================================================================================
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, 2004
COMMISSION FILE NUMBER 1-15081
UnionBanCal Corporation
(Exact name of registrant as specified in its charter)
DELAWARE 94-1234979
(State of Incorporation) (I.R.S. Employer
Identification No.)
400 CALIFORNIA STREET
SAN FRANCISCO, CALIFORNIA 94104-1302
(Address and zip code of principal executive offices)
Registrant's telephone number: (415) 765-2969
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
--- ---
Number of shares of Common Stock outstanding at October 29, 2004: 149,502,442
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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 Stockholders' 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......................................................... 24
Executive Overview................................................... 24
Critical Accounting Policies......................................... 25
Financial Performance................................................ 27
Net Interest Income.................................................. 31
Noninterest Income................................................... 34
Noninterest Expense.................................................. 35
Income Tax Expense................................................... 35
Loans................................................................ 36
Cross-Border Outstandings............................................ 38
Provision for Credit Losses.......................................... 38
Allowance for Credit Losses.......................................... 38
Nonperforming Assets................................................. 41
Loans 90 Days or More Past Due and Still Accruing.................... 43
Quantitative and Qualitative Disclosures About Market Risk........... 43
Liquidity Risk....................................................... 47
Regulatory Capital................................................... 48
Business Segments.................................................... 49
Regulatory Matters................................................... 57
Certain Business Risk Factors........................................ 58
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 62
Item 4. Controls and Procedures........................................ 62
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 63
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.... 63
Item 6. Exhibits....................................................... 64
Signatures............................................................. 65
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) 2003 2004 CHANGE
- -------------------------------------------------- ------------- ------------- -------
RESULTS OF OPERATIONS:
Net interest income(1).......................... $ 401,736 $ 413,102 2.83%
(Reversal of) provision for credit losses....... 20,000 (10,000) nm
Noninterest income.............................. 201,470 215,954 7.19
Noninterest expense............................. 348,861 372,391 6.74
------------- -------------
Income before income taxes(1)................... 234,345 266,665 13.79
Taxable-equivalent adjustment................... 647 1,012 56.41
Income tax expense.............................. 78,653 102,215 29.96
------------- -------------
Net income...................................... $ 155,045 $ 163,438 5.41
============= =============
PER COMMON SHARE:
Net income--basic............................... $ 1.04 $ 1.11 6.73%
Net income--diluted............................. 1.02 1.09 6.86
Dividends(2).................................... 0.31 0.36 16.13
Book value (end of period)...................... 25.32 28.04 10.74
Common shares outstanding (end of period)(3).... 145,105,566 147,163,392 1.42
Weighted average common shares outstanding
--basic(3).................................... 149,528,298 147,554,853 (1.32)
Weighted average common shares outstanding
--diluted(3).................................. 151,561,790 150,379,127 (0.78)
BALANCE SHEET (END OF PERIOD):
Total assets.................................... $ 42,602,745 $ 46,990,605 10.30%
Total loans..................................... 26,047,376 28,625,086 9.90
Nonaccrual loans................................ 341,039 180,156 (47.17)
Nonperforming assets............................ 344,347 190,763 (44.60)
Total deposits.................................. 35,957,805 39,342,229 9.41
Medium and long-term debt....................... 417,369 820,460 96.58
Junior subordinated debt........................ -- 15,904 nm
Trust preferred securities...................... 356,629 -- nm
Stockholders' equity............................ 3,674,107 4,126,159 12.30
BALANCE SHEET (PERIOD AVERAGE):
Total assets.................................... $ 41,913,515 $ 45,713,280 9.07%
Total loans..................................... 26,331,986 28,147,293 6.89
Earning assets.................................. 37,855,869 41,427,609 9.44
Total deposits.................................. 34,902,964 38,114,310 9.20
Stockholders' equity............................ 3,834,834 4,067,953 6.08
FINANCIAL RATIOS:
Return on average assets(4)..................... 1.47% 1.42%
Return on average stockholders' equity(4)....... 16.04 15.98
Efficiency ratio(5)............................. 57.85 59.20
Net interest margin(1).......................... 4.22 3.98
Dividend payout ratio........................... 29.81 32.43
Tangible equity ratio........................... 8.05 8.03
Tier 1 risk-based capital ratio................. 10.96 9.99
Total risk-based capital ratio.................. 12.58 12.52
Leverage ratio.................................. 8.73 8.27
Allowance for credit losses to total loans...... 2.11 1.69
Allowance for credit losses to nonaccrual loans. 161.43 267.97
Net loans charged off to average total loans(4). 0.58 0.12
Nonperforming assets to total loans and
foreclosed assets............................. 1.32 0.67
Nonperforming assets to total assets............ 0.81 0.41
- ---------------------------------
<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) Common shares outstanding reflects common shares issued less treasury
shares.
