================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002 Commission file number 1-15081 UNIONBANCAL CORPORATION State of Incorporation: CALIFORNIA I.R.S. Employer Identification No. 94-1234979 400 CALIFORNIA STREET SAN FRANCISCO, CALIFORNIA 94104-1302 Registrant's telephone number (415) 765-2969 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Number of shares of Common Stock outstanding at April 30, 2002: 156,855,456 ================================================================================ UNIONBANCAL CORPORATION AND SUBSIDIARIES TABLE OF CONTENTS PAGE NUMBER ------ PART I FINANCIAL INFORMATION Consolidated Financial Highlights..................................... 2 Item 1. Financial Statements: Condensed Consolidated Statements of Income........................ 3 Condensed Consolidated Balance Sheets.............................. 4 Condensed Consolidated Statements of Changes in Shareholders' Equity............................................................ 5 Condensed Consolidated Statements of Cash Flows.................... 6 Notes to Condensed Consolidated Financial Statements............... 7 Item 2. Management's Discussion and Analysis: Introduction....................................................... 15 Summary............................................................ 15 Business Segments.................................................. 17 Net Interest Income................................................ 26 Noninterest Income................................................. 27 Noninterest Expense................................................ 29 Income Tax Expense................................................. 30 Loans.............................................................. 30 Cross-Border Outstandings.......................................... 31 Provision for Credit Losses........................................ 32 Allowance for Credit Losses........................................ 32 Nonperforming Assets............................................... 36 Loans 90 Days or More Past Due and Still Accruing.................. 36 Quantitative and Qualitative Disclosure about Interest Rate Risk Management................................................... 36 Liquidity.......................................................... 38 Regulatory Capital................................................. 39 Certain Business Risk Factors...................................... 40 Item 3. Market Risk................................................... 44 PART II OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders........... 45 Item 6. Exhibits and Reports on Form 8-K.............................. 46 Signatures............................................................... 47 PART I. FINANCIAL INFORMATION UNIONBANCAL CORPORATION AND SUBSIDIARIES CONSOLIDATED FINANCIAL HIGHLIGHTS (UNAUDITED) PERCENT CHANGE TO AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2002 FROM: ------------------------------------------- -------------------------- (DOLLARS IN THOUSANDS, EXCEPT MARCH 31, DECEMBER 31, MARCH 31, MARCH 31, DECEMBER 31, PER SHARE DATA) 2001 2001 2002 2001 2001 - --------------------------------------- ----------- ----------- ----------- --------- ------------ RESULTS OF OPERATIONS: Net interest income(1).............. $387,883 $380,386 $380,973 (1.78)% 0.15% Provision for credit losses......... 100,000 70,000 55,000 (45.00) 21.43) Noninterest income.................. 180,807 193,801 171,451 (5.17) (11.53) Noninterest expense................. 307,485 308,195 323,363 5.16 4.92 ----------- ----------- ----------- Income before income taxes(1)....... 161,205 195,992 174,061 7.97 (11.19) Taxable-equivalent adjustment....... 622 419 533 (14.31) 27.21 Income tax expense.................. 53,296 63,711 58,751 10.24 (7.79) ----------- ----------- ----------- Net income.......................... $107,287 $131,862 $114,777 6.98% (12.96)% =========== =========== =========== PER COMMON SHARE: Net income--basic.................... $0.68 $0.84 $0.73 7.35% (13.10)% Net income--diluted.................. 0.67 0.84 0.73 8.96 (13.10) Dividends........................... 0.25 0.25 0.25 -- -- Book value (end of period).......... 21.02 22.66 22.81 8.52 0.66 Common shares outstanding (end of period).......................... 158,567,213 156,483,511 156,336,338 (1.41) (0.09) Weighted average common shares outstanding--basic................ 158,893,347 156,746,606 156,228,149 (1.68) (0.33) Weighted average common shares outstanding--diluted.............. 159,269,148 157,890,507 157,810,613 (0.92) (0.05) BALANCE SHEET (END OF PERIOD): Total assets........................ $35,823,050 $36,038,746 $36,221,931 1.11% 0.51% Total loans......................... 25,976,936 24,994,030 25,098,097 (3.38) 0.42 Nonperforming assets................ 438,980 492,482 452,761 3.14 (8.07) Total deposits...................... 27,208,128 28,556,199 28,758,849 5.70 0.71 Medium and long-term debt........... 199,688 399,657 399,673 100.15 -- Trust preferred securities.......... 366,526 363,928 361,903 (1.26) (0.56) Common equity....................... 3,332,998 3,546,242 3,566,502 7.01 0.57 BALANCE SHEET (PERIOD AVERAGE): Total assets........................ $34,427,990 $34,838,155 $35,083,527 1.90% 0.70% Total loans......................... 26,417,626 25,366,890 25,127,757 (4.88) (0.94) Earning assets...................... 31,068,242 31,477,853 31,976,493 2.92 1.58 Total deposits...................... 25,767,673 27,353,182 27,568,947 6.99 0.79 Common equity....................... 3,337,940 3,625,459 3,624,767 8.59 (0.02) FINANCIAL RATIOS: Return on average assets(2)......... 1.26% 1.50% 1.33% Return on average common equity(2).. 13.04 14.43 12.84 Efficiency ratio(3)................. 54.07 53.68 58.51 Net interest margin(1).............. 5.04 4.81 4.80 Dividend payout ratio............... 36.76 29.76 34.25 Tangible equity ratio............... 9.16 9.62 9.64 Tier 1 risk-based capital ratio..... 10.49 11.47 11.63 Total risk-based capital ratio...... 12.32 13.35 13.50 Leverage ratio...................... 10.22 10.53 10.65 Allowance for credit losses to total loans............................ 2.47 2.54 2.51 Allowance for credit losses to nonaccrual loans................. 149.09 129.00 139.11 Net loans charged off to average total loans(2)................... 1.10 1.02 0.97 Nonperforming assets to total loans, distressed loans held for sale, and foreclosed assets............ 1.69 1.97 1.80 Nonperforming assets to total assets 1.23 1.37 1.25 - ------------------------------- <FN> (1) Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent. (2) Annualized. (3) The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income), as a percentage of net interest income (taxable-equivalent basis) and noninterest income. </FN> 2 ITEM 1. FINANCIAL STATEMENTS UNIONBANCAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) FOR THE THREE MONTHS ENDED MARCH 31, ---------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) 2001 2002 - ------------------------------------------------------------------------------ ---------- --------- INTEREST INCOME Loans...................................................................... $536,489 $375,798 Securities................................................................. 67,308 81,336 Interest bearing deposits in banks......................................... 966 496 Federal funds sold and securities purchased under resale agreements........ 1,029 4,059 Trading account assets..................................................... 2,900 691 ---------- --------- Total interest income................................................... 608,692 462,380 ---------- --------- INTEREST EXPENSE Domestic deposits.......................................................... 135,117 59,935 Foreign deposits........................................................... 25,543 6,264 Federal funds purchased and securities sold under repurchase agreements.... 25,800 1,949 Commercial paper........................................................... 20,413 3,974 Medium and long-term debt.................................................. 3,196 2,412 UnionBanCal Corporation--obligated mandatorily redeemable preferred securities of subsidiary grantor trust................................... 6,022 3,963 Other borrowed funds....................................................... 5,340 3,443 ---------- --------- Total interest expense.................................................. 221,431 81,940 ---------- --------- NET INTEREST INCOME........................................................... 387,261 380,440 Provision for credit losses................................................ 100,000 55,000 ---------- --------- Net interest income after provision for credit losses................... 287,261 325,440 ---------- --------- NONINTEREST INCOME Service charges on deposit accounts........................................ 57,020 66,143 Trust and investment management fees....................................... 39,681 36,725 Merchant transaction processing fees....................................... 19,066 20,701 International commissions and fees......................................... 17,110 18,223 Brokerage commissions and fees............................................. 8,915 9,632 Merchant banking fees...................................................... 9,248 6,945 Securities gains (losses), net............................................. 2,266 (2,566) Other...................................................................... 27,501 15,648 ---------- --------- Total noninterest income................................................ 180,807 171,451 ---------- --------- NONINTEREST EXPENSE Salaries and employee benefits............................................. 164,487 177,794 Net occupancy.............................................................. 22,759 23,381 Equipment.................................................................. 15,798 16,340 Communications............................................................. 11,702 13,941 Merchant transaction processing............................................ 12,914 12,916 Professional services...................................................... 7,824 9,503 Data processing............................................................ 8,949 8,991 Foreclosed asset expense................................................... 13 125 Other...................................................................... 63,039 60,372 ---------- --------- Total noninterest expense............................................... 307,485 323,363 ---------- --------- Income before income taxes................................................. 160,583 173,528 Income tax expense......................................................... 53,296 58,751 ---------- --------- NET INCOME.................................................................... $107,287 $114,777 ========== ========= NET INCOME PER COMMON SHARE--BASIC............................................ $0.68 $0.73 ========== ========= NET INCOME PER COMMON SHARE--DILUTED.......................................... $0.67 $0.73 ========== ========= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--BASIC............................. 158,893 156,228 ========== ========= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--DILUTED........................... 159,269 157,811 ========== ========= See accompanying notes to condensed consolidated financial statements. 3 UNIONBANCAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (UNAUDITED) MARCH 31, DECEMBER 31, MARCH 31, (DOLLARS IN THOUSANDS) 2001 2001 2002 - ------------------------------------------------------------------------ ----------- ------------ ----------- ASSETS Cash and due from banks................................................. $ 2,827,758 $ 2,682,392 $ 1,787,942 Interest bearing deposits in banks...................................... 60,083 64,162 110,147 Federal funds sold and securities purchased under resale agreements..... 744,500 918,400 2,109,600 ----------- ------------ ----------- Total cash and cash equivalents...................................... 3,632,341 3,664,954 4,007,689 Trading account assets.................................................. 385,772 229,697 221,179 Securities available for sale: Securities pledged as collateral..................................... 310,933 137,922 120,560 Held in portfolio.................................................... 4,160,742 5,661,160 5,289,210 Loans (net of allowance for credit losses: March 31, 2001, $642,334; December 31, 2001, $634,509; March 31, 2002, $629,367)............... 25,334,602 24,359,521 24,468,730 Due from customers on acceptances....................................... 225,081 182,440 136,303 Premises and equipment, net............................................. 480,232 494,534 489,915 Intangible assets....................................................... 2,447 16,176 15,292 Goodwill................................................................ 52,772 68,623 68,623 Other assets............................................................ 1,238,128 1,223,719 1,404,430 ----------- ------------ ----------- Total assets......................................................... $35,823,050 $36,038,746 $36,221,931 =========== ============ =========== LIABILITIES Domestic deposits: Noninterest bearing.................................................. $10,966,658 $12,314,150 $11,878,768 Interest bearing..................................................... 13,867,381 14,160,113 14,540,336 Foreign deposits: Noninterest bearing.................................................. 260,686 404,708 404,378 Interest bearing..................................................... 2,113,403 1,677,228 1,935,367 ----------- ------------ ----------- Total deposits....................................................... 27,208,128 28,556,199 28,758,849 Federal funds purchased and securities sold under repurchase agreements............................................................. 1,436,474 418,814 369,565 Commercial paper........................................................ 1,437,467 830,657 900,851 Other borrowed funds.................................................... 540,625 700,403 900,360 Acceptances outstanding................................................. 225,081 182,440 136,303 Other liabilities....................................................... 1,076,063 1,040,406 827,925 Medium and long-term debt............................................... 199,688 399,657 399,673 UnionBanCal Corporation--obligated mandatorily redeemable preferred securities of subsidiary grantor trust................................. 366,526 363,928 361,903 ----------- ------------ ----------- Total liabilities.................................................... 32,490,052 32,492,504 32,655,429 ----------- ------------ ----------- Commitments and contingencies SHAREHOLDERS' EQUITY Preferred stock: Authorized 5,000,000 shares, no shares issued or outstanding as of March 31, 2001, December 31, 2001, and March 31, 2002................ -- -- -- Common stock--no stated value: Authorized 300,000,000 shares, issued 158,567,213 shares as of March 31, 2001, 156,483,511 shares as of December 31, 2001, and 156,336,338 shares as of March 31, 2002.............................. 1,256,085 1,181,925 1,172,479 Retained earnings....................................................... 1,974,095 2,231,384 2,307,150 Accumulated other comprehensive income.................................. 102,818 132,933 86,873 ----------- ------------ ----------- Total shareholders' equity........................................... 3,332,998 3,546,242 3,566,502 ----------- ------------ ----------- Total liabilities and shareholders' equity........................... $35,823,050 $36,038,746 $36,221,931 =========== ============ =========== See accompanying notes to condensed consolidated financial statements. 4 UNIONBANCAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) FOR THE THREE MONTHS ENDED MARCH 31, ----------------------------------------------------- (DOLLARS IN THOUSANDS) 2001 2002 - ----------------------------------------------------------------------- ----------------------- ----------------------- COMMON STOCK Balance, beginning of period........................................ $1,275,587 $1,181,925 Dividend reinvestment plan.......................................... 8 38 Deferred compensation--restricted stock awards...................... (9) (3) Stock options exercised............................................. 2,070 25,345 Common stock repurchased(1)......................................... (21,571) (34,826) ---------- ---------- Balance, end of period........................................... $1,256,085 $1,172,479 ---------- ---------- RETAINED EARNINGS Balance, beginning of period........................................ $1,906,093 $2,231,384 Net income.......................................................... 107,287 $107,287 114,777 $114,777 Dividends on common stock(2)........................................ (39,671) (39,048) Deferred compensation--restricted stock awards...................... 386 37 ---------- ---------- Balance, end of period........................................... $1,974,095 $2,307,150 ---------- ---------- ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance, beginning of period........................................ $29,885 $132,933 Cumulative effect of accounting change (SFAS No.133)(3), net of tax expense of $13,754 in 2001....................................... 22,205 -- Unrealized net gains on cash flow hedges, net of tax expense of $14,164 and $578 in the first three months of 2001 and 2002, respectively..................................................... 22,866 933 Less: reclassification adjustment for net gains on cash flow hedges included in net income, net of tax expense of $1,203 and $11,177 in the first three months of 2001 and 2002, respectively......... (1,943) (18,044) -------- -------- Net unrealized gains (losses) on cash flow hedges................... 20,923 (17,111) Unrealized holding gains (losses) arising during the period on securities available for sale, net of tax expense (benefit) of $19,689 and $(18,904) in the first three months of 2001 and 2002, respectively..................................................... 31,785 (30,519) Less: reclassification adjustment for losses (gains) on securities available for sale included in net income, net of tax expense (benefit) of $867 and $(981) in the first three months of 2001 and 2002, respectively........................................... (1,399) 1,585 -------- -------- Net unrealized gains (losses) on securities available for sale...... 30,386 (28,934) Foreign currency translation adjustment, net of tax benefit of $360 and $9 in the first three months of 2001 and 2002, respectively.. (581) (15) -------- -------- Other comprehensive income (loss)................................... 72,933 72,933 (46,060) (46,060) ---------- -------- ---------- -------- Total comprehensive income.......................................... $180,220 $68,717 ======== ======== Balance, end of period........................................... $102,818 $86,873 ---------- ---------- TOTAL SHAREHOLDERS' EQUITY..................................... $3,332,998 $3,566,502 ========== ========== - ------------------------------------------ <FN> (1) Common stock repurchased includes commission costs. (2) Dividends per share were $0.25 for the first three months of 2001 and 2002. Dividends are based on UnionBanCal Corporation's shares outstanding as of the declaration date. (3) Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities". </FN> See accompanying notes to condensed consolidated financial statements. 