================================================================================
- --------------------------------------------------------------------------------
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, 2003
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
(Address and zip code of principal executive offices)
Registrant's telephone number: (415) 765-2969
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
--- ---
Number of shares of Common Stock outstanding at April 30, 2003: 150,086,567
- --------------------------------------------------------------------------------
================================================================================
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............................................................... 17
Summary.................................................................... 18
Business Segments.......................................................... 19
Net Interest Income........................................................ 27
Noninterest Income......................................................... 28
Noninterest Expense........................................................ 30
Income Tax Expense......................................................... 30
Loans...................................................................... 31
Cross-Border Outstandings.................................................. 32
Provision for Credit Losses................................................ 32
Allowance for Credit Losses................................................ 33
Nonperforming Assets....................................................... 37
Loans 90 Days or More Past Due and Still Accruing.......................... 37
Quantitative and Qualitative Disclosure about Interest Rate Risk
Management................................................................ 38
Liquidity.................................................................. 41
Regulatory Capital......................................................... 42
Certain Business Risk Factors.............................................. 43
Item 3. Market Risk........................................................ 47
Item 4. Controls and Procedures............................................ 47
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 48
Item 4. Submission of Matters to a Vote of Security Holders................ 48
Item 6. Exhibits and Reports on Form 8-K................................... 49
Signatures................................................................... 50
Certifications............................................................... 51
PART I. FINANCIAL INFORMATION
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL HIGHLIGHTS
(UNAUDITED)
AS OF AND FOR THE THREE MONTHS ENDED
-------------------------------------------
MARCH 31, MARCH 31, PERCENT
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2003 CHANGE
- -------------------------------------------------------- ------------ ------------ -------
RESULTS OF OPERATIONS:
Net interest income(1)................................ $ 380,973 $ 391,404 2.74%
Provision for credit losses........................... 55,000 30,000 (45.45)
Noninterest income.................................... 159,749 185,776 16.29
Noninterest expense................................... 311,661 342,605 9.93
------------ ------------
Income before income taxes(1)......................... 174,061 204,575 17.53
Taxable-equivalent adjustment......................... 533 624 17.07
Income tax expense.................................... 58,751 68,434 16.48
------------ ------------
Net income............................................ $ 114,777 $ 135,517 18.07%
============ ============
PER COMMON SHARE:
Net income--basic..................................... $ 0.73 $ 0.90 23.29%
Net income--diluted................................... 0.73 0.89 21.92
Dividends(2).......................................... 0.25 0.28 12.00
Book value (end of period)............................ 22.81 25.35 11.14
Common shares outstanding (end of period)............. 156,336,338 150,217,620 (3.91)
Weighted average common shares outstanding--basic..... 156,228,149 150,616,367 (3.59)
Weighted average common shares outstanding--diluted... 157,810,613 152,012,570 (3.67)
BALANCE SHEET (END OF PERIOD):
Total assets.......................................... $ 36,221,931 $ 40,387,343 11.50%
Total loans........................................... 25,098,097 26,536,272 5.73
Nonaccrual loans...................................... 452,428 386,583 (14.55)
Nonperforming assets.................................. 452,761 386,972 (14.53)
Total deposits........................................ 28,758,849 33,252,751 15.63
Medium and long-term debt............................. 399,673 418,388 4.68
Trust preferred securities............................ 361,903 363,050 0.32
Shareholders' equity.................................. 3,566,502 3,808,025 6.77
BALANCE SHEET (PERIOD AVERAGE):
Total assets.......................................... $ 35,083,527 $ 38,348,203 9.31%
Total loans........................................... 25,127,757 26,723,057 6.35
Earning assets........................................ 31,976,493 34,826,771 8.91
Total deposits........................................ 27,568,947 31,078,388 12.73
Shareholders' equity.................................. 3,624,767 3,874,293 6.88
FINANCIAL RATIOS:
Return on average assets(3)........................... 1.33% 1.43%
Return on average shareholders' equity(3)............. 12.84 14.19
Efficiency ratio(4)................................... 57.61 59.35
Net interest margin(1)................................ 4.80 4.53
Dividend payout ratio................................. 34.25 31.11
Tangible equity ratio................................. 9.64 9.00
Tier 1 risk-based capital ratio....................... 11.63 11.33
Total risk-based capital ratio........................ 13.50 13.08
Leverage ratio........................................ 10.65 9.80
Allowance for credit losses to total loans............ 2.51 2.21
Allowance for credit losses to nonaccrual loans....... 139.11 151.64
Net loans charged off to average total loans(3)....... 0.97 0.80
Nonperforming assets to total loans, distressed loans
held for sale, and foreclosed assets.................. 1.80 1.46
Nonperforming assets to total assets.................. 1.25 0.96
- -----------
<FN>
(1) Amounts are on a taxable-equivalent basis using the federal statutory tax
rate of 35 percent.
(2) Dividends per share reflect dividends declared on UnionBanCal Corporation's
common stock outstanding as of the declaration date.
(3) Annualized.
(4) 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 $0.1 million in the first three months of 2002 and 2003, respectively.
</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) 2002 2003
- -------------------------------------------------------------------------------- ------------ -----------
INTEREST INCOME
Loans......................................................................... $ 375,798 $ 362,975
Securities.................................................................... 81,336 79,863
Interest bearing deposits in banks............................................ 496 962
Federal funds sold and securities purchased under resale agreements........... 4,059 1,677
Trading account assets........................................................ 691 927
------------ -----------
Total interest income......................................................... 462,380 446,404
------------ -----------
INTEREST EXPENSE
Domestic deposits............................................................. 59,935 41,571
Foreign deposits.............................................................. 6,264 3,206
Federal funds purchased and securities sold under repurchase agreements....... 1,949 1,327
Commercial paper.............................................................. 3,974 2,728
Medium and long-term debt..................................................... 2,412 1,866
UnionBanCal Corporation--obligated mandatorily redeemable preferred securities
of subsidiary grantor trust.................................................. 3,963 3,671
Other borrowed funds.......................................................... 3,443 1,255
------------ -----------
Total interest expense........................................................ 81,940 55,624
------------ -----------
NET INTEREST INCOME............................................................. 380,440 390,780
Provision for credit losses................................................... 55,000 30,000
------------ -----------
Net interest income after provision for credit losses......................... 325,440 360,780
------------ -----------
NONINTEREST INCOME
Service charges on deposit accounts........................................... 66,143 72,287
Trust and investment management fees.......................................... 36,725 32,675
International commissions and fees............................................ 18,223 19,613
Insurance commissions......................................................... 7,153 13,005
Card processing fees, net..................................................... 8,545 9,687
Brokerage commissions and fees................................................ 9,632 8,866
Foreign exchange trading gains, net........................................... 6,447 6,934
Merchant banking fees......................................................... 6,945 6,018
Securities losses, net........................................................ (2,566) (522)
Other......................................................................... 2,502 17,213
------------ -----------
Total noninterest income...................................................... 159,749 185,776
------------ -----------
NONINTEREST EXPENSE
Salaries and employee benefits................................................ 178,876 198,107
Net occupancy................................................................. 23,381 27,636
Equipment..................................................................... 16,340 16,671
Communications................................................................ 13,941 13,844
Professional services......................................................... 9,503 12,014
Data processing............................................................... 8,991 8,484
Foreclosed asset expense...................................................... 125 51
Other......................................................................... 60,504 65,798
------------ -----------
Total noninterest expense..................................................... 311,661 342,605
------------ -----------
Income before income taxes.................................................... 173,528 203,951
Income tax expense............................................................ 58,751 68,434
------------ -----------
NET INCOME...................................................................... $ 114,777 $ 135,517
============ ===========
NET INCOME PER COMMON SHARE--BASIC.............................................. $ 0.73 $ 0.90
============ ===========
NET INCOME PER COMMON SHARE--DILUTED............................................ $ 0.73 $ 0.89
============ ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--BASIC............................... 156,228 150,616
============ ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--DILUTED............................. 157,811 152,013
============ ===========
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) 2002 2002 2003
- ------------------------------------------------------------------------ ----------- ------------ ------------
ASSETS
Cash and due from banks.................................................. $1,787,942 $2,823,573 $2,480,626
Interest bearing deposits in banks....................................... 110,147 278,849 226,893
Federal funds sold and securities purchased under resale agreements...... 2,109,600 1,339,700 1,736,800
----------- ------------ ------------
Total cash and cash equivalents........................................ 4,007,689 4,442,122 4,444,319
Trading account assets................................................... 221,179 276,021 305,102
Securities available for sale:
Securities pledged as collateral....................................... 120,560 157,823 117,092
Held in portfolio...................................................... 5,289,210 7,180,677 7,014,363
Loans (net of allowance for credit losses: March 31, 2002, $629,367;
December 31, 2002, $609,190; March 31, 2003, $586,197)................. 24,468,730 25,828,893 25,950,075
Due from customers on acceptances........................................ 136,303 62,469 128,401
Premises and equipment, net.............................................. 489,915 504,666 504,451
Intangible assets........................................................ 15,292 38,518 37,541
Goodwill................................................................. 68,623 150,542 150,846
Other assets............................................................. 1,404,430 1,528,042 1,735,153
----------- ------------ ------------
Total assets...........................................................$36,221,931 $40,169,773 $40,387,343
=========== ============ ============
LIABILITIES
Domestic deposits:
Noninterest bearing....................................................$11,878,768 $15,537,906 $15,727,203
Interest bearing....................................................... 14,540,336 15,258,479 15,944,421
Foreign deposits:
Noninterest bearing.................................................... 404,378 583,836 434,258
Interest bearing....................................................... 1,935,367 1,460,594 1,146,869
----------- ------------ ------------
Total deposits......................................................... 28,758,849 32,840,815 33,252,751
Federal funds purchased and securities sold under repurchase agreements.. 369,565 334,379 282,135
Commercial paper......................................................... 900,851 1,038,982 852,494
Other borrowed funds..................................................... 900,360 267,047 139,821
Acceptances outstanding.................................................. 136,303 62,469 128,401
Other liabilities........................................................ 827,925 1,083,836 1,142,278
Medium and long-term debt................................................ 399,673 418,360 418,388
UnionBanCal Corporation--obligated mandatorily redeemable preferred
securities of subsidiary grantor trust................................. 361,903 365,696 363,050
----------- ------------ ------------
Total liabilities...................................................... 32,655,429 36,411,584 36,579,318
----------- ------------ ------------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock:
Authorized 5,000,000 shares, no shares issued or outstanding as of
March 31, 2002, December 31, 2002, and March 31, 2003.................. -- -- --
Common stock--no stated value:
Authorized 300,000,000 shares, issued 156,336,338 shares as of March 31,
2002, 150,702,363 shares as of December 31, 2002, and 150,217,620 shares
as of March 31, 2003................................................... 1,172,479 926,460 905,668
Retained earnings........................................................ 2,307,150 2,591,635 2,685,019
Accumulated other comprehensive income................................... 86,873 240,094 217,338
----------- ------------ ------------
Total shareholders' equity............................................. 3,566,502 3,758,189 3,808,025
----------- ------------ ------------
Total liabilities and shareholders' equity.............................$36,221,931 $40,169,773 $40,387,343
=========== ============ ============
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) 2002 2003
- ------------------------------------------------------------------------- ----------------------- -----------------------
COMMON STOCK
Balance, beginning of period........................................... $1,181,925 $926,460
Dividend reinvestment plan............................................. 38 10
Deferred compensation--restricted stock................................ (3) --
Stock options exercised................................................ 25,345 5,691
Common stock repurchased(1)............................................ (34,826) (26,493)
---------- ----------
Balance, end of period................................................. $1,172,479 $905,668
---------- ----------
RETAINED EARNINGS
Balance, beginning of period........................................... $2,231,384 $2,591,635
Net income............................................................. 114,777 $114,777 135,517 $135,517
Dividends on common stock(2)........................................... (39,048) (42,189)
Deferred compensation--restricted stock................................ 37 56
---------- ----------
Balance, end of period................................................. $2,307,150 $2,685,019
---------- ----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of period........................................... $132,933 $240,094
Unrealized net gains on cash flow hedges, net of tax expense of $578
and $129 in the first three months of 2002 and 2003, respectively.... 933 208
Less: reclassification adjustment for net gains on cash flow hedges
included in net income, net of tax expense of $11,177 and $4,699 in
the first three months of 2002 and 2003, respectively................ (18,044) (7,587)
-------- --------
Net reduction in unrealized gains on cash flow hedges.................. (17,111) (7,379)
Unrealized holding losses arising during the period on securities
available for sale, net of tax benefit of $18,094 and $9,331 in the
first three months of 2002 and 2003, respectively.................... (30,519) (15,063)
Less: reclassification adjustment for losses on securities available
for sale included in net income, net of tax benefit of $981 and $200
in the first three months of 2002 and 2003, respectively............. 1,585 322
-------- --------
Net unrealized losses on securities available for sale................. (28,934) (14,741)
Foreign currency translation adjustment, net of tax benefit of $9 and
$394 in the first three months of 2002 and 2003, respectively........ (15) (636)
-------- --------
Other comprehensive loss............................................... (46,060) (46,060) (22,756) (22,756)
---------- -------- ---------- --------
Total comprehensive income............................................. $68,717 $112,761
======== ========
Balance, end of period................................................. $86,873 $217,338
---------- ----------
TOTAL SHAREHOLDERS' EQUITY............................................. $3,566,502 $3,808,025
========== ==========
- -----------
<FN>
(1) Common stock repurchased includes commission costs.
(2) Dividends per share were $0.25 and $0.28 for the first three months of
2002 and 2003, respectively. Dividends are based on UnionBanCal
Corporation's shares outstanding as of the declaration date.