(4) Annualized.
(5) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income
(taxable-equivalent basis) and noninterest income.
nm--not meaningful
</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) 2003 2004 CHANGE
- -------------------------------------------------- ------------- ------------- -------
RESULTS OF OPERATIONS:
Net interest income(1).......................... $ 1,179,562 $ 1,214,986 3.00%
(Reversal of) provision for credit losses....... 75,000 (25,000) nm
Noninterest income.............................. 590,412 758,169 28.41
Noninterest expense............................. 1,042,465 1,121,899 7.62
------------- -------------
Income before income taxes(1)................... 652,509 876,256 34.29
Taxable-equivalent adjustment................... 1,916 2,617 36.59
Income tax expense.............................. 215,273 321,617 49.40
------------- -------------
Net income...................................... $ 435,320 $ 552,022 26.81
============= =============
PER COMMON SHARE:
Net income--basic............................... $ 2.90 $ 3.74 28.97%
Net income--diluted............................. 2.87 3.68 28.22
Dividends(2).................................... 0.90 1.03 14.44
Book value (end of period)...................... 25.32 28.04 10.74
Common shares outstanding (end of period)(3).... 145,105,566 147,163,392 1.42
Weighted average common shares outstanding
--basic(3).................................... 150,059,789 147,547,527 (1.67)
Weighted average common shares outstanding
--diluted(3).................................. 151,544,757 150,026,647 (1.00)
BALANCE SHEET (END OF PERIOD):
Total assets.................................... $ 42,602,745 $ 46,990,605 10.30%
Total loans..................................... 26,047,376 28,625,086 9.90
Nonaccrual loans................................ 341,039 180,156 (47.17)
Nonperforming assets............................ 344,347 190,763 (44.60)
Total deposits.................................. 35,957,805 39,342,229 9.41
Medium and long-term debt....................... 417,369 820,460 96.58
Junior subordinated debt........................ -- 15,904 nm
Trust preferred securities...................... 356,629 -- nm
Stockholders' equity............................ 3,674,107 4,126,159 12.30
BALANCE SHEET (PERIOD AVERAGE):
Total assets.................................... $ 40,025,749 $ 44,463,183 11.09%
Total loans..................................... 26,522,687 27,046,262 1.97
Earning assets.................................. 36,263,471 40,222,338 10.92
Total deposits.................................. 32,870,184 37,290,976 13.45
Stockholders' equity............................ 3,875,990 3,984,194 2.79
FINANCIAL RATIOS:
Return on average assets(4)..................... 1.45% 1.66%
Return on average stockholders' equity(4)....... 15.02 18.51
Efficiency ratio(5)............................. 58.90 56.83
Net interest margin(1).......................... 4.35 4.03
Dividend payout ratio........................... 31.03 27.54
Tangible equity ratio........................... 8.05 8.03
Tier 1 risk-based capital ratio................. 10.96 9.99
Total risk-based capital ratio.................. 12.58 12.52
Leverage ratio.................................. 8.73 8.27
Allowance for credit losses to total loans...... 2.11 1.69
Allowance for credit losses to nonaccrual loans. 161.43 267.97
Net loans charged off to average total loans(4). 0.73 0.15
Nonperforming assets to total loans and
foreclosed assets............................. 1.32 0.67
Nonperforming assets to total assets............ 0.81 0.41
- --------------------------------------
<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) Common shares outstanding reflects common shares issued less treasury
shares.
(4) Annualized.