5 UNIONBANCAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE THREE MONTHS ENDED MARCH 31, -------------------------- (DOLLARS IN THOUSANDS) 2001 2002 - -------------------------------------------------------------------------------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................................... $ 107,287 $ 114,777 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for credit losses............................................... 100,000 55,000 Depreciation, amortization and accretion.................................. 19,693 19,637 Provision for deferred income taxes....................................... 6,192 28,674 Loss (gain) on securities available for sale.............................. (2,266) 2,566 Net (increase) decrease in trading account assets......................... (46,077) 8,518 Other, net................................................................ 185,482 (426,639) ---------- ---------- Total adjustments......................................................... 263,024 (312,244) ---------- ---------- Net cash provided by (used in) operating activities.......................... 370,311 (197,467) ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale......................... 224,833 1,106 Proceeds from matured and called securities available for sale............... 170,854 346,379 Purchases of securities available for sale................................... (667,367) (11,657) Net increase in loans........................................................ (38,349) (158,071) Other, net................................................................... (19,429) (10,074) ---------- ---------- Net cash provided by (used in) investing activities....................... (329,458) 167,683 ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in deposits.......................................... (75,055) 202,650 Net increase (decrease) in federal funds purchased and securities sold under repurchase agreements.................................................. 48,807 (49,249) Net increase in commercial paper and other borrowed funds.................... 342,852 270,151 Common stock repurchased..................................................... (21,571) (34,826) Payments of cash dividends................................................... (39,824) (39,143) Other, net................................................................... 18,023 23,359 ---------- ---------- Net cash provided by financing activities................................. 273,232 372,942 ---------- ---------- Net increase in cash and cash equivalents....................................... 314,085 343,158 Cash and cash equivalents at beginning of period................................ 3,322,979 3,664,954 Effect of exchange rate changes on cash and cash equivalents.................... (4,723) (423) ---------- ---------- Cash and cash equivalents at end of period...................................... $3,632,341 $4,007,689 ========== ========== CASH PAID (RECEIVED) DURING THE PERIOD FOR: Interest..................................................................... $ 250,846 $ 79,347 Income taxes................................................................. (7,853) 192,694 SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Loans transferred to foreclosed assets (OREO) and/or distressed loans held for sale............................................................... $ 7,391 $ 116 Securities transferred from held to maturity to available for sale at the adoption of SFAS No. 133.................................................... 23,529 -- See accompanying notes to condensed consolidated financial statements. 6 UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2002 (UNAUDITED) NOTE 1--BASIS OF PRESENTATION AND NATURE OF OPERATIONS The unaudited condensed consolidated financial statements of UnionBanCal Corporation and subsidiaries (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Rules and Regulations of the Securities and Exchange Commission. However, they do not include all of the disclosures necessary for annual financial statements in conformity with US GAAP. The results of operations for the period ended March 31, 2002 are not necessarily indicative of the operating results anticipated for the full year. Accordingly, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's Form 10-K for the year ended December 31, 2001. The preparation of financial statements in conformity with US GAAP also requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates. In November 1999, July 2000, and April 2001 the Company announced stock repurchase plans of $100 million each. The Company repurchased $17 million of common stock in 1999, $130 million in 2000, $108 million in 2001 and $35 million in the first quarter of 2002. As of March 31, 2002, $10 million of common stock is authorized for repurchase. At March 31, 2002, The Bank of Tokyo-Mitsubishi, Ltd. (BTM), which is a wholly-owned subsidiary of Mitsubishi Tokyo Financial Group, owned approximately 68 percent of UnionBanCal Corporation. Certain amounts for prior periods have been reclassified to conform to current financial statement presentation. NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations be accounted for by a single method--the purchase method. This Statement eliminates the pooling-of-interests method but carries forward without reconsideration the guidance in Accounting Principles Board (APB) Opinion No. 16, "Business Combinations," and SFAS No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises," related to the application of the purchase method of accounting. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001, and all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. Goodwill and intangible assets acquired in a transaction completed after June 30, 2001 were accounted for in accordance with the amortization and nonamortization provisions of SFAS No. 142. SFAS No. 142 significantly changes the accounting for goodwill and other intangible assets subsequent to their initial recognition. This Statement requires that goodwill and some intangible assets no longer be amortized, but tested for impairment at least annually by comparing the fair value of those assets with their recorded amounts. SFAS No. 142 was adopted as of January 1, 2002, the amortization of existing goodwill ceased and the carrying amount of goodwill was allocated to the applicable reporting units. The allocation was based on the sources of previously recognized goodwill as well as the reporting units to which the related acquired net assets were assigned. 7 UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 2002 (UNAUDITED) NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED) Management's expectations about which reporting units had benefited from the synergies of acquired businesses was considered in the allocation process. The Company elected to perform a transitional impairment test by May 31, 2002, with measurement as of date of adoption. As of March 31, 2002, goodwill was $69 million, none of which is expected to be impaired. Net income and earnings per share for the quarters ended March 31, 2001 and 2002 were adjusted to exclude goodwill amortization expense (net of taxes of $1.1 million) as follows: FOR THE THREE MONTHS ENDED -------------------------- MARCH 31, MARCH 31, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2001 2002 - --------------------------------------------- ----------- ----------- NET INCOME: Reported net income.............................. $ 107,287 $ 114,777 Goodwill amortization, net of income tax......... 1,995 0 Adjusted net income.............................. $ 109,282 $ 114,777 BASIC EARNING PER SHARE: Reported net income.............................. $ 0.68 $ 0.73 Goodwill amortization............................ 0.01 0.00 Adjusted net income.............................. $ 0.69 $ 0.73 DILUTED EARNING PER SHARE: Reported net income.............................. $ 0.67 $ 0.73 Goodwill amortization............................ 0.01 0.00 Adjusted net income.............................. $ 0.68 $ 0.73 During the first quarter ending March 31, 2002, no goodwill or intangible assets were acquired, impaired, and/or written off. All previously acquired intangible assets are subject to amortization. INTANGIBLE ASSETS SUBJECT TO AMORTIZATION Intangible assets amortization expense, for the quarter ended March 31, 2002, was $0.9 million. No residual value is expected for these intangible assets. The components of intangible assets were as follows: MARCH 31, 2002 --------------------------------------------------- GROSS CARRYING ACCUMULATED NET CARRYING (DOLLARS IN MILLIONS) AMOUNT AMORTIZATION AMOUNT - --------------------- -------------- ------------ ------------ Rights-to-expiration.................. $15.0 $0.7 $14.3 Core deposit intangible............... 8.3 7.3 1.0 -------------- ------------ ------------ Total identifiable intangible assets.. $23.3 $8.0 $15.3 ============== ============ ============ Amortization expense for the net carrying amount of all identifiable intangible assets with definite lives at March 31, 2002 is approximately $2.9 million for the remainder of the year ending December 31, 2002, and $3.0 million, $2.4 million, $2.1 million, $1.8 million, and $1.6 million for the years ending December 31, 2003 through 2007, respectively. 8 UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 2002 (UNAUDITED) NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED) ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This Statement addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to the legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development, and/or the normal operation of a long-lived asset. A legal obligation is an obligation that a party is required to settle as a result of an existing or enacted law, statute, ordinance, or written or oral contract, or by legal construction of a contract under the doctrine of promissory estoppel. This Statement is effective for fiscal years beginning after June 15, 2002. Management believes that adopting this Statement will not have a material impact on the Company's financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business. SFAS No. 144 establishes a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. This Statement carries over the framework established in SFAS No. 121, and was adopted by the Company on January 1, 2002. The adoption of this Statement had no material impact on the Company's financial position or results of operations. NOTE 3--EARNINGS PER SHARE Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS incorporates the dilutive effect of common stock equivalents outstanding on an average basis during the period. Stock options are a common stock equivalent. The following table presents a reconciliation of basic and diluted EPS for the three months ended March 31, 2001 and 2002: THREE MONTHS ENDED MARCH 31, ------------------------------------------------- 2001 2002 ---------------------- --------------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) BASIC DILUTED BASIC DILUTED - ----------------------------------------------------------- -------- -------- -------- -------- Net Income................................................. $107,287 $107,287 $114,777 $114,777 ======== ======== ======== ======== Weighted average common shares outstanding................. 158,893 158,893 156,228 156,228 Additional shares due to: Assumed conversion of dilutive stock options............ -- 376 -- 1,583 -------- -------- -------- -------- Adjusted weighted average common shares outstanding........ 158,893 159,269 156,228 157,811 ======== ======== ======== ======== Net income per share....................................... $0.68 $0.67 $0.73 $0.73 ======== ======== ======== ======== 9 UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 2002 (UNAUDITED) NOTE 4--COMPREHENSIVE INCOME The following table presents a summary of the components of accumulated other comprehensive income (loss): NET UNREALIZED GAINS NET UNREALIZED GAINS (LOSSES) ON SECURITIES FOREIGN CURRENCY (LOSSES) ON AVAILABLE FOR SALE TRANSLATION ADJUSTMENT CASH FLOW HEDGES ------------------------ ---------------------- --------------------- FOR THE THREE MONTHS ENDED MARCH 31, ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) 2001 2002 2001 2002 2001 2002 - ---------------------- --------- --------- --------- -------- ------- -------- Beginning balance............................. $41,879 $ 83,271 $(11,191) $(12,205) $ -- $62,840 Cumulative effect of accounting change, net of tax........................................ -- -- -- -- 22,205 -- Change during the period...................... 30,386 (28,934) (581) (15) 20,923 (17,111) --------- --------- --------- -------- ------- -------- Ending balance................................ $72,265 $ 54,337 $(11,772) $(12,220) $43,128 $45,729 ========= ========= ========= ======== ======= ======== MINIMUM PENSION ACCUMULATED OTHER LIABILITY ADJUSTMENT COMPREHENSIVE INCOME (LOSS) ------------------------- --------------------------- FOR THE THREE MONTHS ENDED MARCH 31, -------------------------------------------------------- (DOLLARS IN THOUSANDS) 2001 2002 2001 2002 - ---------------------- ---------- ---------- ------------ ---------- Beginning balance....................................... $(803) $(973) $29,885 $132,933 Cumulative effect of accounting change, net of tax...... -- -- 22,205 -- Change during the period................................ -- -- 50,728 (46,060) ---------- ---------- ------------ ---------- Ending balance.......................................... $(803) $(973) $102,818 $86,873 ========== ========== ============ ========== NOTE 5--BUSINESS SEGMENTS The Company is organized based on the products and services that it offers and operates in four principal areas: o The Community Banking and Investment Services Group offers a full range of banking services, primarily to individuals and small businesses, delivered primarily through a tri-state network of branches and ATM's. These services include commercial loans, mortgages and home equity lines of credit, consumer loans, deposit services and cash management as well as fiduciary, private banking, investment and asset management services for individuals and institutions, and risk management and insurance products for businesses and individuals. o The Commercial Financial Services Group primarily provides tailored credit and cash management services to large corporate and middle market companies. Services include commercial and project loans, real estate financing, asset-based financing, trade finance and letters of credit, lease financing, customized cash management services and selected capital markets products. o The International Banking Group provides correspondent banking and trade-finance products and services to financial institutions, and extends primarily short-term credit to corporations engaged in international business. The group's revenue predominately relates to foreign customers. 10 UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 2002 (UNAUDITED) NOTE 5--BUSINESS SEGMENTS (CONTINUED) o The Global Markets Group manages the Company's wholesale funding needs, securities portfolio, and interest rate and liquidity risks. The group also offers a broad range of risk management and trading products to institutional and business clients of the Company through the businesses described above. The information, set forth in the table on the following page, reflects selected income statement items and selected balance sheet items by business unit. The information presented does not necessarily represent the business units' financial condition and results of operations as if they were independent entities. Included in the table is the amount of goodwill for each reporting unit as of March 31, 2002. Prior to January 1, 2002, all goodwill was held at the corporate level. Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to US GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies. The information in this table is derived from the internal management reporting system used by management to measure the performance of the segments and the Company overall. The management reporting system assigns balance sheet and income statement items to each segment based on internal management accounting policies. Net interest income is determined by the Company's internal funds transfer pricing system, which assigns a cost of funds or a credit for funds to assets or liabilities based on their type, maturity or repricing characteristics. Noninterest income and expense directly attributable to a segment are assigned to that business, other than restructuring charges (credits). Certain indirect costs, such as operations and technology expense, are allocated to the segments based on studies of billable unit costs for product or data processing. Other indirect costs, such as corporate overhead, are allocated to the business segments based on a predetermined percentage of usage. Under the Company's risk-adjusted return on capital (RAROC) methodology, credit expense is charged to business segments based upon expected losses arising from credit risk. In addition, the attribution of economic capital is related to unexpected losses arising from credit, market and operational risks. "Other" is comprised of goodwill amortization for periods prior to January 1, 2002, certain parent company non-bank subsidiaries, the elimination of the fully taxable-equivalent basis amounts, the amount of the provision for credit losses (over)/under the RAROC expected loss for the period, the earnings associated with the unallocated equity capital and allowance for credit losses, and the residual costs of support groups. In addition, it includes two units, the Credit Management Group, which manages nonperforming assets, and the Pacific Rim Corporate Group, which offers financial products to Asian- 11 UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 2002 (UNAUDITED) NOTE 5--BUSINESS SEGMENTS (CONTINUED) owned subsidiaries located in the US. On an individual basis, none of the items in "Other" are significant to the Company's business. COMMUNITY BANKING AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL SERVICES GROUP SERVICES GROUP BANKING GROUP --------------------- -------------------- -------------------- AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, ------------------------------------------------------------------------- 2001 2002 2001 2002 2001 2002 - ---------------------------------------------- -------- -------- -------- -------- -------- -------- RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS) AND ASSETS (DOLLARS IN MILLIONS): Total revenue(1).............................. $273,173 $288,103 $229,079 $201,470 $25,105 $25,593 Net income (loss)............................. $ 50,682 $ 53,752 $ 79,263 $ 47,759 $ 6,590 $ 6,147 Goodwill...................................... $ -- $ 55 $ -- $ 14 $ -- $ -- Total assets at period end.................... $ 9,505 $ 10,641 $ 17,859 $ 15,546 $ 1,375 $ 1,388 MARKETS GROUP OTHER CORPORATION --------------------- -------------------- -------------------- AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, ------------------------------------------------------------------------- 2001 2002 2001 2002 2001 2002 - ---------------------------------------------- -------- -------- -------- -------- -------- -------- RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS) AND ASSETS (DOLLARS IN MILLIONS): Total revenue(1).............................. $ 2,040 $ 11,351 $ 38,671 $ 25,374 $568,068 $551,891 Net income (loss)............................. $ (7,000) $ 4,561 $(22,248) $ 2,558 $107,287 $114,777 Goodwill...................................... $ -- $ -- $ 85 $ -- $ 85 $ 69 Total assets at period end.................... $ 5,596 $ 7,719 $ 1,488 $ 928 $ 35,823 $ 36,222 - ---------------------------------------------- <FN> (1) Total revenue is comprised of net interest income and noninterest income </FN> NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING Derivative positions are integral components of the Company's designated asset and liability management activities. The Company uses interest rate derivative instruments as part of its management of asset and liability positions. Derivatives are used to manage interest rate risk relating to specified groups of assets and liabilities, primarily LIBOR-based commercial loans, trust preferred securities and medium-term notes. CASH FLOW HEDGES HEDGING STRATEGIES FOR VARIABLE RATE LOANS AND CERTIFICATES OF DEPOSITS The Company engages in several types of cash flow hedging strategies for which the hedged transactions are forecasted future loan interest payments, and the hedged risk is the variability in those payments due to changes in the designated benchmark rate, e.g., US dollar LIBOR. In these strategies, the hedging instruments are matched with groups of variable rate loans such that the tenor of the variable rate loans and that of the hedging instrument is identical. Cash flow hedging strategies include the utilization of purchased floor, cap, corridor options and interest rate swaps. 