</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) 2002 2003
- -------------------------------------------------------------------------------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................................... $ 114,777 $ 135,517
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Provision for credit losses................................................... 55,000 30,000
Depreciation, amortization and accretion...................................... 19,637 26,728
Provision for deferred income taxes........................................... 28,674 25,520
Loss on securities available for sale......................................... 2,566 522
Net increase in prepaid expenses.............................................. (90,796) (90,504)
Net (increase) decrease in fees and other charges receivable.................. 31,026 (60,338)
Net (increase) decrease in trading account assets............................. 8,518 (29,081)
Other, net.................................................................... (366,869) (30,036)
---------- ----------
Total adjustments............................................................. (312,244) (127,189)
---------- ----------
Net cash provided by (used in) operating activities........................... (197,467) 8,328
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale.......................... 1,106 2,600
Proceeds from matured and called securities available for sale................ 346,379 629,435
Purchases of securities available for sale.................................... (11,657) (452,657)
Net increase in loans......................................................... (158,071) (145,671)
Other, net.................................................................... (10,074) (20,765)
---------- ----------
Net cash provided by investing activities..................................... 167,683 12,942
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits...................................................... 202,650 411,936
Net decrease in federal funds purchased and securities sold under repurchase
agreements.................................................................. (49,249) (52,244)
Net increase (decrease) in commercial paper and other borrowed funds.......... 270,151 (313,714)
Common stock repurchased...................................................... (34,826) (26,493)
Payments of cash dividends.................................................... (39,143) (42,438)
Other, net.................................................................... 23,359 5,065
---------- ----------
Net cash provided by (used in) financing activities........................... 372,942 (17,888)
---------- ----------
Net increase in cash and cash equivalents....................................... 343,158 3,382
Cash and cash equivalents at beginning of period................................ 3,664,954 4,442,122
Effect of exchange rate changes on cash and cash equivalents.................... (423) (1,185)
---------- ----------
Cash and cash equivalents at end of period...................................... $4,007,689 $4,444,319
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest...................................................................... $ 79,347 $ 50,419
Income taxes.................................................................. 193 9,905
Loans transferred to foreclosed assets (OREO) and/or distressed loans held
for sale.................................................................... $ 116 $ --
See accompanying notes to condensed consolidated financial statements.
6
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(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, 2003 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, 2002. 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.
UnionBanCal Corporation is a commercial bank holding company and has, as
its major subsidiary, a banking subsidiary, Union Bank of California, N.A. (the
Bank). The Company provides a wide range of financial services to consumers,
small businesses, middle-market companies and major corporations, primarily in
California, Oregon, and Washington, but also nationally and internationally.
Since November 1999 through March 31, 2003, the Company has announced stock
repurchase plans totaling $400 million. The Company repurchased $86 million and
$27 million in 2002 and the first quarter of 2003, respectively, as part of
these repurchase plans. As of March 31, 2003, $33 million of the Company's
common stock is authorized for repurchase. In addition, on August 27, 2002, the
Company announced that it purchased $300 million of its common stock from its
majority owner, The Bank of Tokyo-Mitsubishi, Ltd. (BTM), which is a
wholly-owned subsidiary of Mitsubishi Tokyo Financial Group, Inc. At March 31,
2003, BTM owned approximately 65 percent of the Company's outstanding common
stock.
Certain amounts for prior periods have been reclassified to conform to
current financial statement presentation.
STOCK-BASED COMPENSATION-TRANSITION AND DISCLOSURE
In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure," which amends SFAS No. 123,
"Accounting for Stock-Based Compensation." This Statement provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. It also amends the disclosure
requirements to require prominent disclosure in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
disclosure requirements under this Statement are effective for financial
statements issued after December 15, 2002.
As allowed under the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended, the Company has chosen to continue to
recognize compensation expense using the intrinsic value-based method of valuing
stock options prescribed in Accounting Principles Board Opinion (APB)
7
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION AND NATURE OF OPERATIONS (CONTINUED)
No. 25, "Accounting for Stock Issued to Employees" and related Interpretations.
Under the intrinsic value-based method, compensation cost is measured as the
amount by which the quoted market price of the Company's stock at the date of
grant exceeds the stock option exercise price.
At March 31, 2003, the Company has two stock-based employee compensation
plans. For further discussion concerning our stock-based employee compensation
plans see Note 14--"Management Stock Plan" of the Notes to Consolidated
Financial Statements included in the Form 10-K for the year ended December 31,
2002. Only restricted stock awards have been reflected in compensation expense,
while all options granted under those plans had an exercise price equal to the
market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation.
QUARTER ENDED
MARCH 31,
---------------------
(DOLLARS IN THOUSANDS) 2002 2003
- ------------------------------------------------------------------------------- -------- --------
AS REPORTED NET INCOME......................................................... $114,777 $135,517
Stock option-based employee compensation expense (determined under fair
value based method for all awards, net of taxes)............................. (4,178) (5,956)
-------- --------
Pro forma net income, after stock option-based employee compensation expense... $110,599 $129,561
======== ========
EARNINGS PER SHARE--BASIC
As reported.................................................................... $ 0.73 $ 0.90
Pro forma...................................................................... $ 0.71 $ 0.86
EARNINGS PER SHARE--DILUTED
As reported.................................................................... $ 0.73 $ 0.89
Pro forma...................................................................... $ 0.70 $ 0.85
Compensation cost associated with the Company's unvested restricted stock
issued under the management stock plan is measured based on the market price of
the stock at the grant date and is expensed over the vesting period.
Compensation expense related to restricted stock awards for the first quarters
of 2002 and 2003 was not significant.
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR GUARANTORS AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 expands on the accounting
guidance of Statements No. 5, 57, and 107 and incorporates without change the
provisions of FIN 34, which is superseded. FIN 45 elaborates on the existing
disclosure requirements for most guarantees and requires that guarantors
recognize a liability for the fair value of guarantees at inception. The
disclosure requirements of FIN 45 are effective for financial statements periods
ending after December 15, 2002. The initial recognition and measurement
provisions of FIN 45 are applied on a prospective basis to guarantees issued or
modified after December 31, 2002. A complete
8
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
description of significant guarantees that have been entered into by the Company
may be found in "Note 7--Guarantees." Adopting the measurement provisions of FIN
45 did not have a material impact in the first quarter of 2003 and management
believes that it will not have a material impact on the Company's future
financial position or results of operations.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." The purpose of this interpretation is to provide guidance on
how to identify a variable interest entity (VIE) and determine when the assets,
liabilities, noncontrolling interests, and results of operations of a VIE need
to be included in a company's consolidated financial statements. A company that
holds variable interests in an entity will need to consolidate that entity if
the company's interest in the VIE is such that the company will absorb a
majority of the VIE's expected losses and/or receive a majority of the VIE's
expected residual returns, if they occur. New disclosure requirements are also
prescribed by FIN 46. FIN 46 became effective upon its issuance. As of March 31,
2003, the Company does not believe it has any VIE's for which this
interpretation would be applicable.
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, 2002 and 2003.
THREE MONTHS ENDED MARCH 31,
-------------------------------------------------
2002 2003
---------------------- ---------------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) BASIC DILUTED BASIC DILUTED
- ------------------------------------------------------ -------- -------- -------- --------
Net Income............................................ $114,777 $114,777 $135,517 $135,517
======== ======== ======== ========
Weighted average common shares outstanding............ 156,228 156,228 150,616 150,616
Additional shares due to:
Assumed conversion of dilutive stock options........ -- 1,583 -- 1,397
-------- -------- -------- --------
Adjusted weighted average common shares outstanding... 156,228 157,811 150,616 152,013
======== ======== ======== ========
Net income per share.................................. $ 0.73 $ 0.73 $ 0.90 $ 0.89
======== ======== ======== ========
9
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 4--ACCUMULATED OTHER COMPREHENSIVE INCOME
The following table presents a summary of the components of accumulated
other comprehensive income.
NET UNREALIZED GAINS
NET UNREALIZED GAINS ON SECURITIES FOREIGN CURRENCY
ON CASH FLOW HEDGES AVAILABLE FOR SALE TRANSLATION ADJUSTMENT
--------------------- --------------------- -----------------------
FOR THE THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003 2002 2003
- ------------------------------ ------- -------- ------- -------- -------- --------
Beginning balance............. $62,840 $104,368 $83,271 $147,450 $(12,205) $(10,649)
Change during the period...... (17,111) (7,379) (28,934) (14,741) (15) (636)
------- -------- ------- -------- -------- --------
Ending balance................ $45,729 $ 96,989 $54,337 $132,709 $(12,220) $(11,285)
======= ======== ======= ======== ======== ========
MINIMUM PENSION ACCUMULATED OTHER
LIABILITY ADJUSTMENT COMPREHENSIVE INCOME
-------------------- --------------------
FOR THE THREE MONTHS ENDED MARCH 31,
----------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003
- ----------------------------------------------------------- ------ ------- -------- --------
Beginning balance.......................................... $ (973) $(1,075) $132,933 $240,094
Change during the period................................... -- -- (46,060) (22,756)
------ ------- -------- --------
Ending balance............................................. $ (973) $(1,075) $86,873 $217,338
====== ======= ======== ========
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 range of
banking services, primarily to individuals and small businesses,
delivered generally through a tri-state network of branches and ATM's.
These services include commercial loans, mortgages, home equity lines
of credit, consumer loans, cash management and deposit services, 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 provides credit and cash
management and deposit 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, 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.
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
10
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 5--BUSINESS SEGMENTS (CONTINUED)
trading products to institutional and business clients of the Company
through the businesses described above.
The information, set forth in the tables on the following page, reflects
selected income statement and balance sheet items by business unit. The
information presented does not necessarily represent the business units'
financial condition and results of operations were they independent entities.
Unlike financial accounting, there is no authoritative body of guidance for
management accounting equivalent to US GAAP. Consequently, reported results are
not necessarily comparable with those presented by other companies.
The information in this table is derived from the internal management
reporting system used by management to measure the performance of the business
segments and the Company overall. The management reporting system assigns
balance sheet and income statement items to each business 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 business segment are assigned to that business. 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" 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 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 amount;
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 Pacific Rim Corporate Group, with assets at March 31, 2003 of
$337.6 million, which offers a range of credit, deposit, and
investment management products and services to companies in the US,
which are affiliated with companies headquartered in Japan; and
o the residual costs of support groups.
11
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 5--BUSINESS SEGMENTS (CONTINUED)
The business units' results for the prior periods have been restated to
reflect transfer pricing changes and 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,
------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- --------------------------------------------------- -------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income................................ $182,999 $214,043 $156,195 $184,067 $ 9,505 $10,220
Noninterest income................................. 93,065 106,281 45,704 53,894 16,088 15,483
-------- -------- -------- -------- ------- -------
Total revenue...................................... 276,064 320,324 201,899 237,961 25,593 25,703
Noninterest expense................................ 180,492 205,232 83,907 89,498 15,143 14,924
Credit expense (income)............................ 9,029 7,740 46,985 49,496 495 505
-------- -------- -------- -------- ------- -------
Income before income tax expense (benefit)......... 86,543 107,352 71,007 98,967 9,955 10,274
Income tax expense (benefit)....................... 33,103 41,063 23,057 31,845 3,808 3,930
-------- -------- -------- -------- ------- -------
Net income (loss).................................. $ 53,440 $ 66,289 $ 47,950 $ 67,122 $ 6,147 $ 6,344
-------- -------- -------- -------- ------- -------
TOTAL ASSETS (dollars in millions):................ $ 10,641 $ 12,300 $ 15,550 $ 15,318 $ 1,388 $ 2,146
======== ======== ======== ======== ======= =======
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
---------------------- ------------------- ---------------------
AS OF AND FOR THE THREE MONTHS ENDED MARCH 31,
--------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- --------------------------------------------------- ------- -------- ------- ------- -------- --------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income................................ $12,705 $(33,618) $19,036 $16,068 $380,440 $390,780
Noninterest income................................. 1,518 1,526 3,374 8,592 159,749 185,776
------- -------- ------- ------- -------- --------
Total revenue...................................... 14,223 (32,092) 22,410 24,660 540,189 576,556
Noninterest expense................................ 3,914 4,113 28,205 28,838 311,661 342,605
Credit expense (income)............................ 50 50 (1,559) (27,791) 55,000 30,000
------- -------- ------- ------- -------- --------
Income (loss) before income tax expense (benefit).. 10,259 (36,255) (4,236) 23,613 173,528 203,951
Income tax expense (benefit)....................... 3,924 (13,868) (5,141) 5,464 58,751 68,434
------- -------- ------- ------- -------- --------
Net income (loss).................................. $ 6,335 $(22,387) $ 905 $18,149 $114,777 $135,517
------- -------- ------- ------- -------- --------
TOTAL ASSETS (dollars in millions):................ $ 7,718 $ 9,359 $ 925 $ 1,264 $ 36,222 $ 40,387
======= ======== ======= ======= ======== ========
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
derivatives to manage the sensitivity of the Company's net interest income to
changes in interest rates. These instruments are used to manage interest rate
risk relating to specified groups of assets and liabilities, primarily
LIBOR-based commercial loans, certificates of deposit, trust preferred
securities and medium-term notes.
12
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
(CONTINUED)
CASH FLOW HEDGES
HEDGING STRATEGIES FOR VARIABLE RATE LOANS AND CERTIFICATES OF DEPOSIT
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. The maximum length of time
over which the Company is hedging these exposures is 6.5 years.
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 floor 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 the relevant
LIBOR index to the extent it falls below the corridor's lower strike rate.
The Company uses interest rate collars to hedge the variable cash flows
associated with 1-month LIBOR or 3-month LIBOR indexed loans. Net payments to be
received under the collar contracts offset the decline in loan interest income
caused by the relevant LIBOR index falling below the collar's strike rate while
net payments to be paid will reduce the increase in loan interest income caused
by the LIBOR index rising above the collar's cap strike rate.
The Company uses interest rate swaps to hedge the variable cash flows
associated with 1-month LIBOR or 3-month LIBOR indexed loans. 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 the relevant LIBOR index.
