================================================================================
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 September 30, 2003
Commission file number 1-15081
UNIONBANCAL CORPORATION
State of Incorporation: Delaware 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 Exchange Act). Yes X No
--- ---
Number of shares of Common Stock outstanding at October 31, 2003:
145,417,533
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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.............................. 4
Condensed Consolidated Balance Sheets.................................... 5
Condensed Consolidated Statements of Changes in Shareholders' Equity..... 6
Condensed Consolidated Statements of Cash Flows.......................... 7
Notes to Condensed Consolidated Financial Statements..................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations:
Introduction............................................................. 20
Summary.................................................................. 21
Business Segments........................................................ 22
Net Interest Income...................................................... 32
Noninterest Income....................................................... 35
Noninterest Expense...................................................... 37
Income Tax Expense....................................................... 38
Loans.................................................................... 38
Cross-Border Outstandings................................................ 40
Provision for Credit Losses.............................................. 41
Allowance for Credit Losses.............................................. 41
Nonperforming Assets..................................................... 45
Loans 90 Days or More Past Due and Still Accruing........................ 46
Quantitative and Qualitative Disclosure about Interest Rate Risk
Management (Other Than Trading)..................................... 46
Liquidity Risk........................................................... 49
Regulatory Capital....................................................... 50
Certain Business Risk Factors............................................ 51
Item 3. Quantitative and Qualitative Disclosure About Market Risk............ 55
Item 4. Controls and Procedures.............................................. 55
PART II
OTHER INFORMATION
Item 5. Other Information.................................................... 56
Item 6. Exhibits and Reports on Form 8-K..................................... 56
Signatures...................................................................... 57
PART I. FINANCIAL INFORMATION
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL HIGHLIGHTS
(Unaudited)
AS OF AND FOR THE THREE MONTHS ENDED
------------------------------------------
SEPTEMBER 30, SEPTEMBER 30, PERCENT
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2003 CHANGE
- ----------------------------------------------------------------- ------------- ------------- -------
RESULTS OF OPERATIONS:
Net interest income(1)........................................ $ 392,636 $ 401,736 2.32%
Provision for credit losses................................... 40,000 20,000 (50.00)
Noninterest income............................................ 169,116 201,470 19.13
Noninterest expense........................................... 317,824 348,861 9.77
------------- -------------
Income before income taxes(1)................................. 203,928 234,345 14.92
Taxable-equivalent adjustment................................. 534 647 21.16
Income tax expense............................................ 65,163 78,653 20.70
------------- -------------
Net income....................................................... $ 138,231 $ 155,045 12.16%
============= =============
PER COMMON SHARE:
Net income--basic............................................. $ 0.89 $ 1.04 16.85%
Net income--diluted........................................... 0.88 1.02 15.91
Dividends(2).................................................. 0.28 0.31 10.71
Book value (end of period).................................... 24.22 25.32 4.54
Common shares outstanding (end of period)..................... 150,220,119 145,105,566 (3.40)
Weighted average common shares outstanding--basic............. 154,889,552 149,528,298 (3.46)
Weighted average common shares outstanding--diluted........... 156,709,715 151,561,790 (3.29)
BALANCE SHEET (END OF PERIOD):
Total assets.................................................. $ 37,608,001 $ 42,602,745 13.28%
Total loans................................................... 25,962,159 26,047,376 0.33
Nonaccrual loans.............................................. 395,212 341,039 (13.71)
Nonperforming assets.......................................... 395,521 344,347 (12.94)
Total deposits................................................ 30,588,080 35,957,805 17.55
Medium and long-term debt..................................... 418,369 417,369 (0.24)
Trust preferred securities.................................... 370,286 356,629 (3.69)
Shareholders' equity.......................................... 3,637,945 3,674,107 0.99
BALANCE SHEET (PERIOD AVERAGE):
Total assets.................................................. $ 35,803,475 $ 41,913,515 17.07%
Total loans................................................... 25,971,483 26,331,986 1.39
Earning assets................................................ 32,757,523 37,855,869 15.56
Total deposits................................................ 28,455,452 34,902,964 22.66
Shareholders' equity.......................................... 3,814,927 3,834,834 0.52
FINANCIAL RATIOS:
Return on average assets(3)................................... 1.53% 1.47%
Return on average shareholders' equity(3)..................... 14.38 16.04
Efficiency ratio(4)........................................... 56.57 57.85
Net interest margin(1)........................................ 4.77 4.22
Dividend payout ratio......................................... 31.46 29.81
Tangible equity ratio......................................... 9.38 8.05
Tier 1 risk-based capital ratio............................... 11.14 10.96
Total risk-based capital ratio................................ 12.89 12.58
Leverage ratio................................................ 10.13 8.73
Allowance for credit losses to total loans.................... 2.40 2.11
Allowance for credit losses to nonaccrual loans............... 157.66 161.43
Net loans charged off to average total loans(3)............... 0.64 0.58
Nonperforming assets to total loans and foreclosed assets..... 1.52 1.32
Nonperforming assets to total assets.......................... 1.05 0.81
- --------------------------------
<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.
</FN>
2
PART I. FINANCIAL INFORMATION
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL HIGHLIGHTS
(Unaudited)
AS OF AND FOR THE NINE MONTHS ENDED
------------------------------------------
SEPTEMBER 30, SEPTEMBER 30, PERCENT
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2003 CHANGE
- ----------------------------------------------------------------- ------------- ------------- -------
RESULTS OF OPERATIONS:
Net interest income(1)........................................ $ 1,159,907 $ 1,179,562 1.69%
Provision for credit losses................................... 145,000 75,000 (48.28)
Noninterest income............................................ 504,465 590,412 17.04
Noninterest expense........................................... 946,102 1,042,465 10.19
------------- -------------
Income before income taxes(1)................................. 573,270 652,509 13.82
Taxable-equivalent adjustment................................. 1,604 1,916 19.45
Income tax expense............................................ 188,716 215,273 14.07
------------- -------------
Net income.................................................... $ 382,950 $ 435,320 13.68%
============= =============
PER COMMON SHARE:
Net income--basic.............................................$ 2.45 $ 2.90 18.37%
Net income--diluted........................................... 2.43 2.87 18.11
Dividends(2).................................................. 0.81 0.90 11.11
Book value (end of period).................................... 24.22 25.32 4.54
Common shares outstanding (end of period)..................... 150,220,119 145,105,566 (3.40)
Weighted average common shares outstanding--basic............. 156,139,173 150,059,789 (3.89)
Weighted average common shares outstanding--diluted........... 157,892,168 151,544,757 (4.02)
BALANCE SHEET (END OF PERIOD):
Total assets..................................................$ 37,608,001 $ 42,602,745 13.28%
Total loans................................................... 25,962,159 26,047,376 0.33
Nonaccrual loans.............................................. 395,212 341,039 (13.71)
Nonperforming assets.......................................... 395,521 344,347 (12.94)
Total deposits................................................ 30,588,080 35,957,805 17.55
Medium and long-term debt..................................... 418,369 417,369 (0.24)
Trust preferred securities.................................... 370,286 356,629 (3.69)
Shareholders' equity.......................................... 3,637,945 3,674,107 0.99
BALANCE SHEET (PERIOD AVERAGE):
Total assets..................................................$ 35,541,802 $ 40,025,749 12.62%
Total loans................................................... 25,562,452 26,522,687 3.76
Earning assets................................................ 32,472,409 36,263,471 11.67
Total deposits................................................ 28,085,461 32,870,184 17.04
Shareholders' equity.......................................... 3,730,273 3,875,990 3.91
FINANCIAL RATIOS:
Return on average assets(3)................................... 1.44% 1.45%
Return on average shareholders' equity(3)..................... 13.73 15.02
Efficiency ratio(4)........................................... 56.84 58.90
Net interest margin(1)........................................ 4.77 4.35
Dividend payout ratio......................................... 33.06 31.03
Tangible equity ratio......................................... 9.38 8.05
Tier 1 risk-based capital ratio............................... 11.14 10.96
Total risk-based capital ratio................................ 12.89 12.58
Leverage ratio................................................ 10.13 8.73
Allowance for credit losses to total loans.................... 2.40 2.11
Allowance for credit losses to nonaccrual loans............... 157.66 161.43
Net loans charged off to average total loans(3)............... 0.83 0.73
Nonperforming assets to total loans and foreclosed assets..... 1.52 1.32
Nonperforming assets to total assets.......................... 1.05 0.81
- ------------------------------
<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.
</FN>
3
ITEM 1. FINANCIAL STATEMENTS
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -------------------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2003 2002 2003
- ---------------------------------------------------------------- -------- -------- ---------- ----------
INTEREST INCOME
Loans........................................................ $381,989 $349,918 $1,136,359 $1,067,806
Securities................................................... 77,518 93,252 237,098 251,151
Interest bearing deposits in banks........................... 773 922 1,898 3,014
Federal funds sold and securities purchased under resale
agreements................................................. 1,467 2,532 10,354 8,210
Trading account assets....................................... 1,366 870 2,987 2,740
-------- -------- ---------- ----------
Total interest income.................................... 463,113 447,494 1,388,696 1,332,921
-------- -------- ---------- ----------
INTEREST EXPENSE
Domestic deposits............................................ 52,049 34,984 167,395 116,772
Foreign deposits............................................. 4,727 1,991 17,096 8,008
Federal funds purchased and securities sold under
repurchase agreements...................................... 1,789 689 5,134 2,763
Commercial paper............................................. 4,488 1,723 12,998 7,397
Medium and long-term debt.................................... 2,375 1,738 7,198 5,422
UnionBanCal Corporation--obligated mandatorily redeemable
preferred securities of subsidiary grantor trust........... 3,921 3,607 11,832 10,930
Other borrowed funds......................................... 1,662 1,673 8,740 3,983
-------- -------- ---------- ----------
Total interest expense................................... 71,011 46,405 230,393 155,275
-------- -------- ---------- ----------
NET INTEREST INCOME............................................. 392,102 401,089 1,158,303 1,177,646
Provision for credit losses.................................. 40,000 20,000 145,000 75,000
-------- -------- ---------- ----------
Net interest income after provision for credit losses.... 352,102 381,089 1,013,303 1,102,646
-------- -------- ---------- ----------
NONINTEREST INCOME
Service charges on deposit accounts.......................... 68,629 81,832 204,641 232,061
Trust and investment management fees......................... 35,368 35,429 109,680 101,245
International commissions and fees........................... 20,131 22,223 57,593 63,112
Insurance commissions........................................ 6,259 15,814 19,969 45,056
Card processing fees, net.................................... 9,068 10,335 26,343 29,357
Brokerage commissions and fees............................... 9,034 7,549 27,614 24,614
Merchant banking fees........................................ 6,819 9,312 22,845 21,521
Foreign exchange trading gains, net.......................... 8,193 7,574 21,653 21,466
Securities gains (losses), net............................... 1,017 (2,618) 2,986 7,042
Other........................................................ 4,598 14,020 11,141 44,938
-------- -------- ---------- ----------
Total noninterest income................................. 169,116 201,470 504,465 590,412
-------- -------- ---------- ----------
NONINTEREST EXPENSE
Salaries and employee benefits............................... 182,275 205,302 547,251 602,338
Net occupancy................................................ 27,340 31,342 75,750 91,844
Equipment.................................................... 16,343 15,680 48,650 48,705
Communications............................................... 13,186 12,661 39,695 39,859
Professional services........................................ 10,350 12,676 30,789 38,256
Data processing.............................................. 7,944 7,659 24,475 23,887
Foreclosed asset expense (income)............................ 18 (79) 130 (28)
Other........................................................ 60,368 63,620 179,362 197,604
-------- -------- ---------- ----------
Total noninterest expense................................ 317,824 348,861 946,102 1,042,465
-------- -------- ---------- ----------
Income before income taxes................................... 203,394 233,698 571,666 650,593
Income tax expense........................................... 65,163 78,653 188,716 215,273
-------- -------- ---------- ----------
NET INCOME...................................................... $138,231 $155,045 $ 382,950 $ 435,320
======== ======== ========== ==========
NET INCOME PER COMMON SHARE--BASIC.............................. $ 0.89 $ 1.04 $ 2.45 $ 2.90
======== ======== ========== ==========
NET INCOME PER COMMON SHARE--DILUTED............................ $ 0.88 $ 1.02 $ 2.43 $ 2.87
======== ======== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--BASIC............... 154,890 149,528 156,139 150,060
======== ======== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--DILUTED............. 156,710 151,562 157,892 151,545
======== ======== ========== ==========
See accompanying notes to condensed consolidated financial statements.