12 UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 2002 (UNAUDITED) NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING (CONTINUED) The Company uses purchased interest rate floors to hedge the variable cash flows associated with 1-month LIBOR or 3-month LIBOR indexed loans. Payments received under the floor contract offset the decline in loan interest income caused by the relevant LIBOR index falling below the floor's strike rate. The Company uses interest rate corridors to hedge the variable cash flows associated with 1-month LIBOR or 3-month LIBOR indexed loans. Net payments to be received under the floor corridor contracts offset the decline in loan interest income caused by the relevant LIBOR index falling below the corridor's upper strike rate, but only to the extent the index falls to the lower strike rate. The corridor will not provide protection from declines in LIBOR to the extent it falls below the corridor's lower strike rate. The Company uses interest rate swaps to hedge the variable cash flows associated with 1-month LIBOR or 3-month LIBOR indexed loan portfolio. Payments to be received (or paid) under the swap contracts will offset the fluctuations in loan interest income caused by changes in the relevant LIBOR index. As such, these instruments hedge all fluctuations in the loans' interest income caused by changes in LIBOR. The Company uses purchased interest rate caps to hedge the variable interest cash flows associated with the forecasted issuance and rollover of short-term, fixed rate negotiable certificates of deposits (CDs). In these hedging relationships, the Company hedges the LIBOR component of the CD rates, which is either 3-month LIBOR or 6-month LIBOR, based on the CD's original term to maturity, which reflects their repricing frequency. Net payments to be received under the cap contract offset the increase in interest expense caused by the relevant LIBOR index rising above the cap's strike rate. Hedging transactions are structured at inception so that the notional amounts of the hedge are matched with an equal principal amount of loans or CDs, the index and repricing frequencies of the hedge matches those of the loans or CDs, and the period in which the designated hedged cash flows occur is equal to the term of the hedge. As such, most of the ineffectiveness in the hedging relationship results from the mismatch between the timing of reset dates on the hedge versus those of the loans or CDs. During the first quarter of 2002, the Company recognized a net loss of $0.1 million due to ineffectiveness, which is recognized in noninterest expense. FAIR VALUE HEDGES HEDGING STRATEGY FOR UNIONBANCAL CORPORATION--OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY GRANTOR TRUSTS (TRUST PREFERRED SECURITIES) The Company engages in an interest rate hedging strategy in which an interest rate swap is associated with a specific interest bearing liability, UnionBanCal Corporation's Trust Preferred Securities, in order to convert the liability from a fixed rate to a floating rate instrument. This strategy mitigates the changes in fair value of the hedged liability caused by changes in the designated benchmark interest rate, US dollar LIBOR. Fair value hedging transactions are structured at inception so that the notional amounts of the swap match an associated principal amount of the Trust Preferred Securities. The interest payment dates, the expiration date, and the embedded call option of the swap match those of the Trust Preferred Securities. 13 UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 31, 2002 (UNAUDITED) NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING (CONTINUED) The ineffectiveness on the fair value hedges during the first quarter of 2002 was a net loss of $0.1 million, which is recognized in noninterest expense. HEDGING STRATEGY FOR MEDIUM-TERM NOTES The Company engages in an interest rate hedging strategy in which an interest rate swap is associated with a specified interest bearing liability, UnionBanCal Corporation's five year, medium-term debt, in order to convert the liability from a fixed rate to a floating rate instrument. This strategy mitigates the changes in fair value of the hedged liability caused by changes in the designated benchmark interest rate, US dollar LIBOR. The fair value hedging transaction for the medium-term notes was structured at inception to mirror all of the provisions of the medium-term notes, which allows the Company to assume that no ineffectiveness exists. OTHER The Company uses foreign currency forward contracts as a means of managing foreign exchange rate risk associated with assets and/or liabilities denominated in foreign currencies. The Company values the forward contracts, the assets and/or the liabilities at fair value, with the resultant gain or loss recognized in noninterest income. NOTE 7--SUBSEQUENT EVENT On December 19, 2001, the Company announced in a press release that it had reached a definitive agreement to acquire First Western Bank, a Simi Valley, California-based bank with branches in Ventura and Los Angeles counties. First Western Bank had assets of $224 million as of April 30, 2002. The acquisition closed May 13, 2002. On April 24, 2002, the Board of Directors declared a quarterly cash dividend of $0.28 per share of common stock, an increase of 12 percent. The dividend will be paid on July 5, 2002 to shareholders of record as of June 7, 2002. On April 24, 2002, the Board of Directors authorized the repurchase of an additional $100 million of the company's common stock. On April 30, 2002, the Company announced in a press release that it has reached a definitive agreement to acquire a substantial portion of the trust and institutional custody business from First National Bank of San Diego, and its subsidiary, Generations Trust Bank, with offices in San Diego and Los Angeles counties. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THIS DOCUMENT INCLUDES FORWARD-LOOKING INFORMATION, WHICH IS SUBJECT TO THE "SAFE HARBOR" CREATED BY SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. OUR MANAGEMENT MAY MAKE FORWARD-LOOKING STATEMENTS IN OTHER SECURITIES AND EXCHANGE COMMISSION FILINGS, PRESS RELEASES, NEWS ARTICLES, CONFERENCE CALLS WITH WALL STREET ANALYSTS AND SHAREHOLDERS AND WHEN WE ARE SPEAKING ON BEHALF OF UNIONBANCAL CORPORATION. FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY THE FACT THAT THEY DO NOT RELATE STRICTLY TO HISTORICAL OR CURRENT FACTS. OFTEN, THEY INCLUDE THE WORDS "BELIEVE," "EXPECT," "ANTICIPATE," "INTEND," "PLAN," "ESTIMATE," "PROJECT," OR WORDS OF SIMILAR MEANING, OR FUTURE OR CONDITIONAL VERBS SUCH AS "WILL," "WOULD," "SHOULD," "COULD," OR "MAY." THESE FORWARD-LOOKING STATEMENTS ARE INTENDED TO PROVIDE INVESTORS WITH ADDITIONAL INFORMATION WITH WHICH THEY MAY ASSESS OUR FUTURE POTENTIAL. ALL OF THESE FORWARD-LOOKING STATEMENTS ARE BASED ON ASSUMPTIONS ABOUT AN UNCERTAIN FUTURE AND ARE BASED ON INFORMATION AVAILABLE AT THE DATE SUCH STATEMENTS ARE ISSUED. THERE ARE NUMEROUS RISKS AND UNCERTAINTIES THAT COULD AND WILL CAUSE ACTUAL RESULTS TO DIFFER FROM THOSE DISCUSSED IN OUR FORWARD-LOOKING STATEMENTS. MANY OF THESE FACTORS ARE BEYOND OUR ABILITY TO CONTROL OR PREDICT AND COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR STOCK PRICE, FINANCIAL CONDITION, RESULTS OF OPERATIONS OR PROSPECTS. SUCH RISKS AND UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, THE FOLLOWING FACTORS: ADVERSE ECONOMIC CONDITIONS IN CALIFORNIA, GLOBAL POLITICAL AND GENERAL ECONOMIC CONDITIONS RELATED TO THE TERRORIST ATTACKS ON SEPTEMBER 11, 2001 AND THEIR AFTERMATH, ADVERSE ECONOMIC CONDITIONS AFFECTING CERTAIN INDUSTRIES, FLUCTUATIONS IN INTEREST RATES, THE CONTROLLING INTEREST IN US BY THE BANK OF TOKYO-MITSUBISHI, LTD., WHICH IS A WHOLLY-OWNED SUBSIDIARY OF MITSUBISHI TOKYO FINANCIAL GROUP, INC., COMPETITION IN THE BANKING INDUSTRY, RESTRICTIONS ON DIVIDENDS, ADVERSE EFFECTS OF CURRENT AND FUTURE BANKING RULES, REGULATIONS AND LEGISLATION, AND RISKS ASSOCIATED WITH VARIOUS STRATEGIES WE MAY PURSUE, INCLUDING POTENTIAL ACQUISITIONS, DIVESTITURES AND RESTRUCTURINGS. SEE ALSO THE SECTION ENTITLED "CERTAIN BUSINESS RISK FACTORS" LOCATED NEAR THE END OF THIS SECTION, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION". INTRODUCTION We are a California-based, commercial bank holding company with consolidated assets of $36.2 billion at March 31, 2002. At March 31, 2002, Union Bank of California, N.A. was the third largest commercial bank in California, based on total assets and total deposits in California. UnionBanCal Corporation and its banking subsidiary, Union Bank of California, N.A., was created on April 1, 1996 by the combination of Union Bank with BanCal Tri-State Corporation and its banking subsidiary, The Bank of California, N.A. The combination was accounted for as a reorganization of entities under common control, similar to a pooling of interests. Under stock repurchase plans authorized in November 1999, July 2000, and April 2001 of $100 million each, we repurchased $17 million of common stock in 1999, $130 million in 2000, $108 million in 2001, and $35 million in the first quarter of 2002. As of April 30, 2002, $10 million of common stock is authorized for repurchase. In April 2002, an additional $100 million was authorized to repurchase. At March 31, 2002, The Bank of Tokyo-Mitsubishi, Ltd. owned approximately 68 percent of the UnionBanCal Corporation. SUMMARY Reported net income was $114.8 million, or $0.73 per diluted common share, in the first quarter of 2002, compared with $107.3 million, or $0.67 per diluted common share, in the first quarter of 2001. This increase in diluted earnings per share of 9 percent above the first quarter of 2001 was due to a $45.0 million, or 45 percent, decrease in provision for credit losses, partially offset by a $9.4 million, or 5 percent, decrease in noninterest income, a $6.9 million, or 2 percent, decrease in net interest income (on 15 a taxable-equivalent basis), and a $15.9 million, or 5 percent, increase in noninterest expense. Other highlights of the first quarter of 2002 include: o Net interest income, on a taxable-equivalent basis, was $381.0 million in the first quarter of 2002, a decrease of $6.9 million, or 2 percent, over the first quarter of 2001. Net interest margin in the first quarter of 2002 was 4.80 percent, a decrease of 24 basis points from the first quarter of 2001. o A provision for credit losses of $55.0 million was recorded in the first quarter of 2002, compared with $100.0 million in the first quarter of 2001. This resulted from management's regular assessment of overall credit quality, loan portfolio composition, business and economic conditions in relation to the level of the allowance for credit losses. The allowance for credit losses was $629.4 million, or 139 percent of total nonaccrual loans, at March 31, 2002, compared with $642.3 million, or 149 percent of total nonaccrual loans, at March 31, 2001. o Noninterest income was $171.5 million in the first quarter of 2002, a decrease of $9.4 million, or 5 percent, from the first quarter of 2001. Noninterest income, excluding a $20.7 million gain recognized on the exchange of our STAR system stock in the prior year quarter, increased $11.3 million, or 7 percent. This 7 percent growth included service charges on deposit accounts growth of $9.1 million, or 16 percent, insurance commissions from our December 2002 acquisition of Armstrong/Robitaille Business and Insurance Services of $7.2 million, merchant transaction processing fees growth of $1.6 million, or 9 percent, and a decrease in trust and investment management fees of $3.0 million, or 7 percent and merchant banking fees of $2.3 million, or 25 percent. In addition, we had residual value writedowns in our auto lease portfolio of $6.0 million in the first quarter of 2002 compared with $17.3 million in 2001. o Noninterest expense was $323.4 million in the first quarter of 2002, an increase of $15.9 million, or 5 percent, over the first quarter of 2001. Salaries and employee benefits increased $13.3 million, or 8 percent, primarily due to higher incentives of $5.8 million, higher salaries of $4.6 million, and higher employee benefits of $2.9 million. o Income tax expense in the first quarter of 2002 was $58.8 million, a 34 percent effective income tax rate. For the first quarter of 2001, the effective income tax rate was 33 percent. o Return on average assets increased to 1.33 percent in the first quarter of 2002 compared to 1.26 percent in the first quarter of 2001. Our return on average common equity decreased to 12.84 percent in the first quarter of 2002 compared to 13.04 percent in the first quarter of 2001. o Total loans at March 31, 2002 were $25.1 billion, a decrease of $878.8 million, or 3.4 percent, over March 31, 2001. o Nonperforming assets were $452.8 million at March 31, 2002, an increased $13.8 million, or 3 percent, over March 31, 2001. Nonperforming assets as a percentage of total assets increased to 1.25 percent at March 31, 2002, compared with 1.23 percent at March 31, 2001. Total nonaccrual loans were $452.4 million at March 31, 2002, compared with $430.8 million at March 31, 2001, resulting in an increase in the ratio of nonaccrual loans to total loans to 1.80 percent at March 31, 2002 from 1.66 percent at March 31, 2001. o Our Tier 1 and total risk-based capital ratios were 11.63 percent and 13.50 percent, respectively, at March 31, 2002, compared with 10.49 percent and 12.32 percent, respectively, at March 31, 2001. Our leverage ratio was 10.65 percent at March 31, 2002 compared with 10.22 percent at March 31, 2001. 16 BUSINESS SEGMENTS We segregate our operations into four primary business units for the purpose of management reporting, as shown in the table on the following page. The results show the financial performance of our major business units. The Risk Adjusted Return on Capital (RAROC) methodology used seeks to attribute economic capital to business units consistent with the level of risk they assume. These risks are primarily credit risk, market risk and operational risk. Credit risk is the potential loss in economic value due to the likelihood that the obligor will not perform as agreed. Market risk is the potential loss in fair value due to changes in interest rates, currency rates and volatilities. Operational risk is the potential loss due to failures in internal control, system failures, or external events. The following table reflects the condensed income statements, selected average balance sheet items and selected financial ratios for each of our primary business units. The information presented does not necessarily represent the business units' financial condition and results of operations as if they were independent entities. Also, the table has been expanded to include performance center earnings. A performance center is a special unit of the bank whose income generating activities, unlike typical profit centers, are based on other business segment units' customer base. A performance center has direct interactions with customers, and its purpose is to foster cross selling with a total profitability view of the product and services it manages. For example, the Global Foreign Exchange & Derivatives unit, within the Global Markets Group, is a performance center that manages the foreign exchange and derivatives activities within the Global Markets organization, however the revenues generated and expenses incurred for those transactions entered into to accommodate our customers are allocated to other business segments where the customer relationships reside. Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to US GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies. The RAROC measurement methodology recognizes credit expense for expected losses arising from credit risk and attributes economic capital related to unexpected losses arising from credit, market and operational risks. As a result of the methodology used by the RAROC model to calculate expected losses, differences between the provision for credit losses and credit expense in any one period could be significant. However, over an economic cycle, the cumulative provision for credit losses and credit expense for expected losses should be substantially the same. Business unit results are based on an internal management reporting system used by management to measure the performance of the units and UnionBanCal Corporation as a whole. Our management reporting system identifies balance sheet and income statement items to each business unit based on internal management accounting policies. Net interest income is determined using our internal funds transfer pricing system, which assigns a cost of funds to assets or a credit for funds to liabilities and capital, based on their type, maturity or repricing characteristics. Noninterest income and expense directly or indirectly attributable to a business unit are assigned to that business. The business units are assigned the costs of products and services directly attributable to their business activity through standard unit cost accounting based on volume of usage. All other corporate expenses (overhead) are assigned to the business units based on a predetermined percentage of usage. 17 We have restated the business units' results for the prior periods to reflect any reorganization changes that may have occurred. COMMUNITY BANKING AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL SERVICES GROUP SERVICES GROUP BANKING GROUP ---------------------- ---------------------- -------------------- AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, --------------------------------------------------------------------------- 2001 2002 2001 2002 2001 2002 -------- -------- -------- -------- -------- -------- RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income........................... $177,569 $183,336 $185,716 $155,766 $ 10,008 $ 9,505 Noninterest income............................ 95,604 104,767 43,363 45,704 15,097 16,088 Total revenue................................. 273,173 288,103 229,079 201,470 25,105 25,593 Noninterest expense........................... 178,487 192,070 74,796 83,868 13,258 15,143 Credit expense (income)....................... 12,610 8,985 32,494 46,905 1,174 495 Income before income tax expense (benefit).... 