(5) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income
(taxable-equivalent basis) and noninterest income.
nm--not meaningful
</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,
-------------------- ----------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2003 2004 2003 2004
- ----------------------------------------------------- -------- -------- ---------- ----------
INTEREST INCOME
Loans............................................. $349,918 $350,587 $1,067,806 $1,014,288
Securities........................................ 93,252 106,172 251,151 320,082
Interest bearing deposits in banks................ 922 2,744 3,014 4,773
Federal funds sold and securities purchased under
resale agreements............................... 2,532 1,616 8,210 6,503
Trading account assets............................ 870 1,140 2,740 2,558
-------- -------- ---------- ----------
Total interest income........................... 447,494 462,259 1,332,921 1,348,204
-------- -------- ---------- ----------
INTEREST EXPENSE
Domestic deposits................................. 34,984 34,876 116,772 100,609
Foreign deposits.................................. 1,991 5,007 8,008 9,900
Federal funds purchased and securities sold under
repurchase agreements........................... 689 2,861 2,763 4,094
Commercial paper.................................. 1,723 1,697 7,397 3,883
Medium and long-term debt......................... 1,738 4,369 5,422 11,201
Preferred securities and trust notes.............. 3,607 242 10,930 2,553
Other borrowed funds.............................. 1,673 1,117 3,983 3,595
-------- -------- ---------- ----------
Total interest expense.......................... 46,405 50,169 155,275 135,835
-------- -------- ---------- ----------
NET INTEREST INCOME................................. 401,089 412,090 1,177,646 1,212,369
(Reversal of) provision for credit losses......... 20,000 (10,000) 75,000 (25,000)
-------- -------- ---------- ----------
Net interest income after (reversal of)
provision for credit losses................... 381,089 422,090 1,102,646 1,237,369
-------- -------- ---------- ----------
NONINTEREST INCOME
Service charges on deposit accounts............... 81,832 87,555 232,061 258,682
Trust and investment management fees.............. 35,429 39,089 101,245 111,699
Insurance commissions............................. 15,814 17,463 45,056 57,850
International commissions and fees................ 17,380 18,906 49,581 54,553
Card processing fees, net......................... 10,335 4,653 29,357 28,901
Merchant banking fees............................. 9,312 11,682 21,521 26,863
Foreign exchange gains, net....................... 7,574 8,548 21,466 25,186
Brokerage commissions and fees.................... 7,549 8,527 24,614 24,847
Securities gains (losses), net.................... (2,618) (6) 7,042 1,612
Other............................................. 18,863 19,537 58,469 167,976
-------- -------- ---------- ----------
Total noninterest income........................ 201,470 215,954 590,412 758,169
-------- -------- ---------- ----------
NONINTEREST EXPENSE
Salaries and employee benefits.................... 205,302 216,767 602,338 653,787
Net occupancy..................................... 31,342 33,206 91,844 96,961
Equipment......................................... 15,680 16,289 48,705 50,443
Software.......................................... 11,996 13,560 34,921 39,463
Communications.................................... 12,661 12,850 39,859 39,295
Professional services............................. 12,676 12,375 38,256 33,968
Foreclosed asset expense (income)................. (79) (10) (28) 526
Other............................................. 59,283 67,354 186,570 207,456
-------- -------- ---------- ----------
Total noninterest expense....................... 348,861 372,391 1,042,465 1,121,899
-------- -------- ---------- ----------
Income before income taxes........................ 233,698 265,653 650,593 873,639
Income tax expense................................ 78,653 102,215 215,273 321,617
-------- -------- ---------- ----------
NET INCOME.......................................... $155,045 $163,438 $ 435,320 $ 552,022
======== ======== ========== ==========
NET INCOME PER COMMON SHARE--BASIC.................. $ 1.04 $ 1.11 $ 2.90 $ 3.74
======== ======== ========== ==========
NET INCOME PER COMMON SHARE--DILUTED................ $ 1.02 $ 1.09 $ 2.87 $ 3.68
======== ======== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--BASIC... 149,528 147,555 150,060 147,548
======== ======== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--DILUTED. 151,562 150,379 151,545 150,027
