 million (20.7%) from the third quarter of 1998. For the first nine months of 1999 noninterest expense totaled $175.1 million, an increase of $16.9 million (10.7%) from the first nine months of 1998. This increase is primarily due to the additional personnel added as a result of the acquisition of NATC, integration expenses of $1.1 million related to the APSB acquisition, the hiring of additional personnel related to new branch openings and other growth opportunities, and a more performance based compensation structure. Of the $1.1 million of integration expenses, $0.5 million were paid in the third quarter and $0.6 million reflects an accrual for new check orders of $0.3 million and unbilled integration costs of $0.3 million. All of the $0.2 million of NATC integration expenses accrued in 1998 were paid in the first half of 1999. Noninterest expense levels for the remainder of 1999 are expected to be higher than in 1998 reflecting the growth of the Company and the acquisition of NATC and APSB. 8 The Year 2000 issue is the result of computer programs written using two digits (rather than four) to define years. Computers or other equipment with date-sensitive software may recognize "00" as 1900 rather than 2000. This could result in system failure or miscalculations. If the Company or significant customers, suppliers or other third parties fail to properly address Year 2000 issues, the Company's ability to operate could be affected. The Company's Year 2000 Readiness discussion follows: During the first nine months of 1999, efforts continued to address Year 2000 matters in accordance with the Company's five-phase project plan, which covers information technology as well as embedded systems. The five phases are awareness, assessment, renovation, validation and implementation with contingency planning as a part of the validation phase. As previously reported, the Company has completed all five phases and met all regulatory guidelines. As an additional precaution, the Company has developed a contingency plan for each of its mission critical business units which establishes trigger dates for implementation of the plan for each software application. The field testing for contingency plans has been completed. At this time, the Bank is implementing its transition strategy and finalizing steps for the Year 2000 weekend. However, these plans do not guarantee that circumstances beyond the Company's control will not adversely impact operations. At this time, based on assessments and testing to date, the Company does not foresee any Year 2000 issues that would materially impair the Bank's ability to conduct business. The Company is engaged in the ongoing process of considering and examining whether or not there would be a material effect on its business, net income or balance sheet if its vendors, suppliers and customers do not become Year 2000 compliant in a timely manner. With regard to customer readiness, the Company has queried and continues to query all commercial borrowers with loans of $1.0 million and over. For those customers having responded, it has been determined that their compliance efforts at this time appear satisfactory or their business would not be significantly affected by Year 2000 matters. In addition, there is a group of customers who have indicated their compliance will be in the future and the Company continues to monitor their progress. The Company in its review of the adequacy of its allowance for credit losses has considered the potential for Year 2000 risks to its borrowers. Where the Company is a third party vendor to customers, as in the area of cash management, the Company appears to have reached Year 2000 readiness. The Company's analysis of the corporate counterparties for its investments and current hedging position has also been completed. The Company continues to monitor the premises it occupies for any risks. In the first nine months of 1999, approximately $1.8 million was directly and indirectly expensed on Year 2000 matters. This amount excludes hardware and software that was replaced in the normal course of business. Total direct and indirect expenses are expected to be approximately $2.5 million for all of 1999. The Company's effective tax rate of 34.8% in the third quarter of 1999 was slightly lower than the previous year's third quarter and for all of 1998 reflecting an increase in state tax credits received as an incentive for making or renewing loans in certain designated areas in and around Los Angeles. It is expected that the Company's tax rate will remain in the 35.0% range for the remainder of 1999 due to state tax credits and the Company's additional investment in affordable housing limited partnerships. 