The Company uses purchased interest rate caps to hedge the variable
interest cash flows associated with the forecasted issuance and rollover of
short-term, fixed rate negotiable certificates of deposit (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 occurs is equal to
the term of the hedge. As such, most of the ineffectiveness in the hedging
relationship results from
13
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
(CONTINUED)
the mismatch between the timing of reset dates on the hedge versus those of the
loans or CDs. In the first quarter of 2003, the Company recognized a net gain of
$0.1 million due to ineffectiveness, which is recognized in noninterest expense,
compared to a net loss of $0.1 million in the first quarter of 2002.
FAIR VALUE HEDGES
HEDGING STRATEGY FOR UNIONBANCAL CORPORATION--OBLIGATED MANDATORILY
REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY GRANTOR TRUST (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.
The ineffectiveness on the fair value hedges in the first quarter of 2003 was a
net gain of $0.1 million, compared to a net loss of $0.1 million in the first
quarter of 2002.
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 issuance, 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.
The Company uses To-Be-Announced (TBA) contracts to fix the price and yield
of anticipated purchases or sales of mortgage-backed securities that will be
delivered at an agreed upon date. This strategy hedges the risk of variability
in the cash flows to be paid or received upon settlement of the TBA contract.
14
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 7--GUARANTEES
Standby and commercial letters of credit are conditional commitments issued
to guarantee the performance of a customer to a third party. Standby letters of
credit generally are contingent upon the failure of the customer to perform
according to the terms of the underlying contract with the third party, while
commercial letters of credit are issued specifically to facilitate foreign or
domestic trade transaction. The majority of these types of commitments have
terms of one year or less. Collateral may be obtained based on management's
credit assessment of the customer. As of March 31, 2003, the Company's maximum
exposure to loss for standby and commercial letters of credit is $2.8 billion
and $282.4 million, respectively.
The Company has contingent consideration agreements that guarantee
additional payments to acquired insurance agencies' shareholders based on the
agencies future performance in excess of established revenue and/or earnings
before interest, taxes, depreciation and amortization (EBITDA) thresholds. If
the insurance agencies' future performance exceeds these thresholds during a
three-year period, the Company will be liable to make payments to former
shareholders. As of March 31, 2003, the Company has a maximum exposure of $12.9
million for these agreements, which expire December 2005.
The Company is fund manager for limited liability corporations issuing
low-income housing investments. Low-income housing investments provide tax
benefits to investors in the form of tax deductions from operating losses and
tax credits. To facilitate the sale of these investments, the Company guarantees
the timely completion of projects and delivery of tax benefits throughout the
investment term. Guarantees may include a minimum rate of return, the
availability of tax credits, and operating deficit thresholds over a ten-year
average period. Additionally, the Company receives project completion and tax
credit guarantees from the limited liability corporations issuing the
investments that reduce the Company's ultimate exposure to loss. As of March 31,
2003, the Company's maximum exposure to loss under these guarantees is limited
to a return of investor capital and minimum investment yield, or $77.0 million.
The Company maintains a liability of $2.6 million for these guarantees.
The Company has guarantees that obligate it to perform if its affiliates
are unable to discharge their obligations. These obligations include guarantee
of trust preferred securities, commercial paper obligations and leveraged lease
transactions. Guarantees issued by the Bank for an affiliate's commercial paper
program are done in order to facilitate their sale. As of March 31, 2003, the
Bank had a maximum exposure to loss under these guarantees of $852.5 million,
which have an average term of less than one year. The Bank's guarantee is fully
collateralized by a pledged deposit. UnionBanCal Corporation guarantees its
subsidiaries' leveraged lease transactions, which have terms ranging from 15 to
30 years. Following the original funding of the leveraged lease transactions,
UnionBanCal Corporation has no material obligation to be satisfied. As of March
31, 2003, UnionBanCal Corporation had a maximum exposure to loss of $33.0
million for these agreements.
NOTE 8--SUBSEQUENT EVENTS
On April 1, 2003, the Company completed its acquisition of Tanner Insurance
Brokers, Inc, a regional insurance broker based in Pleasanton, California.
On April 7, 2003, the Company signed a definitive agreement to acquire
Monterey Bay Bank, a community bank with $610 million in assets and 8 branches.
The Company will pay a consideration of
15
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2003
(UNAUDITED)
NOTE 8--SUBSEQUENT EVENTS (CONTINUED)
approximately $96.5 million, comprising approximately equal parts cash and
common stock. The acquisition is expected to close in the third quarter of 2003.
On April 23, 2003, the Board of Directors declared a quarterly cash
dividend of $0.31 per share of common stock. The dividend will be paid on July
3, 2003 to shareholders of record as of June 6, 2003.
On April 23, 2003, the Board of Directors authorized the repurchase of an
additional $100 million of the Company's common stock.
On April 23, 2003, the shareholders of the Company's common stock approved
a proposal to change UnionBanCal Corporation's state of incorporation from
California to Delaware. Subject to regulatory approvals, the reincorporation is
expected to be completed by the end of the third quarter of 2003.
16
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. WE MAY MAKE
FORWARD-LOOKING STATEMENTS IN OTHER UNITED STATES SECURITIES AND EXCHANGE
COMMISSION (SEC) 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.
WE DO NOT UNDERTAKE TO UPDATE FORWARD-LOOKING STATEMENTS TO REFLECT FACTS,
CIRCUMSTANCES, ASSUMPTIONS OR EVENTS THAT OCCUR AFTER THE DATE THE
FORWARD-LOOKING STATEMENTS ARE MADE.
THERE ARE NUMEROUS RISKS AND UNCERTAINTIES THAT COULD AND WILL CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN OUR FORWARD-LOOKING
STATEMENTS. MANY OF THESE FACTORS ARE BEYOND OUR ABILITY TO CONTROL OR PREDICT
AND COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR STOCK PRICE, FINANCIAL
CONDITION, AND 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, THE
WAR IN IRAQ, ADVERSE ECONOMIC CONDITIONS AFFECTING CERTAIN INDUSTRIES, INCLUDING
POWER COMPANIES AND THE AIRLINE INDUSTRY, FLUCTUATIONS IN INTEREST RATES, THE
CONTROLLING INTEREST IN US OF THE BANK OF TOKYO-MITSUBISHI, LTD. (BTM), 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 "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION."
ALL REPORTS THAT WE FILE ELECTRONICALLY WITH THE SEC, INCLUDING THE ANNUAL
REPORT ON FORM 10-K, QUARTERLY REPORTS ON FORM 10-Q, AND CURRENT REPORTS ON FORM
8-K, AS WELL AS ANY AMENDMENTS TO THOSE REPORTS, ARE ACCESSIBLE AT NO COST ON
OUR INTERNET WEBSITE AT WWW.UBOC.COM. THESE FILINGS ARE ALSO ACCESSIBLE ON THE
SEC'S WEBSITE AT WWW.SEC.GOV.
INTRODUCTION
We are a California-based, commercial bank holding company incorporated in
California, with consolidated assets of $40.4 billion at March 31, 2003. At
March 31, 2003, Union Bank of California, N.A. (the Bank) was the fourth 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., were 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.
Since November 1999 through March 31, 2003, we have announced stock
repurchase plans totaling $400 million. We repurchased $86 million and $27
million in 2002 and the first quarter of 2003, respectively, as part of these
repurchase plans. As of March 31, 2003, $33 million of our common stock is
authorized for repurchase. In addition, on August 27, 2002, we announced that we
purchased $300 million of our common stock from our majority owner, BTM. At
March 31, 2003, BTM owned approximately 65 percent of our outstanding common
stock.
17
SUMMARY
Net income was $135.5 million, or $0.89 per diluted common share, in the
first quarter of 2003, compared with $114.8 million, or $0.73 per diluted common
share, in the first quarter of 2002. This increase in diluted earnings per share
of $0.16, or 22 percent, above the first quarter of 2002 was due to a $26.0
million, or 16 percent, increase in noninterest income, a $25.0 million, or 46
percent, decrease in provision for credit losses, and a $10.4 million, or 3
percent, increase in net interest income (on a taxable-equivalent basis), partly
offset by a $30.9 million, or 10 percent, increase in noninterest expense. Other
highlights of the first quarter of 2003 include:
o Net interest income, on a taxable-equivalent basis, was $391.4 million
in the first quarter of 2003, an increase of $10.4 million, or 3
percent, over the first quarter of 2002. Net interest margin in the
first quarter of 2003 was 4.53 percent, a decrease of 27 basis points
from the first quarter of 2002.
o A provision for credit losses of $30.0 million was recorded in the
first quarter of 2003 compared with $55.0 million in the first quarter
of 2002. This resulted from management's regular assessment of overall
credit quality, loan portfolio composition, and business and economic
conditions in relation to the level of the allowance for credit
losses. The allowance for credit losses was $586.2 million, or 152
percent of total nonaccrual loans, at March 31, 2003, compared with
$629.4 million, or 139 percent of total nonaccrual loans, at March 31,
2002.
o Noninterest income was $185.8 million in the first quarter of 2003, an
increase of $26.0 million, or 16 percent, from the first quarter of
2002. This increase included a $6.1 million increase in service
charges on deposit accounts, a decline in private capital securities
losses, net of $6.8 million, a $5.9 million increase in insurance
commissions mostly associated with our acquisition of John Burnham &
Company, and lower residual value writedowns on auto leases of $5.7
million, partly offset by a $4.1 million decrease in trust and
investment management fees.
o Noninterest expense was $342.6 million in the first quarter of 2003,
an increase of $30.9 million, or 10 percent, over the first quarter of
2002. Salaries and employee benefits increased by $19.2 million, or 11
percent, primarily attributable to higher salaries of $9.4 million and
higher employee benefits of $8.6 million.
o Income tax expense in the first quarter of 2003 was $68.4 million, a
34 percent effective income tax rate. For the first quarter of 2002,
the effective income tax rate was also 34 percent.
o Return on average assets increased to 1.43 percent in the first
quarter of 2003 compared to 1.33 percent in the first quarter of 2002.
Our return on average shareholders' equity increased to 14.19 percent
in the first quarter of 2003 compared to 12.84 percent in the first
quarter of 2002.
o Total loans at March 31, 2003 were $26.5 billion, an increase of $1.4
billion, or 6 percent, from March 31, 2002 mainly due to a $1.3
billion increase in our residential mortgage portfolio.
o Nonperforming assets were $387.0 million at March 31, 2003, a decrease
of $65.8 million, or 15 percent, from March 31, 2002. Nonperforming
assets, as a percentage of total assets, decreased to 0.96 percent at
March 31, 2003, compared with 1.25 percent at March 31, 2002. Total
nonaccrual loans were $386.6 million at March 31, 2003, compared with
$452.4 million at March 31, 2002, contributing to a decrease in the
ratio of nonaccrual loans to total loans of 1.46 percent at March 31,
2003 from 1.80 percent at March 31, 2002.
o Our Tier 1 and total risk-based capital ratios were 11.33 percent and
13.08 percent, respectively, at March 31, 2003, compared with 11.63
percent and 13.50 percent, respectively, at March 31, 2002. Our
leverage ratio was 9.80 percent at March 31, 2003 compared with 10.65
percent at March 31, 2002.
18
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 equity
prices. 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 tables have 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. 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. A
performance center's purpose is to foster cross-selling with a total
profitability view of the products and services it manages. For example, the
Global Markets Trading and Sales unit, within the Global Markets Group, is a
performance center that manages the foreign exchange, derivatives, and fixed
income securities activities within the Global Markets organization. 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.
19
We have restated the business units' results for the prior periods to
reflect transfer pricing changes and 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,
-------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
-------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER
EARNINGS (DOLLARS IN THOUSANDS):
Net interest income.............................. $182,999 $214,043 $156,195 $184,067 $ 9,505 $10,220
Noninterest income............................... 93,065 106,281 45,704 53,894 16,088 15,483
-------- -------- -------- -------- ------- -------
Total revenue.................................... 276,064 320,324 201,899 237,961 25,593 25,703
Noninterest expense.............................. 180,492 205,232 83,907 89,498 15,143 14,924
Credit expense (income).......................... 9,029 7,740 46,985 49,496 495 505
-------- -------- -------- -------- ------- -------
Income (loss) before income tax expense (benefit) 86,543 107,352 71,007 98,967 9,955 10,274
Income tax expense (benefit)..................... 33,103 41,063 23,057 31,845 3,808 3,930
-------- -------- -------- -------- ------- -------
Net income (loss)................................ $ 53,440 $ 66,289 $ 47,950 $ 67,122 $ 6,147 $ 6,344
======== ======== ======== ======== ======= =======
PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income.............................. $ 222 $ 186 $ (346) $ (191) $ -- $ 4
Noninterest income............................... (10,874) (8,706) 13,412 13,184 885 332
Noninterest expense.............................. (8,050) (7,047) 6,721 7,148 766 252
Net income (loss)................................ (1,627) (930) 3,961 3,653 73 52
Total loans (dollars in millions)................ 25 27 (45) (47) -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................... $ 9,543 $ 11,130 $ 14,121 $ 13,516 $ 1,016 $ 1,525
Total assets..................................... 10,417 12,198 15,754 15,414 1,310 1,923
Total deposits(1)................................ 14,791 17,166 7,906 9,969 1,558 1,518
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............... 38% 42% 12% 16% 38% 44%
Return on average assets(2)...................... 2.08 2.20 1.23 1.76 1.90 1.34
Efficiency ratio(3).............................. 65.4 64.1 41.6 37.6 59.2 58.1
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
---------------------- ---------------------- --------------------
AS OF AND FOR THE THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
------- -------- ------- ------- -------- --------
RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER
EARNINGS (DOLLARS IN THOUSANDS):
Net interest income............................ $12,705 $(33,618) $19,036 $16,068 $380,440 $390,780
Noninterest income............................. 1,518 1,526 3,374 8,592 159,749 185,776
------- -------- ------- ------- -------- --------
Total revenue.................................. 14,223 (32,092) 22,410 24,660 540,189 576,556
Noninterest expense............................ 3,914 4,113 28,205 28,838 311,661 342,605
Credit expense (income)........................ 50 50 (1,559) (27,791) 55,000 30,000
------- -------- ------- ------- -------- --------
Income (loss) before income tax expense (benefit) 10,259 (36,255) (4,236) 23,613 173,528 203,951
Income tax expense (benefit)................... 3,924 (13,868) (5,141) 5,464 58,751 68,434
------- -------- ------- ------- -------- --------
Net income (loss).............................. $ 6,335 $(22,387) $ 905 $18,149 $114,777 $135,517
======= ======== ======= ======= ======== ========
PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income............................ $ -- $ (102) $ 124 $ 103 $ -- $ --
Noninterest income............................. (6,634) (8,072) 3,211 3,262 -- --
Noninterest expense............................ (1,015) (1,628) 1,578 1,275 -- --
Net income (loss).............................. (3,470) (4,042) 1,063 1,267 -- --
Total loans (dollars in millions).............. -- -- 20 20 -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................. $ 100 $ 214 $ 348 $ 338 $ 25,128 $ 26,723
Total assets................................... 6,725 7,967 878 846 35,084 38,348
Total deposits(1).............................. 2,416 1,207 898 1,218 27,569 31,078
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............. 5% (9)% na na na na
Return on average assets(2).................... 0.38 (1.15) na na 1.33% 1.43%
Efficiency ratio(3)............................ 27.5 (12.8) na na 57.6 59.3
- -----------
<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 and noninterest
income. Foreclosed asset expense was $0.1 million in both the first
quarters of 2002 and 2003.
na = not applicable
</FN>
20
COMMUNITY BANKING AND INVESTMENT SERVICES GROUP
The Community Banking and Investment Services Group provides financial
products including a set of credit, deposit, trust, risk management, and
insurance products delivered through branches, relationship managers, private
bankers, trust administrators, and insurance agents to individuals and small
businesses.