======== ======== ========== ==========
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) 2003 2003 2004
- ----------------------------------------------------------- ------------- ------------ -------------
ASSETS
Cash and due from banks.................................... $ 2,619,580 $ 2,494,127 $ 2,229,306
Interest bearing deposits in banks......................... 341,230 235,158 544,520
Federal funds sold and securities purchased under resale
agreements............................................... 1,325,470 769,720 1,045,275
------------- ------------ -------------
Total cash and cash equivalents.......................... 4,286,280 3,499,005 3,819,101
Trading account assets..................................... 320,199 252,929 288,814
Securities available for sale:
Securities pledged as collateral......................... 68,440 106,560 124,896
Held in portfolio........................................ 9,930,281 10,660,332 11,868,627
Loans (net of allowance for credit losses: September 30,
2003, $550,550; December 31, 2003, $532,970;
September 30, 2004, $482,762)............................ 25,496,826 25,411,658 28,142,324
Due from customers on acceptances.......................... 52,816 71,078 64,752
Premises and equipment, net................................ 506,321 509,734 501,962
Intangible assets.......................................... 49,288 49,592 60,977
Goodwill................................................... 215,903 226,556 320,835
Other assets............................................... 1,676,391 1,711,023 1,798,317
------------- ------------ -------------
Total assets............................................. $ 42,602,745 $ 42,498,467 $ 46,990,605
============= ============ =============
LIABILITIES
Domestic deposits:
Noninterest bearing...................................... $ 16,854,483 $ 16,668,773 $ 19,021,245
Interest bearing......................................... 17,320,728 17,146,858 17,919,160
Foreign deposits:
Noninterest bearing...................................... 556,687 619,249 719,792
Interest bearing......................................... 1,225,907 1,097,403 1,682,032
------------- ------------ -------------
Total deposits......................................... 35,957,805 35,532,283 39,342,229
Federal funds purchased and securities sold under
repurchase agreements.................................... 284,764 280,968 648,864
Commercial paper........................................... 678,903 542,270 615,816
Other borrowed funds....................................... 240,803 212,088 150,503
Acceptances outstanding.................................... 52,816 71,078 64,752
Other liabilities.......................................... 939,549 934,916 1,205,918
Medium and long-term debt.................................. 417,369 820,488 820,460
Junior subordinated debt payable to subsidiary grantor
trust.................................................... -- 363,940 15,904
UnionBanCal Corporation--obligated mandatorily redeemable
preferred securities of subsidiary grantor trust......... 356,629 -- --
------------- ------------ -------------
Total liabilities........................................ 38,928,638 38,758,031 42,864,446
------------- ------------ -------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock:
Authorized 5,000,000 shares, no shares issued or
outstanding as of September 30, 2003, December 31,
2003, and September 30, 2004........................... -- -- --
Common stock, par value $1 per share at September 30,
2003, December 31, 2003 and September 30, 2004:
Authorized 300,000,000 shares, issued 145,105,566
shares as of September 30, 2003, 146,000,156 shares
as of December 31, 2003, and 149,529,292 shares as
of September 30, 2004.................................. 145,106 146,000 149,529
Additional paid-in capital................................. 520,876 555,156 728,791
Treasury stock--242,000 shares as of December 31, 2003
and 2,365,900 shares as of September 30, 2004............ -- (12,846) (131,464)
Retained earnings.......................................... 2,893,240 2,999,884 3,400,117
Accumulated other comprehensive income (loss).............. 114,885 52,242 (20,814)
------------- ------------ -------------
Total stockholders' equity............................... 3,674,107 3,740,436 4,126,159
------------- ------------ -------------
Total liabilities and stockholders' equity............... $ 42,602,745 $ 42,498,467 $ 46,990,605
============= ============ =============
See accompanying notes to condensed consolidated financial statements.