82,076 87,048 121,789 70,697 10,673 9,955 Income tax expense (benefit).................. 31,394 33,296 42,526 22,938 4,083 3,808 Net income (loss)............................. $ 50,682 $53,752 $ 79,263 $ 47,759 $ 6,590 $ 6,147 PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income........................... $ 1,189 $411 $ 2,658 $ 8,578 $ -- $ -- Noninterest income............................ (1,914) (10,841) 6,176 14,069 66 885 Noninterest expense........................... (1,058) (7,790) 4,362 9,687 220 766 Total loans (dollars in millions)............. 78 121 643 1,045 -- -- AVERAGE BALANCES (DOLLARS IN MILLIONS): Total loans(1)................................ $ 8,449 $9,542 $ 16,546 $ 14,122 $ 968 $ 1,016 Total assets.................................. 9,439 10,417 18,383 15,751 1,423 1,310 Total deposits(1)............................. 14,001 14,791 6,801 7,906 1,411 1,558 FINANCIAL RATIOS: Return on risk adjusted capital(2)............ 35% 39% 18% 12% 29% 38% Return on average assets(2)................... 2.18 2.09 1.75 1.23 1.88 1.90 Efficiency ratio(3)........................... 65.34 66.67 32.65 41.63 52.81 59.17 GLOBAL UNIONBANCAL MARKETS GROUP OTHER CORPORATION ---------------------- ---------------------- -------------------- AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, --------------------------------------------------------------------------- 2001 2002 2001 2002 2001 2002 -------- -------- -------- -------- -------- -------- RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income........................... $ (1,919) $ 9,833 $ 15,887 $ 22,000 $387,261 $380,440 Noninterest income............................ 3,959 1,518 22,784 3,374 180,807 171,451 Total revenue................................. 2,040 11,351 38,671 25,374 568,068 551,891 Noninterest expense........................... 13,376 3,914 27,568 28,368 307,485 323,363 Credit expense (income)....................... -- 50 53,722 (1,435) 100,000 55,000 Income before income tax expense (benefit).... (11,336) 7,387 (42,619) (1,559) 160,583 173,528 Income tax expense (benefit).................. (4,336) 2,826 (20,371) (4,117) 53,296 58,751 Net income (loss)............................. $ (7,000) $ 4,561 $(22,248) $ 2,558 $107,287 $114,777 PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS): Net interest income........................... $ -- $ -- $ (3,847) $ (8,989) $ -- $ -- Noninterest income............................ (5,163) (6,634) 835 2,521 -- -- Noninterest expense........................... (1,058) (1,015) (2,466) (1,648) -- -- Total loans (dollars in millions)............. -- -- (721) (1,166) -- -- AVERAGE BALANCES (DOLLARS IN MILLIONS): Total loans(1)................................ $ 40 $ 100 $ 415 $ 348 $ 26,418 $ 25,128 Total assets.................................. 4,471 6,725 712 881 34,428 35,084 Total deposits(1)............................. 2,766 2,416 789 898 25,768 27,569 FINANCIAL RATIOS: Return on risk adjusted capital(2)............ (15)% 4% na na na na Return on average assets(2)................... (0.64) 0.28 na na 1.26% 1.33% Efficiency ratio(3)........................... 655.9 34.48 na na 54.07 58.51 - ----------- <FN> (1) Represents loans and deposits for each business segment after allocation between the segments of loans and deposits originated in one segment but managed by another segment. (2) Annualized (3) The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income), as a percentage of net interest income (taxable-equivalent basis) and noninterest income. Foreclosed asset expense was $13 thousand in the first quarter of 2001 and $125 thousand in the first quarter of 2002. na=not applicable </FN> 18 COMMUNITY BANKING AND INVESTMENT SERVICES GROUP The Community Banking and Investment Services Group strives to provide the best possible financial products to individuals and small businesses including a broad set of credit, deposit, trust products, and risk management and insurance products delivered through branches, relationship managers, private bankers, trust administrators, and insurance agents. The Community Banking and Investment Services Group provides its customers with high quality customer service executed through a number of responsive and efficient delivery channels. In first quarter of 2002, net income increased $3.1 million, or 6 percent, compared to the prior year. Total revenue increased $14.9 million, or 6 percent, compared to a year earlier. Increased asset and deposit volumes offset the effect of a significantly lower interest rate environment leading to an increase of $5.8 million in net interest income over the prior year. Noninterest income was $9.2 million higher than the prior year. However, excluding auto lease residual writedowns of $6.0 million and $17.3 million, in 2002 and 2001, respectively, and the impact of performance center earnings, noninterest income increased $6.8 million, or 6 percent, compared to a year earlier. Noninterest expense increased $13.6 million, or 8 percent, compared to a year earlier with the majority of that increase being attributable to higher salaries and employee benefits and an increase in advertising expense mainly related to deposit gathering, small business growth, and residential loan growth year-over-year. In 2002, the Community Banking and Investment Services Group has been emphasizing growth in the consumer asset portfolio, expanding wealth management services, extending the small business franchise, expanding the branch network, and expanding cross selling activities throughout the bank. The strategy for growing the consumer asset portfolio primarily focuses on mortgage and home equity products, originated through the branch network, as well as through channels such as wholesalers, correspondents, and whole loan purchases. Residential loans have grown by $1.7 billion, or 47 percent, since the same period last year. The Wealth Management division is focused on becoming the preferred provider of banking and investment products for affluent individuals in geographic areas already served by us. We seek to achieve this distinction by providing superior service, offering a broad product suite, increasing the number of banking locations convenient to the targeted clientele and improving our cross-selling programs. Our acquisition of Copper Mountain Trust Company in January 2001 has enhanced our growing custody and 401(k) administration businesses. Core elements of the initiative to extend our small business franchise include enhancing the sales force, increasing marketing activities, introducing new insurance and trade finance products, adding new locations, and developing online capabilities to complement physical distribution. Expansion of the distribution network will be achieved through acquisitions and de novo branching. We believe that expansion opportunities exist in both Southern California, where we have a particularly strong presence, and Northern California. In addition, the implementation of several new performance centers in late 2001 and 2002 has improved cross selling activity, which has led to the transfer of noninterest income from the Community Banking and Investment Services Group to the Commercial Financial Services Group. While the Community Banking and Investment Services Group continues to be responsible for the manufacturing and sales activities of these performance centers, the noninterest income is now associated with the market where the relationship is domiciled. In addition to our traditional network channels, the Community Banking and Investment Services Group has established alliances with Navicert Financial Corporation, doing business as NIX Check Cashing and Operation Hope. This alliance has allowed our small business and consumer clients access to a unique blend of financial services combining the NIX Check Cashing services, Union Bank of California Banking Services and Operation Hope small business education services. ATM and other account services are available today through selected NIX Check Cashing locations with future services planned to include applications for consumer loans, credit cards, new and used car loans, home equity loans and residential mortgages. The NIX Check Cashing alliance complements our current network of 15 Cash and Save(R) outlets located throughout Southern and Central California. 19 The Community Banking and Investment Services Group is comprised of five major divisions: Community Banking, Wealth Management, Institutional Services and Asset Management, Government and Not-For-Profit Markets, and Insurance Services. COMMUNITY BANKING serves over one million consumer households and businesses through its 244 full-service branches in California, six full-service branches in Oregon and Washington, and its network of 483 proprietary ATMs. Customers may also access our services 24 hours a day by telephone or through our Bank@Home product at www.UBOC.com. In addition, the division offers automated teller and point-of-sale debit services through our membership in the STAR System, the largest shared ATM network in the western United States. This division is organized by service delivery method, by markets and by geography. We serve our customers in the following ways: o through community banking branches, which serve consumers and businesses with checking and deposit services, as well as various types of consumer financing; o through on-line access to our internet banking services, which augment our physical delivery channels by providing a wide array of customer transaction, bill payment and loan payment services; o through business banking centers, which serve businesses with annual sales up to $5 million; and o through in-store branches, which also serve consumers and businesses. WEALTH MANAGEMENT provides private banking services to our affluent clientele as well as brokerage products and services. o The Private Bank focuses primarily on delivering integrated and customized financial services to high net worth individuals with sophisticated financial needs as well as to professional service firms. Specific products and services include trust and estate services, investment account management services, and customized deposit and credit products. The Private Bank's strategy is to expand its business by leveraging existing Bank client relationships, increasing its geographic market coverage and the breadth of its products and services. Through 12 existing locations, the Private Bank relationship managers offer all of our available products and services. o Our brokerage products and services are provided through UBOC Investment Services, Inc., a registered broker/dealer offering a full line of investment products to individuals and institutional clients. Its primary strategy is to further penetrate our existing client base. INSTITUTIONAL SERVICES AND ASSET MANAGEMENT provides investment management and administration services for a broad range of individuals and institutions. o HighMark Capital Management, Inc., a registered investment advisor, provides investment advisory services to affiliated domestic and offshore mutual funds, including the HighMark Funds. It also provides advisory services to Union Bank of California trust clients, including corporations, pension funds and individuals. HighMark Capital Management also provides mutual fund support services. HighMark Capital Management's strategy is to increase assets under management by broadening its client base and helping to expand the distribution of shares of its mutual fund clients. 20 o Institutional Services provides custody, corporate trust, and retirement plan services. Custody Services provides both domestic and international safekeeping/settlement services in addition to securities lending. Corporate Trust acts as trustee for corporate and municipal debt issues. Retirement Services provides a full range of defined benefit and defined contribution administrative services, including trustee services, administration, investment management, and 401(k) valuation services. The client base of Institutional Services includes financial institutions, corporations, government agencies, unions, insurance companies, mutual funds, investment managers, and non-profit organizations. Institutional Services strategy is to continue to leverage and expand our position in our target markets by providing excellent service, strong technical capabilities, and product expertise. o Copper Mountain Trust provides custody, retirement plan, and investment management services. Based in Portland, Oregon, their focus is on the Pacific Northwest market. Their close ties to the area allow Copper Mountain to provide high quality, personalized service to their institutional client base. Copper Mountain also provides a unique "manager of managers" investment style which has been well received by the market. GOVERNMENT AND NOT-FOR-PROFIT MARKETS provides a full range of treasury management, investment, and trust services to government entities and not-for-profit organizations. o The group, which primarily focuses on local, state, and federal agencies, includes an expanding product offering to the Native American government market. Niche markets have been developed that service colleges, universities, trade associations, cultural institutions, and religious non-profit organizations. The group's strategy is to expand its market presence by continued delivery of innovative cash management products, internet based technology solutions, and expanding its tax-exempt lending capabilities to meet existing clients' needs. INSURANCE SERVICES provides a full range of cost-effective risk management services and insurance products to business and retail customers. o The group, which includes our fourth quarter 2001 acquisition of Armstrong/Robitaille Business and Insurance Services, a regional insurance broker, offers its risk management and insurance products through offices in California and Oregon. Through alliances with other financial institutions, the Community Banking and Investment Services Group offers additional products and services, such as credit cards, leasing, and asset-based and leveraged financing. The group competes with larger banks by providing service quality superior to that of its major competitors. The group's primary means of competing with community banks include its large and convenient branch network and its reputation for innovative use of technology to deliver banking services. We also offer convenient banking hours to consumers through our drive-through banking locations and selected branches that are open seven days a week. The group competes with a number of commercial banks, internet banks, savings associations and credit unions, as well as more specialized financial service providers such as investment brokerage companies, consumer finance companies, and residential real estate lenders. The group's primary competitors are other major depository institutions such as Bank of America, California Federal, Washington Mutual and Wells Fargo, as well as smaller community banks in the markets in which we operate. COMMERCIAL FINANCIAL SERVICES GROUP The Commercial Financial Services Group offers customized financing and cash management services to middle market and large corporate businesses primarily headquartered in the western United States. 21 The Commercial Financial Services Group has continued to focus on customer segmentation, allowing the group to provide specialized financing expertise to specific geographic markets and industry segments such as Energy, Entertainment, Real Estate and Retail. Relationship managers and credit executives in the Commercial Financial Services Group provide credit services including commercial loans, accounts receivable and inventory financing, project financing, lease financing, trade financing and real estate financing. In addition to credit services, the group offers its customers access to high quality cash management services delivered through specialized deposit managers with extensive experience in cash management solutions for businesses. In the first quarter of 2002, net income decreased $31.5 million, or 40 percent, compared to the prior year. Net interest income decreased $30.0 million due to the lower interest rate environment, which ties our wholesale liabilities closely to the effects of the lower treasury bill rates. The impact on earnings of decreasing asset balances was mitigated by a significantly lower cost of funds resulting from this lower interest rate environment. Noninterest income increased $2.3 million, including a net loss of $6.9 million in the private equity portfolio compared with net gain of $0.3 million in the first quarter of 2001, mainly attributable to a 22 percent growth in all other noninterest income. This 22 percent growth was primarily due to higher deposit-related service fees and the implementation of new performance centers within the bank. Noninterest expense increased $9.1 million, or 12 percent, compared to a year earlier due to higher expenses to support increased product sales and deposit volume. Credit expense increased $14.4 million due to a refinement in the RAROC credit metrics that were implemented late 2001 and not reflected in our first quarter of 2001 results. The group's initiatives during 2002 include expanding wholesale deposit activities, increasing domestic trade financing and expanding the item processing business. Loan growth strategies include originating, underwriting and syndicating loans in core competency markets, such as the California middle market, commercial real estate, energy, entertainment, equipment leasing and commercial finance. The Commercial Financial Services Group operates a strong processing business, including services such as check processing, front-end item processing, cash vault services and digital imaging. Opportunities for outsourcing these capabilities for correspondent banks, and credit unions are significant. In the processing business, Commercial Financial Services Group intends to build new capabilities, in addition to leveraging existing capabilities. Some new initiatives underway include cash management products with internet delivery, check truncation at point-of-sale, digital certificates and e-bill payment and presentment. The combination of expanded products and an emphasis on core competencies are expected to contribute to growth in operating earnings in 2002. The Commercial Financial Services Group is comprised of the following business units: o the Commercial Banking Division, which serves California middle-market and large corporate companies with traditional commercial lending, trade financing, and asset-based loans; o the Corporate Deposit Services Division, which provides deposit and cash management expertise to clients in the middle market, large corporate market and specialized industries; o the Institutional and Deposit Services Division, which provides deposit and cash management expertise to clients in specific deposit-intensive industries; o the Corporate Capital Markets Division, which provides merchant and investment banking related products and services; o the National Banking Division, which provides credit services to a variety of specialized industries including retailers, finance companies and insurance companies, as well as large corporate clients headquartered outside the United States; o the Real Estate Industries Division, which provides real estate lending products such as construction loans, commercial mortgages and bridge financing; 22 o the Energy Capital Services Division, which provides custom financing and project financing to oil and gas companies, as well as power and utility companies, in California and Texas; and o the Communications, Media and Entertainment Division, which provides custom financing