4
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED) (UNAUDITED)
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 2002 2002 2003
- --------------------------------------------------------------------- ------------- ------------ -------------
ASSETS
Cash and due from banks.............................................. $ 2,184,714 $ 2,823,573 $ 2,619,580
Interest bearing deposits in banks................................... 139,323 278,849 341,230
Federal funds sold and securities purchased under resale
agreements......................................................... 1,137,550 1,339,700 1,325,470
------------- ------------ -------------
Total cash and cash equivalents................................... 3,461,587 4,442,122 4,286,280
Trading account assets............................................... 383,749 276,021 320,199
Securities available for sale:
Securities pledged as collateral.................................. 132,974 157,823 68,440
Held in portfolio................................................. 6,061,875 7,109,498 9,930,281
Loans (net of allowance for credit losses: September 30, 2002,
$623,078; December 31, 2002, $609,190; September 30, 2003,
$550,550)......................................................... 25,339,081 25,828,893 25,496,826
Due from customers on acceptances.................................... 68,605 62,469 52,816
Premises and equipment, net.......................................... 492,687 504,666 506,321
Intangible assets.................................................... 23,119 38,518 49,288
Goodwill............................................................. 93,279 150,542 215,903
Other assets......................................................... 1,551,045 1,599,221 1,676,391
------------- ------------ -------------
Total assets...................................................... $ 37,608,001 $ 40,169,773 $ 42,602,745
============= ============ =============
LIABILITIES
Domestic deposits:
Noninterest bearing............................................... $ 14,125,497 $ 15,537,906 $ 16,854,483
Interest bearing.................................................. 14,701,824 15,258,479 17,320,728
Foreign deposits:
Noninterest bearing............................................... 401,202 583,836 556,687
Interest bearing.................................................. 1,359,557 1,460,594 1,225,907
------------- ------------ -------------
Total deposits.................................................... 30,588,080 32,840,815 35,957,805
Federal funds purchased and securities sold under repurchase
agreements......................................................... 303,307 334,379 284,764
Commercial paper..................................................... 880,170 1,038,982 678,903
Other borrowed funds................................................. 218,282 267,047 240,803
Acceptances outstanding.............................................. 68,605 62,469 52,816
Other liabilities.................................................... 1,122,957 1,083,836 939,549
Medium and long-term debt............................................ 418,369 418,360 417,369
UnionBanCal Corporation--obligated mandatorily redeemable
preferred securities of subsidiary grantor trust.................. 370,286 365,696 356,629
------------- ------------ -------------
Total liabilities................................................. 33,970,056 36,411,584 38,928,638
------------- ------------ -------------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock:
Authorized 5,000,000 shares, no shares issued or outstanding
as of September 30, 2002, December 31, 2002, and
September 30, 2003................................................ -- -- --
Common stock, par value $1 per share at September 30, 2003, and
no stated value at September 30, 2002, and December 31, 2002(1):
Authorized 300,000,000 shares, issued 150,220,119 shares as
of September 30, 2002, 150,702,363 shares as of December 31,
2002, and 145,105,566 shares as of September 30, 2003............. 907,088 926,460 145,106
Additional paid-in capital........................................... -- -- 520,876
Retained earnings.................................................... 2,488,873 2,591,635 2,893,240
Accumulated other comprehensive income............................... 241,984 240,094 114,885
------------- ------------ -------------
Total shareholders' equity........................................ 3,637,945 3,758,189 3,674,107
------------- ------------ -------------
Total liabilities and shareholders' equity........................ $ 37,608,001 $ 40,169,773 $ 42,602,745
============= ============ =============
- --------------------------------
<FN>
(1) On September 30, 2003, UnionBanCal Corporation changed its state of
incorporation from California to Delaware, establishing a par value of $1
per share of common stock.
</FN>
See accompanying notes to condensed consolidated financial statements.
5
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003
- ------------------------------------------------------------------------- ------------------------ -------------------------
COMMON STOCK
Balance, beginning of period.......................................... $1,181,925 $ 926,460
Reincorporation(1).................................................... -- (520,876)
Dividend reinvestment plan............................................ 85 34
Deferred compensation--restricted stock................................ 255 282
Stock options exercised............................................... 72,953 35,792
Stock issued in bank acquisitions..................................... 23,852 48,254
Common stock repurchased(2)........................................... (371,982) (344,840)
---------- ----------
Balance, end of period............................................. $ 907,088 $ 145,106
---------- ----------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of period.......................................... $ -- $ --
Reincorporation(1).................................................... -- 520,876
---------- ----------
Balance, end of period............................................. $ -- $ 520,876
---------- ----------
RETAINED EARNINGS
Balance, beginning of period.......................................... $2,231,384 $2,591,635
Net income............................................................ 382,950 $382,950 435,320 $435,320
Dividends on common stock(3).......................................... (125,345) (133,603)
Deferred compensation--restricted stock................................... (116) (112)
---------- ----------
Balance, end of period............................................. $2,488,873 $2,893,240
---------- ----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of period.......................................... $ 132,933 $ 240,094
Unrealized net gains on cash flow hedges, net of tax expense of $61,525
and $18,408 in the first nine months of 2002 and 2003, respectively... 99,325 29,718
Less: reclassification adjustment for net gains on cash flow hedges
included in net income, net of tax expense of $31,920 and $41,878 in
the first nine months of 2002 and 2003, respectively.................. (51,532) (67,607)
-------- --------
Net increase (reduction) in unrealized gains on cash flow hedges...... 47,793 (37,889)
Unrealized holding gains (losses) arising during the period on
securities available for sale, net of tax expense (benefit) of $38,360
and $(51,920) in the first nine months of 2002 and 2003, respectively. 61,927 (83,819)
Less: reclassification adjustment for gains on securities available for
sale included in net income, net of tax expense of $1,142 and $2,694 in
the first nine months of 2002 and 2003, respectively.................. (1,844) (4,348)
-------- --------
Net unrealized gains (losses) on securities available for sale........ 60,083 (88,167)
Foreign currency translation adjustment, net of tax expense of $728 and
$525 in the first nine months of 2002 and 2003, respectively.......... 1,175 847
Other comprehensive income............................................ 109,051 109,051 (125,209) (125,209)
---------- -------- ---------- --------
Total comprehensive income............................................ $492,001 $310,111
======== ========
Balance, end of period............................................. $ 241,984 $ 114,885
---------- ----------
TOTAL SHAREHOLDERS' EQUITY....................................... $3,637,945 $3,674,107
========== ==========
- ----------------------------------
<FN>
(1) On September 30, 2003, UnionBanCal Corporation changed its state of
incorporation from California to Delaware, establishing a par value of $1
per share of common stock.
(2) Common stock repurchased includes commission costs.
(3) Dividends per share were $0.81 and $0.90 for the first nine months of 2002
and 2003, respectively. Dividends per share are based on UnionBanCal
Corporation's shares outstanding as of the declaration date.
</FN>
See accompanying notes to condensed consolidated financial statements.
6
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
------------------------------
(DOLLARS IN THOUSANDS) 2002 2003
- --------------------------------------------------------------------------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................................. $ 382,950 $ 435,320
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses...................................... 145,000 75,000
Depreciation, amortization and accretion......................... 62,563 87,332
Provision for deferred income taxes.............................. 42,941 60,425
Gain on securities available for sale............................ (2,986) (7,042)
Net increase in prepaid expenses................................. (90,962) (89,272)
Net increase (decrease) in accrued expenses...................... 111,449 (103,652)
Net increase in trading account assets........................... (154,052) (44,178)
Loans originated for resale...................................... (502,542) (269,186)
Net proceeds from sale of loans originated for resale............ 499,871 291,198
Other, net....................................................... (192,675) (159,887)
----------- -----------
Total adjustments................................................ (81,393) (159,262)
----------- -----------
Net cash provided by operating activities............................... 301,557 276,058
=========== ===========
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale.................... 175,552 308,051
Proceeds from matured and called securities available for sale.......... 856,160 2,689,120
Purchases of securities available for sale.............................. (1,425,404) (5,849,353)
Net (increase) decrease in loans........................................ (1,008,214) 758,743
Net cash received (paid) in acquisitions................................ 64,689 (60,920)
Purchases of premises and equipment..................................... (55,256) (70,192)
Other, net.............................................................. 20,963 823
----------- -----------
Net cash used in investing activities............................ (1,371,510) (2,223,728)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits................................................ 1,827,256 2,650,264
Net decrease in federal funds purchased and securities sold
under repurchase agreements........................................... (115,507) (49,615)
Net decrease in commercial paper and other borrowed funds............... (432,608) (386,323)
Common stock repurchased................................................ (371,982) (344,840)
Payments of cash dividends.............................................. (122,228) (130,896)
Stock options exercised................................................. 72,953 35,792
Other, net.............................................................. 1,260 881
----------- -----------
Net cash provided by financing activities........................ 859,144 1,775,263
----------- -----------
Net decrease in cash and cash equivalents.................................. (210,809) (172,407)
Cash and cash equivalents at beginning of period........................... 3,664,954 4,442,122
Effect of exchange rate changes on cash and cash equivalents............... 7,442 16,565
----------- -----------
Cash and cash equivalents at end of period................................. $ 3,461,587 $ 4,286,280
=========== ===========
CASH PAID DURING THE PERIOD FOR:
Interest $ 237,723 $ 155,469
Income taxes............................................................ 110,253 187,723
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisitions:
Fair value of assets acquired.................................... $ 256,276 $ 721,749
Purchase price:
Cash........................................................... (20,940) (83,597)
Stock issued................................................... (23,852) (48,254)
----------- -----------
Liabilities assumed.............................................. $ 211,484 $ 589,898
=========== ===========
See accompanying notes to condensed consolidated financial statements.
7
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 September 30, 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/A 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, the Company has announced stock repurchase plans
totaling $500 million and as of September 30, 2003 has expended $385 million.
The Company repurchased $86 million and $45 million of common stock in 2002 and
the first nine months of 2003, respectively, as part of these repurchase plans.
As of September 30, 2003, $115 million of the Company's common stock is
authorized for repurchase. In addition, the Company purchased $600 million of
its common stock, $300 million in August 2002 and $300 million in September
2003, from its majority owner, The Bank of Tokyo-Mitsubishi, Ltd. (BTM), which
is a wholly-owned subsidiary of Mitsubishi Tokyo Financial Group, Inc. At
September 30, 2003, BTM owned approximately 63 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, as amended, the Company
has chosen to continue to recognize compensation expense using the intrinsic
value-based method of valuing stock options
8
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 2003
(Unaudited)
NOTE 1--BASIS OF PRESENTATION AND NATURE OF OPERATIONS (Continued)
prescribed in Accounting Principles Board Opinion (APB) 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 September 30, 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/A 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.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003
- --------------------------------------------------------- -------- -------- -------- --------
AS REPORTED NET INCOME................................... $138,231 $155,045 $382,950 $435,320
Stock option-based employee compensation expense
(determined under fair value based method
for all awards, net of taxes).......................... (5,778) (6,479) (15,696) (18,962)
-------- -------- -------- --------
Pro forma net income, after stock option-based
employee compensation expense........................... $132,453 $148,566 $367,254 $416,358
======== ======== ======== ========
EARNINGS PER SHARE--BASIC
As reported.............................................. $ 0.89 $ 1.04 $ 2.45 $ 2.90
Pro forma................................................ $ 0.86 $ 0.99 $ 2.35 $ 2.77
EARNINGS PER SHARE--DILUTED
As reported.............................................. $ 0.88 $ 1.02 $ 2.43 $ 2.87
Pro forma................................................ $ 0.85 $ 0.98 $ 2.33 $ 2.75
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 third quarters
and the first nine months of 2002 and 2003 was not significant.
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging
9
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 2003
(Unaudited)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (Continued)
Activities." The changes in this Statement improve financial reporting by
requiring that contracts with comparable characteristics be accounted for
similarly. SFAS No. 149 is effective for contracts entered into or modified
after September 30, 2003, except as stated below, and for hedging relationships
designated after September 30, 2003. All provisions of SFAS No. 149 should be
applied prospectively.
The provisions of SFAS No. 149 that relate to SFAS No. 133 implementation
issues that have been effective for fiscal quarters that began prior to June 15,
2003, will be applied in accordance with their respective effective dates. In
addition, the provisions of SFAS No. 149, which relate to forward purchases or
sales of when-issued securities or other securities that do not exist, will be
applied to both existing contracts and new contracts entered into after
September 30, 2003. Management believes that adoption of the provisions of this
Statement will not have a material impact on the Company's financial position or
results of operations.
ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." The
Statement establishes standards for how the Company should classify and measure
certain financial instruments with characteristics of both liabilities and
equity. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and is otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The new standards for the
classification and measurement of financial instruments should be applied
retroactively. Any gain or loss resulting from the implementation of SFAS No.
150 will be reported as a cumulative effect of a change in accounting principle.
Adoption of this Statement did not have a material impact on the Company's
financial position or results of operations.
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 statement 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 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 at the adoption date and management believes that it will not
have a material impact on the Company's future financial position or results of
operations.
10
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 2003
(Unaudited)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (Continued)
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. On October 9, 2003, the FASB issued FASB Staff Position
(FSP) No. FIN 46-6 deferring the effective date for applying the provisions of
FIN 46. The Company need not apply the provisions of FIN 46 to an interest held
in a VIE created before February 1, 2003 until December 31, 2003. As of
September 30, 2003, management believes the Company does not have any VIE's for
which this interpretation would require consolidation. However, under FIN 46,
the Company's subsidiary, which issued trust preferred securities, will be
deconsolidated. Deconsolidation of this entity in the fourth quarter of 2003
will cause total assets and total liabilities to increase by approximately $10.8
million with no change to the Company's results of operations.
For additional information on recently issued accounting pronouncements and
other significant accounting principles, see Note 1--"Summary of Significant
Accounting Policies and Nature of Operations" of the Notes to Consolidated
Financial Statements included in the Form 10-K/A for the year ended December 31,
2002.