9 The following table presents the components of net interest income on a fully taxable equivalent basis for the three months ended September 30, 1999 and 1998. NET INTEREST INCOME SUMMARY SEPTEMBER 30, 1999 SEPTEMBER 30, 1998 ------------------------------------ ------------------------------------ INTEREST AVERAGE INTEREST AVERAGE AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST DOLLARS IN THOUSANDS BALANCE EXPENSE RATE BALANCE EXPENSE RATE - -------------------- ------------------------------------ ------------------------------------ ASSETS Earning assets (1) Loans: Commercial $2,575,814 $ 56,213 8.66% $2,241,282 $ 49,867 8.83% Residential first mortgages 1,072,815 19,318 7.14 1,035,779 19,966 7.65 Real estate - construction 304,777 7,270 9.46 223,136 6,543 11.63 Real estate - commercial mortgage 859,944 19,062 8.79 751,291 17,369 9.17 Installment 52,666 1,376 10.37 51,345 958 7.40 ---------- -------- ---------- --------- Total loans (2) 4,866,016 103,239 8.42 4,302,833 94,703 8.73 Securities 1,015,193 17,326 6.77 818,243 13,877 6.73 Federal funds sold and securities purchased under resale agreements 32,766 432 5.23 31,067 420 5.36 Trading account securities 68,477 799 4.63 72,837 1,095 5.96 ---------- -------- ---------- --------- Total earning assets 5,982,452 121,796 8.08 5,224,980 110,095 8.36 -------- --------- Allowance for credit losses (141,756) (136,083) Cash and due from banks 283,545 304,435 Other nonearning assets 367,053 275,427 ---------- ---------- Total assets $6,491,294 $5,668,759 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing deposits: Interest checking accounts $ 396,533 445 0.45 $ 372,978 929 0.99 Money market accounts 967,247 7,206 2.96 917,014 7,128 3.08 Savings deposits 203,404 1,164 2.27 166,525 1,542 3.67 Time deposits - under $100,000 192,038 2,289 4.73 193,123 2,584 5.31 Time deposits - $100,000 and over 963,554 12,484 5.14 780,447 10,603 5.39 ---------- -------- ---------- --------- Total interest-bearing deposits 2,722,776 23,588 3.44 2,430,087 22,786 3.72 Federal funds purchased and securities sold under repurchase agreements 549,034 7,003 5.06 414,103 5,713 5.47 Other borrowings 540,670 7,256 5.32 350,958 5,330 6.03 ---------- -------- --------- --------- Total interest-bearing liabilities 3,812,480 37,847 3.94 3,195,148 33,829 4.20 -------- --------- Noninterest-bearing deposits 2,062,740 1,866,634 Other liabilities 57,381 68,467 Shareholders' equity 558,693 538,510 ---------- ---------- Total liabilities and shareholders' equity $6,491,294 $5,668,759 ========== ========== Net interest spread 4.14% 4.16% ===== ===== Fully taxable equivalent net interest income $ 83,949 $ 76,266 ======== ========== Net interest margin 5.57% 5.79% ===== ===== (1) Includes average nonaccrual loans of $22,791 and $31,239 for 1999 and 1998, respectively. (2) Loan income includes loan fees of $4,823 and $3,116 for 1999 and 1998, respectively. 10 The following table presents the components of net interest income on a fully taxable equivalent basis for the nine months ended September 30, 1999 and 1998. NET INTEREST INCOME SUMMARY SEPTEMBER 30, 1999 SEPTEMBER 30, 1998 ------------------------------------ ------------------------------------ INTEREST AVERAGE INTEREST AVERAGE AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST DOLLARS IN THOUSANDS BALANCE EXPENSE RATE BALANCE EXPENSE RATE - -------------------- ------------------------------------ ------------------------------------ ASSETS Earning assets (1) Loans: Commercial $2,499,067 $160,463 8.58% $2,128,408 $144,618 9.08% Residential first mortgages 1,042,781 56,344 7.22 1,028,118 58,684 7.63 Real estate - construction 274,247 19,748 9.63 174,332 14,763 11.32 Real estate - commercial mortgage 794,976 53,371 8.98 760,594 54,768 9.63 Installment 50,089 3,745 10.00 51,340 3,808 9.92 ---------- -------- ---------- --------- Total loans (2) 4,661,160 293,671 8.42 4,142,792 276,641 8.93 Securities 1,038,691 51,588 6.64 811,616 41,046 6.76 Federal funds sold and securities purchased under resale agreements 35,836 1,416 5.28 43,850 1,827 5.57 Trading account securities 66,750 2,058 4.12 59,041 2,632 5.96 ---------- -------- ---------- --------- Total earning assets 5,802,437 348,733 