to middle market and large corporate clients in their defined industries. The group competes with other banks primarily on the basis of its reputation as a "business bank," the quality of its relationship managers, and the delivery of superior customer service. We are recognized in California as having a superior "business banking" reputation relative to other large banks. We are also highly rated among financial institutions for our cash management services and systems. The group's main strategy is to target industries and companies for which the group can reasonably expect to be one of a customer's primary banks. Consistent with its strategy, the group attempts to serve a large part of its targeted customers' credit and depository needs. The group competes with a variety of other financial services companies. Competitors include other major California banks, as well as regional, national and international banks. In addition, we compete with investment banks, commercial finance companies, leasing companies, and insurance companies. INTERNATIONAL BANKING GROUP The International Banking Group focuses on providing correspondent banking and trade finance related products and services to international financial institutions worldwide, primarily in Asia. This focus includes products and services such as letters of credit, international payments, collections and financing of mostly short-term transactions. The group also serves certain foreign firms and US corporate clients in selected countries where we have branches, including Hong Kong, Japan, Korea, the Philippines and Taiwan. In the US, the group serves subsidiaries and affiliates of non-Japanese Asian companies and US branches/agencies of foreign banks. The majority of the revenue generated by the International Banking Group is from customers domiciled outside of the US. In the first quarter of 2002, net income decreased $0.4 million, or 7 percent, compared to the prior year. Total revenue in the first quarter of 2002 increased $0.5 million, or 2 percent, compared to a year earlier. Despite higher deposit volumes, net interest income decreased $0.5 million over the prior year, mainly due to the lower interest rate environment. Noninterest income was $1.0 million higher than the prior year mainly attributable to higher foreign remittance commissions reflecting a strategic focus on this business. Noninterest expense increased $1.9 million, or 14 percent, compared to a year earlier with the majority of that increase being attributable to higher systems expenditure. And lastly, contributing to the group's overall increase in net income was lower portfolio exposure resulting in a $0.7 million reduction in credit expense compared to the prior year. The nature of the International Banking Group's business revolves around short-term, trade financing mostly to banks and service-related income, which tends to result in significantly lower credit risk when compared to other lending activities. The group has a long and stable history of providing correspondent banking and trade-related products and services to international financial institutions. We believe the group continues to be a market leader, achieving strong customer loyalty in the correspondent banking market by providing high quality products and services at competitive prices. The International Banking Group, headquartered in San Francisco, also maintains representative offices in Asia and Latin America and an international banking subsidiary in New York. GLOBAL MARKETS GROUP The Global Markets Group conducts business activities primarily to support the previously described business groups and their customers. This group offers a broad range of risk management products, such as foreign exchange contracts and interest rate swaps and options. It trades money market, government, agency, and other securities to meet investment needs of institutional and business clients of UnionBanCal 23 Corporation. Another primary area of the group is treasury management for UnionBanCal Corporation, which encompasses wholesale funding, liquidity management, interest rate risk management, including securities portfolio management, and hedging activities. In the first quarter of 2002, net income was $4.6 million compared to a loss of $7.0 million in the prior year. Total revenue in the first quarter of 2002 increased $9.3 million, or 456 percent, compared to a year earlier primarily resulting from a 612 percent increase in net interest income, partially offset by a 62 percent decrease in noninterest income. The declining interest rate environment was mitigated, in the first quarter of 2002, due to the effectiveness of our asset/liability management strategy, which resulted in higher net interest income of $11.8 million compared to the prior year. Noninterest income decreased $2.4 million compared to the first quarter of 2001. This decrease was mainly due to no gains on the sale of securities in our securities available for sale portfolio in the current year compared to net gains of $1.0 million in the prior year and a higher distribution of performance center earnings to other business segments of the bank in the current year. Noninterest expense decreased $9.5 million, or 71 percent, compared to a year earlier, primarily as a result of the effects of adoption of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" in the prior year. OTHER "Other" includes the following items: o corporate activities that are not directly attributable to one of the four major business units. Included in this category are goodwill amortization for periods prior to January 1, 2002 and certain other nonrecurring items such as merger and integration expense, certain parent company non-bank subsidiaries, and the elimination of the fully taxable-equivalent basis amounts; o the adjustment between the credit expense under RAROC and the provision for credit losses under US GAAP and earnings associated with unallocated equity capital; o the Credit Management Group, containing the Special Assets Division, which includes $439.0 million and $452.8 million of nonperforming assets as of March 31, 2001 and 2002, respectively; o the Pacific Rim Corporate Group, which offers a range of credit, deposit, and investment management products and services to companies in the US, which are affiliated with companies headquartered outside the US, mostly in Japan; and o the residual costs of support groups. Net income for "Other" in the first quarter of 2002 was $2.6 million. The results were impacted by the following factors: o credit expense (income) of ($1.4) million was due to the difference between the $55.0 million in provision for credit losses calculated under our US GAAP methodology and the $56.4 million in expected losses for the reportable business segments, which utilizes the RAROC methodology; o net interest income of $22.0 million, which resulted from the differences between the credit for equity for the reportable segments under RAROC and the net interest income earned by UnionBanCal Corporation, and a credit for demand deposits in the Pacific Rim Corporate Group; o noninterest income of $3.4 million; and o noninterest expense of $28.4 million. 24 Net loss for "Other" in the first quarter of 2001 was $22.2 million. The results were impacted by the following factors: o credit expense of $53.7 million due to the difference between the $100.0 million in provision for credit losses calculated under our US GAAP methodology and the $46.3 million in expected losses for the reportable business segments, which utilizes the RAROC methodology; offset by o net interest income of $15.9 million, which resulted from the differences between the credit for equity for the reportable segments under RAROC and the net interest income earned by UnionBanCal Corporation, and a credit for demand deposits in the Pacific Rim Corporate Group; o noninterest income of $22.8 million, which included a $20.7 million gain recognized when our stock holding in STAR System was exchanged for Concord EFS stock; and o noninterest expense of $27.6 million. 25 NET INTEREST INCOME The table below shows the major components of net interest income and net interest margin. FOR THE THREE MONTHS ENDED ---------------------------------------------------------------------------------------- MARCH 31, 2001 MARCH 31, 2002 ----------------------------------------- ---------------------------------------- INTEREST AVERAGE INTEREST AVERAGE AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ (DOLLARS IN THOUSANDS) BALANCE EXPENSE(1) RATE(1) BALANCE EXPENSE(1) RATE(1) - ---------------------- ----------- ---------- ------- ----------- ----------- ------- ASSETS Loans:(2) Domestic........................ $25,380,787 $ 519,034 8.28% $24,088,142 $ 368,062 6.17% Foreign(3)...................... 1,036,839 17,514 6.85 1,039,615 7,922 3.09 Securities--taxable................. 4,082,781 66,187 6.49 5,552,344 80,663 5.81 Securities--tax-exempt.............. 67,280 1,652 9.82 38,233 991 10.37 Interest bearing deposits in banks. 79,239 966 4.94 84,408 496 2.38 Federal funds sold and securities purchased under resale agreements 73,036 1,029 5.71 936,382 4,059 1.76 Trading account assets............. 348,280 2,932 3.41 237,369 720 1.23 ----------- ---------- ----------- ----------- Total earning assets....... 31,068,242 609,314 7.93 31,976,493 462,913 5.84 ---------- ----------- Allowance for credit losses........ (634,963) (644,379) Cash and due from banks............ 2,194,017 1,942,621 Premises and equipment, net........ 480,724 496,269 Other assets....................... 1,319,970 1,312,523 ----------- ----------- Total assets............... $34,427,990 $35,083,527 =========== =========== LIABILITIES Domestic deposits: Interest bearing................ $ 6,140,117 41,342 2.73 $ 7,459,506 23,157 1.26 Savings and consumer time....... 3,320,967 29,912 3.65 3,549,262 16,970 1.94 Large time...................... 4,426,993 63,863 5.85 3,485,482 19,808 2.30 Foreign deposits(3)................ 2,033,685 25,543 5.09 1,749,251 6,264 1.45 ----------- ---------- ----------- ----------- Total interest bearing deposits................ 15,921,762 160,660 4.09 16,243,501 66,199 1.65 ----------- ---------- ----------- ----------- Federal funds purchased and securities sold under repurchase agreements...................... 1,829,372 25,800 5.72 541,182 1,949 1.46 Commercial paper................... 1,478,564 20,413 5.60 919,259 3,974 1.75 Other borrowed funds............... 396,311 5,340 5.46 698,053 3,443 2.00 Medium and long-term debt.......... 200,000 3,196 6.48 399,989 2,412 2.45 UnionBanCal Corporation--obligated mandatorily redeemable preferred securities of subsidiary grantor trust........................... 352,130 6,022 6.83 352,300 3,963 4.46 ----------- ---------- ----------- ----------- Total borrowed funds....... 4,256,377 60,771 5.78 2,910,783 15,741 2.19 ----------- ---------- ----------- ----------- Total interest bearing liabilities............. 20,178,139 221,431 4.45 19,154,284 81,940 1.73 ---------- ----------- Noninterest bearing deposits....... 9,845,911 11,325,446 Other liabilities.................. 1,066,000 979,030 ----------- ----------- Total liabilities............ 31,090,050 31,458,760 SHAREHOLDERS' EQUITY Common equity...................... 3,337,940 3,624,767 ----------- ----------- Total shareholders' equity. 3,337,940 3,624,767 ----------- ----------- Total liabilities and shareholders' equity.... $34,427,990 $35,083,527 =========== =========== Net interest income/margin (taxable-equivalent basis)...... 387,883 5.04% 380,973 4.80% Less: taxable-equivalent adjustment 622 533 ---------- ----------- Net interest income........ $ 387,261 $ 380,440 ========== =========== - ----------------------------------- <FN> (1) Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent. (2) Average balances on loans outstanding include all nonperforming loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield. (3) Foreign loans and deposits are those loans and deposits originated in foreign branches. </FN> 26 Net interest income is interest earned on loans and investments less interest expense on deposit accounts and borrowings. Primary factors affecting the level of net interest income include the margin between the yield earned on interest earning assets and the rate paid on interest bearing liabilities, as well as the volume and composition of average interest earning assets and average interest bearing liabilities. Net interest income, on a taxable-equivalent basis, was $381.0 million in the first quarter of 2002, compared with $387.9 million in the first quarter of 2001. This decrease of $6.9 million, or 2 percent, was attributable primarily to the decreasing interest rate environment throughout the prior year, partly mitigated by increasing average noninterest bearing deposits year-over-year. Decreasing market rates resulted in a lower average yield of 209 basis points on average earning assets of $32.0 billion, which were partly offset by lower cost of fund rates on our interest bearing liabilities of 272 basis points on average balances of $19.2 billion. Mitigating the impact of this lower interest rate environment was an increase in average earning assets of $0.9 million, funded by a $1.5 billion, or 15 percent, increase in average noninterest bearing deposits. The resulting impact of these changes on our net interest margin was a decrease of 24 basis points to 4.80 percent. Average earning assets were $32.0 billion in the first quarter of 2002, compared with $31.1 billion in the first quarter of 2001. This growth was attributable to a $1.4 billion, or 35 percent, increase in average securities, offset by a $1.3 billion, or 5 percent, decrease in average loans. The increase in average securities, which were comprised primarily of fixed rate available for sale securities, reflected liquidity and interest rate risk management actions. The decline in average loans was mostly due to a $2.9 billion decrease in average commercial loans mainly attributable to slower loan growth due to economic conditions, loan sales, and a reduction in our exposure in nonrelationship syndicated loans. The decrease in commercial loans was partly offset by an increase in average residential mortgages of $1.7 billion, which was a result of a strategic portfolio shift from more volatile commercial loans. Other loan categories included an increase in average commercial mortgages of $306.6 million and a decrease in average consumer loans and lease financing of $338.1 million and $157.5 million, respectively. NONINTEREST INCOME FOR THE THREE MONTHS ENDED ---------------------------------------------------- INCREASE (DECREASE) MARCH 31, MARCH 31, --------------------- (DOLLARS IN THOUSANDS) 2001 2002 AMOUNT PERCENT - ---------------------- --------- --------- -------- -------- Service charges on deposit accounts...... $ 57,020 $ 66,143 $ 9,123 16.00% Trust and investment management fees..... 39,681 36,725 (2,956) (7.45) Merchant transaction processing fees..... 19,066 20,701 1,635 8.58 International commissions and fees....... 17,110 18,223 1,113 6.51 Brokerage commissions and fees........... 8,915 9,632 717 8.04 Insurance commissions.................... -- 7,153 7,153 nm Merchant banking fees.................... 9,248 6,945 (2,303) (24.90) Foreign exchange trading gains, net...... 6,220 6,447 227 3.65 Securities gains (losses), net........... 2,266 (2,566) (4,832) nm Gain on exchange of STAR System stock.... 20,700 -- (20,700) (100.00) Other.................................... 581 2,048 1,467 252.50 --------- --------- -------- Total noninterest income................. $ 180,807 $ 171,451 $ (9,356) (5.17)% ========= ========= ======== ======== - ---------------------------- <FN> nm = not meaningful </FN> In the first quarter of 2002, noninterest income was $171.5 million, a decrease of $9.4 million, or 5 percent, over the first quarter of 2001. This decrease was primarily due to a $20.7 million gain recognized when our stock holding in STAR System was exchanged for Concord EFS stock in the prior year. 27 Excluding the gain on the exchange of our STAR System holdings, noninterest income increased $11.3 million, or 7 percent. This increase was mainly attributable to a $9.1 million increase in service charges on deposit accounts, a $7.2 million increase related to the incremental revenues associated with our December 2001 acquisition of the Armstrong/Robitaille Business and Insurance Services, and a $1.6 million increase in merchant transaction processing fees, partially offset by a $2.9 million decrease in trust and investment management fees, a $2.3 million decrease in merchant banking fees, and a $4.8 million decrease in net securities gains. Revenue from service charges on deposit accounts was $66.1 million, an increase of 16 percent over the first quarter of 2001. The increase was primarily attributable to an 8 percent increase in average business demand deposits and reductions in the earnings credit rates, caused by the lower interest environment, on analyzed deposit accounts, which resulted in customers paying fees for services rather than increasing required deposit balances. Trust and investment management fees were $36.7 million, a decrease of 7 percent over the first quarter of 2001. This decrease is attributable to declining market conditions and their impact on transaction and asset-based fees. Total assets under administration increased from the first quarter of 2001 by $1.4 billion, or 1 percent. Merchant transaction processing fees were $20.7 million, an increase of 9 percent over the first quarter of 2001. The increase was primarily due to the introduction of our enhanced Gold and Platinum version of our standard Master Money Card (debit card) aimed at stimulating consumer usage for higher dollar purchases and an increase in the volume of credit card drafts deposited by merchants. Brokerage commissions and fees were $9.6 million, an increase of 8 percent over the first quarter of 2001. The increase was primarily due to higher brokerage commissions on sales of non-proprietary mutual funds resulting from market conditions in the current quarter. Merchant banking fees were $6.9 million, a decrease of 25 percent from the first quarter of 2001. The decrease was primarily attributable to lower demand for syndication and investment banking activities as a result of current market conditions. Securities losses, net, were $2.6 million compared to securities gains, net, of $2.3 million in the prior year. In the prior year quarter, we realized net gains of $5.6 million on the sale of securities, partially offset by permanent writedowns of securities of $3.3 million. In the current quarter, we realized gains of $0.4 million on the sale of securities, partially offset by permanent writedowns of securities of $3.0 million. Other noninterest income was $2.0 million, an increase of $1.5 million, or 253 percent, over the first quarter of 2001. This increase was mainly attributable to lower auto lease residual writedowns of $6.0 million in the first quarter of 2002 compared to $17.3 million in the first quarter of 2001. This increase was partially offset by higher permanent writedowns on nonpublic securities of $5.4 million in the current quarter, a $3.1 million gain on the sale of leased equipment in the prior year, and a higher provision of $1.2 million for potential losses on interest rate derivatives in the current quarter. 28 NONINTEREST EXPENSE FOR THE THREE MONTHS ENDED ------------------------------------------------ INCREASE (DECREASE) MARCH 31, MARCH 31, ------------------- (DOLLARS IN THOUSANDS) 2001 2002 AMOUNT PERCENT - ------------------------------------------ --------- --------- ------- ------- Salaries and other compensation........... $ 130,973 $ 141,341 $10,368 7.92% Employee benefits......................... 