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 and nine months ended September 30, 2002 and 2003.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------ --------------------------------------------------
2002 2003 2002 2003
--------------------- ---------------------- --------------------- ---------------------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE DATA) BASIC DILUTED BASIC DILUTED BASIC DILUTED BASIC DILUTED
- ------------------------- -------- -------- -------- -------- -------- -------- -------- --------
Net Income............... $138,231 $138,231 $155,045 $155,045 $382,950 $382,950 $435,320 $435,320
======== ======== ======== ======== ======== ======== ======== ========
Weighted average common
shares outstanding..... 154,890 154,890 149,528 149,528 156,139 156,139 150,060 150,060
Additional shares due to:
Assumed conversion of
dilutive stock options -- 1,820 -- 2,034 -- 1,753 -- 1,485
-------- -------- -------- -------- -------- -------- -------- --------
Adjusted weighted average
common shares
outstanding............ 154,890 156,710 149,528 151,562 156,139 157,892 150,060 151,545
======== ======== ======== ======== ======== ======== ======== ========
Net income per share..... $ 0.89 $ 0.88 $ 1.04 $ 1.02 $ 2.45 $ 2.43 $ 2.90 $ 2.87
======== ======== ======== ======== ======== ======== ======== ========
11
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 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 NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------
(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..... 47,793 (37,889) 60,083 (88,167) 1,175 847
-------- -------- -------- -------- -------- ---------
Ending balance............... $110,633 $ 66,479 $143,354 $ 59,283 $(11,030) $ (9,802)
======== ======== ======== ======== ======== =========
MINIMUM PENSION ACCUMULATED OTHER
LIABILITY ADJUSTMENT COMPREHENSIVE INCOME
--------------------- --------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003
- ------------------------------------------------------ -------- -------- -------- ---------
Beginning balance..................................... $ (973) $ (1,075) $132,933 $ 240,094
Change during the period.............................. -- -- 109,051 (125,209)
-------- -------- -------- ---------
Ending balance........................................ $ (973) $ (1,075) $241,984 $ 114,885
======== ======== ======== =========
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. 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
12
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 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 pages, 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 these tables 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 adjustment between the tax expense calculated under RAROC using a
tax rate of 38.25 percent and the Company's effective tax rates;
o the Pacific Rim Corporate Group, with assets at September 30, 2003 of
$295 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.
13
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 2003
(Unaudited)
NOTE 5--BUSINESS SEGMENTS (Continued)
The business units' results for the prior periods have been restated to
reflect certain transfer pricing changes and any reorganization changes that may
have occurred.
COMMUNITY BANKING COMMERCIAL FINANCIAL INTERNATIONAL
AND INVESTMENT SERVICES SERVICES GROUP BANKING GROUP
----------------------- --------------------- --------------------
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- --------------------------------------------- --------- -------- -------- -------- -------- -------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income.......................... $ 197,080 $231,992 $173,635 $219,812 $ 9,153 $10,545
Noninterest income........................... 96,823 110,908 47,290 67,591 17,268 18,117
--------- -------- -------- -------- -------- -------
Total revenue................................ 293,903 342,900 220,925 287,403 26,421 28,662
Noninterest expense.......................... 175,543 202,269 99,091 103,182 15,746 15,418
Credit expense (income)...................... 7,528 7,996 47,215 39,397 474 511
--------- -------- -------- -------- -------- -------
Income before income tax expense (benefit)... 110,832 132,635 74,619 144,824 10,201 12,733
Income tax expense (benefit)................. 42,393 50,733 23,485 49,002 3,902 4,870
--------- -------- -------- -------- -------- -------
Net income (loss)............................ $ 68,439 $ 81,902 $ 51,134 $ 95,822 $ 6,299 $ 7,863
========= ======== ======== ======== ======== =======
TOTAL ASSETS, END OF PERIOD (dollars in
millions): $ 11,026 $ 12,958 $ 16,103 $ 14,255 $ 1,680 $ 2,012
========= ======== ======== ======== ======== =======
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
---------------------- --------------------- ---------------------
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- ------------------------------------------------- -------- -------- -------- -------- -------- --------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income.............................. $ (6,763) $(78,254) $ 18,997 $ 16,994 $392,102 $401,089
Noninterest income............................... 2,561 (1,097) 5,174 5,951 169,116 201,470
-------- -------- -------- -------- -------- --------
Total revenue.................................... (4,202) (79,351) 24,171 22,945 561,218 602,559
Noninterest expense.............................. 3,756 3,926 23,688 24,066 317,824 348,861
Credit expense (income).......................... 50 50 (15,267) (27,954) 40,000 20,000
-------- -------- -------- -------- -------- --------
Income (loss) before income tax expense (benefit) (8,008) (83,327) 15,750 26,833 203,394 233,698
Income tax expense (benefit)..................... (3,063) (31,872) (1,554) 5,920 65,163 78,653
-------- -------- -------- -------- -------- --------
Net income (loss)................................ $ (4,945) $(51,455) $ 17,304 $ 20,913 $138,231 $155,045
======== ======== ======== ======== ======== ========
TOTAL ASSETS, END OF PERIOD (dollars in
millions):..................................... $ 7,863 $ 12,046 $ 936 $ 1,332 $ 37,608 $ 42,603
======== ======== ======== ======== ======== ========
14
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 2003
(Unaudited)
NOTE 5--BUSINESS SEGMENTS (Continued)
COMMUNITY BANKING COMMERCIAL FINANCIAL INTERNATIONAL
AND INVESTMENT SERVICES SERVICES GROUP BANKING GROUP
---------------------- --------------------- --------------------
AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- ------------------------------------------------- -------- -------- -------- -------- -------- -------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income.............................. $567,837 $650,542 $499,248 $616,175 $ 28,024 $30,593
Noninterest income............................... 280,221 324,367 150,268 187,055 49,988 59,690
-------- -------- -------- -------- -------- -------
Total revenue.................................... 848,058 974,909 649,516 803,230 78,012 90,283
Noninterest expense.............................. 524,327 599,386 285,795 307,622 46,155 45,600
Credit expense (income).......................... 25,419 23,778 141,735 124,004 1,428 1,563
-------- -------- -------- -------- -------- -------
Income before income tax expense (benefit)....... 298,312 351,745 221,986 371,604 30,429 43,120
Income tax expense (benefit)..................... 114,104 134,543 70,463 122,843 11,639 16,493
-------- -------- -------- -------- -------- -------
Net income (loss)................................ $184,208 $217,202 $151,523 $248,761 $ 18,790 $26,627
======== ======== ======== ======== ======== =======
TOTAL ASSETS, END OF PERIOD (dollars
in millions):.................................. $ 11,026 $ 12,958 $ 16,103 $ 14,255 $ 1,680 $ 2,012
======== ======== ======== ======== ======== =======
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
----------------------- --------------------- ------------------------
AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- ----------------------------------------- -------- --------- -------- -------- ---------- ----------
RESULTS OF OPERATIONS (DOLLARS IN
THOUSANDS):
Net interest income...................... $ 5,955 $(172,029) $ 57,239 $ 52,365 $1,158,303 $1,177,646
Noninterest income....................... 8,788 2,311 15,200 16,989 504,465 590,412
-------- --------- -------- -------- ---------- ----------
Total revenue............................ 14,743 (169,718) 72,439 69,354 1,662,768 1,768,058
Noninterest expense...................... 11,677 11,726 78,148 78,131 946,102 1,042,465
Credit expense (income).................. 150 150 (23,732) (74,495) 145,000 75,000
-------- --------- -------- -------- ---------- ----------
Income (loss) before income tax expense
(benefit)............................. 2,916 (181,594) 18,023 65,718 571,666 650,593
Income tax expense (benefit)............. 1,115 (69,459) (8,605) 10,853 188,716 215,273
-------- --------- -------- -------- ---------- ----------
Net income (loss)........................ $ 1,801 $(112,135) $ 26,628 $ 54,865 $ 382,950 $ 435,320
======== ========= ======== ======== ========== ==========
TOTAL ASSETS, END OF PERIOD (dollars in
millions):............................ $ 7,863 $ 12,046 $ 936 $ 1,332 $ 37,608 $ 42,603
======== ========= ======== ======== ========== ==========
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.
15
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 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. At September 30, 2003, the
weighted average life of these cash flow hedges is approximately 1.6 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 and cap corridors 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 these cap contracts offset the increase in
interest expense caused by the relevant LIBOR index rising above the caps'
strike rates. Cap corridors will not provide protection from increases in the
relevant LIBOR index to the extent it rises above the cap corridor's upper
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
16
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 2003
(Unaudited)
NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
(Continued)
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 the mismatch between
the timing of reset dates on the hedge versus those of the loans or CDs. In the
third quarter of 2003, the Company recognized a net gain of less than $0.1
million due to ineffectiveness, which is recognized in noninterest expense,
compared to a net gain of $0.2 million in the third 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 third quarter of 2003
resulted in a net gain of less than $0.1 million, compared to a net loss of less
than $0.1 million in the third 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, 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.
17
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 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 transactions. 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 September 30, 2003, the Company's
maximum exposure to loss for standby and commercial letters of credit is $2.9
billion and $228.1 million, respectively. At September 30, 2003, the carrying
value of the Company's standby and commercial letters of credit, which is
included in "Other liabilities" on the condensed consolidated balance sheet,
total $5.8 million.
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 September 30, 2003, the Company has a maximum exposure of
$10.5 million for these agreements, which expire March 2006.
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 September
30, 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 $3.0 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 September 30, 2003,
the Bank had a maximum exposure to loss under these guarantees, which have an
average term of less than one year, of $698.2 million. 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
September 30, 2003, UnionBanCal Corporation had no exposure to loss for these
agreements.
NOTE 8--ACQUISITIONS
On July 1, 2003, the Company completed its acquisition of Monterey Bay
Bank, a savings and loan association headquartered in Watsonville, California
and recorded approximately $34 million in goodwill
18
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 2003
(Unaudited)
NOTE 8--ACQUISITIONS (Continued)
and approximately $8 million in core deposit intangibles. The core deposit
intangibles will be amortized on an accelerated basis over their economic useful
life of a weighted average 5 years.
NOTE 9--SUBSEQUENT EVENTS AND PENDING ACQUISITIONS
On September 25, 2003, the Company signed a definitive agreement to acquire
Business Bancorp, the parent company of Business Bank of California, a $676
million asset commercial bank headquartered in San Bernardino, California.
Business Bank of California has approximately 235 employees and 15 full-service
branches in two distinct markets: the Southern California Inland Empire and the
San Francisco Bay Area. The Company will pay between approximately $117.7
million and $134.9 million in cash and common stock. The transaction is expected
to be completed during the first quarter of 2004.
On October 22, 2003, the Board of Directors declared a quarterly cash
dividend of $0.31 per share of common stock. The dividend will be paid on
January 2, 2004 to shareholders of record as of December 5, 2003.
On October 24, 2003, UnionBanCal Corporation filed a registration statement
on Form S-3 with the Securities and Exchange Commission in connection with an
offer to be made to current and former participants in the Union Bank of
California 401(k) Plan to rescind the previous purchases made with salary
deferral or rollover or after-tax contributions within the Plan from October 24,
2002 through October 23, 2003, of up to 450,775 shares of UnionBanCal
Corporation common stock. UnionBanCal Corporation is conducting the rescission
offer because it has determined that these shares of UnionBanCal Corporation
common stock may not have been registered in a timely manner under the
Securities Act of 1933. Management does not believe that, based on our current
estimates, the amount required to fund payments under the rescission offer will
be material to the Company's financial position or results of operations.
During October and November 2003, Southern California suffered extensive
wildfires in the Counties of Los Angeles, Ventura, San Diego, San Bernardino and
Riverside. These wildfires burned nearly 750,000 acres and damaged or destroyed
more than 3,500 homes and other properties. The fires have now been contained.
Based upon the information currently available, including the effect that these
wildfires have had on the Company's Southern California facilities and
operations, and on collateral securing loans made by the Bank in the affected
areas, management does not believe that wildfire related losses will have a
material effect on the Company's financial condition or results of operations.
19
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, INCLUDING THE POSSIBLE IMPACT OF THE RECENT WILDFIRES
IN SOUTHERN CALIFORNIA, GLOBAL POLITICAL AND GENERAL ECONOMIC CONDITIONS RELATED
TO THE TERRORIST ATTACKS ON SEPTEMBER 11, 2001, AND THEIR AFTERMATH, THE
CONTINUING HOSTILITIES 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
OPERATIONS."
ALL REPORTS THAT WE FILE ELECTRONICALLY WITH THE SEC, INCLUDING THE ANNUAL
REPORT ON FORM 10-K OR 10-K/A, 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 with
consolidated assets of $42.6 billion at September 30, 2003. On September 30,
2003, UnionBanCal Corporation changed its state of incorporation from California
to Delaware. At September 30, 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, we have announced stock repurchase plans totaling $500
million and as of September 30, 2003 we have expended $385 million. We
repurchased $86 million and $45 million of common stock in 2002 and the first
nine months of 2003, respectively, as part of these repurchase plans. As of
September 30, 2003, $115 million of our common stock is authorized for
repurchase. In addition, we purchased $600 million of our common stock, $300
million in August 2002 and $300 million in September 2003, from our majority
owner, BTM. At September 30, 2003, BTM owned approximately 63 percent of our
outstanding common stock.