5
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
ACCUMULATED TOTAL
ADDITIONAL OTHER STOCK-
NUMBER COMMON PAID-IN TREASURY RETAINED COMPREHENSIVE HOLDERS'
(IN THOUSANDS, EXCEPT SHARES) OF SHARES STOCK(1) CAPITAL STOCK EARNINGS INCOME (LOSS) EQUITY
- --------------------------------- ----------- -------- ---------- --------- ---------- ------------- ----------
BALANCE DECEMBER 31, 2002........ 150,702,363 $926,460 $ -- $ -- $2,591,635 $ 240,094 $3,758,189
-------- ---------- --------- ---------- ------------- ----------
Comprehensive income
Net income--For the nine months
ended September 30, 2003..... 435,320 435,320
Other comprehensive income, net
of tax:
Net change in unrealized
gains on cash flow hedges.. (37,889) (37,889)
Net change in unrealized
gains on securities
available for sale........ (88,167) (88,167)
Foreign currency translation
adjustment................. 847 847
----------
Total comprehensive income 310,111
Reincorporation(1)............... (520,876) 520,876 --
Dividend reinvestment plan....... 5,289 34 34
Deferred compensation--restricted
stock awards................... 6,000 282 (112) 170
Stock options exercised.......... 1,018,175 35,792 35,792
Stock issued in acquisitions..... 1,149,106 48,254 48,254
Common stock repurchased(2)...... (7,775,367) (344,840) (344,840)
Dividends declared on common
stock, $0.90 per share(3)...... (133,603) (133,603)
-------- ---------- --------- ---------- ------------- ----------
Net change....................... (781,354) 520,876 -- 301,605 (125,209) (84,082)
----------- -------- ---------- --------- ---------- ------------- ----------
BALANCE SEPTEMBER 30, 2003....... 145,105,566 $145,106 $ 520,876 $ -- $2,893,240 $ 114,885 $3,674,107
=========== ======== ========== ========= ========== ============= ==========
BALANCE DECEMBER 31, 2003........ 146,000,156 $146,000 $ 555,156 $ (12,846) $2,999,884 $ 52,242 $3,740,436
-------- ---------- --------- ---------- ------------- ----------
Comprehensive income
Net income--For the nine months
ended September 30, 2004..... 552,022 552,022
Other comprehensive income, net
of tax:
Net change in unrealized
gains on cash flow hedges.. (30,285) (30,285)
Net change in unrealized
losses on securities
available for sale......... (43,404) (43,404)
Foreign currency translation
adjustment................. 633 633
----------
Total comprehensive income....... 478,966
Dividend reinvestment plan....... 308 17 17
Deferred compensation--restricted
stock awards................... 185 185
Stock options exercised.......... 1,520,109 1,520 61,223 62,743
Stock issued in acquisitions..... 2,008,719 2,009 112,569 114,578
Common stock repurchased(2)...... (174) (118,618) (118,792)
Dividends declared on common
stock, $1.03 per share(3)...... (151,974) (151,974)
-------- ---------- --------- ---------- ------------- ----------
Net change....................... 3,529 173,618 (118,618) 400,233 (73,056) 385,723
----------- -------- ---------- --------- ---------- ------------- ----------
BALANCE SEPTEMBER 30, 2004....... 149,529,292 $149,529 $ 728,791 $(131,464) $3,400,117 $ (20,814) $4,126,159
=========== ======== ========== ========= ========== ============= ==========
- -----------------------------
<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. All repurchases
subsequent to September 29, 2003, are reflected in Treasury Stock.
(3) Dividends 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) 2003 2004
- ---------------------------------------------------------------------- ----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................................... $ 435,320 $ 552,022
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
(Reversal of) provision for credit losses......................... 75,000 (25,000)
Depreciation, amortization and accretion.......................... 87,332 100,631
Provision for deferred income taxes............................... 60,425 29,411
Gains on securities available for sale............................ (7,042) (1,612)
Net increase in prepaid expenses.................................. (89,272) (96,009)
Net increase (decrease) in accrued expenses and other liabilities. (189,413) 230,364
Net (increase) decrease in other assets, net of acquisitions...... (101,842) 183,393
Net increase in trading account assets............................ (44,178) (35,885)
Loans originated for resale....................................... (269,186) (661,342)
Net proceeds from sale of loans originated for resale............. 291,198 518,739
Other, net........................................................ 27,716 19,606
----------- ----------
Total adjustments................................................. (159,262) 262,296
----------- ----------
Net cash provided by (used in) operating activities................. 276,058 814,318
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale................ 308,051 13,479
Proceeds from matured and called securities available for sale...... 2,689,120 3,177,262
Purchases of securities available for sale, net of acquisitions..... (5,849,353) (4,386,300)
Net (increase) decrease in loans, net of acquisitions............... 758,743 (2,152,469)
Net cash provided by (paid in) acquisitions......................... (60,920) 28,086
Purchases of premises and equipment................................. (70,192) (58,064)
Other, net.......................................................... 823 1,866
----------- ----------
Net cash provided by (used in) investing activities............... (2,223,728) (3,376,140)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits, net of acquisitions............ 2,650,264 3,066,571
Net increase (decrease) in federal funds purchased and securities
sold under repurchase agreements.................................. (49,615) 367,896
Net increase (decrease) in commercial paper and other borrowed funds (386,323) 11,961
Repayment of junior subordinated debt............................... -- (360,825)
Common stock repurchased............................................ (344,840) (118,792)
Payments of cash dividends.......................................... (130,896) (144,146)
Stock options exercised............................................. 35,792 62,743
Other, net.......................................................... 881 650
----------- ----------
Net cash provided by (used in) financing activities............... 1,775,263 2,886,058
----------- ----------
Net increase (decrease) in cash and cash equivalents.................. (172,407) 324,236
Cash and cash equivalents at beginning of period...................... 4,442,122 3,499,005
Effect of exchange rate changes on cash and cash equivalents.......... 16,565 (4,140)
----------- ----------
Cash and cash equivalents at end of period............................ $ 4,286,280 $3,819,101
=========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest............................................................ $ 155,469 $ 122,236
Income taxes........................................................ 187,723 230,094
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisitions:
Fair value of assets acquired..................................... $ 721,749 $ 991,887
Purchase price:
Cash............................................................ (83,597) (33,772)
Stock issued.................................................... (48,254) (114,578)
----------- ----------
Liabilities assumed............................................... $ 589,898 $ 843,537
=========== ==========
See accompanying notes to condensed consolidated financial statement.