33,514 36,453 2,939 8.77 --------- --------- ------- Salaries and employee benefits......... 164,487 177,794 13,307 8.09 Net occupancy............................. 22,759 23,381 622 2.73 Equipment................................. 15,798 16,340 542 3.43 Communications............................ 11,702 13,941 2,239 19.13 Merchant transaction processing........... 12,914 12,916 2 0.02 Software.................................. 7,531 11,510 3,979 52.83 Advertising and public relations.......... 6,606 10,008 3,402 51.50 Professional services..................... 7,824 9,503 1,679 21.46 Data processing........................... 8,949 8,991 42 0.47 Intangible asset amortization............. 3,538 884 (2,654) (75.01) Foreclosed asset expense.................. 13 125 112 861.54 Other..................................... 45,364 37,970 (7,394) (16.30) --------- --------- ------- Total noninterest expense........... $ 307,485 $ 323,363 $15,878 5.16% ========= ========= ======= In the first quarter of 2002, noninterest expense was $323.4 million, an increase of $15.9 million, or 5 percent, over the same period in 2001. This increase was mostly due to a $13.3 million increase in salaries and employee benefits, a $4.0 million increase in software expense, a $3.4 million increase in advertising and public relations expense, a $2.2 million increase in communications expense, and a $1.7 million increase in professional services expense. These increases were partially offset by a $2.7 million decrease in intangible asset expense mostly attributable to the implementation of SFAS 142, "Goodwill and Other Intangible Assets," in the current quarter, which eliminated the amortization of goodwill, and a $7.4 million decrease in other noninterest expense. Salaries and employee benefits were $177.8 million, an increase of 8 percent over the first quarter of 2001. This increase was primarily due to increases necessary to achieve our strategic goals to expand key businesses, to annual merit increases, and to higher medical costs. Software expense was $11.5 million, an increase of 53 percent over the first quarter of 2001. This increase was primarily attributable to increased software purchases and development to support strategic technology initiatives. Advertising and public relations expenses were $10.0 million, an increase of 52 percent over the first quarter of 2001. This increase was primarily attributable to advertising expenses for deposit gathering and small business and consumer product growth. Communications expense was $13.9 million, an increase of 19 percent over the first quarter of 2001. This increase was primarily attributable to higher costs associated with increased rates and usage for data and voice communication. Professional services expense was $9.5 million, an increase of 21 percent over the first quarter of 2001. This increase was primarily attributable to consulting costs associated with several projects including information technology and process improvement. Other noninterest expense was $38.0 million, a decrease of 16 percent over the first quarter of 2001. This decrease was due to the recognition of a $6.2 million loss at the adoption of SFAS No. 133 and higher derivative-related expenses of $3.5 million due to changes in the value of a portion of the interest rate options that were excluded from hedge accounting under SFAS No. 133, both in the prior year. 29 INCOME TAX EXPENSE Income tax expense in the first quarter of 2002 was $58.8 million, a 34 percent effective income tax rate. For the first quarter of 2001, the effective income tax rate was 33 percent. LOANS The following table shows loans outstanding by loan type. PERCENT CHANGE TO MARCH 31, 2002 FROM: --------------------------- MARCH 31, DECEMBER 31, MARCH 31, MARCH 31, DECEMBER 31, (DOLLARS IN THOUSANDS) 2001 2001 2002 2001 2001 - ---------------------- ----------- ------------ ----------- --------- ------------ Domestic: Commercial, financial and industrial... $13,557,200 $ 11,476,361 $10,963,101 (19.13)% (4.47)% Construction........................... 1,031,882 1,059,847 1,096,869 6.30 3.49 Mortgage: Residential......................... 3,633,525 4,788,219 5,350,998 47.27 11.75 Commercial.......................... 3,350,980 3,590,318 3,691,561 10.16 2.82 ----------- ------------ ----------- Total mortgage.................... 6,984,505 8,378,537 9,042,559 29.47 7.93 Consumer: Installment......................... 1,548,926 1,200,047 1,088,716 (29.71) (9.28) Revolving lines of credit........... 740,786 859,021 906,110 22.32 5.48 ----------- ------------ ----------- Total consumer.................... 2,289,712 2,059,068 1,994,826 (12.88) (3.12) Lease financing........................ 1,082,474 979,242 933,012 (13.81) (4.72) ----------- ------------ ----------- Total loans in domestic offices... 24,945,773 23,953,055 24,030,367 (3.67) 0.32 Loans originated in foreign branches...... 1,031,163 1,040,975 1,067,730 3.55 2.57 ----------- ------------ ----------- Total loans....................... $25,976,936 $ 24,994,030 $25,098,097 (3.38)% 0.42% =========== ============ =========== Our lending activities are predominantly domestic, with such loans comprising 96 percent of the total loan portfolio at March 31, 2002. Total loans at March 31, 2002 were $25.1 billion, a decrease of 3 percent, from the prior year. The decrease was mainly attributable to a decline in the commercial, financial and industrial loan portfolio of $2.6 billion and a decline in the consumer loan portfolio of $294.9 million, partially offset by an increase in the residential mortgage portfolio of $1.7 billion and an increase in the commercial mortgage portfolio of $340.6 million. Commercial, financial and industrial loans represent the largest category in the loan portfolio. These loans are extended principally to corporations, middle market businesses, and small businesses, with no industry concentration exceeding 10 percent of total commercial, financial and industrial loans. At March 31, 2002 and 2001, the commercial, financial and industrial loan portfolio was $11.0 billion, or 44 percent of total loans, and $13.6 billion, or 52 percent of total loans, respectively. The decrease of $2.6 billion, or 19 percent, from the prior year was primarily attributable to current economic conditions, loans sales, and reductions in our exposure in nonrelationship syndicated loans. The reduction in commercial, financial, and industrial loans is consistent with our strategy to reduce our exposure in more volatile commercial loans and increase the percentage of more stable consumer loans. The construction loan portfolio totaled $1.1 billion, or 4 percent of total loans, at March 31, 2002, compared with $1.0 billion, or 4 percent of total loans, at March 31, 2001. This growth of $65.0 million, or 6 percent, from the prior year was primarily attributable to a reasonably stable Southern California housing market during 2001, despite the slowdown in the economy. 30 Commercial mortgages were $3.7 billion, or 15 percent of total loans, at March 31, 2002, compared with $3.4 billion, or 13 percent of total loans, at March 31, 2001. The mortgage loan portfolio consists of loans on commercial and industrial projects primarily in California. The increase in commercial mortgages of $340.6 million, or 10 percent, from March 31, 2001, was primarily due to the demand for commercial mortgages, which continues to reflect a reasonably stable Southern California real estate market. Residential mortgages were $5.4 billion, or 21 percent of total loans, at March 31, 2002, compared with $3.6 billion, or 14 percent of total loans, at March 31, 2001. The residential mortgage portfolio consists of residential loans secured by one-to-four family residential properties primarily in California. The increase in residential mortgages of $1.8 billion, or 47 percent, from March 31, 2001, continues to be influenced by our strategic decision to increase our residential mortgage portfolio through additional wholesale and correspondence channels. Consumer loans totaled $2.0 billion, or 8 percent of total loans, at March 31, 2002, compared with $2.3 billion, or 9 percent of total loans, at March 31, 2001. The decrease of $294.9 million, or 13 percent, was attributable to the impact of our decision to exit the indirect auto lending and auto leasing businesses in the third quarter of 2000, partially offset by an increase in home equity loans. Lease financing totaled $933.0 million, or 4 percent of total loans, at March 31, 2002, compared with $1.1 billion, or 4 percent of total loans, at March 31, 2001. As we previously announced, effective April 20, 2001, we had discontinued our auto leasing activity. Loans originated in foreign branches totaled $1.1 billion, or 4 percent of total loans, at March 31, 2002 and $1.0 billion, or 4 percent of total loans, at March 31, 2001. CROSS-BORDER OUTSTANDINGS Our cross-border outstandings reflect certain additional economic and political risks that are not reflected in domestic outstandings. These risks include those arising from exchange rate fluctuations and restrictions on the transfer of funds. The following table sets forth our cross-border outstandings as of March 31, 2001, December 31, 2001 and March 31, 2002 for each country where such outstandings exceeded 1 percent of total assets. The cross-border outstandings were compiled based upon category and domicile of ultimate risk and are comprised of balances with banks, trading account assets, securities available for sale, securities purchased under resale agreements, loans, accrued interest receivable, acceptances outstanding and investments with foreign entities. The amounts outstanding for each country exclude local currency outstandings. For those individual countries shown in the table below, we do not have significant local currency outstandings that are not hedged or are not funded by local currency borrowings. PUBLIC CORPORATIONS FINANCIAL SECTOR AND OTHER TOTAL (DOLLARS IN MILLIONS) INSTITUTIONS ENTITIES BORROWERS OUTSTANDINGS - --------------------------------- ------------ -------- ------------ ------------ March 31, 2001 Korea............................ $471 $ - $28 $499 December 31, 2001 Korea............................ $514 $ - $ - $514 March 31, 2002 Korea............................ $493 $ - $ - $493 31 PROVISION FOR CREDIT LOSSES We recorded a $55 million provision for credit losses in the first quarter of 2002, compared with a $100 million provision for credit losses for the same period in the prior year. Provisions for credit losses are charged to income to bring our allowance for credit losses to a level deemed appropriate by management based on the factors discussed under "Allowance for Credit Losses" below. Our provision for the first quarter of 2002, was affected by the continuing application of strict standards to the definitions of potential and well-defined weaknesses in our loan portfolio, resulting in high levels of criticized assets. ALLOWANCE FOR CREDIT LOSSES We maintain an allowance for credit losses to absorb losses inherent in the loan portfolio. The allowance is based on our regular, quarterly assessments of the probable estimated losses inherent in the loan portfolio, and to a lesser extent, unused commitments to provide financing. Our methodology for measuring the appropriate level of the allowance relies on several key elements, which include the formula allowance, specific allowances for identified problem loans and portfolio segments, and the unallocated allowance. The formula allowance is calculated by applying loss factors to outstanding loans and certain unused commitments, in each case based on the internal risk grade of such loans, leases and commitments. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and may be adjusted for significant factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. Loss factors are developed in the following ways: o pass graded, for commercial, financial, and industrial loans, as well as all problem graded loan loss factors are derived from a migration model that tracks historical loss over a period, which we believe captures the inherent losses on our loan portfolio; o pass graded loan loss factors are based on the average annual net charge-off rate over a period for commercial real estate loans and construction loans reflective of a full economic cycle; and o pooled loan loss factors (not individually graded loans) are based on expected net charge-offs for one year. Pooled loans are loans that are homogeneous in nature, such as consumer installment, home equity, residential mortgage loans and automobile leases. We believe that a business cycle is a period in which both upturns and downturns in the economy have been reflected. The long-term nature of the recent economic expansion has required us to extend our historical perspective to capture the highs and lows of a more typical economic cycle. Specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate the probability that a loss has been incurred. This amount may be determined either by a method prescribed by SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", or by a method which identifies certain qualitative factors. The unallocated allowance contains amounts that are based on management's evaluation of conditions that are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following, which existed at the balance sheet date: o general economic and business conditions affecting our key lending areas; 32 o credit quality trends (including trends in nonperforming loans expected to result from existing conditions); o collateral values; o loan volumes and concentrations; o seasoning of the loan portfolio; o specific industry conditions within portfolio segments; o recent loss experience in particular segments of the portfolio; o duration of the current business cycle; o bank regulatory examination results; and o findings of our internal credit examiners. Executive management reviews these conditions quarterly in discussion with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's estimate of the effect of such condition may be reflected as a specific allowance, applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's evaluation of the probable loss related to such condition is reflected in the unallocated allowance. The allowance for credit losses is based upon estimates of probable losses inherent in the loan portfolio. The actual losses can vary from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. The loss migration model that is used to establish the loan loss factors for problem graded loans and pass graded commercial, financial, and industrial loans is designed to be self-correcting by taking into account our loss experience over prescribed periods. Similarly, by basing the pass graded loan loss factors over a period reflective of a business cycle, the methodology is designed to take our recent loss experience for commercial real estate mortgages and construction loans into account. Pooled loan loss factors are adjusted quarterly based upon the level of net charge-offs expected by management in the next twelve months. Furthermore, based on management's judgement, our methodology permits adjustments to any loss factor used in the computation of the formula allowance for significant factors, which affect the collectibility of the portfolio as of the evaluation date, but are not reflected in the loss factors. By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon the most recent information that has become available. COMPARISON OF THE TOTAL ALLOWANCE AND RELATED PROVISION FOR CREDIT LOSSES FROM DECEMBER 31, 2001 During the first quarter of 2002, there were no changes in estimation methods or assumptions that affected our methodology for assessing the appropriateness of the formula and specific allowances for credit losses. Changes in estimates and assumptions regarding the effects of economic and business conditions on borrowers and other factors, which are described below, affected the assessment of the unallocated allowance. At December 31, 2001, our total allowance for credit losses was $635 million or 2.54 percent of the total loan portfolio and 129 percent of total nonaccrual loans. At March 31, 2002, our total allowance for credit losses was $629 million, or 2.51 percent of the total loan portfolio and 139 percent of total nonaccrual loans. In addition, the allowance incorporates the results of measuring impaired loans as provided in SFAS No. 114 and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures". These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. At December 31, 2001, total impaired loans 33 were $492 million, and the associated impairment allowance was $98 million compared with $452 million and $91 million, respectively, at March 31, 2002. We recorded a $55 million provision in the first quarter of 2002 as a result of management's assessment of factors, including the continued slow US economy, uncertainty in the communication/media, broadcasting, real estate, and other sectors in domestic markets in which we operate, and changes in the composition of the loan portfolio. Losses inherent in large commercial loans are more difficult to assess because historically these have been more volatile than losses from other credits. CHANGES IN THE FORMULA AND SPECIFIC ALLOWANCES At March 31, 2002, the formula allowance, remained relatively unchanged at $336 million, compared to $325 million at December 31, 2001, an increase of $11 million. At March 31, 2002, the specific allowance was $121 million compared to $138 million at December 31, 2001, a decrease of $17 million. This was due to charge-offs recognized during the quarter and a decline in nonaccrual loans. Our problem credits continue to be centered in the commercial loan portfolio and mostly within syndicated loan purchases. Within our commercial loan portfolio we have seen a higher incidence of problem credits outside our primary areas of industry expertise. Although we continue to see no significant deterioration in the real estate or consumer loan portfolios in aggregate, there is some deterioration in Northern California real estate markets, which is being impacted by the slow down in the technology sector. At March 31, 2002, the unallocated allowance was $172 million, unchanged from $172 million at December 31, 2001. In evaluating the appropriateness of the unallocated allowance, we considered the following factors as well as more general factors such as the interest rate environment and the impact of the economic downturn on those borrowers who have a more leveraged financial profile: o the adverse effects of changes in the economic, regulatory, and technology environments on borrowers in the communications/media industry, which could be in the range of $20 million to $46 million; o the adverse effects of the general weakening in real estate markets, as well as the specific deterioration in Northern California, which could be in the range of $16 million to $32 million; o the adverse effects of the continued soft consumer confidence on borrowers in the retailing industry, which could be in the range of $15 million to $29 million; o the adverse effects of the continued weak economic conditions in certain Asia / Pacific Rim countries and the reduced strength of the Japanese corporate parents of our Pacific Rim borrowers, which could be in the range of $8 million to $17 million; o the adverse effects of the cyclical nature of machinery manufacturing and the slow-down in capital expenditure in response to excess capacity in a recessionary environment, which could be in the range of $5 million to $10 million; and o the adverse effects of declining product life cycles and a slow demand for personal computers on borrowers in the technology industry, which could be in the range of $4 million to $8 million. There can be no assurance that the adverse impact of any of these conditions on us will not be in excess of the ranges set forth above. See "Certain Business Risks Factors". 