20
SUMMARY
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2003
Net income was $155.0 million, or $1.02 per diluted common share, in the
third quarter of 2003, compared with $138.2 million, or $0.88 per diluted common
share, in the third quarter of 2002. This increase in diluted earnings per share
of $0.14, or 16 percent, above the third quarter of 2002 was due to a $32.4
million, or 19 percent, increase in noninterest income, a $20.0 million, or 50
percent, decrease in provision for credit losses, and a $9.1 million, or 2
percent, increase in net interest income (on a taxable-equivalent basis), offset
by a $31.0 million, or 10 percent, increase in noninterest expense, coupled with
a decrease in weighted average shares outstanding from share repurchases. Other
highlights of the third quarter of 2003 include:
o Net interest income, on a taxable-equivalent basis, was $401.7 million
in the third quarter of 2003, an increase of $9.1 million, or 2
percent, over the third quarter of 2002. Net interest margin in the
third quarter of 2003 was 4.22 percent, a decrease of 55 basis points
from the third quarter of 2002.
o A provision for credit losses of $20.0 million was recorded in the
third quarter of 2003 compared with $40.0 million in the third 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 $550.6 million, or 161
percent of total nonaccrual loans, at September 30, 2003, compared
with $623.1 million, or 158 percent of total nonaccrual loans, at
September 30, 2002.
o Noninterest income was $201.5 million in the third quarter of 2003, an
increase of $32.4 million, or 19 percent, from the third quarter of
2002. This increase included a $13.2 million increase in service
charges on deposit accounts, a $9.6 million increase in insurance
commissions mostly associated with our insurance agency acquisitions
and lower net losses of $5.6 million for commercial loans held for
sale, partially offset by a $3.6 million decrease in securities gains,
net.
o Noninterest expense was $348.9 million in the third quarter of 2003,
an increase of $31.0 million, or 10 percent, over the third quarter of
2002. This increase included a $17.6 million increase in salaries and
other compensation, which was primarily attributable to our
acquisitions and new branch openings, higher employee benefits of $5.4
million and a $4.0 million increase in net occupancy expense.
o Income tax expense in the third quarter of 2003 was $78.7 million,
resulting in a 34 percent effective income tax rate. For the third
quarter of 2002, the effective income tax rate was 32 percent, which
included a $3.3 million net reduction to income tax expense resulting
from a change in tax law in the State of California concerning the tax
treatment of loan loss reserves.
o Return on average assets decreased to 1.47 percent in the third
quarter of 2003 compared to 1.53 percent in the third quarter of 2002.
Our return on average shareholders' equity increased to 16.04 percent
in the third quarter of 2003 compared to 14.38 percent in the third
quarter of 2002.
o Total loans at September 30, 2003 were $26.0 billion, an increase of
$85.2 million from September 30, 2002.
o Nonperforming assets were $344.3 million at September 30, 2003, a
decrease of $51.2 million, or 13 percent, from September 30, 2002.
Nonperforming assets, as a percentage of total assets, decreased to
0.81 percent at September 30, 2003, compared with 1.05 percent at
September 30, 2002. The ratio of nonaccrual loans to total loans
decreased to 1.31 percent at September 30, 2003 from 1.52 percent at
September 30, 2002.
o Our Tier 1 and total risk-based capital ratios were 10.96 percent and
12.58 percent, respectively, at September 30, 2003, compared with
11.14 percent and 12.89 percent, respectively, at September 30,
21
2002. Our leverage ratio was 8.73 percent at September 30, 2003,
compared with 10.13 percent at September 30, 2002.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2003
Net income was $435.3 million, or $2.87 per diluted common share, in the
first nine months of 2003, compared with $383.0 million, or $2.43 per diluted
common share, in the first nine months of 2002. This increase in diluted
earnings per share of $0.44, or 18 percent, above the first nine months of 2002
was due to a $85.9 million, or 17 percent, increase in noninterest income, a
$70.0 million, or 48 percent, decrease in provision for credit losses, and a
$19.7 million, or 2 percent, increase in net interest income (on a
taxable-equivalent basis), offset by a $96.4 million, or 10 percent, increase in
noninterest expense; coupled with a decrease in weighted average shares
outstanding due to share repurchases. Other highlights of the first nine months
of 2003 include:
o Net interest income, on a taxable-equivalent basis, was $1.18 billion
in the first nine months of 2003, an increase of $19.7 million, or 2
percent, over the first nine months of 2002. Net interest margin in
the first nine months of 2003 was 4.35 percent, a decrease of 42 basis
points from the first nine months of 2002.
o A provision for credit losses of $75.0 million was recorded in the
first nine months of 2003 compared with $145.0 million in the first
nine months 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.
o Noninterest income was $590.4 million in the first nine months of
2003, an increase of $85.9 million, or 17 percent, from the first nine
months of 2002. This increase included a $27.4 million increase in
service charges on deposit accounts, a $25.1 million increase in
insurance commissions mostly associated with our insurance agency
acquisitions, lower writedowns on private capital investments of $13.6
million, lower residual value writedowns on auto leases of $9.0
million, lower net losses of $8.0 million for commercial loans held
for sale and a $4.1 million increase in net securities gains mainly
attributable to a $9.0 million gain arising from the early call of a
Mexican Brady Bond, partly offset by an $8.4 million decrease in trust
and investment management fees.
o Noninterest expense was $1.04 billion in the first nine months of
2003, an increase of $96.4 million, or 10 percent, over the first nine
months of 2002. This increase included higher salaries and other
compensation of $35.6 million, mostly related to our acquisitions and
new branch openings, higher employee benefits of $19.4 million and a
$16.1 million increase in net occupancy expense.
o Income tax expense in the first nine months of 2003 was $215.3
million, resulting in a 33 percent effective income tax rate. For the
first nine months of 2002, the effective income tax rate was also 33
percent.
o Return on average assets increased slightly to 1.45 percent in the
first nine months of 2003 compared to 1.44 percent in the first nine
months of 2002. Our return on average shareholders' equity increased
to 15.02 percent in the first nine months of 2003 compared to 13.73
percent in the first nine months of 2002.
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
22
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 tables reflect 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.
23
We have restated certain business units' results for the prior periods to
reflect certain transfer pricing changes and any reorganization changes that may
have occurred.
COMMUNITY BANKING
AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL
SERVICES SERVICES GROUP BANKING GROUP
----------------------- --------------------- ------------------------
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
-------- --------- -------- -------- ---------- ----------
RESULTS OF OPERATIONS AFTER PERFORMANCE
CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income............................$197,080 $ 231,992 $173,635 $219,812 $ 9,153 $ 10,545
Noninterest income............................. 96,823 110,908 47,290 67,591 17,268 18,117
-------- --------- -------- -------- ---------- ----------
Total revenue.................................. 293,903 342,900 220,925 287,403 26,421 28,662
Noninterest expense............................ 175,543 202,269 99,091 103,182 15,746 15,418
Credit expense (income)........................ 7,528 7,996 47,215 39,397 474 511
-------- --------- -------- -------- ---------- ----------
Income (loss) before income tax
expense (benefit)............................ 110,832 132,635 74,619 144,824 10,201 12,733
Income tax expense (benefit)................... 42,393 50,733 23,485 49,002 3,902 4,870
-------- --------- -------- -------- ---------- ----------
Net income (loss)..............................$ 68,439 $ 81,902 $ 51,134 $ 95,822 $ 6,299 $ 7,863
======== ========= ======== ======== ========== ==========
PERFORMANCE CENTER EARNINGS (DOLLARS
IN THOUSANDS):
Net interest income............................$ 162 $ 163 $ (252) $ (77) $ -- $ 10
Noninterest income............................. (12,116) (10,963) 16,308 17,739 1,098 305
Noninterest expense............................ (9,409) (9,188) 8,572 9,774 860 59
Net income (loss).............................. (1,588) (1,013) 4,661 4,909 147 158
Total loans (dollars in millions).............. 23 24 (42) (43) -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1).................................$ 10,154 $ 11,801 $ 14,208 $ 12,483 $ 1,219 $ 1,457
Total assets................................... 10,920 12,904 16,016 14,347 1,547 1,913
Total deposits(1).............................. 14,820 17,456 9,789 13,767 1,358 1,555
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............. 47% 45% 13% 24% 37% 50%
Return on average assets(2).................... 2.49 2.52 1.27 2.65 1.62 1.63
Efficiency ratio(3)............................ 59.7 59.0 44.9 35.9 59.6 53.8
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
2002 2003 2002 2003 2002 2003
-------- --------- -------- -------- ---------- ----------
RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER
EARNINGS (DOLLARS IN THOUSANDS):
Net interest income........................... $ (6,763) $ (78,254) $ 18,997 $ 16,994 $ 392,102 $ 401,089
Noninterest income............................ 2,561 (1,097) 5,174 5,951 169,116 201,470
-------- --------- -------- -------- ---------- ----------
Total revenue................................. (4,202) (79,351) 24,171 22,945 561,218 602,559
Noninterest expense........................... 3,756 3,926 23,688 24,066 317,824 348,861
Credit expense (income)....................... 50 50 (15,267) (27,954) 40,000 20,000
-------- --------- -------- -------- ---------- ----------
Income (loss) before income tax expense
(benefit)................................... (8,008) (83,327) 15,750 26,833 203,394 233,698
Income tax expense (benefit).................. (3,063) (31,872) (1,554) 5,920 65,163 78,653
-------- --------- -------- -------- ---------- ----------
Net income (loss)............................. $ (4,945) $ (51,455) $ 17,304 $ 20,913 $ 138,231 $ 155,045
======== ========= ======== ======== ========== ==========
PERFORMANCE CENTER EARNINGS (DOLLARS IN
THOUSANDS):
Net interest income........................... $ -- $ (203) $ 90 $ 107 $ -- $ --
Noninterest income............................ (8,578) (10,605) 3,288 3,524 -- --
Noninterest expense........................... (1,534) (2,123) 1,511 1,478 -- --
Net income (loss)............................. (4,349) (5,362) 1,129 1,308 -- --
Total loans (dollars in millions)............. -- -- 19 19 -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................ $ 103 $ 333 $ 287 $ 258 $ 25,971 $ 26,332
Total assets.................................. 6,562 11,506 758 1,244 35,803 41,914
Total deposits(1)............................. 1,496 837 992 1,288 28,455 34,903
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............ (2)% (21)% na na na na
Return on average assets(2)................... (0.30) (1.77) na na 1.53% 1.47%
Efficiency ratio(3)........................... na na na na 56.6 57.8
- ---------------------------
<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.
na = not applicable
</FN>
24
COMMUNITY BANKING
AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL
SERVICES SERVICES GROUP BANKING GROUP
----------------------- --------------------- ------------------------
AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
-------- --------- -------- -------- ---------- ----------
RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER
EARNINGS (DOLLARS IN THOUSANDS):
Net interest income............................$567,837 $ 650,542 $499,248 $616,175 $ 28,024 $ 30,593
Noninterest income............................. 280,221 324,367 150,268 187,055 49,988 59,690
-------- --------- -------- -------- ---------- ----------
Total revenue.................................. 848,058 974,909 649,516 803,230 78,012 90,283
Noninterest expense............................ 524,327 599,386 285,795 307,622 46,155 45,600
Credit expense (income)........................ 25,419 23,778 141,735 124,004 1,428 1,563
-------- --------- -------- -------- ---------- ----------
Income (loss) before income tax expense
(benefit)..................................... 298,312 351,745 221,986 371,604 30,429 43,120
Income tax expense (benefit)................... 114,104 134,543 70,463 122,843 11,639 16,493
-------- --------- -------- -------- ---------- ----------
Net income (loss)..............................$184,208 $ 217,202 $151,523 $248,761 $ 18,790 $ 26,627
======== ========= ======== ======== ========== ==========
PERFORMANCE CENTER EARNINGS (DOLLARS IN
THOUSANDS):
Net interest income............................$ 606 $ 531 $ (924) $ (444) $ -- $ 24
Noninterest income............................. (36,788) (32,040) 45,845 49,627 3,140 890
Noninterest expense............................ (28,153) (26,415) 24,797 27,585 2,487 394
Net income (loss).............................. (5,042) (3,203) 12,580 13,462 403 321
Total loans (dollars in millions).............. 25 25 (45) (45) -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1).................................$ 9,896 $ 11,383 $ 14,160 $ 13,025 $ 1,095 $ 1,529
Total assets................................... 10,663 12,392 15,925 15,028 1,421 1,948
Total deposits(1).............................. 14,338 16,560 9,328 12,461 1,493 1,515
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............. 43% 43% 13% 20% 39% 57%
Return on average assets(2).................... 2.31 2.34 1.27 2.21 1.77 1.83
Efficiency ratio(3)............................ 61.8 61.5 44.0 38.3 59.2 50.5
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
----------------------- --------------------- ------------------------
AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
-------- --------- -------- -------- ---------- ----------
RESULTS OF OPERATIONS AFTER PERFORMANCE
CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income.................... $ 5,955 $(172,029) $ 57,239 $ 52,365 $1,158,303 $1,177,646
Noninterest income..................... 8,788 2,311 15,200 16,989 504,465 590,412
-------- --------- -------- -------- ---------- ----------
Total revenue.......................... 14,743 (169,718) 72,439 69,354 1,662,768 1,768,058
Noninterest expense.................... 11,677 11,726 78,148 78,131 946,102 1,042,465
Credit expense (income)................ 150 150 (23,732) (74,495) 145,000 75,000
-------- --------- -------- -------- ---------- ----------
Income (loss) before income tax expense
(benefit).............................. 2,916 (181,594) 18,023 65,718 571,666 650,593
Income tax expense (benefit)........... 1,115 (69,459) (8,605) 10,853 188,716 215,273
-------- --------- -------- -------- ---------- ----------
Net income (loss)...................... $ 1,801 $(112,135) $ 26,628 $ 54,865 $ 382,950 $ 435,320
======== ========= ======== ======== ========== ==========
PERFORMANCE CENTER EARNINGS (DOLLARS IN
THOUSANDS):
Net interest income.................... $ -- $ (433) $ 318 $ 322 $ -- $ --
Noninterest income..................... (22,146) (28,553) 9,949 10,076 -- --
Noninterest expense.................... (3,766) (5,776) 4,635 4,212 -- --
Net income (loss)...................... (11,350) (14,332) 3,409 3,752 -- --
Total loans (dollars in millions)...... -- -- 20 20 -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)......................... $ 91 $ 279 $ 320 $ 307 $ 25,562 $ 26,523
Total assets........................... 6,729 9,655 804 1,003 35,542 40,026
Total deposits(1)...................... 1,991 1,037 935 1,297 28,085 32,870
FINANCIAL RATIOS:
Risk adjusted return on capital(2)..... --% (15)% na na na na
Return on average assets(2)............ 0.04 (1.55) na na 1.44% 1.45%
Efficiency ratio(3).................... 79.2 na na na 56.8 58.9
- -------------------------------
<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.
na = not applicable
</FN>
25
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 third quarter of 2003, net income increased $13.5 million, or 20
percent, compared to the third quarter of 2002. Total revenue increased $49.0
million, or 17 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 $34.9 million, or 18 percent, in net interest income over the prior
year. Excluding the impact of performance center earnings, noninterest income
was $12.9 million, or 12 percent, higher than the prior year primarily due to
our acquisitions of John Burnham & Company, in the fourth quarter of 2002, and
Tanner Insurance Brokers, Inc., in the second quarter of 2003, and higher
deposit-related service fees. Noninterest expense increased $26.7 million, or 15
percent, in the third quarter of 2003 compared to the third 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 third quarter of 2002.