7
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(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 (U.S.
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 U.S. GAAP. The
results of operations for the period ended September 30, 2004 are not
necessarily indicative of the operating results anticipated for the full year.
Accordingly, these unaudited condensed consolidated financial statements should
be read in conjunction with the audited consolidated financial statements
included in the Company's Form 10-K for the year ended December 31, 2003. The
preparation of financial statements in conformity with U.S. GAAP also requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expense during the reporting period. Actual results could differ from those
estimates.
UnionBanCal Corporation is a commercial bank holding company and has, as
its major subsidiary, a banking subsidiary, Union Bank of California, N.A. (the
Bank). The Company provides a wide range of financial services to consumers,
small businesses, middle-market companies and major corporations, primarily in
California, Oregon, and Washington, but also nationally and internationally.
Since November 1999 through September 30, 2004, the Company has announced
stock repurchase plans totaling $700 million and as of September 30, 2004 has
repurchased $517 million of common stock under these repurchase plans. The
Company repurchased $58 million, $44 million, $12 million and $63 million of
common stock in 2003, the first quarter of 2004, the second quarter of 2004, and
the third quarter of 2004, respectively, as part of these repurchase plans. As
of September 30, 2004, $183 million of the Company's common stock is authorized
for repurchase. Under separate stock repurchase agreements, 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, 2004, BTM owned approximately 62
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
As allowed under the provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," as amended,
the Company has chosen to continue to recognize compensation expense using the
intrinsic value-based method of valuing stock options prescribed in Accounting
Principles Board Opinion (APB) 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, 2004, the Company has two stock-based employee
compensation plans. For further discussion concerning our stock-based employee
compensation plans see Note 14 of the Notes to Consolidated Financial Statements
included in the Form 10-K for the year ended December 31, 2003. The
8
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION AND NATURE OF OPERATIONS (CONTINUED)
value of the restricted stock awards issued under the plans has been reflected
in compensation expense. Options granted under the plans had an exercise price
equal to the market value of the underlying common stock on the date of grant
and, therefore, were not included in compensation expense as allowed by current
U.S. GAAP.
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.
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------
(DOLLARS IN THOUSANDS) 2003 2004 2003 2004
- --------------------------------------------- -------- -------- -------- ---------
AS REPORTED NET INCOME....................... $155,045 $163,438 $435,320 $552,022
Stock option-based employee compensation
expense (determined under fair value
based method for all awards, net of
taxes)..................................... (6,479) (6,710) (18,962) (19,925)
-------- -------- -------- ---------
Pro forma net income, after stock option-
based employee compensation expense........ $148,566 $156,728 $416,358 $532,097
======== ======== ======== =========
EARNINGS PER SHARE--BASIC
As reported.................................. $ 1.04 $ 1.11 $ 2.90 $ 3.74
Pro forma.................................... $ 0.99 $ 1.06 $ 2.77 $ 3.61
EARNINGS PER SHARE--DILUTED
As reported.................................. $ 1.02 $ 1.09 $ 2.87 $ 3.68
Pro forma.................................... $ 0.98 $ 1.04 $ 2.75 $ 3.55
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 three and nine
months ended September 30, 2003 and 2004 was not significant.