In the first quarter of 2003, net income increased $12.8 million, or 24
percent, compared to the first quarter of 2002. Total revenue increased $44.3
million, or 16 percent, compared to a year earlier. Increased asset and deposit
volumes offset the effect of a lower interest rate environment leading to an
increase of $31.0 million, or 17 percent, in net interest income over the prior
year. Excluding auto lease residual writedowns of $6.0 million and $0.3 million,
in the first quarter of 2002 and 2003, respectively, and the impact of
performance center earnings, noninterest income was $5.3 million, or 4 percent,
higher than the prior year primarily due to our acquisition of John Burnham &
Company, in the fourth quarter of 2002, and higher deposit-related service fees.
Noninterest expense increased $24.7 million, or 14 percent, in the first quarter
of 2003 compared to the first quarter of 2002 with the majority of that increase
being attributable to higher salaries and employee benefits mainly related to
acquisitions, deposit gathering, small business growth and residential loan
growth over the first quarter of 2002.
In 2002, the Community Banking and Investment Services Group emphasized
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 focused on mortgage and home equity
products that may be originated through the branch network, as well as through
channels such as wholesalers, correspondents, and whole loan purchases. As of
March 31, 2003, residential loans have grown by $1.3 billion, or 25 percent,
from the prior year. The Wealth Management division is focused on becoming a
growing provider of banking and investment products for affluent individuals in
geographic areas already served by us. We seek to provide quality service
superior to that of our competitors and offer our customers an attractive
product suite. Core elements of the initiative to extend our small business
franchise include improving our sales force, increasing marketing activities,
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. During 2002, we completed our acquisitions
of Valencia Bank and Trust, a commercial bank with $266 million in assets and
five branches, and First Western Bank, a commercial bank with $224 million in
assets and seven branches.
The Community Banking and Investment Services Group is comprised of six
major divisions: Community Banking, Wealth Management, Institutional Services
and Asset Management, Consumer Asset Management, Government and Not-For-Profit
Markets, and Insurance Services.
COMMUNITY BANKING serves its customers through 261 full-service branches in
California, 6 full-service branches in Oregon and Washington, and a network of
538 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 merchant services.
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 an array of customer
transaction, bill payment and loan payment services;
o through branches and 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.
21
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 financial services to
high net worth individuals with sophisticated financial needs as well
as to professional service firms. Specific products and services
include trust and estate services, investment account management
services, and deposit and credit products. A key strategy of The
Private Bank is to expand its business by leveraging existing Bank
client relationships. Through 13 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
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 institutional clients and its
proprietary mutual funds, the affiliated HighMark Funds. It also
provides advisory services to Union Bank of California, N.A. trust and
agency clients, including corporations, pension funds and individuals.
HighMark Capital Management, Inc. also provides mutual fund support
services. HighMark Capital Management, Inc.'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.
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. As
we announced on April 30, 2002, we acquired a substantial portion of
the trust and institutional custody business of a bank located in
Southern California.
CONSUMER ASSET MANAGEMENT is the centralized underwriting, processing,
servicing, collection and administration for consumer assets including
residential loans and merchant bank cards.
o Consumer Asset Management is centralized in two California sites, one
in San Diego and one in Brea, and
o provides customer and credit management services for consumer loan
products.
CERTAIN INDUSTRY DEVELOPMENTS
Union Bank of California is a member of MasterCard International
Incorporated ("MCI"), VISA U.S.A., Inc. and VISA International, Inc. (together,
"Visa"), is an issuer of debit cards, primarily of the MCI "MasterMoney" card,
and is an MCI and Visa merchant bank card services bank.
In 1996, Wal-Mart Stores, Inc. and several other retailers sued MCI and
Visa in cases now pending in federal court in New York, asserting that MCI and
Visa's rules regarding uniform acceptance of all Visa and MasterCard credit and
debit cards were an illegal tying arrangement.
Prior to trial, MCI and Visa agreed to settle these cases. The settlements
reportedly remain subject to court approval. Neither we nor Union Bank of
California are a party to these suits, and neither will be
22
directly liable for these settlements. However, MCI or Visa may seek to assess,
or assert claims against, their members to fund the settlements. In addition,
even if no direct claim is asserted against members, the implementation of the
settlements could adversely affect their operations.
In the year ended December 31, 2002, interchange income from our debit card
operations was less than one percent of our gross revenues. While our 2003 debit
card interchange income can be expected to be reduced somewhat if the
settlements are approved and implemented in the current year, we cannot predict
what effect the settlements will have on the competitive environment or our
future earnings from debit card operations.
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.
The division, 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 and
universities, trade associations, cultural institutions, and religious
non-profit organizations. The division's strategy is to expand its market
presence by continued delivery of cash management products, internet based
technology solutions, and expanding its tax-exempt lending capabilities to meet
existing clients' needs.
INSURANCE SERVICES provides a range of risk management services and
insurance products to business and retail customers. The group, which includes
our fourth quarter 2001 acquisition of Armstrong/Robitaille, Inc., a regional
insurance broker, and our fourth quarter 2002 acquisition of John Burnham &
Company, 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 attempting to provide service
quality superior to that of its major competitors. The group's primary means of
competing with community banks include its branch network and its technology to
deliver banking services. The group also offers 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, Citibank,
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 financing and cash
management services to middle-market and large corporate businesses primarily
headquartered in the western United States. The Commercial Financial Services
Group has continued to focus specialized financing expertise to specific
geographic markets and industry segments such as energy, entertainment, and real
estate. Relationship managers 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 cash management services delivered through deposit managers with experience
in cash management solutions for businesses.
In the first quarter of 2003, net income increased $19.2 million, or 40
percent, compared to the first quarter of 2002. Net interest income increased
$27.9 million, or 18 percent, partially attributable to the impact of increasing
deposit balances and a lower cost of funds resulting from the lower interest
rate
23
environment. Beginning in 2003, the transfer pricing credit for funds provides
for a floor on analyzed DDA balances, which was triggered during the first
quarter of 2003. Had such a floor existed in the first quarter of 2002, net
interest income would have been higher by approximately $11 million. Excluding
lower net losses in the private equity portfolio of $6.8 million in the first
quarter of 2003, noninterest income increased $1.4 million, or 3 percent. This 3
percent increase was mainly attributable to higher deposit-related service fees.
Noninterest expense increased $5.6 million, or 7 percent, compared to a year
earlier due to higher expenses to support increased product sales and deposit
volume. Credit expense increased $2.5 million mainly attributable to a
refinement in the RAROC allocation of capital and expected losses.
The group's initiatives during 2002 included expanding wholesale deposit
activities and increasing domestic trade financing. Loan growth strategies
included 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 provides strong processing services, including services
such as check processing, front-end item processing, cash vault services and
digital imaging.
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 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 limited
merchant and investment banking related products and services;
o the Real Estate Industries Division, which provides real estate
lending products such as construction loans, commercial mortgages and
bridge financing;
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, nationwide; and
o the National Banking Division, which provides custom financing to
middle-market and large corporate clients in their defined industries
and geographic markets.
The group competes with other banks primarily on the basis of the quality
of its relationship managers, the delivery of quality customer service, and its
reputation as a "business bank."
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, the group competes 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
24
selected countries where we have branches, including Hong Kong, Japan, Korea,
the Philippines and Taiwan. In the US, the group serves mostly 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 2003, net income increased $0.2 million, or 3
percent, compared to the first quarter of 2002. Total revenue in the first
quarter of 2003 increased $0.1 million, or less than 1 percent, compared to the
first quarter of 2002. Net interest income increased $0.7 million, or 8 percent,
from the first quarter of 2002, mainly due to higher loan volume. Noninterest
income was $0.6 million, or 4 percent, lower than the first quarter of 2002,
mainly attributable to lower merchant card activity in the current year, mostly
offset by higher foreign remittance and collection commissions, reflecting a
strategic focus on this business. Noninterest expense decreased $0.2 million, or
1 percent, compared to the first quarter of 2002, with the majority of that
decrease attributable to merchant card activity. Credit expense was relatively
unchanged from the first quarter of 2002. The International Banking Group's
business revolves around short-term trade financing, mostly to banks, which we
believe tends to result in service-related income, as well as, significantly
lower credit risk when compared to other lending activities.
The group has a long history of providing correspondent banking and
trade-related products and services to international financial institutions. We
believe the group continues to achieve strong customer loyalty in the
correspondent banking market. 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 our institutional and business
clients. Another primary area of the group is treasury management for our
Company, which encompasses wholesale funding, liquidity management, interest
rate risk management, including securities portfolio management, and hedging
activities. The Global Markets Group results include the transfer pricing
activity for the Bank, which allocates to the other business segments their cost
of funds on all asset categories or credit for funds in the case of all
liability categories.
In the first quarter of 2003, net loss was $22.4 million compared to net
income of $6.3 million in the first quarter of 2002. Total revenue in the first
quarter of 2003 decreased by $46.3 million, or 326 percent, compared to the
first quarter of 2002, resulting from a $46.3 million decrease in net interest
income. The decrease in net interest income was primarily attributable to a
higher transfer pricing residual in the current quarter caused by significantly
higher quarter-over-prior year quarter growth in deposits, which are priced on
longer-term liability rates, compared to credits on earning assets, which are
priced on more short-term lending rates. Beginning in 2003, the transfer pricing
credit for funds provides for a floor on analyzed DDA balances, which was
triggered during the first quarter 2003. Had such a floor existed in the first
quarter of 2002, net interest income would have declined by approximately $11
million. Compared to the first quarter of 2002, noninterest income was
relatively unchanged in the first quarter of 2003. Compared to the first quarter
of 2002, noninterest expense increased $0.2 million, or 5 percent.
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 certain other
nonrecurring items such as merger and integration
25
expense, certain parent company non-bank subsidiaries, and the
elimination of the fully taxable-equivalent basis amount;
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 Pacific Rim Corporate Group, with assets at March 31, 2003 of
$337.6 million, which offers a range of credit, deposit, and
investment management products and services to companies in the US,
which are affiliated with companies headquartered in Japan; and
o the residual costs of support groups.
Net income for "Other" in the first quarter of 2003 was $18.1 million. The
results were impacted by the following factors:
o Credit expense (income) of ($27.8) million was due to the difference
between the $30.0 million in provision for credit losses calculated
under our US GAAP methodology and the $57.8 million in expected losses
for the reportable business segments, which utilizes the RAROC
methodology;
o Net interest income of $16.1 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 deposits in the Pacific Rim Corporate
Group;
o Noninterest income of $8.6 million; and
o Noninterest expense of $28.8 million.
Net income for "Other" in the first quarter of 2002 was $0.9 million. The
results were impacted by the following factors:
o Credit expense (income) of ($1.6) million was due to the difference
between the $55.0 million in provision for credit losses calculated
under our US GAAP methodology and the $56.6 million in expected losses
for the reportable business segments, which utilizes the RAROC
methodology; offset by
o Net interest income of $19.0 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 deposits in the Pacific Rim Corporate
Group;
o Noninterest income of $3.4 million; and
o Noninterest expense of $28.2 million.
26
NET INTEREST INCOME
The following tables show the major components of net interest income and
net interest margin.