In 2003, the Community Banking and Investment Services Group continues to
emphasize growing 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 September 30, 2003, residential mortgages have grown by $1.3 billion, or
21 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 new branch openings. 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. On July 1, 2003, we completed the
acquisition of Monterey Bay Bank, a $632 million asset savings and loan
association headquartered in Watsonville, California, with eight full-service
branches in the Greater Monterey Bay area.
The Community Banking and Investment Services Group is comprised of five
major divisions: Community Banking, Wealth Management, Institutional Services
and Asset Management, Consumer Asset Management, and Insurance Services.
COMMUNITY BANKING serves its customers through 278 full-service branches in
California, 4 full-service branches in Oregon and Washington, and a network of
547 proprietary ATMs. Customers may also access our services 24 hours a day by
telephone or through our website 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;
26
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.
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 14 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.
CONSUMER ASSET MANAGEMENT provides 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
In 1996, Wal-Mart Stores, Inc. and several other retailers sued
MasterCard International Incorporated ("MCI"), VISA U.S.A., Inc.
and VISA International, Inc. (together, "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, N.A. are a party to
27
these suits, and neither will be directly liable for these
settlements. However, MCI or VISA may seek to assess, or assert
claims against, their members (including Union Bank of
California, N.A.) to fund the settlements.
While our debit card interchange income declined slightly in
2003, our interchange income from debit card operations is less
than one percent of our total revenue. We cannot predict the
effect that the settlements, regardless of a direct claim being
asserted against members, will have on the competitive
environment or our future earnings from debit card operations.
INSURANCE SERVICES provides a range of risk management services and
insurance products to business and retail customers. The group, which includes
our 2001 acquisition of Armstrong/Robitaille, Inc., our 2002 acquisition of John
Burnham & Company, and our 2003 acquisition of Tanner Insurance Brokers, Inc.,
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 and government entities.
In the third quarter of 2003, net income increased $44.7 million, or 87
percent, compared to the third quarter of 2002. Net interest income increased
$46.2 million, or 27 percent, partially attributable to the impact of increasing
deposit balances and a lower cost of funds resulting from the lower interest
rate environment. Beginning in 2003, the transfer pricing credit for funds
provides for a floor on analyzed demand deposit account balances, which was
triggered during the first quarter of 2003. Had such a floor existed in the
third quarter of 2002, net interest income would have been approximately $13
million higher. Excluding higher income in the private equity portfolio of $3.4
million mainly related to lower writedowns on private capital investments in the
third quarter of 2003 compared to the third quarter of 2002, noninterest income
increased $16.9 million, or 34 percent. This 34 percent increase was mainly
attributable to higher deposit-related service fees. Noninterest expense
increased $4.1 million, or 4 percent, compared to a year earlier due to higher
expenses to support increased product sales and deposit volume. Credit
28
expense decreased $7.8 million mainly attributable to a refinement in the RAROC
allocation of capital and expected losses and lower loan balances
year-over-year.
The group's initiatives during 2003 include expanding wholesale deposit
activities and increasing domestic trade financing. Loan strategies include
originating, underwriting and syndicating loans in core competency markets, such
as the California middle-market, commercial real estate, energy, entertainment,
equipment leasing and commercial finance. The Commercial Financial Services
Group 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 and Treasury Management Division, which provides
deposit and cash management expertise to clients in the middle-market,
large corporate market, government agencies and specialized
industries;
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 internationally; and
o the Corporate Capital Markets Division, which provides custom
financing to middle-market and large corporate clients in their
defined industries and geographic markets, together with limited
merchant and investment banking related products and services.
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 primarily focuses on providing
correspondent banking and trade finance related products and services to
international financial institutions worldwide. This focus includes products and
services such as letters of credit, international payments, collections and
financing of mostly short-term transactions. The majority of the revenue
generated by the International Banking Group is from customers domiciled outside
of the US.
In the third quarter of 2003, net income increased $1.6 million, or 25
percent, compared to the third quarter of 2002. Total revenue in the third
quarter of 2003 increased $2.2 million, or 8 percent, compared to the third
quarter of 2002. Net interest income increased $1.4 million, or 15 percent, from
the third quarter of 2002, mainly attributable to both higher deposit and loan
volumes. Noninterest income was $0.9 million, or 5 percent, higher than the
third quarter of 2002 reflecting growth in international remittance and account
analysis fees. Noninterest expense of $15.4 million was relatively unchanged
from the third quarter of 2002. Credit expense of $0.5 million was relatively
unchanged from the third quarter of 2002. The International Banking Group's
business revolves around short-term trade financing, mostly to
29
banks, which provides 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 the
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 third quarter of 2003, net loss was $51.5 million compared to a net
loss of $4.9 million in the third quarter of 2002. Total revenue in the third
quarter of 2003 decreased by $75.1 million, compared to the third quarter of
2002, resulting from a $71.5 million decrease in net interest income. The
decrease in net interest income was primarily attributable to a higher transfer
pricing residual in the third quarter of 2003 resulting from 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 shorter-term lending rates. Beginning in 2003, the transfer pricing
credit for funds provides for a floor on analyzed demand deposit account
balances, which was triggered during the first quarter 2003. Had such a floor
existed in the third quarter of 2002, net interest income would have declined by
approximately $13 million. Noninterest income was $3.7 million, or 143 percent,
lower than the third quarter of 2002, mainly attributable to losses of $2.3
million on the sale of available for sale securities in the third quarter of
2003. Compared to the third quarter of 2002, noninterest expense of $3.9 million
in the third quarter of 2003 was relatively unchanged.
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 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 adjustment between the tax expense calculated under RAROC using a
tax rate of 38.25 percent and the Company's effective tax rates;
o the Pacific Rim Corporate Group, with assets at September 30, 2003 of
$295 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.
30
Net income for "Other" in the third quarter of 2003 was $20.9 million. The
results were impacted by the following factors:
o Credit expense (income) of ($28.0) million was due to the difference
between the $20.0 million in provision for credit losses calculated
under our US GAAP methodology and the $48.0 million in expected losses
for the reportable business segments, which utilizes the RAROC
methodology;
o Net interest income of $17.0 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 $6.0 million; and
o Noninterest expense of $24.1 million.
Net income for "Other" in the third quarter of 2002 was $17.3 million. The
results were impacted by the following factors:
o Credit expense (income) of ($15.3) million was due to the difference
between the $40.0 million in provision for credit losses calculated
under our US GAAP methodology and the $55.3 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 $5.2 million; and
o Noninterest expense of $23.7 million.
31
NET INTEREST INCOME
The following tables show the major components of net interest income and
net interest margin.
FOR THE THREE MONTHS ENDED
-------------------------------------------------------------------------------
SEPTEMBER 30, 2002 SEPTEMBER 30, 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.............................. $24,770,565 $ 374,043 6.00% $24,858,766 $ 342,629 5.48%
Foreign(3)............................ 1,200,918 8,134 2.69 1,473,220 7,581 2.04
Securities--taxable...................... 5,907,792 76,825 5.20 9,928,708 92,553 3.73
Securities--tax-exempt................... 35,761 990 11.08 40,592 1,015 10.00
Interest bearing deposits in banks....... 135,952 773 2.26 246,897 922 1.48
Federal funds sold and securities
purchased under resale agreements..... 327,820 1,467 1.78 980,271 2,532 1.02
Trading account assets................... 378,715 1,415 1.48 327,415 909 1.10
----------- ---------- ----------- ----------
Total earning assets........... 32,757,523 463,647 5.63 37,855,869 448,141 4.71
---------- ----------
Allowance for credit losses.............. (631,581) (570,773)
Cash and due from banks.................. 1,860,183 2,324,389
Premises and equipment, net.............. 497,542 510,205
Other assets............................. 1,319,808 1,793,825
----------- -----------
Total assets................... $35,803,475 $41,913,515
=========== ===========
LIABILITIES
Domestic deposits:
Interest bearing...................... $ 8,292,080 22,855 1.09 $10,952,652 16,586 0.60
Savings and consumer time............. 3,614,192 14,593 1.60 4,116,669 9,990 0.96
Large time............................ 2,679,594 14,601 2.16 2,303,754 8,408 1.45
Foreign deposits(3)...................... 1,369,123 4,727 1.37 1,200,668 1,991 0.66
----------- ---------- ----------- ----------
Total interest bearing deposits 15,954,989 56,776 1.41 18,573,743 36,975 0.79
----------- ---------- ----------- ----------
Federal funds purchased and securities
sold under repurchase agreements...... 487,201 1,789 1.46 393,772 689 0.69
Commercial paper......................... 1,043,111 4,488 1.71 781,552 1,723 0.87
Other borrowed funds..................... 270,795 1,662 2.44 262,512 1,673 2.53
Medium and long-term debt................ 399,697 2,375 2.36 399,761 1,738 1.73
UnionBanCal Corporation--obligated
mandatorily redeemable preferred
securities of subsidiary grantor trust 351,879 3,921 4.48 351,575 3,607 4.10
----------- ---------- ----------- ----------
Total borrowed funds........... 2,552,683 14,235 2.22 2,189,172 9,430 1.71
----------- ---------- ----------- ----------
Total interest bearing
liabilities.................... 18,507,672 71,011 1.52 20,762,915 46,405 0.89
---------- ----------
Noninterest bearing deposits............. 12,500,463 16,329,221
Other liabilities........................ 980,413 986,545
----------- -----------
Total liabilities.............. 31,988,548 38,078,681
SHAREHOLDERS' EQUITY
Common equity............................ 3,814,927 3,834,834
----------- -----------
Total shareholders' equity..... 3,814,927 3,834,834
----------- -----------
Total liabilities and
shareholders' equity........... $35,803,475 $41,913,515
=========== ===========
Net interest income/margin
(taxable-equivalent basis)............ 392,636 4.77% 401,736 4.22%
Less: taxable-equivalent adjustment...... 534 647
---------- ----------
Net interest income............ $ 392,102 $ 401,089
========== ==========
- ------------------------------
<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>
32
FOR THE NINE MONTHS ENDED
-------------------------------------------------------------------------------
SEPTEMBER 30, 2002 SEPTEMBER 30, 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.............................. $24,468,284 $1,113,279 6.08% $24,986,259 $1,043,906 5.58%
Foreign(3)............................ 1,094,168 23,642 2.89 1,536,428 24,742 2.15
Securities--taxable..................... 5,678,095 235,041 5.52 8,220,231 249,073 4.04
Securities--tax-exempt.................. 36,971 2,979 10.75 41,168 3,045 9.86
Interest bearing deposits in banks...... 113,779 1,898 2.23 223,937 3,014 1.80
Federal funds sold and securities
purchased under resale agreements..... 782,607 10,354 1.77 932,496 8,210 1.18
Trading account assets.................. 298,505 3,107 1.39 322,952 2,847 1.18
----------- ---------- ----------- ----------
Total earning assets............. 32,472,409 1,390,300 5.72 36,263,471 1,334,837 4.92
---------- ----------
Allowance for credit losses............. (635,313) (586,418)
Cash and due from banks................. 1,878,616 2,173,775
Premises and equipment, net............. 497,503 508,859
Other assets............................ 1,328,587 1,666,062
----------- -----------
Total assets..................... $35,541,802 $40,025,749
=========== ===========
LIABILITIES
Domestic deposits:
Interest bearing...................... $ 7,881,352 68,564 1.16 $10,087,830 54,194 0.72
Savings and consumer time............. 3,587,824 46,830 1.75 3,937,051 33,583 1.14
Large time............................ 3,125,003 52,001 2.22 2,416,606 28,995 1.60
Foreign deposits(3)..................... 1,576,176 17,096 1.45 1,269,010 8,008 0.84
----------- ---------- ----------- ----------
Total interest bearing deposits.. 16,170,355 184,491 1.53 17,710,497 124,780 0.94
----------- ---------- ----------- ----------
Federal funds purchased and securities
sold under repurchase agreements...... 463,067 5,134 1.48 414,446 2,763 0.89
Commercial paper........................ 999,030 12,998 1.74 899,456 7,397 1.10
Other borrowed funds.................... 543,796 8,740 2.15 191,480 3,983 2.78
Medium and long-term debt............... 399,788 7,198 2.41 399,745 5,422 1.81
UnionBanCal Corporation--obligated
mandatorily redeemable preferred
securities of subsidiary grantor trust 352,183 11,832 4.47 351,594 10,930 4.15
----------- ---------- ----------- ----------
Total borrowed funds............. 2,757,864 45,902 2.22 2,256,721 30,495 1.80
----------- ---------- ----------- ----------
Total interest bearing liabilities 18,928,219 230,393 1.63 19,967,218 155,275 1.04
---------- ----------
Noninterest bearing deposits............ 11,915,106 15,159,687
Other liabilities....................... 968,204 1,022,854
----------- -----------
Total liabilities................ 31,811,529 36,149,759
SHAREHOLDERS' EQUITY
Common equity........................... 3,730,273 3,875,990
----------- -----------
Total shareholders' equity....... 3,730,273 3,875,990
----------- -----------
Total liabilities and
shareholders' equity.......... $35,541,802 $40,025,749
=========== ===========
Net interest income/margin
(taxable-equivalent basis)............ 1,159,907 4.77% 1,179,562 4.35%
Less: taxable-equivalent adjustment..... 1,604 1,916
---------- ----------
Net interest income.............. $1,158,303 $1,177,646
========== ==========
- ------------------------------
<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>
33
Our net interest income is impacted by changes in interest rates, the
steepening and flattening of the yield curve and changes in volumes and mix of
earning assets, deposits, and interest bearing liabilities. In addition, we use
interest rate derivatives as an asset-liability management tool to manage the
effect of changes in interest rates on net interest income. These interest rate
derivatives have offset a portion of the interest rate compression experienced
over the past year. If interest rates remain at their current levels, our net
interest income will be positively impacted by our in-the-money hedge positions
but to a lesser extent, as our existing cash flow hedges mature.