34 CHANGE IN THE TOTAL ALLOWANCE FOR CREDIT LOSSES The following table sets forth a reconciliation of changes in our allowance for credit losses. FOR THE THREE MONTHS ENDED MARCH 31, --------------------- (DOLLARS IN THOUSANDS) 2001 2002 - ------------------------------------------------------------------------- -------- -------- Balance, beginning of period............................................. $613,902 $634,509 Loans charged off: Commercial, financial and industrial.................................. 74,554 62,226 Mortgage.............................................................. 30 180 Consumer.............................................................. 3,338 2,599 Lease financing....................................................... 781 833 Foreign(1)............................................................ -- -- -------- -------- Total loans charged off............................................ 78,703 65,838 Recoveries of loans previously charged off: Commercial, financial and industrial.................................. 5,937 4,516 Mortgage.............................................................. 24 95 Consumer.............................................................. 1,127 908 Lease financing....................................................... 148 201 Foreign(1)............................................................ 14 -- -------- -------- Total recoveries of loans previously charged off................... 7,250 5,720 -------- -------- Net loans charged off............................................ 71,453 60,118 Provision for credit losses.............................................. 100,000 55,000 Foreign translation adjustment and other net deductions.................. (115) (24) -------- -------- Balance, end of period................................................... $642,334 $629,367 ======== ======== Allowance for credit losses to total loans............................... 2.47% 2.51% Provision for credit losses to net loans charged off..................... 139.95 91.49 Net loans charged off to average loans outstanding for the period(2)..... 1.10 0.97 - ---------------------------------- <FN> (1) Foreign loans are those loans originated in foreign branches. (2) Annualized. </FN> Total loans charged off in the first quarter of 2002 decreased by $12.9 million from the first quarter of 2001, primarily due to a $12.3 million decrease in commercial, financial and industrial loans charged off. Charge-offs reflect the realization of losses in the portfolio that were recognized previously through provisions for credit losses. First quarter 2002 recoveries of loans previously charged off decreased by $1.5 million from the same period in 2001. The percentage of net loans charged off to average loans outstanding for the first quarter of 2002 decreased by 13 basis points from the same period in 2001. At March 31, 2002, the allowance for credit losses exceeded the annualized net loans charged off during the first quarter of 2002, reflecting management's belief, based on the foregoing analysis, that there are additional losses inherent in the portfolio. Historical net charge-offs are not necessarily indicative of the amount of net charge-offs that we will realize in the future. 35 NONPERFORMING ASSETS MARCH 31, DECEMBER 31, MARCH 31, (DOLLARS IN THOUSANDS) 2001 2001 2002 - ---------------------------------------------------------------- --------- ------------ --------- Commercial, financial and industrial............................ $ 416,863 $ 471,509 $ 422,900 Construction.................................................... 3,967 -- -- Commercial mortgage............................................. 10,015 17,430 26,426 Lease financing................................................. -- 2,946 2,631 Loans originated in foreign branches............................ -- -- 471 --------- ------------ --------- Total nonaccrual loans....................................... 430,845 491,885 452,428 Foreclosed assets............................................... 1,011 597 333 Distressed loans held for sale.................................. 7,124 -- -- --------- ------------ --------- Total nonperforming assets................................... $ 438,980 $ 492,482 $ 452,761 ========= ============ ========= Allowance for credit losses..................................... $ 642,334 $ 634,509 $ 629,367 ========= ============ ========= Nonaccrual loans to total loans................................. 1.66% 1.97% 1.80% Allowance for credit losses to nonaccrual loans................. 149.09 129.00 139.11 Nonperforming assets to total loans, distressed loans held for sale and foreclosed assets............................ 1.69 1.97 1.80 Nonperforming assets to total assets............................ 1.23 1.37 1.25 At March 31, 2002, nonperforming assets totaled $452.8 million, an increase of $13.8 million, or 3 percent, from March 31, 2001. The increase was due to general deterioration in our loan portfolio. Nonaccrual loans as a percentage of total loans were 1.80 percent at March 31, 2002, compared with 1.66 percent at March 31, 2001. Nonperforming assets as a percentage of total loans, distressed loans held for sale, and foreclosed assets were 1.80 percent at March 31, 2002, compared to 1.69 percent at March 31, 2001. LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING MARCH 31, DECEMBER 31, MARCH 31, (DOLLARS IN THOUSANDS) 2001 2001 2002 - -------------------------------------------- --------- ------------ --------- Commercial, financial and industrial........ $ 17,153 $ 26,571 $ 1,680 Mortgage: Residential.............................. 3,663 4,854 8,561 Commercial............................... 256 2,356 1,567 --------- ------------ --------- Total mortgage........................ 3,919 7,210 10,128 Consumer and other.......................... 2,614 2,579 1,893 --------- ------------ --------- Total loans 90 days or more past due and still accruing.................. $ 23,686 $ 36,360 $ 13,701 ========= ============ ========= QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT INTEREST RATE RISK MANAGEMENT (OTHER THAN TRADING) THE FOLLOWING INFORMATION ON MARKET RISK ASSOCIATED WITH INTEREST RATE RISK IS BEING PROVIDED IN ORDER TO EXPAND THE INFORMATION ON THE ASSUMPTIONS USED IN OUR SIMULATION MODELS, WHICH QUANTIFY OUR SENSITIVITY TO CHANGES IN INTEREST RATES. We engage in asset and liability management activities with the primary purposes of managing the sensitivity of net interest income (NII) to changes in interest rates within limits established by the Board of Directors (Board) and maintaining a risk profile that is consistent with management's strategic objectives. 36 The Asset & Liability Management (ALM) policy approved by the Board requires monthly monitoring of interest rate risk by the Asset & Liability Management Committee (ALCO), which is composed of UnionBanCal Corporation senior executives. As part of the management of our interest rate risk, ALCO may direct changes in the composition of the balance sheet and the extent to which we utilize derivative instruments such as interest rate swaps, floors, and caps. We use two types of simulation models to quantify the sensitivity of NII to changes in interest rates: a shock simulation model and a Monte Carlo simulation model. In both approaches, NII is adjusted to incorporate the effect of certain noninterest expense items related to demand deposit accounts that are nevertheless sensitive to changes in interest rates. Our primary simulation tool involves a shock analysis in which we estimate the impact that immediate and sustained parallel shifts in the yield curve would have on NII over a 12-month horizon. Under policy limits established by the Board, the negative change in simulated NII in either up or down 200 basis point shock scenarios may not exceed 8 percent of NII as measured in the flat rate, or no change, scenario. The following table sets forth the shock sensitivity results in both the up and down 200 basis point scenarios as of December 31, 2001 and March 31, 2002. DECEMBER 31, MARCH 31, (DOLLARS IN MILLIONS) 2001 2002 - ------------------------------------- ------------ --------- +200 basis points.................... $ 15.0 $ 12.6 as a percentage of mean NII.......... 0.99% 0.83% - -200 basis points.................... $(81.1) $(56.3) as a percentage of mean NII.......... 5.35% 3.72% Asset sensitivity, as measured by the shock scenarios, was moderated in the first quarter of 2002 due in part to a decrease in the impact of prepayments on our mortgage-backed securities and residential loan portfolios as measured in the downward shock scenario. However, the short duration nature of our derivative hedges and fixed income portfolio suggest that our risk profile is likely to become more asset-sensitive in 2003 and 2004. With federal funds and LIBOR rates at the end of the first quarter of 2002 already below two percent, a downward shock scenario of 200 basis points would result in short-term rate levels below zero percent. As a result, we believe that a downward shock scenario of 100 basis points provides a more reasonable measure of asset sensitivity in a falling rate environment. As of March 31, 2002, the difference between a flat rate NII and NII after a 100 basis point downward shock was ($15.7) million, or (1.0) percent of a flat rate NII. In the Monte Carlo simulation analysis, we randomly sample up to 300 paths that short-term rates could take over the next 12 months and calculate the NII associated with each path. The result is a probability distribution of 12-month NII outcomes. Earnings-at risk (EaR), defined as the potential negative change in NII, is measured at a 97.5% confidence level and is managed within the limit established by the Board's ALM policy at 5 percent of mean NII. The following table summarizes our EaR as a percentage of mean NII as of December 31, 2001 and March 31, 2002. DECEMBER 31, MARCH 31, (DOLLARS IN MILLIONS) 2001 2002 - -------------------------------------------- ------------ --------- EaR......................................... $12.6 $19.0 EaR as a percentage of mean NII............. 0.86% 1.32% Management's goal in the NII simulations is to capture the risk embedded in today's balance sheet. As a result, asset and liability balances are kept constant throughout the analysis horizon. Two exceptions are non-maturity deposits, which vary with levels of interest rates according to statistically derived balance equations, and discretionary derivative hedges and fixed income portfolios, which are allowed to run off. 37 Additional assumptions are made to model the future behavior of deposit rates and loan spreads based on statistical analysis, management's outlook, and historical experience. The prepayment risks related to residential loans and mortgage-backed securities are measured using industry estimates of prepayment speeds. The sensitivity of the simulation results to the underlying assumptions is tested as a regular part of the risk measurement process by running simulations with different assumptions. In addition, management supplements the official risk measures based on the constant balance sheet assumption with volume-based simulations based on forecasted balances. A third measure that ALCO uses to monitor the Company's risk profile is Economic Value of Equity (EVE). EVE is an estimate of the net present value of the future cash flows associated with all of the Company's assets, liabilities and derivatives. EVE-at-Risk is defined as the negative change in the value of these cash flows resulting from either a +200 basis point or a--200 basis point shock scenario. Although ALCO has identified prototype guidelines for measuring EVE-at-Risk, no official policy limits have been established for EVE by the Board. The Company will continue to improve and refine its EVE methodology in 2002. LIQUIDITY Liquidity risk represents the potential for loss as a result of limitations on our ability to adjust our future cash flows to meet the needs of depositors and borrowers and to fund operations on a timely and cost-effective basis. The ALM policy approved by the Board requires quarterly reviews of our liquidity by the ALCO. Our liquidity management draws upon the strengths of our extensive retail and commercial market business franchise, coupled with the ability to obtain funds for various terms in a variety of domestic and international money markets. Liquidity is managed through the funding and investment functions of the Global Markets Group. Core deposits provide us with a sizable source of relatively stable and low-cost funds. Our average core deposits, which include demand deposits, money market demand accounts, and savings and consumer time deposits, combined with average common shareholders' equity, funded 74 percent of average total assets of $35.1 billion for the first quarter ended March 31, 2002. Most of the remaining funding was provided by short-term borrowings in the form of negotiable certificates of deposit, foreign deposits, federal funds purchased and securities sold under repurchase agreements, commercial paper and other borrowings. In the fourth quarter of 2001, we issued $200 million in medium-term notes, the proceeds of which were utilized for general corporate purposes. Liquidity may also be provided by the sale or maturity of assets. Such assets include interest bearing deposits in banks, federal funds sold and securities purchased under resale agreements, and trading account securities. The aggregate of these assets averaged $1.3 billion during the first quarter of 2002. Additional liquidity may be provided by investment securities available for sale that amounted to $5.4 billion at March 31, 2002 and by loan maturities. 38 REGULATORY CAPITAL The following table summarizes our risk-based capital, risk-weighted assets, and risk-based capital ratios. UNIONBANCAL CORPORATION MINIMUM MARCH 31, DECEMBER 31, MARCH 31, REGULATORY (DOLLARS IN THOUSANDS) 2001 2001 2002 REQUIREMENT - ---------------------- ----------- ------------- ----------- ----------- CAPITAL COMPONENTS Tier 1 capital...... $ 3,511,151 $ 3,661,231 $ 3,729,481 Tier 2 capital...... 615,130 598,812 601,042 ----------- ------------- ----------- Total risk-based capital.......... $ 4,126,281 $ 4,260,043 $ 4,330,523 =========== ============= =========== Risk-weighted assets $33,484,415 $ 31,906,438 $32,077,375 =========== ============= =========== Quarterly average assets........... $34,371,595 $ 34,760,203 $35,010,127 =========== ============= =========== CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - -------------- ----------- ----- ------------- ----- ----------- ----- ---------- ----- Total capital (to risk-weighted assets).......... $ 4,126,281 12.32% $ 4,260,043 13.35% $ 4,330,523 13.50% >$2,566,190 8.0% Tier 1 capital (to risk-weighted assets).......... 3,511,151 10.49 3,661,231 11.47 3,729,481 11.63 >1,283,095 4.0 Leverage(1)......... 3,511,151 10.22 3,661,231 10.53 3,729,481 10.65 >1,400,405 4.0 - ----------------- <FN> (1) Tier 1 capital divided by quarterly average assets (excluding certain intangible assets). </FN> UNION BANK OF CALIFORNIA, N.A. "WELL- MINIMUM CAPITALIZED" MARCH 31, DECEMBER 31, MARCH 31, REGULATORY REGULATORY (DOLLARS IN THOUSANDS) 2001 2001 2002 REQUIREMENT REQUIREMENT - ---------------------- ----------- ------------- ----------- --------------- ---------------- CAPITAL COMPONENTS Tier 1 capital............$ 3,108,454 $ 3,323,096 $ 3,399,757 Tier 2 capital............ 509,362 487,640 489,666 ----------- ------------- ----------- Total risk-based capital..$ 3,617,816 $ 3,810,736 $ 3,889,423 =========== ============= =========== Risk-weighted assets......$33,022,371 $ 31,271,268 $31,442,559 =========== ============= =========== Quarterly average assets..$34,402,681 $ 34,282,625 $34,514,704 =========== ============= =========== CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO - -------------- ----------- ----- ------------- ----- ----------- ----- ----------- ----- ---------- ----- Total capital (to risk-weighted assets)..$ 3,617,816 10.96% $ 3,810,736 12.19% $ 3,889,423 12.37% >$2,515,405 8.0% >$3,144,256 10.0% Tier 1 capital (to risk-weighted assets).. 3,108,454 9.41 3,323,096 10.63 3,399,757 10.81 > 1,257,702 4.0 > 1,886,554 6.0 Leverage(1)............... 3,108,454 9.04 3,323,096 9.69 3,399,757 9.85 > 1,380,588 4.0 > 1,725,735 5.0 - ------------------------ <FN> (1) Tier 1 capital divided by quarterly average assets (excluding certain intangible assets). </FN> We and Union Bank of California, N.A. are subject to various regulations issued by federal banking agencies, including minimum capital requirements. We and Union Bank of California, N.A. are required to maintain minimum ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to quarterly average assets (the leverage ratio). 39 Compared with December 31, 2001, our Tier 1 risk-based capital ratio at March 31, 2002 increased 16 basis points to 11.63 percent, our total risk-based capital ratio increased 15 basis points to 13.50 percent, and our leverage ratio increased 12 basis points to 10.65 percent. The increases in the capital ratios were primarily attributable to higher shareholder equity, partially offset by higher risk-weighted assets. Shareholder equity was higher mainly due to increased retained earnings driven by net income in the first quarter of 2002, partially offset by higher unrealized losses on securities available for sale and on cash flow hedges as recognized in other comprehensive income. Risk-weighted assets were higher mainly due to higher federal funds sold and repurchase agreements balances mostly related to our success in maintaining our higher level of deposits. As of March 31, 2002, management believes the capital ratios of Union Bank of California, N.A. met all regulatory requirements of a "well-capitalized" institution, which are 10 percent for the Total risk-based capital ratio, 6 percent for the Tier 1 risk-based capital ratio and 5 percent for the leverage ratio. CERTAIN BUSINESS RISK FACTORS ADVERSE CALIFORNIA ECONOMIC CONDITIONS COULD ADVERSELY AFFECT OUR BUSINESS A substantial majority of our assets and deposits are generated in California. As a result, poor economic conditions in California may cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio. In the early 1990's, the California economy experienced an economic recession that resulted in increases in the level of delinquencies and losses for us and many of the state's other financial institutions. Economic conditions in California are subject to various uncertainties at this time, including the long-term impact of the California energy crisis and the decline in the technology sector. If economic conditions in California continue to decline, we expect that our level of problem assets could increase accordingly. ADVERSE ECONOMIC FACTORS AFFECTING CERTAIN INDUSTRIES COULD ADVERSELY AFFECT OUR BUSINESS We are subject to certain industry-specific economic factors. For example, a portion of our total loan portfolio is related to real estate. Accordingly, a downturn in the real estate industry in California could have an adverse effect on our operations. Similarly, a portion of our total loan portfolio is to borrowers in the agricultural industry. Adverse weather conditions, combined with low commodity prices, may adversely affect the agricultural industry and, consequently, may impact our business negatively. In addition, auto leases comprise a portion of our total loan portfolio. We ceased originating auto leases in April 2001; however, continued deterioration in the used car market may result in additional losses on the valuation of auto lease residuals on our existing auto leases. We provide loans to businesses in a number of other industries that may be particularly vulnerable to industry-specific economic factors, including the communications/media industry, the retailing industry, and the technology industry. Industry-specific risks are beyond our control and could adversely affect our portfolio of loans, potentially resulting in an increase in nonperforming loans or charge-offs. THE TRAGIC EVENTS OF SEPTEMBER 11 HAVE RESULTED IN INCREASED UNCERTAINTY REGARDING THE OUTLOOK FOR ECONOMIC CONDITIONS The terrorist attacks on the World Trade Center and the Pentagon on September 11, 2001 have resulted in increased uncertainty regarding the economic outlook. Past experience suggests that shocks to American society of far lesser severity have resulted in a temporary loss in consumer and business confidence and a reduction in the rate of economic growth. With the US economy already on the edge of recession before the attacks, a downturn in California's economy remains a distinct possibility. It is not possible at this time to project the economic impact of these events. However, any deterioration in either the US or the California economy could adversely affect our financial condition and results of operations. 