8.04 5,057,299 322,146 8.52 -------- --------- Allowance for credit losses (140,036) (137,742) Cash and due from banks 285,147 309,709 Other nonearning assets 324,281 273,766 ---------- ---------- Total assets $6,271,829 $5,503,032 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing deposits: Interest checking accounts $ 401,807 1,602 0.53 $ 384,482 2,850 0.99 Money market accounts 951,906 20,799 2.92 870,405 19,865 3.05 Savings deposits 192,458 5,297 3.68 167,688 4,520 3.60 Time deposits - under $100,000 185,294 6,526 4.71 204,683 8,050 5.26 Time deposits - $100,000 and over 843,100 30,188 4.79 749,724 29,826 5.32 ---------- -------- ---------- --------- Total interest-bearing deposits 2,574,565 64,412 3.34 2,376,982 65,111 3.66 Federal funds purchased and securities sold under repurchase agreements 570,466 20,952 4.91 375,071 15,280 5.45 Other borrowings 505,140 20,553 5.44 335,240 15,149 6.04 ---------- -------- ---------- --------- Total interest-bearing liabilities 3,650,171 105,917 3.88 3,087,293 95,540 4.14 -------- --------- Noninterest-bearing deposits 1,999,856 1,815,518 Other liabilities 60,018 65,010 Shareholders' equity 561,784 535,211 ---------- ---------- Total liabilities and shareholders' equity $6,271,829 $5,503,032 ========== ========== Net interest spread 4.16% 4.38% ===== ===== Fully taxable equivalent net interest income $242,816 $226,606 ======== ========== Net interest margin 5.58% 5.99% ===== ===== (1) Includes average nonaccrual loans of $23,153 and $33,833 for 1999 and 1998, respectively. (2) Loan income includes loan fees of $13,083 and $8,814 for 1999 and 1998, respectively. 11 The following tables set forth the changes in net interest income on a fully taxable equivalent basis broken down by volume and rates. The change in interest due to both volume and in rate 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. CHANGES IN NET INTEREST INCOME FOR THE THREE MONTHS ENDED SEPTEMBER 30, DOLLARS IN THOUSANDS 1999 VS 1998 - -------------------- ------------------------------------------------------------ INCREASE (DECREASE) DUE TO NET ------------------------------------- INCREASE VOLUME RATE (DECREASE) ---------------- ------------------ ------------------- Interest earned on: Loans $ 12,003 $ (3,467) $ 8,536 Securities 3,366 83 3,449 Trading account securities (62) (234) (296) Federal funds sold and securities purchased under resale agreements 22 (10) 12 ---------------- ------------------ ------------------- Total interest-earning assets 15,329 (3,628) 11,701 ---------------- ------------------ ------------------- Interest paid on: Interest checking deposits 55 (539) (484) Money market deposits 370 (292) 78 Savings deposits 293 (671) (378) Other time deposits 2,355 (769) 1,586 Other borrowings 4,335 (1,119) 3,216 ---------------- ------------------ ------------------- Total interest-bearing liabilities 7,408 (3,390) 4,018 ---------------- ------------------ ------------------- $ 7,921 $ (238) $ 7,683 ================ ================== =================== FOR THE THREE MONTHS ENDED SEPTEMBER 30, DOLLARS IN THOUSANDS 1998 VS 1997 - -------------------- ----------------------------------------------------------- INCREASE (DECREASE) DUE TO NET ------------------------------------- INCREASE VOLUME RATE (DECREASE) ---------------- ------------------ ------------------- Interest earned on: Loans $ 18,832 $ (3,700) $ 15,132 Securities 29 (221) (192) Trading account securities 341 (11) 330 Federal funds sold and securities purchased under resale agreements 125 (18) 107 ---------------- ------------------ ------------------- Total interest-earning assets 19,327 (3,950) 15,377 ---------------- ------------------ ------------------- Interest paid on: Interest checking deposits 66 (18) 48 Money market deposits 882 83 965 Savings deposits (10) 119 109 Other time deposits 2,563 20 2,583 Other borrowings 2,278 234 2,512 ---------------- ------------------ ------------------- Total interest-bearing liabilities 5,779 438 6,217 ---------------- ------------------ ------------------- $ 13,548 $ (4,388) $ 9,160 ================ ================== =================== FOR THE NINE MONTHS ENDED SEPTEMBER 30, DOLLARS IN THOUSANDS 1999 VS 1998 - -------------------- ------------------------------------------------------------ INCREASE (DECREASE) DUE TO NET ------------------------------------- INCREASE VOLUME RATE (DECREASE) ---------------- ------------------ ------------------- Interest