FOR THE THREE MONTHS ENDED
----------------------------------------------------------------------------------------
MARCH 31, 2002 MARCH 31, 2003
----------------------------------------- -----------------------------------------
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......................... $24,088,142 $ 368,062 6.17% $25,186,678 $ 355,073 5.70%
Foreign(3)....................... 1,039,615 7,922 3.09 1,536,379 8,166 2.16
Securities--taxable................ 5,552,344 80,663 5.81 7,014,825 79,179 4.52
Securities--tax-exempt............. 38,233 991 10.37 41,943 1,014 9.67
Interest bearing deposits in banks. 84,408 496 2.38 203,432 962 1.92
Federal funds sold and securities
purchased under resale agreements 936,382 4,059 1.76 536,114 1,677 1.27
Trading account assets............. 237,369 720 1.23 307,400 957 1.26
----------- --------- ----------- ----------
Total earning assets............. 31,976,493 462,913 5.84 34,826,771 447,028 5.18
--------- ----------
Allowance for credit losses........ (644,379) (603,240)
Cash and due from banks............ 1,942,621 2,094,976
Premises and equipment, net........ 496,269 506,964
Other assets....................... 1,312,523 1,522,732
----------- -----------
Total assets..................... $35,083,527 $38,348,203
=========== ===========
LIABILITIES
Domestic deposits:
Interest bearing................. $ 7,459,506 23,157 1.26 $ 9,365,182 18,809 0.81
Savings and consumer time........ 3,549,262 16,970 1.94 3,819,545 12,316 1.31
Large time....................... 3,485,482 19,808 2.30 2,414,309 10,446 1.75
Foreign deposits(3)................ 1,749,251 6,264 1.45 1,384,177 3,206 0.94
----------- --------- ----------- ----------
Total interest bearing deposits.. 16,243,501 66,199 1.65 16,983,213 44,777 1.07
----------- --------- ----------- ----------
Federal funds purchased and
securities sold under repurchase
agreements....................... 541,182 1,949 1.46 517,511 1,327 1.04
Commercial paper................... 919,259 3,974 1.75 923,327 2,728 1.20
Other borrowed funds............... 698,053 3,443 2.00 172,870 1,255 2.94
Medium and long-term debt.......... 399,989 2,412 2.45 399,729 1,866 1.89
UnionBanCal Corporation--obligated
mandatorily redeemable preferred
securities of subsidiary grantor
trust............................ 352,300 3,963 4.46 351,654 3,671 4.13
----------- --------- ----------- ----------
Total borrowed funds.............. 2,910,783 15,741 2.19 2,365,091 10,847 1.85
----------- --------- ----------- ----------
Total interest bearing liabilities 19,154,284 81,940 1.73 19,348,304 55,624 1.16
--------- ----------
Noninterest bearing deposits....... 11,325,446 14,095,175
Other liabilities.................. 979,030 1,030,431
----------- -----------
Total liabilities................ 31,458,760 34,473,910
SHAREHOLDERS' EQUITY
Common equity...................... 3,624,767 3,874,293
----------- -----------
Total shareholders' equity....... 3,624,767 3,874,293
----------- -----------
Total liabilities and
shareholders' equity............. $35,083,527 $38,348,203
=========== ===========
Net interest income/margin
(taxable-equivalent basis)....... 380,973 4.80% 391,404 4.53%
Less: taxable-equivalent adjustment 533 624
--------- ----------
Net interest income.............. $ 380,440 $ 390,780
========= ==========
- -----------
<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>
27
Net interest income, on a taxable-equivalent basis, was $391.4 million in
the first quarter of 2003, compared with $381.0 million in the first quarter of
2002. This increase of $10.4 million, or 3 percent, was attributable primarily
to the impact of the decreasing interest rate environment throughout the prior
year on interest bearing liabilities, increasing average noninterest bearing
deposits, and higher earning assets, partly offset by significantly lower yields
on our earning assets. Decreasing market rates resulted in lower rates on our
interest bearing liabilities of 57 basis points on average balances of $19.3
billion, which was partly offset by a lower average yield of 66 basis points on
average earning assets of $34.8 billion, which was favorably impacted by higher
interest rate derivatives income of $5.4 million. Mitigating the impact of the
lower interest rate environment on our net interest margin was an increase in
average earning assets of $2.8 billion, primarily in residential mortgage loans
and securities, funded by a $2.8 billion, or 25 percent, increase in average
noninterest bearing deposits. The resulting impact of these changes on our net
interest margin was a decrease of 27 basis points, to 4.53 percent.
Average earning assets were $34.8 billion in the first quarter of 2003,
compared with $32.0 billion in 2002. This growth was attributable to a $1.5
billion, or 26 percent, increase in average securities and a $1.6 billion, or 6
percent, increase in average loans. The increase in average securities, which
were comprised primarily of fixed rate securities, reflected liquidity and
interest rate risk management actions. The increase in average loans was mostly
due to a $1.5 billion increase in average residential mortgages, which was a
result of a strategic portfolio shift from more volatile commercial loans. Other
loan activities included an increase in average commercial mortgages of $521.6
million and a decrease in average commercial, financial, and industrial loans of
$404.9 million.
Deposit growth, especially in our title and escrow industries, has been a
continued strength, contributing significantly to our lower cost of funds
year-over-year. Average noninterest bearing deposits were $2.8 billion, or 25
percent, higher in the first quarter of 2003 over the prior year, which included
a $0.8 billion increase in average title and escrow deposits.
NONINTEREST INCOME
FOR THE THREE MONTHS ENDED
------------------------------------------------
INCREASE (DECREASE)
MARCH 31, MARCH 31, -------------------
(DOLLARS IN THOUSANDS) 2002 2003 AMOUNT PERCENT
- -------------------------------------------- --------- --------- ------- -------
Service charges on deposit accounts......... $ 66,143 $ 72,287 $ 6,144 9.29%
Trust and investment management fees........ 36,725 32,675 (4,050) (11.03)
International commissions and fees.......... 18,223 19,613 1,390 7.63
Insurance commissions....................... 7,153 13,005 5,852 81.81
Card processing fees, net................... 8,545 9,687 1,142 13.36
Brokerage commissions and fees.............. 9,632 8,866 (766) (7.95)
Foreign exchange trading gains, net......... 6,447 6,934 487 7.55
Merchant banking fees....................... 6,945 6,018 (927) (13.35)
Securities losses, net...................... (2,566) (522) 2,044 (79.66)
Other....................................... 2,502 17,213 14,711 587.97
--------- --------- -------
Total noninterest income.................. $159,749 $185,776 $26,027 16.29%
========= ========= =======
In the first quarter of 2003, noninterest income was $185.8 million, an
increase of $26.0 million, or 16 percent, over the first quarter of 2002. This
increase was mainly attributable to a $6.1 million increase in service charges
on deposit accounts, $5.9 million increase in insurance commissions mostly
associated with our acquisition of John Burnham & Company, a $4.8 million
decrease in net unrealized losses on private capital securities, and lower
residual value writedowns on auto leases of $5.7 million, partly offset by a
$4.1 million decrease in trust and investment management fees. In addition,
securities losses, net, were $0.5 million in the first quarter of 2003 compared
to securities losses, net, of $2.6 million in the first quarter of 2002.
28
Revenue from service charges on deposit accounts was $72.3 million, an
increase of 9 percent over the first quarter of 2002. This increase was
primarily attributable to a 24 percent increase in quarterly average demand
deposits and reductions in the earnings credit rates, caused by the lower
interest rate 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 $32.7 million, a decrease of $4.1
million, or 11 percent, over the first quarter of 2002. This decrease is
primarily attributable to the decline in equity market values and a continuing
shift by our clients toward lower margin fixed income and money market
investments. Total assets under administration of $132.1 billion at March 31,
2003 decreased by $6.7 billion, or 5 percent, from March 31, 2002.
Insurance commissions were $13.0 million reflecting the incremental
revenues associated with our acquisition of John Burnham & Company in the fourth
quarter of 2002 and growth in insurance commissions at Armstrong/Robitaille,
Inc.
Card processing fees, net, were $9.7 million, an increase of 13 percent
over the first quarter of 2002. This increase was primarily attributable to an
increase in consumer usage of our enhanced Gold and Platinum versions of our
standard "MasterMoney" 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. Effective first quarter of 2003, merchant transaction
processing expenses were reclassified to card processing fees, net, to reflect
our agent relationship for these transactions. The reclassification reduced both
card processing fees and merchant transaction processing expense by $11.7
million for the first quarter of 2002.
Securities losses, net, were $0.5 million compared to securities losses,
net, of $2.6 million in the prior year. In the current quarter, we realized
gains of $0.2 million on the sale of securities, offset by permanent writedowns
on private capital securities of $0.7 million. In the first quarter of 2002, we
realized net gains of $0.4 million on the sale of securities, offset by
permanent writedowns on private capital securities of $3.0 million.
Other noninterest income was $17.2 million, an increase of $14.7 million
from the first quarter of 2002. This increase was mainly attributable to a $4.8
million decrease in net unrealized losses on private capital securities, lower
residual value writedowns on auto leases of $5.7 million, and a $3.3 million
insurance recovery from the September 11, 2001 World Trade Center attack.
29
NONINTEREST EXPENSE
FOR THE THREE MONTHS ENDED
------------------------------------------------
INCREASE (DECREASE)
MARCH 31, MARCH 31, -------------------
(DOLLARS IN THOUSANDS) 2002 2003 AMOUNT PERCENT
- ---------------------------------------------- --------- --------- ------- -------
Salaries and other compensation............... $142,423 $153,060 $10,637 7.47%
Employee benefits............................. 36,453 45,047 8,594 23.58
--------- --------- -------
Salaries and employee benefits.............. 178,876 198,107 19,231 10.75
Net occupancy................................. 23,381 27,636 4,255 18.20
Equipment..................................... 16,340 16,671 331 2.03
Communications................................ 13,941 13,844 (97) (0.70)
Software...................................... 11,510 12,076 566 4.92
Professional services......................... 9,503 12,014 2,511 26.42
Advertising and public relations.............. 10,008 9,667 (341) (3.41)
Data processing............................... 8,991 8,484 (507) (5.64)
Intangible asset amortization................. 884 2,477 1,593 180.20
Foreclosed asset expense...................... 125 51 (74) (59.20)
Other......................................... 38,102 41,578 3,476 9.12
--------- --------- -------
Total noninterest expense................... $311,661 $342,605 $30,944 9.93%
========= ========= =======
In the first quarter of 2003, noninterest expense was $342.6 million, an
increase of $30.9 million, or 10 percent, over the first quarter of 2002. This
increase was primarily due to a $19.2 million increase in salaries and employee
benefits, a $4.3 million increase in net occupancy expense, a $2.5 million
increase in professional services expense, a $1.6 million increase in intangible
asset amortization, and a $3.5 million increase in other noninterest expense.
Salaries and employee benefits were $198.1 million, an increase of 11
percent over the first quarter of 2002. This increase was primarily attributable
to annual merit increases, higher staff levels associated with our recent
acquisitions, and increased health benefits expense, other payroll taxes, and
401(k) plan expenses.
Net occupancy expense was $27.6 million, an increase of 18 percent over the
first quarter of 2002. This increase was primarily attributable to recent
acquisitions, de novo branch creations, other facilities restructuring
initiatives and higher property insurance.
Professional services expense was $12.0 million, an increase of 26 percent
over the first quarter of 2002. This increase was primarily attributable to
increased legal service expenses.
Intangible asset amortization was $2.5 million, an increase of 180 percent
from the first quarter of 2002. This increase was primarily associated with our
acquisitions in the third and fourth quarters of 2002.
Other noninterest expense was $41.6 million, an increase of 9 percent over
the first quarter of 2002. This increase was primarily attributable to an
increase in unguaranteed low-income housing credit investments expense and
higher operating losses.
INCOME TAX EXPENSE
Income tax expense in the first quarter of 2003 was $68.4 million,
resulting in a 34 percent effective income tax rate. For the first quarter of
2002, the effective income tax rate was also 34 percent.
30
LOANS
The following table shows loans outstanding by loan type.
PERCENT CHANGE TO
MARCH 31, 2003 FROM:
----------------------------
MARCH 31, DECEMBER 31, MARCH 31, MARCH 31, DECEMBER 31,
(DOLLARS IN THOUSANDS) 2002 2002 2003 2002 2002
- ------------------------------------------ ----------- ------------ ----------- --------- ------------
Domestic:
Commercial, financial and industrial.... $10,963,101 $10,338,508 $ 9,989,430 (8.88)% (3.38)%
Construction............................ 1,096,869 1,285,204 1,222,501 11.45 (4.88)
Mortgage:
Residential............................. 5,350,998 6,382,227 6,666,441 24.58 4.45
Commercial.............................. 3,691,561 4,150,178 4,189,565 13.49 0.95
----------- ------------ -----------
Total mortgage.......................... 9,042,559 10,532,405 10,856,006 20.05 3.07
Consumer:
Installment............................. 1,088,716 909,787 881,136 (19.07) (3.15)
Revolving lines of credit............... 906,110 1,102,771 1,125,186 24.18 2.03
----------- ------------ -----------
Total consumer.......................... 1,994,826 2,012,558 2,006,322 0.58 (0.31)
Lease financing......................... 933,012 812,918 756,673 (18.90) (6.92)
----------- ------------ -----------
Total loans in domestic offices......... 24,030,367 24,981,593 24,830,932 3.33 (0.60)
Loans originated in foreign branches...... 1,067,730 1,456,490 1,705,340 59.72 17.09
----------- ------------ -----------
Total loans............................. $25,098,097 $26,438,083 $26,536,272 5.73% 0.37%
=========== ============ ===========
Our lending activities are predominantly domestic, with such loans
comprising 94 percent of the total loan portfolio at March 31, 2003. Total loans
at March 31, 2003, were $26.5 billion, an increase of $1.4 billion, or 6
percent, from March 31, 2002. The increase was mainly attributable to an
increase in the residential mortgage portfolio of $1.3 billion, an increase in
the loans originated in foreign branches of $638 million and an increase in the
commercial mortgage portfolio of $498 million, partly offset by a decline in the
commercial, financial and industrial loan portfolio of $974 million and a
decline in lease financing of $176 million.
Commercial, financial and industrial loans represent one of the largest
categories in the loan portfolio. These loans are extended principally to
corporations, middle-market businesses, and small businesses, with no industry
concentration exceeding 10 percent of total loans. This portfolio has a high
degree of geographic diversification based upon our customers' revenue bases,
which we believe lowers our vulnerability to changes in the economic outlook of
any particular region of the US. The commercial, financial and industrial loan
portfolio was $10.0 billion, or 38 percent of total loans, at March 31, 2003,
compared with $11.0 billion, or 44 percent of total loans, at March 31, 2002.
The decrease of $1.0 billion, or 9 percent, from the prior year was primarily
attributable to current economic conditions that has reduced loan demand, loan
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 to more volatile commercial loans and increase
the percentage of more stable consumer loans (including residential mortgages).