40 FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR BUSINESS Significant increases in market interest rates, or the perception that an increase may occur, could adversely affect both our ability to originate new loans and our ability to grow. Conversely, a decrease in interest rates could result in an acceleration in the prepayment of loans. An increase in market interest rates could also adversely affect the ability of our floating-rate borrowers to meet their higher payment obligations. If this occurred, it could cause an increase in nonperforming assets and charge-offs, which could adversely affect our business. FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR MARGIN SPREAD Changes in market interest rates, including changes in the relationship between short-term and long-term market interest rates or between different interest rate indices, can impact our margin spread, that is, the difference between the interest rates we charge on interest earning assets, such as loans, and the interest rates we pay on interest bearing liabilities, such as deposits. The impact, particularly in a falling interest rate environment, could result in an increase in our interest expense relative to interest income. SHAREHOLDER VOTES ARE CONTROLLED BY THE BANK OF TOKYO-MITSUBISHI, LTD.; OUR INTERESTS MAY NOT BE THE SAME AS THE BANK OF TOKYO-MITSUBISHI'S INTERESTS The Bank of Tokyo-Mitsubishi, Ltd., a wholly owned subsidiary of Mitsubishi Tokyo Financial Group, Inc., owns a majority (68 percent as of March 31, 2002) of the outstanding shares of our common stock. As a result, The Bank of Tokyo-Mitsubishi, Ltd. can elect all of our directors and as a result can control the vote on all matters, including determinations such as: approval of mergers or other business combinations; sales of all or substantially all of our assets; any matters submitted to a vote of our shareholders; issuance of any additional common stock or other equity securities; incurrence of debt other than in the ordinary course of business; the selection and tenure of our Chief Executive Officer; payment of dividends with respect to common stock or other equity securities; and matters that might be favorable to The Bank of Tokyo-Mitsubishi, Ltd. A majority of our directors are not officers or employees of UnionBanCal Corporation or any of our affiliates, including The Bank of Tokyo -Mitsubishi, Ltd. However, because of The Bank of Tokyo -Mitsubishi, Ltd.'s control over the election of our directors, The Bank of Tokyo-Mitsubishi, Ltd. could change the composition of our Board of Directors so that the Board would not have a majority of outside directors. The Bank of Tokyo-Mitsubishi, Ltd.'s ability to prevent an unsolicited bid for us or any other change in control could have an adverse effect on the market price for our common stock. THE BANK OF TOKYO-MITSUBISHI, LTD.'S FINANCIAL CONDITION COULD ADVERSELY AFFECT OUR OPERATIONS Although we fund our operations independently of The Bank of Tokyo - -Mitsubishi, Ltd. and believe our business is not necessarily closely related to The Bank of Tokyo-Mitsubishi, Ltd.'s business or outlook, The Bank of Tokyo-Mitsubishi, Ltd.'s credit ratings may affect our credit ratings. Deterioration in The Bank of Tokyo-Mitsubishi, Ltd.'s credit ratings or financial condition could result in an increase in our borrowing costs and could impair our access to the public and private capital markets. The Bank of Tokyo-Mitsubishi, Ltd. is also subject to regulatory oversight and review. Our business operations and expansion plans could be negatively affected by regulatory concerns related to the Japanese financial system and The Bank of Tokyo-Mitsubishi, Ltd. POTENTIAL CONFLICTS OF INTEREST WITH THE BANK OF TOKYO-MITSUBISHI, LTD. COULD ADVERSELY AFFECT US As part of The Bank of Tokyo-Mitsubishi, Ltd.'s normal risk management processes, The Bank of Tokyo-Mitsubishi, Ltd. manages global credit exposures and concentrations on an aggregate basis, including UnionBanCal Corporation. Therefore, at certain levels, our ability to approve certain credits and categories of customers is subject to concurrence by The Bank of Tokyo-Mitsubishi, Ltd. We may wish to 41 extend credit to the same customer as The Bank of Tokyo-Mitsubishi, Ltd. Our ability to do so may be limited for various reasons, including The Bank of Tokyo-Mitsubishi, Ltd.'s aggregate credit exposure and marketing policies. Certain directors' and officers' ownership interests in The Bank of Tokyo-Mitsubishi, Ltd.'s common stock or service as a director or officer or other employee of both us and The Bank of Tokyo-Mitsubishi, Ltd. could create or appear to create potential conflicts of interest, especially since both of us compete in the US banking industry. SUBSTANTIAL COMPETITION IN THE CALIFORNIA BANKING MARKET COULD ADVERSELY AFFECT US Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business in California, as well as nationally and internationally. Our competitors include a large number of state and national banks, thrift institutions and major foreign-affiliated or foreign banks, as well as many financial and non-financial firms that offer services similar to those offered by us. Some of our competitors are community banks that have strong local market positions. Other competitors include large financial institutions (such as Bank of America, California Federal, Washington Mutual, and Wells Fargo) that have substantial capital, technology and marketing resources. Such large financial institutions may have greater access to capital at a lower cost than us, which may adversely affect our ability to compete effectively. RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS COULD LIMIT AMOUNTS PAYABLE TO US As a holding company, a substantial portion of our cash flow typically comes from dividends our bank and nonbank subsidiaries pay to us. Various statutory provisions restrict the amount of dividends our subsidiaries can pay to us without regulatory approval. In addition, if any of our subsidiaries liquidates, that subsidiary's creditors will be entitled to receive distributions from the assets of that subsidiary to satisfy their claims against it before we, as a holder of an equity interest in the subsidiary, will be entitled to receive any of the assets of the subsidiary. ADVERSE EFFECTS OF, OR CHANGES IN, BANKING REGULATIONS OR GOVERNMENTAL FISCAL OR MONETARY POLICIES COULD ADVERSELY AFFECT US We are subject to significant federal and state regulation and supervision, which is primarily for the benefit and protection of our customers and not for the benefit of investors. In the past, our business has been materially affected by these regulations. This trend is likely to continue in the future. Laws, regulations or policies currently affecting us and our subsidiaries may change at any time. Regulatory authorities may also change their interpretation of these statutes and regulations. Therefore, our business may be adversely affected by any future changes in laws, regulations, policies or interpretations, including legislative and regulatory reactions to the terrorist attack on September 11, 2001, and the Enron Corporation bankruptcy. Additionally, our international activities may be subject to the laws and regulations of the jurisdiction where business is being conducted. International laws, regulations and policies affecting us and our subsidiaries may change at any time and affect our business opportunities and competitiveness in these jurisdictions. Due to The Bank of Tokyo-Mitsubishi, Ltd.'s controlling ownership of us, laws, regulations and policies adopted or enforced by the Government of Japan may adversely affect our activities and investments and those of our subsidiaries in the future. Under long-standing policy of the Federal Reserve Board (FRB), a bank holding company is expected to act as a source of financial strength for its subsidiary banks. As a result of that policy, we may be required to commit financial and other resources to our subsidiary bank in circumstances where we might not otherwise do so. Additionally, our business is affected significantly by the fiscal and monetary policies of the federal government and its agencies. We are particularly affected by the policies of the FRB, which regulates the supply of money and credit in the US. Among the instruments of monetary policy available to the FRB are (a) conducting open market operations in US government securities, (b) changing the discount rates of borrowings of depository institutions, (c) imposing or changing reserve requirements against certain 42 borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the FRB may have a material effect on our business, results of operations and financial condition. POSSIBLE FUTURE SALES OF SHARES BY THE BANK OF TOKYO-MITSUBISHI, LTD. COULD ADVERSELY AFFECT THE MARKET FOR OUR STOCK Although The Bank of Tokyo-Mitsubishi, Ltd. has announced it has no plan to sell its majority ownership in us, The Bank of Tokyo-Mitsubishi, Ltd. may sell shares of our common stock in compliance with the federal securities laws. By virtue of The Bank of Tokyo-Mitsubishi, Ltd.'s current control of us, The Bank of Tokyo-Mitsubishi, Ltd. could sell large amounts of shares of our common stock by causing us to file a registration statement that would allow them to sell shares more easily. In addition, The Bank of Tokyo-Mitsubishi, Ltd. could sell shares of our common stock without registration. Although we can make no prediction as to the effect, if any, that such sales would have on the market price of our common stock, sales of substantial amounts of our common stock, or the perception that such sales could occur, could adversely affect the market price of our common stock. If The Bank of Tokyo-Mitsubishi, Ltd. sells or transfers shares of our common stock as a block, another person or entity could become our controlling shareholder. WE MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT OUR OPERATING STRATEGIES From time to time, we develop long-term financial performance goals to guide and measure the success of our operating strategies. We cannot assure you that we will be successful in achieving these long-term goals or that our operating strategies will be successful. Achieving success in these areas is dependent on a number of factors, many of which are beyond our direct control. Factors that may adversely affect our ability to attain our long-term financial performance goals include: o deterioration of our asset quality; o our inability to control noninterest expense, including, but not limited to, rising healthcare costs; o our inability to increase noninterest income; o our inability to decrease reliance on asset revenues; o our ability to sustain loan growth; o our ability to find acquisition targets at valuation levels we find attractive; o regulatory and other impediments associated with making acquisitions; o deterioration in general economic conditions, especially in our core markets; o decreases in net interest margins; o increases in competition; o adverse regulatory or legislative developments; and o unexpected increases in costs related to potential acquisitions. RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR DIVESTITURES OR RESTRUCTURING MAY ADVERSELY AFFECT US We may seek to acquire or invest in companies, technologies, services or products that complement our business. There can be no assurance that we will be successful in completing any such acquisition or investments as this will depend on the availability of prospective target companies at valuation levels we find attractive and the competition for such opportunities from other bidders. In addition, we continue to 43 evaluate the performance of all of our businesses and business lines and may sell a business or business lines. Any acquisitions, divestitures or restructuring may result in the potentially dilutive issuance of equity securities, significant write-offs, including those related to goodwill and other intangible assets and/or the incurrence of debt, any of which could have a material adverse effect on our business, financial condition and results of operations. Acquisitions, divestitures or restructuring could involve numerous additional risks including difficulties in the assimilation or separation of operations, services, products and personnel, the diversion of management's attention from other business concerns, the disruption of our business, and the potential loss of key employees. There can be no assurance that we will be successful in overcoming these or any other significant risks encountered. ITEM 3. MARKET RISK. Our exposure to market risk in the first quarter of 2002 was mitigated in part due to a moderation in asset sensitivity resulting from a decline in the impact of prepayments on the mortgage-backed securities and residential loan portfolios, and the effectiveness of our overall asset/liability management. A complete explanation concerning our market risk exposure is incorporated by reference from the text under the caption "Quantitative and Qualitative Disclosures About Market Risk" in the Form 10-K for the year ended December 31, 2001 and by reference to the previous text in this document under the caption "Quantitative and Qualitative Disclosure about Interest Rate Risk Management (Other Than Trading)". 44 PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Set forth below is information concerning each matter submitted to a vote at the Annual Meeting of Shareholders on April 24, 2002 ("Annual Meeting"): DIRECTORS: Each of the following persons was elected as a director to hold office until the 2003 Annual Meeting of Shareholders or until earlier retirement, resignation or removal. NOMINEE FOR WITHHELD -------------------------------------- ----------- ----------- David R. Andrews...................... 150,430,096 1,073,997 L. Dale Crandall...................... 150,947,661 556,431 Richard D. Farman..................... 150,957,577 546,516 Stanley F. Farrar..................... 150,584,531 919,562 Richard C. Hartnack................... 150,802,214 701,879 Kaoru Hayama.......................... 150,974,706 529,387 Norimichi Kanari...................... 150,436,819 1,067,274 Satoru Kishi.......................... 131,886,009 19,618,084 Monica C. Lozano...................... 150,977,266 526,826 Mary S. Metz.......................... 150,472,188 1,031,905 Raymond E. Miles...................... 150,430,635 1,073,458 J. Fernando Niebla.................... 150,929,253 574,840 Charles R. Rinehart................... 150,967,205 536,888 Carl W. Robertson..................... 150,905,836 598,257 Takaharu Saegusa...................... 150,905,868 598,224 Robert M. Walker...................... 150,733,082 771,010 Kenji Yoshizawa....................... 130,799,535 20,704,558 YEAR 2000 UNIONBANCAL CORPORATION MANAGEMENT STOCK PLAN: Proposal No. 2 to increase the number of shares of common stock which may be awarded under the Year 2000 UnionBanCal Corporation management stock plan: FOR: 134,414,703 AGAINST: 16,837,105 ABSTAIN: 252,284 AUDITORS: Proposal No. 3 to ratify the selection of Deloitte & Touche LLP as independent auditors of UnionBanCal Corporation received the following votes: FOR: 150,162,375 AGAINST: 1,290,169 ABSTAIN: 51,548 45 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: NO. DESCRIPTION ----- ------------------------------------------------------------------------ 3.1 Restated Articles of Incorporation of the Registrant, as amended(1) 3.2 By-laws of the Registrant, as amended January 27, 1999(2) 10.1 UnionBanCal Corporation Management Stock Plan. (As restated effective June 1, 1997)*(3) 10.2 Union Bank of California Deferred Compensation Plan. (January 1, 1997, Restatement, as amended November 21, 1996)*(4) 10.3 Union Bank of California Senior Management Bonus Plan. (Effective January 1, 2000)*(5) 10.4 Richard C. Hartnack Employment Agreement. (Effective January 1, 1998) *(6) 10.5 Robert M. Walker Employment Agreement. (Effective January 1, 1998)*(6) 10.6 Union Bank of California, N.A. Supplemental Executive Retirement Plan. (Effective January 1, 1988) (Amended and restated as of January 1, 1997)*(3) 10.7 Union Bank Financial Services Reimbursement Program. (Effective January 1, 1996)*(7) 10.8 1997 UnionBanCal Corporation Performance Share Plan, as amended. (As amended, effective January 1, 2001) *(5) 10.9 Service Agreement Between Union Bank of California and The Bank of Tokyo-Mitsubishi Ltd. (Effective October 1, 1997)*(3) 10.10 Year 2000 UnionBanCal Corporation Management Stock Plan. (As restated effective January 1, 2000)*(8) 10.11 Union Bank of California, N.A. Supplemental Retirement Plan for Policy Making Officers (Effective November 1, 1999)(9) 10.12 Philip B. Flynn Employment Agreement (Effective September 21, 2000)(10) - ------------ (1) Incorporated by reference to Form 10-K for the year ended December 31, 1998. (2) Incorporated by reference to Form 10-Q for the quarter ended March 31, 1999. (3) Incorporated by reference to Form 10-K for the year ended December 31, 1997. (4) Incorporated by reference to Form 10-K for the year ended December 31, 1996. (5) Incorporated by reference to Form DEF-14A dated March 28, 2001. (6) Incorporated by reference to Form 10-Q for the quarter ended September 30, 1998. (7) Incorporated by reference to Form 8-K dated April 1, 1996. (8) Incorporated by reference to Form 10-Q for the quarter ended June 30, 1999. (9) Incorporated by reference to Form 10-Q for the quarter ended June 30, 2000. (10) Incorporated by reference to Form 10-K for the year ended December 31, 2001. * Management contract or compensatory plan, contract or arrangement. (b) Reports on Form 8-K We filed a report on Form-8K on April 17, 2002 to report that UnionBanCal Corporation issued a press release concerning earnings for first quarter 2002. 46 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. UNIONBANCAL CORPORATION (Registrant) By: /S/ DAVID I. MATSON ---------------------------------------------- David I. Matson EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER (Principal Financial Officer) By: /S/ DAVID A. ANDERSON ---------------------------------------------- David A. Anderson SENIOR VICE PRESIDENT AND CONTROLLER (Principal Accounting Officer) Dated: May 14, 2002 47