earned on: Loans $ 33,394 $ (16,364) $ 17,030 Securities 11,283 (741) 10,542 Trading account securities 313 (887) (574) Federal funds sold and securities purchased under resale agreements (320) (91) (411) ---------------- ------------------ ------------------- Total interest-earning assets 44,670 (18,083) 26,587 ---------------- ------------------ ------------------- Interest paid on: Interest checking deposits 123 (1,371) (1,248) Money market deposits 1,805 (871) 934 Savings deposits 676 101 777 Other time deposits 2,832 (3,994) (1,162) Other borrowings 14,356 (3,280) 11,076 ---------------- ------------------ ------------------- Total interest-bearing liabilities 19,792 (9,415) 10,377 ---------------- ------------------ ------------------- $ 24,878 $ (8,668) $ 16,210 ================ ================== =================== FOR THE NINE MONTHS ENDED SEPTEMBER 30, DOLLARS IN THOUSANDS 1998 VS 1997 - -------------------- ------------------------------------------------------------ INCREASE (DECREASE) DUE TO NET ------------------------------------- INCREASE VOLUME RATE (DECREASE) ---------------- ------------------ ------------------- Interest earned on: Loans $ 55,683 $ (5,060) $ 50,623 Securities (947) (72) (1,019) Trading account securities 446 86 532 Federal funds sold and securities purchased under resale agreements 910 21 931 ---------------- ------------------ ------------------- Total interest-earning assets 56,092 (5,025) 51,067 ---------------- ------------------ ------------------- Interest paid on: Interest checking deposits 145 (52) 93 Money market deposits 1,734 179 1,913 Savings deposits (38) 342 304 Other time deposits 8,750 444 9,194 Other borrowings 5,778 1,207 6,985 ---------------- ------------------ ------------------- Total interest-bearing liabilities 16,369 2,120 18,489 ---------------- ------------------ ------------------- $ 39,723 $ (7,145) $ 32,578 ================ ================== =================== BALANCE SHEET ANALYSIS AVAILABLE-FOR-SALE SECURITY PORTFOLIO Comparative period-end available-for-sale security portfolio balances are presented below: AVAILABLE-FOR-SALE SECURITIES SEPTEMBER 30, DECEMBER 31, 1999 1998 ----------------------------------- ----------------------------------- DOLLARS IN THOUSANDS COST FAIR VALUE COST FAIR VALUE - -------------------- ----------------- ---------------- ----------------- ---------------- U.S. Gov. and federal agency $ 267,101 $ 265,587 $268,838 $ 275,145 Mortgage-backed 382,612 370,846 348,826 351,469 State and Municipal 149,483 147,129 121,743 123,845 Other debt 166,802 154,656 145,852 152,692 ----------------- ---------------- ----------------- ---------------- Total debt securities 965,998 938,218 885,259 903,151 Marketable equity securities 124,609 122,213 104,893 109,375 ----------------- ---------------- ----------------- ---------------- Total securities $1,090,607 $1,060,431 $990,152 $1,012,526 ================= ================ ================= ================ SEPTEMBER 30, 1998 ---------------------------------- DOLLARS IN THOUSANDS COST FAIR VALUE - -------------------- ---------------- ---------------- U.S. Gov. and federal agency $270,032 $279,521 Mortgage-backed 189,559 193,225 State and Municipal 2,179 2,195 Other debt 136,870 138,942 ---------------- ---------------- Total debt securities 598,640 613,883 Marketable equity securities 117,067 120,508 ---------------- ---------------- Total securities $715,707 $734,391 ================ ================ The following table provides the expected remaining maturities and yields (taxable-equivalent basis) of debt securities within the available-for-sale portfolio as of September 30, 1999. DEBT AVAILABLE-FOR-SALE SECURITIES ONE YEAR OVER 1 YEAR OR LESS THRU 5 YEARS ----------------------------------- ----------------------------------- DOLLARS IN THOUSANDS AMOUNT YIELD (%) AMOUNT YIELD (%) - -------------------- ----------------- ---------------- ----------------- ---------------- U.S. Gov. and federal agency $10,059 6.31 $180,936 6.30 Mortgage-backed -- -- -- -- State and Municipal 17,406 6.58 55,352 6.85 Other debt -- -- 103 7.00 ----------------- ---------------- ----------------- ---------------- Total debt securities $27,465 6.48 $236,391 6.42 ================= ================ ================= ================ Amortized cost $27,336 $236,293 ================= ================ ================= ================ OVER 5 YEARS THRU 10 YEARS OVER 10 YEARS ----------------------------------- ---------------------------------- DOLLARS IN THOUSANDS AMOUNT YIELD (%) AMOUNT YIELD (%) - -------------------- ----------------- ---------------- ---------------- ---------------- U.S. Gov. and federal agency $ 74,592 6.34 $ -- -- Mortgage-backed 17,908 6.15 352,937 6.55 State and Municipal 72,831 6.40 1,541 6.31 Other debt 86,209 7.50 68,344 7.98 ----------------- ---------------- ---------------- ---------------- Total debt securities $251,540 6.74 $422,822 6.78 ================= ================ ================= ================ Amortized cost $264,426 $437,943 ================= ================ ================ ================ TOTAL ----------------------------------- DOLLARS IN THOUSANDS AMOUNT YIELD (%) - -------------------- ---------------- ---------------- U.S. Gov. and federal agency $265,587 6.31 Mortgage-backed 370,845 6.53 State and Municipal 147,130 6.60 Other debt 154,656 7.71 ---------------- ---------------- Total debt securities $938,218 6.68 ================ ================ Amortized cost $965,998 ================ ================ Dividend income included in interest income on securities in the Consolidated Statement of Income and Comprehensive Income in the third quarter of 1999 and 1998 were $1.2 million and $1.9 million, and for the nine months were $3.9 million and $6.5 million, respectively. 13 LOAN PORTFOLIO A comparative period-end loan table is presented below: LOANS SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DOLLARS IN THOUSANDS 1999 1998 1998 - -------------------- --------------------- -------------------- --------------------- Commercial $2,693,902 $2,457,946 $2,280,202 Residential first mortgage 1,121,683 1,038,229 1,033,799 Real estate - construction 328,422 237,015 234,519 Real estate - mortgage 974,867 747,711 744,265 Installment 53,050 49,526 51,011 --------------------- -------------------- --------------------- Total loans, gross 5,171,924 4,530,427 4,343,796 Less: Allowance for credit losses (139,015) (135,339) (135,486) --------------------- -------------------- --------------------- Total loans, net $5,032,909 $4,395,088 $4,208,310 ===================== ==================== ===================== Gross loans at September 30, 1999 amounted to $5,171.9 million, up $828.1 million (19.1%) from September 30, 1998 and up $641.5 million (14.2%) from December 31, 1998. This increase includes $266.9 million from the APSB purchase acquisition. Contributing to the $413.7 million increase in commercial loans from September 30, 1998 were $90.6 million from the APSB acquisition, internal loan originations and the purchase of syndicated corporate loans. During the quarter, commercial relationship-originated loans increased $125.3 million while commercial non-relationship syndicated loans increased $31.5 million. The $87.9 million increase in residential first mortgage loans from the year ago quarter resulted from the Bank's own originations. Construction loans, including $2.9 million from APSB, increased by $93.9 million from September 30, 1998 as the Company continued to expand its lending for residential and commercial construction development. Real estate mortgage loans increased $230.6 million from the same period a year ago due to $172.3 million from APSB and internal loan originations. The Company expects that the Bank's loan portfolio will increase from third quarter 1999 levels due primarily to its own internal loan generation activities and loan purchases. The following table presents information concerning nonaccrual loans, ORE, and restructured loans. NONACCRUAL LOANS, ORE AND RESTRUCTURED LOANS SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DOLLARS IN THOUSANDS 1999 1998 1998 - -------------------- --------------------- -------------------- --------------------- Nonaccrual loans: Commercial $ 7,803 $ 4,763 $10,200 Real estate 10,932 17,204 19,664 Installment 581 1,171 2,642 --------------------- -------------------- --------------------- Total 19,316 23,138 32,506 ORE 2,134 3,480 2,148 --------------------- -------------------- --------------------- Total nonaccrual loans and ORE $21,450 $26,618 $34,654 ===================== ==================== ===================== Restructured loans, accruing $ 2,586 $ 1,982 $ 2,847 ===================== ==================== ===================== Total non accrual loans as a percentage of total loans.............. 