We expect to continue to pursue this strategy into 2004.
The construction loan portfolio totaled $1.2 billion, or 5 percent of total
loans, at March 31, 2003, compared with $1.1 billion, or 4 percent of total
loans, at March 31, 2002. This growth of $126 million, or 11 percent, from the
prior year was primarily attributable to a reasonably stable Southern California
housing market, despite the slowdown in the economy.
Commercial mortgages were $4.2 billion, or 16 percent of total loans, at
March 31, 2003, compared with $3.7 billion, or 15 percent, at March 31, 2002.
The mortgage loan portfolio consists of loans on
31
commercial and industrial projects primarily in California. The increase in
commercial mortgages of $498 million, or 13 percent, from March 31, 2002, was
primarily due to demand in the Southern California real estate market.
Residential mortgages were $6.7 billion, or 25 percent of total loans, at
March 31, 2003, compared with $5.4 billion, or 21 percent of total loans, at
March 31, 2002. The increase in residential mortgages of $1.3 billion, or 25
percent, from March 31, 2002, continues to be influenced by our strategic
decision to increase our residential mortgage portfolio through increased
in-house production and additional wholesale and correspondent channels. While
we hold most of the loans we originate, we sell most of our 30-year, fixed rate
residential mortgage loans.
Consumer loans totaled $2.0 billion, or 8 percent of total loans, at March
31, 2003, compared with $2.0 billion, or 8 percent of total loans, at March 31,
2002. The slight increase of $11.5 million, or 1 percent, was primarily
attributable to an increase in home equity loans, partially offset by pay-offs
related to exiting the automobile dealer lending business in the third quarter
of 2000.
Lease financing totaled $756.7 million, or 3 percent of total loans, at
March 31, 2003, compared with $933.0 million, or 4 percent of total loans, at
March 31, 2002. As we previously announced, effective April 20, 2001, we
discontinued our auto leasing activity.
Loans originated in foreign branches totaled $1.7 billion, or 6 percent of
total loans, at March 31, 2003, compared with $1.1 billion, or 4 percent, at
March 31, 2002. The increase in loans originated in foreign branches of $637.6
million, or 60 percent, from March 31, 2002, was primarily attributable to
borrowings from financial institutions due to low US interest rates, in
comparison with higher local interest rates, which made financing of trade
transactions more attractive and increased lending in Canada.
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, 2002, December 31, 2002 and March 31, 2003, for any 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 exclude local currency outstandings. For any
country 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, 2002
Korea........................... $458 $-- $46 $504
December 31, 2002
Korea........................... $599 $-- $75 $674
March 31, 2003
Korea........................... $651 $-- $90 $741
PROVISION FOR CREDIT LOSSES
We recorded a $30 million provision for credit losses in the first quarter
of 2003, compared with a $55 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.
32
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, leases and unused commitments, in each case based on the internal risk
grade of such credit exposures. Changes in risk grades 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 loss factors for commercial, financial, and industrial
loans, as well as all problem graded loan loss factors, are derived
from a migration model that tracks historical losses over a period,
which we believe captures the inherent losses in our loan portfolio;
o pass graded loss factors for commercial real estate loans and
construction loans are based on the average annual net charge-off rate
over a period 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 an economic cycle is a period in which both upturns and
downturns in the economy have been reflected. We calculate loss factors over a
time interval that spans what we believe constitutes a complete and
representative economic cycle.
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to a credit or a
portfolio segment 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 methods
that include a range of probable outcomes based upon certain qualitative
factors.
The unallocated allowance is based on management's evaluation of conditions
that are not directly reflected 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 may not be 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;
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 economic cycle;
33
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 conditions
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 an economic cycle, the methodology is designed to take into
account our recent loss experience for commercial real estate mortgages and
construction loans. Pooled loan loss factors are adjusted quarterly primarily
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, 2002
At December 31, 2002, our total allowance for credit losses was $609
million, or 2.30 percent of the total loan portfolio and 181 percent of total
nonaccrual loans. At March 31, 2003, our total allowance for credit losses was
$586 million, or 2.21 percent of the total loan portfolio and 152 percent of
total nonaccrual loans. In addition, the allowance incorporates the results of
measuring impaired loans as provided in SFAS No. 114 as amended by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan--Income Recognition and
Disclosures." These accounting standards prescribe the measurement methods,
income recognition and disclosures related to impaired loans. At December 31,
2002, total impaired loans were $337 million, and the associated impairment
allowance was $121 million, compared with $387 million and $140 million,
respectively, at March 31, 2003.
During the first quarter of 2003, 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.
As a result of management's assessment of factors, including: the continued
slow US economy; the adverse impact on the airline industry of the war in Iraq,
severe acute respiratory syndrome (SARS), and the generally weak economy;
uncertain, although improving, conditions in the communications/media, power,
and other sectors in domestic markets in which we operate; and growth and
changes in the composition of the loan portfolio, we recorded a $30 million
provision in the first quarter of 2003.
34
CHANGES IN THE FORMULA AND SPECIFIC ALLOWANCES
At March 31, 2003, the formula allowance was $281 million, compared to $294
million at December 31, 2002, a decrease of $13 million. The specific allowance
was $140 million at March 31, 2003, compared to $121 million at December 31,
2002, an increase of $19 million. This increase in the specific allowance was
primarily due to new nonaccrual credits, mirrored, in part, by a similar reason
for the decrease in the formula allowance.
CHANGES IN THE UNALLOCATED ALLOWANCE
At March 31, 2003, the unallocated allowance was $165 million, compared to
$194 million at December 31, 2002, a decrease of $29 million. 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 With respect to the communications/media industry, management
considered the short term adverse effects of the war in Iraq on
advertising revenues, consumer spending and the general economic
environment, which could be in the range of $16 million to $36
million.
o With respect to the commercial real estate sector, management
considered the cyclical weakening in commercial real estate markets
reflecting weak demand, as well as the specific weakness in Northern
California resulting from regional over dependence on the hi-tech
sector and some portfolio concentration in the office and apartment
markets, which could be in the range of $16 million to $32 million.
o With respect to power companies and utilities, management considered
the adverse effects of continued low wholesale power prices, ongoing
accounting concerns, and uncertainties regarding the course of
deregulation on borrowers in the power industry, which could be in the
range of $15 million to $30 million.
o With respect to cross-border loans and acceptances to certain
Asia/Pacific Rim countries, management considered the weak economic
conditions in that region and the reduced strength of Japanese
corporate parent companies, which could be in the range of $9 million
to $17 million.
o With respect to the retail sector, management considered the adverse
effects of the weak economy and low consumer spending in January and
February 2003, which followed a lackluster 2002 holiday season, which
could be in the range of $7 million to $14 million.
o With respect to leasing, management considered the growing problems of
the airline industry including weakness in financial performance and
in collateral values, exacerbated by the war in Iraq and the recent
outbreak of SARS, which could be in the range of $7 million to $13
million.
o With respect to the technology industry, management considered the
adverse effects of continuing excess capacity, depressed capital
spending and further decelerations in consumer spending, which could
be in the range of $5 million to $10 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.
Although in certain instances the downgrading of a loan resulting from
these effects was reflected in the formula allowance, management believes that
in most instances the impact of these events on the collectibility of the
applicable loans may not have been reflected in the level of nonperforming loans
or in the internal risk grading process with respect of such loans. Accordingly,
our evaluation of the probable losses related to these factors was reflected in
the unallocated allowance. The evaluations of the inherent
35
losses with respect to these factors were subject to higher degrees of
uncertainty because they were not identified with specific problem credits.
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) 2002 2003
- -------------------------------------------------------------------------------- -------- --------
Balance, beginning of period.................................................... $634,509 $609,190
Loans charged off:
Commercial, financial and industrial.......................................... 62,226 37,826
Mortgage...................................................................... 180 --
Consumer...................................................................... 2,599 2,656
Lease financing............................................................... 833 19,018
-------- --------
Total loans charged off....................................................... 65,838 59,500
Recoveries of loans previously charged off:
Commercial, financial and industrial.......................................... 4,516 5,579
Mortgage...................................................................... 95 106
Consumer...................................................................... 908 723
Lease financing............................................................... 201 118
-------- --------
Total recoveries of loans previously charged off.............................. 5,720 6,526
-------- --------
Net loans charged off......................................................... 60,118 52,974
Provision for credit losses..................................................... 55,000 30,000
Foreign translation adjustment and other net additions (deductions)............. (24) (19)
-------- --------
Balance, end of period.......................................................... $629,367 $586,197
======== ========
Allowance for credit losses to total loans...................................... 2.51% 2.21%
Provision for credit losses to net loans charged off............................ 91.49 56.63
Net loans charged off to average loans outstanding for the period(1)............ 0.97 0.80
- ----------------
<FN>
(1) Annualized.
</FN>
Total loans charged off in the first quarter of 2003 decreased by $6.3
million from the first quarter of 2002, primarily due to a $24.4 million
decrease in commercial, financial and industrial loans charged off, partly
offset by an $18.2 million increase in lease financing charge offs. Charge-offs
reflect the realization of losses in the portfolio that were recognized
previously through provisions for credit losses.
First quarter 2003 recoveries of loans previously charged off increased by
$0.8 million from the first quarter of 2002. The percentage of net loans charged
off to average loans outstanding for the first quarter of 2003 decreased by 17
basis points from the same period in 2002. At March 31, 2003, the allowance for
credit losses exceeded the annualized net loans charged off during the first
quarter of 2003, 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.
36
NONPERFORMING ASSETS
MARCH 31, DECEMBER 31, MARCH 31,
(DOLLARS IN THOUSANDS) 2002 2002 2003
- -------------------------------------------------------------- --------- ------------ ---------
Commercial, financial and industrial.......................... $422,900 $276,415 $273,196
Commercial mortgage........................................... 26,426 23,980 25,675
Lease financing............................................... 2,631 36,294 84,712
Loan originated in foreign branches........................... 471 -- 3,000
--------- ------------ ---------
Total nonaccrual loans...................................... 452,428 336,689 386,583
Foreclosed assets............................................. 333 715 389
--------- ------------ ---------
Total nonperforming assets.................................. $452,761 $337,404 $386,972
========= ============ =========
Allowance for credit losses................................... $629,367 $609,190 $586,197
========= ============ =========
Nonaccrual loans to total loans............................... 1.80% 1.27% 1.46%
Allowance for credit losses to nonaccrual loans............... 139.11 180.94 151.64
Nonperforming assets to total loans, distressed loans
held for sale and foreclosed assets......................... 1.80 1.28 1.46
Nonperforming assets to total assets.......................... 1.25 0.84 0.96
At March 31, 2003, nonperforming assets totaled $387.0 million, an increase
of $49.6 million, or 15 percent, from December 31, 2002. The increase was
primarily due to our decision to place additional airplane leases on nonaccrual.
Of the $84.7 million of leases reported as nonaccrual, $16.0 million relates to
two airplane leases that are in negotiation to convert to operating leases. When
these lease terms are completed, which is expected during 2003, the airplanes
will be recorded as other assets and depreciated over their remaining useful
lives.
Nonaccrual loans as a percentage of total loans were 1.46 percent at March
31, 2003, compared with 1.80 percent at March 31, 2002. Nonperforming assets as
a percentage of total loans, distressed loans held for sale, and foreclosed
assets were 1.46 percent at March 31, 2003, compared to 1.80 percent at March
31, 2002.
LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING
MARCH 31, DECEMBER 31, MARCH 31,
(DOLLARS IN THOUSANDS) 2002 2002 2003
- ------------------------------------------------------------------ --------- ------------ ---------
Commercial, financial and industrial.............................. $ 1,680 $1,705 $10,413
Construction...................................................... -- 679 --
Mortgage:
Residential..................................................... 8,561 3,211 5,818
Commercial...................................................... 1,567 506 803
--------- ------------ ---------
Total mortgage.................................................. 10,128 3,717 6,621
Consumer and other................................................ 1,893 2,072 2,123
--------- ------------ ---------
Total loans 90 days or more past due and still accruing......... $13,701 $8,173 $19,157
========= ============ =========
37
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. SEE ALSO PART I, ITEM 3 OF THIS DOCUMENT, TITLED "MARKET RISK."
Market risk is the risk of loss to future earnings, to fair values, or to
future cash flows that may result from changes in the price of a financial
instrument. The value of a financial instrument may change as a result of
changes in interest rates, foreign currency exchange rates, commodity prices,
equity prices, and other market changes that affect market risk sensitive
instruments. Market risk is attributable to all market risk sensitive financial
instruments, including securities, loans, deposits, and borrowings, as well as
derivative instruments. Our exposure to market risk is a function of our asset
and liability management activities, our trading activities for our own account,
and our role as a financial intermediary in customer-related transactions. The
objective of market risk management is to avoid excessive exposure of our
earnings and equity to loss and to reduce the volatility inherent in certain
financial instruments.
The management of market risk is governed by policies reviewed and approved
annually by our Board of Directors (Board). The Board assigns responsibility for
market risk management to the Asset & Liability Management Committee (ALCO),
which is composed of UnionBanCal Corporation executives. ALCO meets monthly and
reports quarterly to the Finance and Capital Committee of the Board on
activities related to the management of market risk. As part of the management
of our market risk, ALCO may direct changes in the mix of assets and liabilities
and the extent to which we utilize investment securities and derivative
instruments such as interest rate swaps, caps and floors to hedge our interest
rate exposures. ALCO reviews and approves specific market risk-management
programs involving investment and hedging activities and certain market risk
limits. The ALCO Chairman is responsible for the company-wide management of
market risk. The Treasurer is responsible for implementing funding, investing,
and hedging strategies designed to manage this risk. On a day-to-day basis, the
monitoring of market risk takes place at a centralized level within the Market
Risk Monitoring unit (MRM). MRM is responsible for measuring risks to ensure
compliance with all market risk limits and guidelines incorporated within the
policies and procedures established by the Board and ALCO. MRM reports monthly
to ALCO on trading risk exposures and on compliance with interest rate risk,
securities portfolio and derivatives policy limits. MRM also reports quarterly
to ALCO on the effectiveness of our hedging activities. In addition, periodic
reviews by internal audit and regulators provide further evaluation of controls
over the risk management process.