THREE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2003
Net interest income, on a taxable-equivalent basis, was $401.7 million in
the third quarter of 2003, compared with $392.6 million in the third quarter of
2002. This increase of $9.1 million, or 2 percent, was attributable primarily to
the impact of the decreasing interest rate environment on interest bearing
liabilities, increasing average noninterest bearing deposits, and higher earning
assets, mostly offset by significantly lower yields on our earning assets.
Decreasing market rates resulted in lower average rates on our interest bearing
liabilities of 63 basis points on average balances of $20.8 billion, which was
mostly offset by lower average yields of 92 basis points on average earning
assets of $37.9 billion, which was favorably impacted by higher interest rate
derivatives income of $10.8 million. Mitigating the impact of the lower interest
rate environment on our net interest margin was an increase in average earning
assets of $5.1 billion, primarily in securities and residential mortgage loans,
funded by a $3.8 billion, or 31 percent, increase in average noninterest bearing
deposits. As a result of these changes and a flattening yield curve environment,
as long-term interest rates declined, our net interest margin decreased by 55
basis points, to 4.22 percent.
Average earning assets were $37.9 billion in the third quarter of 2003,
compared with $32.8 billion in the third quarter of 2002. This growth was
attributable to a $4.0 billion, or 68 percent, increase in average securities, a
$652.5 million, or 199 percent, increase in federal funds sold and securities
purchased under resale agreements and a $360.5 million, or 1 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 $1.4
billion increase in average residential mortgages, as we have continued to
strategically shift from non-relationship commercial lending, and a $399.8
million increase in average commercial mortgages, partly offset by a $1.3
billion decrease in average commercial, financial, and industrial loans. The
increase in federal funds sold and securities purchased under resale agreements
was mainly attributed to a significant acceleration in the rate of deposit
growth relative to loan growth.
Deposit growth, especially in our title and escrow industries, has
contributed significantly to our lower cost of funds year-over-year. Average
noninterest bearing deposits were $3.8 billion, or 31 percent, higher in the
third quarter of 2003 over the prior year, which included a $1.2 billion
increase in average title and escrow deposits. We anticipate that the growth
rates in average noninterest bearing deposits will decline from the 2003 growth
rates as refinancings slow down due to interest rate increases.
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2003
Net interest income, on a taxable-equivalent basis, was $1.18 billion in
the first nine months of 2003, compared with $1.16 billion in the first nine
months of 2002. This increase of $19.7 million, or 2 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, more than offset by significantly
lower yields on our earning assets. Decreasing market rates resulted in lower
rates on our interest bearing liabilities of 59 basis points on average balances
of $20.0 billion, which was partly offset by a lower average yield of 80 basis
points on average earning assets of $36.3 billion, which was favorably impacted
by higher interest rate derivatives income of $27.1 million. Mitigating the
impact of the lower interest rate environment on our net interest margin was an
increase in
34
average earning assets of $3.8 billion, primarily in securities and residential
mortgage loans, funded by a $3.2 billion, or 27 percent, increase in average
noninterest bearing deposits. As a result of these changes and a flattening
yield curve environment, as long-term interest rates declined, our net interest
margin decreased by 42 basis points, to 4.35 percent.
Average earning assets were $36.3 billion in the first nine months of 2003,
compared with $32.5 billion in 2002. This growth was attributable to a $2.5
billion, or 45 percent, increase in average securities and a $960.2 million, or
4 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 $1.4 billion increase in average residential mortgages, which was a
result of a strategic portfolio shift from more volatile commercial loans and a
$456.7 million increase in average commercial mortgages, partially offset by a
$774.7 million decrease in average commercial, financial, and industrial loans.
Deposit growth, especially in our title and escrow industries, has
contributed significantly to our lower cost of funds year-over-year. Average
noninterest bearing deposits were $3.2 billion, or 27 percent, higher in the
first nine months of 2003 over the first nine months of 2002, which included a
$1.1 billion increase in average title and escrow deposits.
NONINTEREST INCOME
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
----------------------------------------------- ---------------------------------------------
INCREASE INCREASE
SEPTEMBER 30, SEPTEMBER 30, (DECREASE) SEPTEMBER 30, SEPTEMBER 30, (DECREASE)
(DOLLARS IN THOUSANDS) 2002 2003 AMOUNT PERCENT 2002 2003 AMOUNT PERCENT
- ------------------------------------ ------------- ------------- ------- ------- ------------- ------------- ------ -------
Service charges on deposit accounts. $ 68,629 $ 81,832 $13,203 19.24% $ 204,641 $ 232,061 $27,420 13.40%
Trust and investment management fees 35,368 35,429 61 0.17 109,680 101,245 (8,435) (7.69)
International commissions and fees.. 20,131 22,223 2,092 10.39 57,593 63,112 5,519 9.58
Insurance commissions............... 6,259 15,814 9,555 152.66 19,969 45,056 25,087 125.63
Card processing fees, net........... 9,068 10,335 1,267 13.97 26,343 29,357 3,014 11.44
Brokerage commissions and fees...... 9,034 7,549 (1,485) (16.44) 27,614 24,614 (3,000) (10.86)
Merchant banking fees............... 6,819 9,312 2,493 36.56 22,845 21,521 (1,324) (5.80)
Foreign exchange trading gains, net. 8,193 7,574 (619) (7.56) 21,653 21,466 (187) (0.86)
Securities gains (losses), net...... 1,017 (2,618) (3,635) nm 2,986 7,042 4,056 135.83
Other............................... 4,598 14,020 9,422 204.92 11,141 44,938 33,797 303.36
------------- ------------- ------- ------------- ------------- ------
Total noninterest income......... $ 169,116 $ 201,470 $32,354 19.13% $ 504,465 $ 590,412 $85,947 17.04%
============= ============= ======= ============= ============= ======
- -----------------------------
<FN>
nm = not meaningful.
</FN>
THREE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2003
In the third quarter of 2003, noninterest income was $201.5 million, an
increase of $32.4 million, or 19 percent, over the third quarter of 2002. This
increase was mainly attributable to a $13.2 million increase in service charges
on deposit accounts, a $9.6 million increase in insurance commissions, and lower
net losses of $5.6 million for commercial loans held for sale.
Revenue from service charges on deposit accounts was $81.8 million, an
increase of $13.2 million or 19 percent over the third quarter of 2002. This
increase was primarily attributable to a 25 percent increase in quarterly
average demand deposits (excluding title and escrow deposits) and overdraft fees
of $3.5 million associated with a new overdraft program introduced in April
2003.
Trust and investment management fees were $35.4 million, up slightly from
the third quarter of 2002. Total assets under administration were $147.1 billion
as of September 30, 2003, an increase of $17.4 billion, or 13 percent, from
September 30, 2002. The increase in asset levels has been in lower earning,
non-managed assets, while higher earning managed assets have declined. The
change in the mix of assets
35
has led to the relatively flat revenue levels. In addition, the current low
interest rate environment has led to a significant reduction in balances in the
HighMark money market funds.
Insurance commissions were $15.8 million, an increase of $9.6 million, or
153 percent, over the third quarter of 2002, primarily reflecting the
incremental revenues associated with our insurance agency acquisitions.
Other noninterest income was $14.0 million, an increase of $9.4 million, or
205 percent from the third quarter of 2002. This increase included:
o lower net losses of $5.6 million for commercial loans held for sale,
and
o lower writedowns on private capital investments of $3.7 million in the
third quarter of 2003 compared to the third quarter of 2002 as the
economy appears to be improving. Our private capital investments
include direct investments in private and public companies and
indirect investments in private equity funds. The fair values of
publicly traded investments are determined by using quoted market
prices. Investments that are not publicly traded are initially valued
at cost and subsequent adjustments to fair value are estimated based
on a company's business model, current projected financial
performance, liquidity and overall economic and market conditions.
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2003
In the first nine months of 2003, noninterest income was $590.4 million, an
increase of $85.9 million, or 17 percent, over the first nine months of 2002.
This increase was mainly attributable to a $27.4 million increase in service
charges on deposit accounts, a $25.1 million increase in insurance commissions,
lower writedowns on private capital investments of $13.6 million, lower residual
value writedowns on auto leases of $9.0 million, lower net losses of $8.0
million for commercial loans held for sale, a $5.5 million increase in
international commissions and fees and a $4.1 million increase in net securities
gains mainly attributable to a $9.0 million gain arising from the early call of
a Mexican Brady Bond, partly offset by an $8.4 million decrease in trust and
investment management fees.
Revenue from service charges on deposit accounts was $232.1 million, an
increase of $27.4 million, or 13 percent, over the first nine months of 2002.
This increase was primarily attributable to a 22 percent increase in average
demand deposits (excluding title and escrow deposits) over the first nine months
of 2002 and overdraft fees of $7.0 million associated with a new overdraft
program introduced in April 2003.
Trust and investment management fees were $101.2 million, a decrease of
$8.4 million, or 8 percent, from the first nine months of 2002. This decrease is
primarily attributable to the decline in equity market values and lower revenues
as our clients shift toward fixed income investments. In addition, the current
low interest rate environment has led to a significant reduction in balances in
the HighMark money market funds.
International commissions and fees were $63.1 million, an increase of $5.5
million, or 10 percent, reflecting a stronger growth in international markets.
Insurance commissions were $45.1 million, an increase of $25.1 million, or
126 percent, reflecting the incremental revenues associated with our insurance
agency acquisitions, and growth in insurance commissions at
Armstrong/Robitaille, Inc.
Securities gains, net, were $7.0 million compared to securities gains, net,
of $3.0 million in the first nine months of 2002. In the first nine months of
2003, we realized a gain of $9.0 million on an early call of a Mexican Brady
Bond.
Other noninterest income was $44.9 million, an increase of $33.8 million,
or 303 percent, from the first nine months of 2002. This increase was mainly
attributable to lower writedowns on private capital investments of $13.6
million, reflecting an improving economy, a decrease of $9.0 million in residual
value
36
writedowns on auto leases, as our auto lease portfolio liquidates, lower net
losses of $8.0 million for commercial loans held for sale and $3.7 million in
insurance recoveries from the September 11, 2001 World Trade Center attack
recorded in the current year.
NONINTEREST EXPENSE
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
----------------------------------------------- ---------------------------------------------
INCREASE INCREASE
SEPTEMBER 30, SEPTEMBER 30, (DECREASE) SEPTEMBER 30, SEPTEMBER 30, (DECREASE)
(DOLLARS IN THOUSANDS) 2002 2003 AMOUNT PERCENT 2002 2003 AMOUNT PERCENT
- ------------------------------------ ------------- ------------- ------- ------- ------------- ------------- ------ -------
Salaries and other compensation..... $ 152,057 $ 169,705 $17,648 11.61% $ 448,690 $ 484,333 $35,643 7.94%
Employee benefits................... 30,218 35,597 5,379 17.80 98,561 118,005 19,444 19.73
------------- ------------- ------- ------------- ------------- ------
Salaries and employee benefits... 182,275 205,302 23,027 12.63 547,251 602,338 55,087 10.07
Net occupancy....................... 27,340 31,342 4,002 14.64 75,750 91,844 16,094 21.25
Equipment........................... 16,343 15,680 (663) (4.06) 48,650 48,705 55 0.11
Communications...................... 13,186 12,661 (525) (3.98) 39,695 39,859 164 0.41
Professional services............... 10,350 12,676 2,326 22.47 30,789 38,256 7,467 24.25
Software............................ 10,061 11,996 1,935 19.23 31,610 34,921 3,311 10.47
Advertising and public relations.... 9,145 9,227 82 0.90 27,774 28,587 813 2.93
Data processing..................... 7,944 7,659 (285) (3.59) 24,475 23,887 (588) (2.40)
Intangible asset amortization....... 1,497 2,587 1,090 72.81 3,661 8,291 4,630 126.47
Foreclosed asset expense (income)... 18 (79) (97) nm 130 (28) (158) nm
Other............................... 39,665 39,810 145 0.37 116,317 125,805 9,488 8.16
------------- ------------- ------- ------------- ------------- ------
Total noninterest expense........ $ 317,824 $ 348,861 $31,037 9.77% $ 946,102 $ 1,042,465 $96,363 10.19%
============= ============= ======= ============= ============= ======
- ---------------------------
<FN>
nm = not meaningful.