0.37% 0.51% 0.75 Total non accrual loans and ORE as a percentage of total loans and ORE...... 0.41 0.59 0.80 Allowance for credit losses to total loans... 2.69 2.99 3.12 Allowance for credit losses to nonaccrual loans.................... 719.69 584.92 416.80 14 The table below summarizes the approximate changes in nonaccrual loans for the quarters and nine months ended September 30, 1999 and September 30, 1998. CHANGES IN NONACCRUAL LOANS FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------------------- ------------------------------------- DOLLARS IN MILLIONS 1999 1998 1999 1998 - ------------------- --------------------- ----------------- ----------------- ------------------ Balance, beginning of period $26.5 $33.2 $ 23.1 $ 27.6 Additions from acquisitions 0.6 -- 0.6 3.1 Loans placed on nonaccrual 4.0 5.4 18.9 30.2 Charge offs (7.0) (1.9) (7.7) (9.5) Loans returned to accrual status (1.0) -- (1.2) -- Repayments (including interest applied to principal) (3.8) (4.2) (14.4) (18.9) --------------------- ----------------- ----------------- ------------------ Balance, end of period $19.3 $32.5 $ 19.3 $ 32.5 ===================== ================= ================= ================== At September 30, 1999, in addition to loans disclosed above as nonaccrual or restructured, management had also identified $9.4 million of problem loans about which the ability of the borrowers to comply with the present loan repayment terms in the future is questionable. ALLOWANCE FOR CREDIT LOSSES The following table summarizes average loans outstanding and changes in the allowance for credit losses for the periods presented: CHANGES IN ALLOWANCE FOR CREDIT LOSSES FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------------------- -------------------------------------- DOLLARS IN MILLIONS 1999 1998 1999 1998 - ------------------- --------------------- ----------------- ----------------- ------------------ Average amount of loans outstanding $4,866.0 $4,302.8 $4,661.2 $4,142.8 ===================== ================= ================= ================== Balance of allowance for credit losses, beginning of period $ 140.2 $ 135.8 $ 135.3 $ 137.8 Loans charged off: Commercial 7.2 1.9 9.6 12.9 Real estate 0.3 1.2 0.5 2.1 --------------------- ----------------- ----------------- ------------------ Total loans charged off 7.5 3.1 10.1 15.0 --------------------- ----------------- ----------------- ------------------ Less recoveries of loans previously charged off: Commercial 2.5 2.4 9.7 9.5 Real estate 0.4 0.4 0.7 0.5 --------------------- ----------------- ----------------- ------------------ Total recoveries 2.9 2.8 10.4 10.0 --------------------- ----------------- ----------------- ------------------ Net loans (charged off)/recovered (4.6) (0.3) 0.3 (5.0) Additions to allowance charged to earnings -- -- -- -- Additions to allowance from acquisitions 3.4 -- 3.4 2.7 --------------------- ----------------- ----------------- ------------------ Balance, end of period $ 139.0 $ 135.5 $ 139.0 $ 135.5 ===================== ================= ================= ================== Ratio of net charge-offs to average loans 0.09% 0.01% N/M 0.12% ===================== ================= ================= ================== Ratio of allowance for credit losses to total period end loans 2.69% 3.12% ================= ================== 15 CAPITAL ADEQUACY REQUIREMENT The following table presents the regulatory standards for "well capitalized" institutions and the capital ratios for the Company and the Bank at September 30, 1999, December 31, 1998 and September 30, 1998. REGULATORY WELL CAPITALIZED SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, STANDARDS 1999 1998 1998 ------------------------------------------------------------------------------------ CITY NATIONAL CORPORATION - ------------------------------ Tier 1 leverage 4.00% 7.09% 7.99% 8.33% Tier 1 risk-based capital 6.00 7.98 9.43 9.81 Total risk-based capital 10.00 11.44 13.20 13.69 CITY NATIONAL BANK - ------------------------------ Tier 1 leverage 4.00% 6.77% 7.53% 7.90% Tier 1 risk-based capital 6.00 7.63 8.90 9.28 Total risk-based capital 10.00 11.09 12.65 13.17 Lower capital ratios than in previous quarters resulted from the goodwill generated from the all-cash acquisition of APSB completed in August 1999. Under the Company's current one million-share common stock buyback program, which was announced on July 29, 1999, a total of 248,400 shares were repurchased during the third quarter of 1999 at a cost of $8.2 million. As of October 