We have separate and distinct methods for managing the market risk
associated with our trading activities and our asset and liability management
activities, as described below.
INTEREST RATE RISK MANAGEMENT (OTHER THAN TRADING)
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 and maintaining a risk
profile that is consistent with management's strategic objectives.
The Asset & Liability Management (ALM) Policy approved by the Board
requires monthly monitoring of interest rate risk by ALCO through a variety of
modeling techniques that are used to quantify the sensitivity of NII to changes
in interest rates. As directed by ALCO, and in consideration of the importance
of our demand deposit accounts as a funding source, NII is adjusted in the
official policy risk measure to incorporate the effect of certain noninterest
expense items related to these deposits that are nevertheless sensitive to
changes in interest rates. In managing interest rate risk, ALCO monitors NII
sensitivity on both an adjusted and unadjusted basis.
Our unhedged NII remains inherently asset sensitive, meaning that our
assets generally reprice more quickly than our liabilities, particularly our
core deposits. Since the NII associated with an asset sensitive
38
balance sheet tends to decrease when interest rates decline and increase when
interest rates rise, derivative hedges and the securities portfolio are used to
manage this risk. In the first quarter of 2003, we entered into $1 billion of
derivative hedges, including $500 million in receive-fixed swaps and $500
million in floors, to offset the adverse impact that declining interest rates
would have on the interest income generated by our variable rate commercial
loans. For a further discussion of derivative instruments and our hedging
strategies, see Note 16--"Derivative Instruments" of the Notes to Consolidated
Financial Statements included in our Form 10-K filed on December 31, 2002. In
addition, we continued to increase the size of our securities portfolio in
response to strong growth in core deposits, which respond more slowly to changes
in market rates than wholesale liabilities. Together, our hedging and investment
activities resulted in a marginally asset sensitive risk profile for the hedged
balance sheet with respect to parallel yield curve shifts.
However, our NII is also sensitive to non-parallel shifts in the yield
curve. In general, our NII increases when the yield curve steepens (specifically
when short rates, under one year, drop and long rates, beyond one year, rise),
while a flattening curve tends to depress our NII and net interest margin. In
this respect, our NII is asset sensitive when measured against changes in long
rates and slightly liability sensitive when measured against changes in short
rates. This asset sensitivity in relation to a flattening of the yield curve is
manifested in the NII simulations primarily by an acceleration of mortgage
prepayments (in both the residential portfolio and investment securities
portfolio) when long rates decline. Prepayments depress NII even if interest
rates do not change because the cash flows from the prepaid assets that were
booked at higher rates must be reinvested at lower prevailing rates. As a
result, a continuation of the recent high volume of prepayments will further
compress our net interest margin and negatively affect NII in the coming months,
even if market rates remain at current levels.
Our official NII policy measure involves a simulation of "Earnings-at-Risk"
(EaR) in which we estimate the impact that gradual, ramped-on parallel shifts in
the yield curve would have on NII over a 12-month horizon. Under the Board's
policy limits, the negative change in simulated NII in either the up or down 200
basis point shock scenarios may not exceed 4 percent of NII as measured in the
base case, or no change, scenario. The following table sets forth the simulation
results in both the up and down 200 basis point ramp scenarios as of March 31,
2003(1):
DECEMBER 31, MARCH 31,
(DOLLARS IN MILLIONS) 2002 2003
- ------------------------------------------- ------------ ---------
+200 basis points.......................... $ 16.9 $ 15.4
as a percentage of base case NII........... 1.13% 1.04%
- -200 basis points.......................... $(17.4) $(15.3)
as a percentage of base case NII........... 1.16% 1.04%
- --------------
(1) For these policy simulations, NII is adjusted to incorporate the effect of
certain noninterest expense items related to demand deposits that are
nevertheless sensitive to changes in interest rates.
EaR in the down 200 basis point scenario was $15.3 million, or 1.04% of
adjusted NII in the base case scenario, well within the Board's guidelines.
However, with federal funds and LIBOR rates already below two percent, a
downward ramp scenario of 200 basis points would result in short-term rate
levels below zero percent. As a result, we believe that a downward ramp scenario
of 100 basis points provides a more reasonable measure of asset sensitivity in a
falling interest rate environment. As of March 31, 2003, the difference between
adjusted NII in the base case and adjusted NII after a gradual 100 basis point
downward ramp was minus $4.8 million, or .32% percent of the base case.
Management's goal in the NII simulations is to capture the risk embedded in
the 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
39
equations, and discretionary derivative hedges and fixed income portfolios,
which are allowed to run off. 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 of NII based on forecasted
balances and with value-based simulations that measure the sensitivity of
economic-value-of-equity (EVE) to changes in interest rates. We believe that,
together, these simulations provide management with a reasonably comprehensive
view of the sensitivity of our operating results to changes in interest rates,
at least over the measurement horizon. However, as with any financial model, the
underlying assumptions are inherently uncertain and subject to refinement as
modeling techniques and theory improve and historical data becomes more readily
accessible. Consequently, our simulation models cannot predict with certainty
how rising or falling interest rates might impact net interest income. Actual
and simulated NII results will differ to the extent there are differences
between actual and assumed interest rate changes, balance sheet volumes, and
management strategies, among other factors.
TRADING ACTIVITIES
We enter into trading account activities primarily as a financial
intermediary for customers, and, to a minor extent, for our own account. By
acting as a financial intermediary, we are able to provide our customers with
access to a wide range of products from the securities, foreign exchange, and
derivatives markets. In acting for our own account, we may take positions in
some of these instruments with the objective of generating trading profits.
These activities expose us to two primary types of market risk: interest rate
and foreign currency exchange risk.
In order to manage interest rate and foreign currency exchange risk
associated with our trading activities, we utilize a variety of non-statistical
methods including: position limits for each trading activity, daily marking of
all positions to market, daily profit and loss statements, position reports, and
independent verification of all inventory pricing. Additionally, MRM reports
positions and profits and losses daily to the Treasurer and trading managers and
weekly to the ALCO Chairman. ALCO is provided reports on a monthly basis. We
believe that these procedures, which stress timely communication between MRM and
senior management, are the most important elements of the risk management
process.
We use a form of Value at Risk (VaR) methodology to measure the overall
market risk inherent in our trading account activities. Under this methodology,
management statistically calculates, with 97.5 percent confidence, the potential
loss in fair value that we might experience if an adverse shift in market prices
or rates were to occur within a period of 5 business days. The amount of VaR is
managed within limits well below the maximum limit established by Board policy
at 0.5 percent of shareholders' equity. The VaR model incorporates a number of
key assumptions, including assumed holding period and historical volatility
based on 3 years of historical market data updated quarterly. The following
table sets forth the average, high and low VaR during the year for our trading
activities.
DECEMBER 31, 2002 MARCH 31, 2003
----------------- --------------
AVERAGE HIGH LOW AVERAGE HIGH LOW
(DOLLARS IN THOUSANDS) VAR VAR VAR VAR VAR VAR
- ---------------------------------- ------- ---- --- ------- ---- ---
Foreign exchange.................. $256 $546 $88 $155 $293 $67
Securities........................ 213 543 45 207 463 97
Consistent with our business strategy of focusing on the sale of capital
markets products to customers, we manage our trading risk exposures at
conservative levels, well below the trading risk policy limits established by
the Board. As a result, our foreign exchange business continues to derive the
bulk of its
40
revenue from customer-related transactions. We take inter-bank trading positions
only on a limited basis and we do not take any large or long-term strategic
positions in the market for the Bank's own portfolio. In 2002, we continued to
grow our customer-related foreign exchange business while maintaining an
essentially unchanged inter-bank trading risk profile as measured under our VaR
methodology.
The Securities Trading & Institutional Sales group serves the fixed income
needs of our institutional clients and acts as the fixed income wholesaler for
our broker/dealer subsidiary, UBOC Investment Services, Inc. As with our foreign
exchange business, we continue to generate the vast majority of our securities
income from customer-related transactions.
Our interest rate derivative contracts include $4.6 billion of derivative
contracts entered into as an accommodation for customers. We act as an
intermediary and match these contracts at a profit with contracts with major
dealers, thus neutralizing the related market risk.
LIQUIDITY RISK
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
ALCO. Additionally, ALCO conducts monthly ongoing reviews of our liquidity
situation. Liquidity is managed through this ALCO coordination process on a
Bank-wide basis, encompassing all major business units. The operating management
of liquidity is implemented through the funding and investment functions of the
Global Markets Group. Our liquidity management draws upon the strengths of our
extensive retail and commercial core deposit franchise, coupled with the ability
to obtain funds for various terms in a variety of domestic and international
money markets. Our securities portfolio represents a significant source of
additional liquidity.
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, savings, and consumer time deposits, combined with
average common shareholders' equity, funded 81 percent of average total assets
of $38.3 billion for the first quarter of 2003. Most of the remaining funding
was provided by short-term borrowings in the form of negotiable certificates of
deposit, large time deposits, foreign deposits, federal funds purchased,
securities sold under repurchase agreements, commercial paper, and other
borrowings. The securities portfolio provides additional enhancement to our
liquidity position, which may be created through either securities sales, or
repurchase agreements. Liquidity may also be provided by the sale or maturity of
assets. Such assets include interest-bearing deposits in banks, federal funds
sold, securities purchased under resale agreements, and trading account
securities. The aggregate of these assets averaged $1.0 billion for the quarter
ended March 31, 2003. Additional liquidity may be provided through loan
maturities and sales.
41
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) 2002 2002 2003 REQUIREMENT
- --------------------------- ----------------- ----------------- ----------------- -----------------
CAPITAL COMPONENTS
Tier 1 capital............. $ 3,729,481 $ 3,667,237 $ 3,739,690
Tier 2 capital............. 601,042 573,858 576,214
----------------- ----------------- -----------------
Total risk-based capital... $ 4,330,523 $ 4,241,095 $ 4,315,904
================= ================= =================
Risk-weighted assets....... $32,077,375 $32,811,441 $33,001,706
================= ================= =================
Quarterly average assets... $35,010,127 $37,595,002 $38,169,532
================= ================= =================
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------------- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to risk-
weighted assets)...........$4,330,523 13.50% $4,241,095 12.93% $4,315,904 13.08% >$2,640,136 8.0%
-
Tier 1 capital (to risk-
weighted assets)........... 3,729,481 11.63 3,667,237 11.18 3,739,690 11.33 > 1,320,068 4.0
-
Leverage(1).................. 3,729,481 10.65 3,667,237 9.75 3,739,690 9.80 > 1,526,781 4.0
-
- ---------------------
<FN>
(1) Tier 1 capital divided by quarterly average assets (excluding certain
intangible assets).
</FN>
UNION BANK OF CALIFORNIA, N.A.
MINIMUM "WELL-CAPITALIZED"
MARCH 31, DECEMBER 31, MARCH 31, REGULATORY REGULATORY
(DOLLARS IN THOUSANDS) 2002 2002 2003 REQUIREMENT REQUIREMENT
- ---------------------- ----------------- ----------------- ----------------- ----------------- --------------------
CAPITAL COMPONENTS
Tier 1 capital............... $ 3,399,757 $ 3,334,720 $ 3,448,720
Tier 2 capital............... 489,666 484,062 486,329
----------------- ----------------- -----------------
Total risk-based capital..... $ 3,889,423 $ 3,818,782 $ 3,935,049
================= ================= =================
Risk-weighted assets......... $31,442,559 $32,161,047 $32,389,193
================= ================= =================
Quarterly average assets..... $34,514,704 $37,019,328 $37,368,882
================= ================= =================
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------------- ---------- ----- ------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to risk-
weighted assets). . $3,889,423 12.37% $3,818,782 11.87% $3,935,049 12.15% >$2,591,135 8.0% >$3,238,919 10.0%
- -
Tier 1 capital (to risk-
weighted assets)... 3,399,757 10.81 3,334,720 10.37 3,448,720 10.65 > 1,295,568 4.0 > 1,943,352 6.0
- -
Leverage(1).......... 3,399,757 9.85 3,334,720 9.01 3,448,720 9.23 > 1,494,755 4.0 > 1,868,444 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 of
the federal banking agencies, including minimum capital requirements. We both
are required to maintain minimum ratios of Total and Tier 1 capital to
risk-weighted assets and of Tier 1 capital to quarterly average assets (the
leverage ratio).
Compared with December 31, 2002, our Tier 1 risk-based capital ratio at
March 31, 2003, increased 15 basis points to 11.33 percent, our total risk-based
capital ratio increased 15 basis points to 13.08 percent, and our leverage ratio
increased 5 basis points to 9.80 percent. The increase in our capital ratios was
primarily attributable to an increase in shareholders' equity, partly offset by
an increase in risk-weighted assets.
As of March 31, 2003, management believes the capital ratios of Union Bank
of California, N.A. met all regulatory requirements of "well-capitalized"
institutions, which are 10 percent for the total risk-based capital ratio, 6
percent for the Tier 1 risk-based capital ratio and 5 percent for the leverage
ratio.
42
CERTAIN BUSINESS RISK FACTORS
ADVERSE CALIFORNIA ECONOMIC CONDITIONS COULD ADVERSELY AFFECT OUR BUSINESS
A substantial majority of our assets, deposits and fee income are generated
in California. As a result, poor economic conditions in California may cause us
to incur losses associated with higher default rates and decreased collateral
values in our loan portfolio. Economic conditions in California are subject to
various uncertainties at this time, including the long-term impact of the
California energy crisis, the decline in the technology sector and the
California state government's budgetary difficulties. If economic conditions in
California continue to decline, we expect that our level of problem assets could
increase.