</FN>
THREE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2003
In the third quarter of 2003, noninterest expense was $348.9 million, an
increase of $31.0 million, or 10 percent, over the third quarter of 2002. This
increase was primarily due to a $23.0 million increase in salaries and employee
benefits and a $4.0 million increase in net occupancy.
Salaries and employee benefits were $205.3 million, an increase of $23.0
million, or 13 percent, over the third quarter of 2002. This increase was
primarily attributable to annual merit increases, higher staff levels associated
with our recent acquisitions, higher performance-related incentive expense, and
increased insurance and health benefits expenses due to increasing healthcare
costs.
Net occupancy expense was $31.3 million, an increase of $4.0 million, or 15
percent over the third quarter of 2002. This increase was primarily attributable
to recent acquisitions, new branch openings, other facilities restructuring
initiatives and higher property insurance.
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2003
In the first nine months of 2003, noninterest expense was $1.04 billion, an
increase of $96.4 million, or 10 percent, over the first nine months of 2002.
This increase was primarily due to a $55.1 million increase in salaries and
employee benefits and a $16.1 million increase in net occupancy, including $4.2
million related to the write-off of certain leasehold improvements.
Salaries and employee benefits were $602.3 million, an increase of $55.1
million, or 10 percent, over the first nine months of 2002. This increase was
primarily attributable to annual merit increases, higher staff levels mostly
associated with our recent acquisitions, higher performance-related incentive
expense, increased insurance and health benefits expense due to increasing
healthcare costs, and higher 401(k) plan expenses.
Net occupancy expense was $91.8 million, an increase of $16.1 million, or
21 percent, over the first nine months of 2002. This increase was primarily
attributable to recent acquisitions, new branch openings,
37
other facilities restructuring initiatives, higher property insurance and a $4.2
million write-off of certain leasehold improvements.
Professional services expense was $38.3 million, an increase of $7.5
million, or 24 percent over the first nine months of 2002. This increase was
primarily attributable to increased legal services, consulting and other
professional service expenses.
Intangible asset amortization was $8.3 million, an increase of $4.6
million, or 126 percent, from the first nine months of 2002. This increase was
primarily associated with our acquisitions in the fourth quarter of 2002 and in
2003.
Other noninterest expense was $125.8 million, an increase of $9.5 million,
or 8 percent, over the first nine months of 2002. This increase was primarily
attributable to a $6.4 million increase in low-income housing credit (LIHC)
amortization expense mostly related to a higher number of LIHC investments in
the current year and higher operating losses of $3.9 million mostly related to
an increase in the provision for contingency losses associated with various
lawsuits.
INCOME TAX EXPENSE
Income tax expense in the third quarter of 2003 was $78.7 million,
resulting in a 34 percent effective income tax rate. For the third quarter of
2002, the effective income tax rate was 32 percent, which included a $3.3
million net reduction to income tax expense resulting from a change in tax law
in the State of California concerning the tax treatment of loan loss reserves.
Income tax expense in the first nine months of 2003 was $215.3 million,
resulting in a 33 percent effective income tax rate. For the first nine months
of 2002, the effective income tax rate was also 33 percent.
LOANS
The following table shows loans outstanding by loan type.
PERCENT CHANGE TO
SEPTEMBER 30, 2003 FROM:
----------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31,
(DOLLARS IN THOUSANDS) 2002 2002 2003 2002 2002
- ------------------------------------ ------------- ------------- ------------- ------------- -------------
Domestic:
Commercial, financial and
industrial.................... $10,759,876 $ 10,338,508 $ 9,277,969 (13.77)% (10.26)%
Construction..................... 1,259,435 1,285,204 1,127,915 (10.44) (12.24)
Mortgage:
Residential................... 5,852,932 6,382,227 7,106,098 21.41 11.34
Commercial.................... 3,950,568 4,150,178 4,310,957 9.12 3.87
------------- ------------- -------------
Total mortgage.............. 9,803,500 10,532,405 11,417,055 16.46 8.40
Consumer:
Installment................... 899,263 909,787 867,133 (3.57) (4.69)
Revolving lines of credit..... 1,057,245 1,102,771 1,168,374 10.51 5.95
------------- ------------- -------------
Total consumer.............. 1,956,508 2,012,558 2,035,507 4.04 1.14
Lease financing.................. 836,688 812,918 668,074 (20.15) (17.82)
------------- ------------- -------------
Total loans in domestic
offices................... 24,616,007 24,981,593 24,526,520 (0.36) (1.82)
Loans originated in foreign branches 1,346,152 1,456,490 1,520,856 12.98 4.42
------------- ------------- -------------
Total loans................. $ 25,962,159 $ 26,438,083 $ 26,047,376 0.33% (1.48)%
============= ============= =============
38
Our lending activities are predominantly domestic, with such loans
comprising 94 percent of the total loan portfolio at September 30, 2003. Total
loans at September 30, 2003, were $26.0 billion, an increase of $85 million, or
0.3 percent, from September 30, 2002. The increase was mainly attributable to an
increase in the residential mortgage portfolio of $1.3 billion, an increase in
the commercial mortgage portfolio of $360 million, and an increase in the loans
originated in foreign branches of $175 million, partly offset by a decline in
the commercial, financial and industrial loan portfolio of $1.5 billion and a
decline in lease financing of $169 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 $9.3 billion, or 36 percent of total loans, at September 30, 2003,
compared with $10.8 billion, or 41 percent of total loans, at September 30,
2002. The decrease of $1.5 billion, or 14 percent, from the prior year was
primarily attributable to current economic conditions that have reduced loan
demand in some segments. Loan sales and managed exits also contributed to the
decline and are 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).
The construction loan portfolio totaled $1.1 billion, or 4 percent of total
loans, at September 30, 2003, compared with $1.3 billion, or 5 percent of total
loans, at September 30, 2002. This decrease of $132 million, or 10 percent, from
the prior year was primarily attributable to the slowing economy and its impact
on development and construction projects.
Commercial mortgages were $4.3 billion, or 17 percent of total loans, at
September 30, 2003, compared with $4.0 billion, or 15 percent, at September 30,
2002. The mortgage loan portfolio consists of loans on commercial and industrial
projects primarily in California. The increase in commercial mortgages of $360
million, or 9 percent, from September 30, 2002, was primarily due to our
acquisition of Monterey Bay Bank in the third quarter of 2003.
Residential mortgages were $7.1 billion, or 27 percent of total loans, at
September 30, 2003, compared with $5.9 billion, or 23 percent of total loans, at
September 30, 2002. The increase in residential mortgages of $1.3 billion, or 21
percent, from September 30, 2002, continues to be influenced by high refinance
market due to low rates. While we hold most of the loans we originate, we sell
most of our 30-year, fixed rate non-Community Reinvestment Act (CRA) residential
mortgage loans.
Consumer loans totaled $2.0 billion, or 8 percent of total loans,
substantially unchanged from September 30, 2002. A slight increase in consumer
loans of $79.0 million, or 4 percent, was primarily attributable to an increase
in home equity loans, partially offset by pay-offs related to the run-off of the
automobile dealer lending business exited in the third quarter of 2000. The
indirect automobile dealer lending portfolio at September 30, 2003 was $68.3
million.
Lease financing totaled $668.1 million, or 3 percent of total loans, at
September 30, 2003, compared with $836.7 million, or 3 percent of total loans,
at September 30, 2002. As we announced in 2001, we have ceased originating auto
leases. At September 30, 2003, our portfolio had declined to $119.6 million and
will decline 40 percent by December 2003, 90 percent by December 2004, and will
fully mature by mid-year 2006.
Loans originated in foreign branches totaled $1.5 billion, or 6 percent of
total loans, at September 30, 2003, compared with $1.3 billion, or 5 percent, at
September 30, 2002. The increase in loans originated in foreign branches of
$174.7 million, or 13 percent, from September 30, 2002, was primarily
attributable to higher trade finance borrowings from financial institutions
attracted to lower US interest rates and increased lending in Canada where we
established a branch in 2002.
39
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 September 30, 2002, December 31, 2002 and September 30, 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
- ------------------------------ ------------ -------- ------------ ------------
September 30, 2002
Korea......................... $580 $-- $55 $635
December 31, 2002
Korea......................... $599 $-- $75 $674
September 30, 2003
Korea......................... $636 $-- $42 $678
40
PROVISION FOR CREDIT LOSSES
We recorded a $20 million provision for credit losses in the third quarter
of 2003, compared with a $40 million provision for credit losses for the same
period in the prior year. The provision for credit losses in the first nine
months of 2003 was $75 million, compared with a $145 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.
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 we believe is reflective of 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," as amended
by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income
Recognition and Disclosures" 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);
41
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;
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 180.9 percent of total
nonaccrual loans. At September 30, 2003, our total allowance for credit losses
was $551 million, or 2.11 percent of the total loan portfolio and 161.4 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. These accounting standards prescribe the measurement methods, income
recognition and disclosures related to impaired loans. At December 31, 2002,
total impaired loans were $300 million, and the associated impairment allowance
was $106 million, compared with $289 million and $93 million, respectively, at
September 30, 2003. On September 30, 2003 and December 31, 2002, the total
allowance for credit losses for off-balance sheet commitments was $78.5 million
and $75.4 million, respectively.
During the third 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, except
for an adjustment in the years in the historical period used to calculate loss
factors, which resulted in a $14 million increase to the allocated allowance. We
believe that this adjustment more
42
closely reflects the current economic environment. 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.
We recorded a $20 million provision in the third quarter of 2003, which
took into consideration the following factors: fragility of the U.S. economy;
weakness in capital spending and employment growth; and trends in credit
quality.
CHANGES IN THE FORMULA AND SPECIFIC ALLOWANCES
At September 30, 2003, the formula allowance was $272 million, compared to
$294 million at December 31, 2002, a decrease of $22 million. The decline in the
formula allowance is primarily related to lower levels of criticized credits.
The specific allowance was $104 million at September 30, 2003, compared to $121
million at December 31, 2002, a decrease of $17 million. The decrease in the
specific allowance is due to slightly lower average loss content on reduced
levels of impaired loans.
CHANGES IN THE UNALLOCATED ALLOWANCE
At September 30, 2003, the unallocated allowance was $175 million, compared
to $194 million at December 31, 2002, a decrease of $19 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 commercial real estate sector, management
considered the continuing weak demand growth and excess supply in many
markets with the national office vacancy rate continuing to rise and
average rents falling, as well as the specific weakness in Northern
California resulting from regional over-dependence on the technology
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 the communications/media industry, management
considered the impact of low consumer confidence on consumer spending
and weak, although improving, advertising revenues, as well as the
increasingly competitive environment facing telecommunication
carriers, which could be in the range of $11 million to $31 million.
o With respect to power companies and utilities, management considered
the continuing excess capacity and weak prices in the power generation
market, compounded by the costs and disruptions of moving out of
merchant generation and energy trading operations, which could be in
the range of $14 million to $28 million.
o With respect to cross-border loans and acceptances to certain
Asia/Pacific Rim countries, management considered the effects of
slower US growth up to very recently, Japan's continuing struggle to
break out of recession and the need for further structural reform
across most of the East Asian region, which could be in the range of
$8 million to $17 million.
o With respect to the retail sector, management considered the adverse
effects of still weak labor markets, high consumer debt levels and
near-record personal bankruptcies, which could be in the range of $6
million to $12 million.
o With respect to the State of California, management considered the
adverse effects of the recent Gubernatorial recall, which aggravated
an already volatile political environment and uncertain fiscal
situation, and the severity of challenges that the new Governor will
face, which could be in the range of $6 million to $12 million.