31, 1999, a total of 280,800 shares were repurchased under this program at a cost of $9.3 million. Shares purchased under the buyback program will be reissued for the acquisition of The Pacific Bank, upon the exercise of stock options and for other general corporate purposes. On October 27, 1999, the Company declared a regular quarterly dividend of $0.165 per share, payable November 22, 1999 to shareholders of record as of November 10, 1999. ASSET/LIABILITY MANAGEMENT The principal objectives of asset/liability management are to maximize net interest margin subject to margin volatility and liquidity constraints. Margin volatility results when the rate reset (or repricing) characteristics of assets are materially different from those of the Company's liabilities. Liquidity risk results from the mismatching of asset and liability cash flows. Management chooses asset/liability strategies that promote stable earnings and reliable funding. Interest rate risk and funding positions are kept within limits established by the Company's board of directors to ensure that risk-taking is not excessive and that liquidity is properly managed. The Company has established three measurement processes to quantify and manage exposure to interest rate risk: net interest income simulation modeling, gap analysis, and present value of equity analysis. Net interest income simulations are used to identify the direction and severity of interest rate risk exposure across a twelve month forecast horizon. Gap analysis provides insight into structural mismatches of assets and liability repricing characteristics and reflects the attrition and prepayment behavior of deposit and loan customers. Present value of equity calculations are used to estimate the theoretical price sensitivity of shareholder equity to changes in interest rates. The Company uses simulation modeling to estimate the potential effects of changing interest rates. This process allows the Company to fully explore the complex relationships within the gap over time and various interest rate scenarios. Income simulation is the primary tool used to manage interest rate risk. The use of interest rate swaps to manage interest rate exposure involves the risk of dealing with counterparties and their ability to meet contractual terms. These counterparties must receive appropriate credit approval before the 16 Company enters into an interest rate contract. Notional principal amounts express the volume of these transactions, although the amounts potentially subject to credit and market risks are much smaller. The Company's interest rate swaps are entered into as hedges against a decrease in interest income generated from prime based loans if the prime decreased or to convert fixed rate deposits and debt into floating rate liabilities. The Company has not entered into transactions involving any other interest rate derivative financial instruments, such as interest rate floors, caps and interest rate futures contracts. As of September 30, 1999, the Company has $985.0 million of notional principal in "receive" fixed-pay LIBOR interest rate swaps, of which $520.0 million have maturities greater than one year. The Company's interest-rate risk-management instruments had a fair value of $(4.5) million and $6.4 million at September 30, 1999 and December 31, 1998, respectively, with no exposure to credit risk at September 30, 1999 and $6.4 million at December 31, 1998. The credit exposure represents the cost to replace, on a present value basis and at current market rates, the net positive value of all contracts for each counterparty that were outstanding at the end of the period. The Company's swap agreements require the deposit of collateral to mitigate the amount of credit risk if certain credit exposure thresholds are exceeded. As of September 30, 1999, the Company had deposited $2.0 million par value in securities to mitigate credit exposure. At September 30, 1999, the Company's outstanding foreign exchange contracts totaled $43.3 million. The Company enters into foreign exchange contracts with its customers and counterparty banks solely for the purpose of offsetting or hedging transaction and economic exposures arising out of commercial transactions. The Company's policies prohibit outright speculation by the Company and its employees. The Company actively manages its foreign exchange exposures within prescribed risk limits and controls. All foreign exchange contracts outstanding at