THE CONTINUING WAR ON TERRORISM CONTRIBUTES TO THE CONTINUING DOWNTURN IN
US ECONOMIC CONDITIONS
On-going acts or threats of terrorism and actions taken by the US or other
governments as a result of such acts or threats have contributed to the
continuing downturn in US economic conditions and could further adversely affect
business and economic conditions in the US generally and in our principal
markets. For example, the events of September 11, 2001, caused a decrease in air
travel in the US, which adversely affected the airline industry and many other
travel-related industries, including those operating in California.
ADVERSE ECONOMIC FACTORS AFFECTING CERTAIN INDUSTRIES COULD ADVERSELY
AFFECT OUR BUSINESS
We are subject to certain industry-specific economic factors. For example,
a significant and increasing portion of our total loan portfolio is related to
residential real estate. Accordingly, a downturn in the real estate and housing
industries 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 declining
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 remaining auto
leases. We provide financing 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, the airlines
industry, the power 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.
RISKS ASSOCIATED WITH CURTAILED MARKET ACCESS OF POWER COMPANIES COULD
AFFECT OUR PORTFOLIO CREDIT QUALITY
The failure of Enron Corporation, coupled with continued turbulence in the
energy markets, has significantly impacted debt ratings and equity valuations of
a broad spectrum of power companies, particularly those involved in energy
trading and in deregulated or non-regulated markets. These developments have
sharply reduced these companies' ability to access public debt and equity
markets, contributing to heightened liquidity pressures. Should these negative
trends continue and/or intensify, the credit quality of certain of our borrowers
could be adversely affected.
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, further decreases 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.
43
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
or other borrowings. The impact, particularly in a falling interest rate
environment, could result in a decrease in our interest income relative to
interest expense.
SHAREHOLDER VOTES ARE CONTROLLED BY BTM; OUR INTERESTS MAY NOT BE THE SAME
AS BTM'S INTERESTS
BTM, a wholly owned subsidiary of Mitsubishi Tokyo Financial Group, Inc.,
owns a majority (approximately 65 percent as of March 31, 2003) of the
outstanding shares of our common stock. As a result, BTM 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 other matters that
might be favorable to BTM.
A majority of our directors are not officers or employees of UnionBanCal
Corporation or any of our affiliates, including BTM. However, because of BTM's
control over the election of our directors, BTM could change the composition of
our Board of Directors so that the Board would not have a majority of outside
directors. BTM'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.
POSSIBLE FUTURE SALES OF SHARES BY BTM COULD ADVERSELY AFFECT THE MARKET
FOR OUR STOCK
BTM may sell shares of our common stock in compliance with the federal
securities laws. By virtue of BTM's current control of us, BTM 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, BTM
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 BTM sells or transfers shares of our common stock
as a block, another person or entity could become our controlling shareholder.
BTM'S FINANCIAL CONDITION COULD ADVERSELY AFFECT OUR OPERATIONS
Although we fund our operations independently of BTM and believe our
business is not necessarily closely related to BTM's business or outlook, BTM's
credit ratings may affect our credit ratings. BTM is also subject to regulatory
oversight and review by Japanese and US regulatory authorities. Our business
operations and expansion plans could be negatively affected by regulatory
concerns related to the Japanese financial system and BTM.
POTENTIAL CONFLICTS OF INTEREST WITH BTM COULD ADVERSELY AFFECT US
BTM's view of possible new businesses, strategies, acquisitions,
divestitures or other initiatives may differ from ours. This may delay or hinder
us from pursuing such initiatives.
Also, as part of BTM's normal risk management processes, BTM manages global
credit exposures and concentrations on an aggregate basis, including UnionBanCal
Corporation. Therefore, at certain levels or in certain circumstances, our
ability to approve certain credits or other banking transactions and categories
of customers is subject to the concurrence of BTM. We may wish to extend credit
or furnish other banking
44
services to the same customers as BTM. Our ability to do so may be limited for
various reasons, including BTM's aggregate credit exposure and marketing
policies. Certain directors' and officers' ownership interests in BTM's common
stock or service as a director or officer or other employee of both us and BTM
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, Citibank, 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.
Banks, securities firms, and insurance companies can now combine in a new
type of financial services company called a "financial holding company."
Financial holding companies can offer virtually any type of financial service,
including banking, securities underwriting, insurance (both agency and
underwriting), and merchant banking. Recently, a number of foreign banks have
acquired financial services companies in the US, further increasing competition
in the US market.
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
liquidate, that subsidiary's creditors will be entitled to receive distributions
from the assets of that subsidiary to satisfy their claims against it before we,
as a holder of an equity interest in the subsidiary, will be entitled to receive
any of the assets of the subsidiary.
ADVERSE EFFECTS OF, OR CHANGES IN, BANKING OR OTHER LAWS AND REGULATIONS OR
GOVERNMENTAL FISCAL OR MONETARY POLICIES COULD ADVERSELY AFFECT US
We are subject to significant federal and state regulation and supervision,
which is primarily for the benefit and protection of our customers and 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, including accounting standards and interpretations
currently affecting us and our subsidiaries may change at any time. Regulatory
authorities may also change their interpretation of these statutes and
regulations. Therefore, our business may be adversely affected by any future
changes in laws, regulations, policies or interpretations, including legislative
and regulatory reactions to the terrorist attack on September 11, 2001, and
future acts of terrorism, and the Enron Corporation, WorldCom, Inc. and other
major US corporate bankruptcies and reports of accounting irregularities at US
public companies, including various large and publicly traded companies.
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 BTM'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.
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 Federal Reserve Board
45
(FRB), which regulates the supply of money and credit in the US. Under
long-standing policy of the 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. 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 by depository institutions, (c) imposing or changing reserve
requirements against certain borrowings by banks and their affiliates. These
methods are used in varying degrees and combinations to directly affect the
availability of bank loans and deposits, as well as the interest rates charged
on loans and paid on deposits. The policies of the FRB may have a material
effect on our business, results of operations and financial condition.
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 can make no
assurances 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 employee and healthcare costs;
o our inability to increase noninterest income;
o our inability to decrease reliance on revenues generated from assets;
o our ability to manage 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 our net interest margin;
o increases in competition;
o adverse regulatory or legislative developments; and
o unexpected increases in costs related to 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 investment 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 evaluate the performance of all of our businesses and
business lines and may sell a business or business line. Any acquisitions,
divestitures or restructuring may result in the issuance of potentially dilutive
equity securities, significant write-offs, including those related to goodwill
and other intangible assets, and/or the incurrence of debt, any of which could
have a material adverse effect on our business, financial condition and results
of operations. Acquisitions, divestitures or restructuring could involve
numerous additional risks including difficulties in obtaining any required
regulatory approvals and in the assimilation or separation of operations,
services, products and personnel, the diversion of management's attention from
other business concerns, higher than expected deposit attrition (run-off),
divestitures required by
46
regulatory authorities, 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
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,
2002 and by reference to Part I, Item 2 of this document under the captions
"Quantitative and Qualitative Disclosure about Interest Rate Risk Management
(Other Than Trading)," "Liquidity," and "Certain Business Risk Factors."
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on their
evaluation as of March 31, 2003, our principal executive officer and principal
financial officer have concluded that our disclosure controls and procedures (as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934 (Exchange Act) are effective to ensure that information required to be
disclosed by us in reports we file or submit under the Exchange Act is recorded,
processed, summarized, and reported within the time periods specified in
Securities and Exchange Commission (SEC) rules and forms.
(b) CHANGES IN INTERNAL CONTROLS. These officers have also concluded that
there were no significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the date of their
evaluation and that there were no significant deficiencies or material
weaknesses in such controls, and therefore there were no corrective actions
taken.
47
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to various pending and threatened legal actions that arise
in the normal course of business. We maintain reserves for losses from legal
actions that are both probable and estimable.
Union Bank of California, our major subsidiary (the Bank), has been named
in two suits pending in the United States District Court for the Central
District of California, Christensen v. Union Bank of California (formerly
captioned as Rockoff v Union Bank of California et al)(filed December 21, 2001)
and Neilson v Union Bank of California et al (filed September 4, 2002), and one
suit in Los Angeles County Superior Court, Kilpatrick v Orrick Harrington &
Sutcliffe, et al, (filed April 22, 2003 as to the Bank). The plaintiffs in these
suits collectively seek in excess of $250 million alleged to have been lost by
those who invested money in various investment arrangements conducted by an
individual named Reed Slatkin. Mr. Slatkin is alleged to have been operating a
fraudulent investment scheme commonly referred to as a "Ponzi" scheme. The
plaintiffs in the Christensen case are various investors in the arrangements
conducted by Mr. Slatkin and the plaintiffs in the Neilson case include both
investors and the trustee of Mr. Slatkin's bankruptcy estate. A substantial
majority of those who invested with Mr. Slatkin had no relationship with the
Bank. A small minority, comprising less than five percent of the investors, had
custodial accounts with the Bank. The Neilson case seeks to impose liability
upon the Bank and two other financial institutions for both the losses suffered
by those custodial customers as well as investors who had no relationship with
the Bank. The plaintiff in the Kilpatrick case is an individual investor who
seeks recovery of funds placed in an account for a limited liability company
which he formed with Slatkin.
Another suit has been filed with regard to an unrelated "Ponzi" scheme
perpetrated by PinnFund, USA, located in San Diego, California. The victims of
this scheme have filed suit against the Bank seeking $235 million. They assert
that the Bank improperly opened and administered a deposit account, which was
used by PinnFund in furtherance of the fraud.
Although these claims are in the preliminary stages, the Bank has numerous
legal defenses, which it will invoke. Based on our evaluation to date of these
claims, management believes that they will not result in a material adverse
effect on our financial position or results of operations. In addition, we
believe that the disposition of all other claims currently pending will also not
have a material adverse effect on our financial position or results of
operations.
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 23, 2003 ("Annual Meeting"):
DIRECTORS: Each of the following persons was elected as a director to hold
office until the 2004 Annual Meeting of Shareholders or until earlier
retirement, resignation or removal.
NOMINEE FOR WITHHELD
- --------------------------------------- ----------- ----------
David R. Andrews....................... 130,710,843 16,719,455
L. Dale Crandall....................... 130,704,785 16,725,513
Richard D. Farman...................... 146,619,580 810,717
Stanley F. Farrar...................... 146,613,958 816,339
Michael J. Gillfillan.................. 135,750,466 11,679,832
Richard C. Hartnack.................... 146,603,769 826,529
Kaoru Hayama........................... 146,588,985 841,312
Norimichi Kanari....................... 146,605,273 825,024
Satoru Kishi........................... 122,312,537 25,117,760
Monica C. Lozano....................... 146,607,666 822,631
48
NOMINEE FOR WITHHELD
- --------------------------------------- ----------- ----------
Mary S. Metz........................... 130,655,666 16,774,631
Takahiro Moriguchi..................... 145,961,740 1,468,558
J. Fernando Niebla..................... 146,601,287 829,010
Charles R. Rinehart.................... 135,674,894 11,755,403
Carl W. Robertson...................... 146,602,322 827,975
Takaharu Saegusa....................... 146,266,920 1,163,377
Robert M. Walker....................... 146,570,441 859,857
PROPOSAL TO CHANGE STATE OF INCORPORATION: Proposal No. 2 to change
UnionBanCal Corporation's state of incorporation from California to Delaware
received the following votes:
For: 124,211,679
Against: 16,338,848
Abstain: 396,681
AUDITORS: Proposal No. 3 to ratify the selection of Deloitte & Touche LLP
as independent auditors of UnionBanCal Corporation received the following votes:
For: 127,287,113
Against: 17,845,989
Abstain: 59,313
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS:
NO. DESCRIPTION
- ------- ----------------------------------------------------------------------
2.0 Agreement and Plan of Merger, dated as of March 11, 2003 between
UnionBanCal Corporation, a Delaware Corporation and UnionBanCal
Corporation, a California Corporation(1)
99.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002(2)
99.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002(2)
- -----------
(1) Incorporated by reference to Annex A to the UnionBanCal Definitive Proxy
Statement on Schedule 14A, filed on March 20, 2003
(2) Provided herewith
(B) REPORTS ON FORM 8-K
We filed a report on Form 8-K on January 7, 2003 reporting under Item 5 and
Item 7 thereof to file certain exhibits in connection with UnionBanCal's
Registration Statement on Form S-23 (file No. 333-03040)
We furnished a report on Form 8-K on March 14, 2003 reporting under Item 9
thereof, which included the written certification statements of our chief
executive officer and chief financial officer with respect to our annual report
on Form 10-K for the period ended December 31, 2002, filed with the Securities
and Exchange Commission on March 14, 2003, as required by section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. section 1350).
We furnished a report on Form 8-K on April 16, 2003 reporting under Item 9
thereof that UnionBanCal Corporation issued a press release concerning earnings
for the first quarter of 2003.
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, UnionBanCal Corporation has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
UNIONBANCAL CORPORATION
(Registrant)
By: /S/ NORIMICHI KANARI
------------------------------------------------
Norimichi Kanari
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
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)
Date: May 14, 2003
50
CERTIFICATIONS
I, Norimichi Kanari, certify that:
1. I have reviewed this quarterly report on Form 10-Q of UnionBanCal
Corporation (the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in
this quarterly report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the
audit committee of Registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Registrant's
ability to record, process, summarize and report financial data
and have identified for the Registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's
internal controls; and
6. The Registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 14, 2003
By: /S/ NORIMICHI KANARI
---------------------------------------
Norimichi Kanari
PRESIDENT AND
CHIEF EXECUTIVE OFFICER
51
I, David I. Matson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of UnionBanCal
Corporation (the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in
this quarterly report;
4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the
audit committee of Registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Registrant's
ability to record, process, summarize and report financial data
and have identified for the Registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's
internal controls; and
6. The Registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: May 14, 2003
By: /S/ DAVID I. MATSON
---------------------------------------------------
David I. Matson
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(Principal Financial Officer)
52