43
o With respect to leasing, management considered the ongoing problems of
the airline industry as it continues to struggle with the weaker
economy, the sluggish recovery of international travel and high fuel
prices, which could be in the range of $5 million to $11 million.
o With respect to the technology industry, management considered weak,
although improving, capital spending in the US, as well as the effects
of steepening price declines resulting in less robust revenue growth,
which could be in the range of $4 million to $9 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 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 FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003
- ----------------------------------------------------- -------- -------- -------- --------
Balance, beginning of period......................... $624,948 $558,282 $634,509 $609,190
Loans charged off:
Commercial, financial and industrial.............. 48,284 41,457 178,462 130,413
Commercial mortgage............................... 1,572 7,286 1,592 7,286
Consumer.......................................... 2,370 2,058 7,605 7,143
Lease financing................................... 479 518 1,986 32,726
Foreign(1)........................................ -- 2,220 -- 2,220
-------- -------- -------- --------
Total loans charged off....................... 52,705 53,539 189,645 179,788
Recoveries of loans previously charged off:
Commercial, financial and industrial.............. 8,769 13,845 26,108 32,432
Construction...................................... -- -- 40 --
Commercial mortgage............................... 75 -- 214 150
Consumer.......................................... 2,012 1,276 3,793 2,695
Lease financing................................... 115 183 497 352
-------- -------- -------- --------
Total recoveries of loans previously
charged off................................... 10,971 15,304 30,652 35,629
-------- -------- -------- --------
Net loans charged off...................... 41,734 38,235 158,993 144,159
Provision for credit losses.......................... 40,000 20,000 145,000 75,000
Foreign translation adjustment and other
net additions(2)................................... (136) 10,503 2,562 10,519
-------- -------- -------- --------
Balance, end of period............................... $623,078 $550,550 $623,078 $550,550
======== ======== ======== ========
Allowance for credit losses to total loans........... 2.40% 2.11% 2.40% 2.11%
Provision for credit losses to net loans
charged off........................................ 95.85 52.31 91.20 52.03
Net loans charged off to average loans
outstanding for the period(3)...................... 0.64 0.58 0.83 0.73
- ------------------------------
<FN>
(1) Foreign loans are those loans originated in foreign branches.
(2) Includes $10.3 million relates to the Monterey Bay Bank acquisition in the
third quarter of 2003 and $2.4 million for the First Western Bank
acquisition in 2002.
(3) Annualized.
</FN>
44
Total loans charged off in the third quarter of 2003 increased by $0.8
million from the third quarter of 2002. Charge-offs reflect the realization of
losses in the portfolio that were recognized previously through provisions for
credit losses.
Third quarter 2003 recoveries of loans previously charged off increased by
$4.3 million from the third quarter of 2002. The percentage of net loans charged
off to average loans outstanding for the third quarter of 2003 decreased by 6
basis points from the same period in 2002. At September 30, 2003, the allowance
for credit losses exceeded the annualized net loans charged off during the third
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.
NONPERFORMING ASSETS
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 2002 2002 2003
- ---------------------------------------------- ------------- ------------ -------------
Commercial, financial and industrial.......... $ 367,888 $ 276,415 $ 243,877
Construction.................................. 1,096 -- 1,554
Commercial mortgage........................... 24,133 23,980 42,758
Lease financing............................... 2,095 36,294 52,085
Loan originated in foreign branches........... -- -- 765
------------- ------------ -------------
Total nonaccrual loans..................... 395,212 336,689 341,039
Foreclosed assets............................. 309 715 3,308
------------- ------------ -------------
Total nonperforming assets................. $ 395,521 $ 337,404 $ 344,347
============= ============ =============
Allowance for credit losses................... $ 623,078 $ 609,190 $ 550,550
============= ============ =============
Nonaccrual loans to total loans............... 1.52% 1.27% 1.31%
Allowance for credit losses to nonaccrual
loans....................................... 157.66 180.94 161.43
Nonperforming assets to total loans and
foreclosed assets........................... 1.52 1.28 1.32
Nonperforming assets to total assets.......... 1.05 0.84 0.81
At September 30, 2003, nonperforming assets totaled $344.3 million, an
increase of $6.9 million, or 2 percent, from December 31, 2002. This relatively
small increase was primarily due to a significant reduction in inflows of new
nonperforming loans during 2003. The increase in nonaccrual loans was primarily
due to our decision to place additional airplane leases on nonaccrual, partially
offset by our decision during the second quarter of 2003, to return two airplane
leases, totaling $18.3 million, to accrual status. In addition, we placed two
San Francisco Bay Area office loans, totaling approximately $22.8 million, on
nonaccrual status in the second quarter of 2003.
Nonaccrual loans as a percentage of total loans were 1.31 percent at
September 30, 2003, compared with 1.52 percent at September 30, 2002.
Nonperforming assets as a percentage of total loans and foreclosed assets were
1.32 percent at September 30, 2003, compared to 1.52 percent at September 30,
2002.
45
LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 2002 2002 2003
- ---------------------------------------------- ------------- ------------ -------------
Commercial, financial and industrial.......... $ 565 $ 1,705 $ 21,598
Construction.................................. -- 679 --
Mortgage:
Residential................................ 4,127 3,211 1,777
Commercial................................. -- 506 982
------------- ------------ -------------
Total mortgage.......................... 4,127 3,717 2,759
Consumer and other............................ 2,121 2,072 1,706
------------- ------------ -------------
Total loans 90 days or more past due
and still accruing....................... $ 6,813 $ 8,173 $ 26,063
============= ============ =============
The increase in commercial, financial, and industrial loans 90 days or more
past due, but still accruing is attributable to one loan of $17.8 million that
is current on its interest payments but is past its maturity date. We expect
that this facility will be refinanced in the fourth quarter of 2003 and will not
become a nonperforming asset.
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 "QUANTITATIVE AND
QUALITATIVE DISCLOSURE ABOUT 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
the administration of market risk management to the Chief Executive Officer who
designates the chairman of the Asset & Liability Management Committee (ALCO), a
committee 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
46
also reports quarterly to ALCO on the effectiveness of our hedging activities.
In addition, periodic reviews by our internal audit department 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 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 third quarter of 2003, we entered into $1 billion in interest rate
floors to offset the adverse impact that declining interest rates could have on
the interest income generated by our variable rate commercial loans. We
continued to increase the size of our securities portfolio in response to strong
growth in core deposits. Our recent purchases were concentrated in short
duration securities to maintain flexibility to respond to changes in interest
rates. 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/A for the year ended December 31,
2002.
Together, our hedging and investment activities resulted in an essentially
neutral 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
securities portfolio) when long rates decline. In the current rate environment,
run off of fixed rate assets, including prepayments, depress NII even if
interest rates do not change because the cash flows from the repaid and prepaid
assets that were booked at higher rates must be reinvested at lower prevailing
rates. As a result, we expect the low prevailing rates, coupled with 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
47
no change, scenario. The following table sets forth the simulation results in
both the up and down 200 basis point ramp scenarios as of June 30, 2003 and
September 30, 2003(1):
JUNE 30, SEPTEMBER 30,
(DOLLARS IN MILLIONS) 2003 2003
- --------------------------------------- -------- -------------
- -200 basis points...................... $ 6.7 $ 17.3
as a percentage of base case NII....... 0.46% 1.13%
- -200 basis points...................... $ (2.4) $ (16.0)
as a percentage of base case NII....... 0.17% 1.21%
- ----------------------
<FN>
(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.
</FN>
EaR in the down 200 basis point scenario was ($16.0) million, or 1.21
percent 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. 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 September 30, 2003, the difference
between adjusted NII in the base case and adjusted NII after a gradual 100 basis
point downward ramp was a negative $6.5 million, or .45 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
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.
48
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, Market Risk
Monitoring (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
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 year-to-date VaR for our trading activities.
DECEMBER 31, 2002 SEPTEMBER 30, 2003
------------------------- -------------------------
AVERAGE HIGH LOW AVERAGE HIGH LOW
(DOLLARS IN THOUSANDS) VAR VAR VAR VAR VAR VAR
- ----------------------------------------- ------- ---- --- ------- ---- ---
Foreign exchange......................... $ 256 $546 $88 $ 144 $340 $57
Securities............................... 213 543 45 213 463 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 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. We
continue 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 department 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 included as of September 30, 2003,
$3.8 billion of derivative contracts entered into as an accommodation for
customers. We act as an intermediary and match these contracts, at a credit
spread, to 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.
49
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 84 percent of average total assets
of $41.9 billion for the third 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 $1.6 billion for the quarter
ended September 30, 2003. Additional liquidity may be provided through loan
maturities and sales. In the third quarter of 2003, the Company terminated the
issuance of commercial paper under the UnionBanCal Corporation's commercial
paper program. UnionBanCal Commercial Funding Corporation (a UnionBanCal
Corporation subsidiary) continues to issue commercial paper under an existing
commercial paper program. The proceeds of this commercial paper program are
deposited in Union Bank of California, N.A. and used for Bank funding.
REGULATORY CAPITAL
The following tables summarize our risk-based capital, risk-weighted
assets, and risk-based capital ratios.
UNIONBANCAL CORPORATION
MINIMUM
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, REGULATORY
(DOLLARS IN THOUSANDS) 2002 2002 2003 REQUIREMENT
- -------------------------- ----------------- ----------------- ----------------- ------------------
CAPITAL COMPONENTS
Tier 1 capital............ $ 3,617,173 $ 3,667,237 $ 3,632,898
Tier 2 capital............ 568,163 573,858 537,737
Total risk-based capital.. $ 4,185,336 $ 4,241,095 $ 4,170,635
Risk-weighted assets...... $ 32,457,228 $ 32,811,441 $ 33,144,336
Quarterly average assets.. $ 35,690,024 $ 37,595,002 $ 41,624,946
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------------------------- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to risk-
weighted assets)........ $4,185,336 12.89% $4,241,095 12.93% $4,170,635 12.58% >$2,651,547 8.0%
-
Tier 1 capital (to risk-
weighted assets)........ 3,617,173 11.14 3,667,237 11.18 3,632,898 10.96 > 1,325,773 4.0
-
Leverage(1)............... 3,617,173 10.13 3,667,237 9.75 3,632,898 8.73 > 1,664,998 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"
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, REGULATORY REGULATORY
(DOLLARS IN THOUSANDS) 2002 2002 2003 REQUIREMENT REQUIREMENT
- -------------------------- ----------------- ----------------- ----------------- ------------------ ------------------
CAPITAL COMPONENTS
Tier 1 capital............ $ 3,271,284 $ 3,334,720 $ 3,306,884
Tier 2 capital............ 479,792 484,062 467,814
Total risk-based capital.. $ 3,751,076 $ 3,818,782 $ 3,774,698
Risk-weighted assets...... $ 31,803,655 $ 32,161,047 $ 32,520,713
Quarterly average assets.. $ 35,160,630 $ 37,019,328 $ 41,044,744
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------------------------- ---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to risk-
weighted assets)........ $3,751,076 11,79% $3,818,782 11.87% $3,774,698 11.61% >$2,601,657 8.0% >$3,252,071 10.0%
- -
Tier 1 capital (to risk-
weighted assets)........ 3,271,284 10.29 3,334,720 10.37 3,306,884 10.17 > 1,300,829 4.0 > 1,951,243 6.0
- -
Leverage(1)............... 3,271,284 9.30 3,334,720 9.01 3,306,884 8.06 > 1,641,790 4.0 > 2,052,237 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).
50
Compared with December 31, 2002, our Tier 1 risk-based capital ratio at
September 30, 2003, decreased 22 basis points to 10.96 percent, our total
risk-based capital ratio decreased 35 basis points to 12.58 percent, and our
leverage ratio decreased 102 basis points to 8.73 percent. The decrease in our
capital ratios was primarily attributable to lower Tier 1 capital primarily
resulting from a decrease in shareholders' equity including the purchase of $300
million of our common stock, in September 2003, from BTM, higher goodwill
associated with our recent acquisitions (which reduces both Tier 1 and 2
capital), coupled with an increase in risk-weighted assets.
As of September 30, 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.
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, recent wildfires
in Southern California and the California state government's recent budgetary
crisis and continuing fiscal difficulties. If economic conditions in California
continue to decline, we expect that our level of problem assets could increase.
THE CONTINUING WAR ON TERRORISM COULD FURTHER ADVERSELY AFFECT US ECONOMIC
CONDITIONS
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 downturn
in US economic conditions experienced recently 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. 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 retail industry, the airline 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.
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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.
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 63 percent as of September 30, 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
52
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 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 as 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.
53
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 (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, and (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;
54
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 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. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT 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/A 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 Risk," and "Certain Business Risk Factors."
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on their
evaluation as of September 30, 2003, our principal executive officer and
principal financial officer have concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) 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
during the third quarter of 2003 there was no significant change in our internal
control over financial reporting that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
55
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
ANNUAL MEETING OF SHAREHOLDERS: The Annual Meeting of Shareholders will be
held on Wednesday, April 28, 2004, at 9:30 a.m. upon the approval of the Board
of Directors, expected at the December 2003 meeting. Shareholders who expect to
present a proposal at the 2004 Annual Meeting of Shareholders for publication in
the Company's proxy statement and action on the proxy form or otherwise for such
meeting must submit their proposal by November 25, 2003. The proposal must be
mailed to the Corporate Secretary of the Company at 400 California Street, Mail
Code 1-001-16, San Francisco, CA 94104. Without such notice, proxy holders
appointed by the Board of Directors of the Company will be entitled to exercise
their discretionary voting authority when the proposal is raised at the annual
meeting, without any discussion of the proposal in the proxy statement.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS:
NO. DESCRIPTION
- ---- ----------------------------------------------------------------------
3.1 Restated Certificate of Incorporation of the Registrant (effective
September 30, 2003)(1)
3.2 By-laws of UnionBanCal Corporation (a Delaware Corporation) (effective
September 30, 2003)(1)
31.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002(1)
31.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002(1)
32.1 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(1)
32.2 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(1)
- ------------------------------------
(1) Filed herewith
(B) REPORTS ON FORM 8-K
We furnished a report on Form 8-K on July 16, 2003 reporting under Item 9
thereof that UnionBanCal Corporation issued a press release concerning earnings
for the second quarter of 2003.
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SIGNATURES
Pursuant to the requirements 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: November 13, 2003
57