September 30, 1999 had remaining maturities of six months or less. LIQUIDITY MANAGEMENT The Company continues to manage its liquidity through the combination of core deposits, federal funds purchased, repurchase agreements, collateralized borrowing lines at the Federal Reserve Bank and the Federal Home Loan Bank of San Francisco, and a portfolio of securities available-for-sale. Liquidity is also provided by maturing securities and loans. In addition as part of the Company's year 2000 planning, a $50 million Federal Home Loan Bank Commitment is in place. Average core deposits and shareholders' equity comprised 68.5% of total funding in the third quarter of 1999, compared to 71.5% in the third quarter of 1998. This decrease has required that the Company increase its use of more costly alternative funding sources. Despite the decrease in percentage of funding derived from core deposits and shareholders' equity, the Company has not faced any liquidity constraints. 17 CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The Company wishes to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 as to "forward looking" statements in this Quarterly Report which are not historical facts. The Company cautions readers that the following important factors could affect the Company's business and cause actual results to differ materially from those expressed in any forward looking statement made by, or on behalf of, the Company. - --Economic conditions. The Company's results are strongly influenced by general economic conditions in its market area, Southern California, and a deterioration in these conditions could have a material adverse impact on the quality of the Bank's loan portfolio and the demand for its products and services. In particular, changes in economic conditions in the real estate and entertainment industries may affect the Company's performance. - --Interest rates. Management anticipates that interest rates will remain flat or slightly higher. If interest rates vary substantially from present levels, this may cause the Company's results to differ materially. - --Government regulation and monetary policy. All forward looking statements presume a continuation of the existing regulatory environment and U.S. Government monetary policies. The banking industry is subject to extensive federal and state regulations, and significant new laws or changes in, or repeal of, existing laws may cause results to differ materially. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Bank, primarily through open market operations in U.S. Government securities, the discount rate for member bank borrowing and bank reserve requirements, and a material change in these policies would be likely to have an impact on results. - --Competition. The Bank competes with numerous other domestic and foreign financial institutions and non-depository financial intermediaries. Results may differ if circumstances affecting the nature or level of competition change, such as the merger of competing financial institutions. - --Credit quality. A significant source of risk arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Bank has adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the Bank's credit portfolio, but such policies and procedures may not prevent unexpected losses that could adversely affect the Company's results. - --Other risks. From time to time, the Company details other risks to its business and/or its financial results in its filings with the Securities and Exchange Commission. While management believes that its assumptions regarding these and other factors on which forward looking statements are based are reasonable, such assumptions are necessarily speculative in nature, and actual outcomes can be expected to differ to some degree. Consequently, there can be no assurance that the results described in such forward looking statements will, in fact, be achieved. 18 PART 11. 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 None (b) Reports on Form 8-K The company filed a report on Form 8-K on September 22, 1999 under item 5 announcing the definitive agreement plan for the acquisition of The Pacific Bank. Included in the report is a press release dated September 22, 1999 and an information presentation. 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 15, 1999 /s/ FRANK P. PEKNY ------------------------ -------------------------------- FRANK P. PEKNY Executive Vice President and Chief Financial Officer 19