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." This Statement addresses
the financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. It requires an entity to record a liability for an obligation associated
with the retirement of an asset at the time the liability is incurred by
capitalizing the cost as part of the carrying value of the related asset and
depreciating it over the remaining useful life of the asset. This Statement was
effective for the Company on January 1, 2003 and did not have a material impact
on the Company's financial position or results of operations.
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement replaces the
accounting and reporting provisions of Emerging Issues Task
9
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." It requires that costs associated with an
exit or disposal activity be recognized when a liability is incurred rather than
at the date an entity commits to an exit plan. This Statement was effective on
January 1, 2003 and 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 Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." The Interpretation elaborates on
the existing disclosure requirements for most guarantees and requires that
guarantors recognize a liability for the fair value of certain guarantees at
inception. The disclosure requirements of this Interpretation were effective for
financial statements ending after December 15, 2002. The initial recognition and
measurement provisions of this Interpretation were applied on a prospective
basis to guarantees issued or modified after December 31, 2002. The adoption of
this Interpretation did not have a material impact on the Company's financial
position or results of operations.
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 Activities." SFAS No. 149 was effective for contracts entered into
or modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. The provisions of the Statement, with certain exceptions, are
required to be applied prospectively. The adoption of this Statement did 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. This Statement was effective for financial instruments entered into or
modified after May 31, 2003, and to other instruments effective at the beginning
of the first interim period beginning after June 15, 2003. Adoption of this
Statement did not have a material impact on the Company's financial position or
results of operations.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities." FIN 46 provides guidance on how
to identify a variable interest entity (VIE), and 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 VIE exists when either the
total equity investment at risk is
10
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
not sufficient to permit the entity to finance its activities by itself, or the
equity investors lack a controlling financial interest or they have voting
rights that are not proportionate to their economic interest. 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. FIN 46 also requires additional
disclosures by primary beneficiaries and other significant variable interest
holders.
In December 2003, the FASB issued FIN 46R, a revision of FIN 46. FIN 46R
clarifies that only the holder of a variable interest can ever be a VIE's
primary beneficiary. FIN 46R delays the effective date of FIN 46 for all
entities created subsequent to January 31, 2003 and non-SPE's (special-purpose
entities) created prior to February 1, 2003 to reporting periods ending after
March 15, 2004. Entities created prior to February 1, 2004 and defined as SPE's
must apply either the provisions of FIN 46 or early adopt the provisions of FIN
46R by the first reporting period ending after December 15, 2003. The adoption
of FIN 46R on January 1, 2004 did not have a material impact on the Company's
financial position or results of operations.
ACCOUNTING FOR EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER
POSTRETIREMENT BENEFITS
In December 2003, the FASB issued SFAS No. 132R, a revision of SFAS No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits,
an amendment of FASB Statements No. 87, 88, and 106." The Statement expands the
disclosure requirements of SFAS No. 132 to include information describing types
of plan assets, investment strategy, measurement date(s), plan obligations, cash
flows, and components of net period benefit costs of defined pension plans and
other defined benefit postretirement plans. The Statement is effective for
financial statements with fiscal years ending after December 15, 2003. The
expanded disclosures required by SFAS No. 132R are disclosed in Note 7 of the
Notes to Consolidated Financial Statements in the Form 10-K for the year ended
December 31, 2003. For further information on the impact of adoption and
disclosure required under SFAS No. 132R, see Note 10 of the Notes to Condensed
Consolidated Financial Statements included in this Form 10-Q.
ACCOUNTING FOR CERTAIN LOANS ACQUIRED IN A TRANSFER
In December 2003, under clearance of the FASB, the Accounting Standards
Executive Committee (AcSEC) of the AICPA issued Statement of Position (SOP)
03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer."
This SOP establishes accounting standards for discounts on purchased loans when
the discount is attributable to credit quality. The SOP requires that the loan
discount, rather than contractual amounts, establishes the investor's estimate
of undiscounted expected future principal and interest cash flows as a benchmark
for yield and impairment measurements. The SOP prohibits the carryover or
creation of a valuation allowance in the initial accounting for these loans.
This SOP is effective for loans acquired in years ending after December 15,
2004. Management believes that adoption of this Statement will not have a
material impact on the Company's financial position or results of operations at
adoption.
THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO
CERTAIN INVESTMENTS
In March 2004, the Emerging Issues Task Force reached consensus on certain
incremental issues related to Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to
11
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
Certain Investments." In addition to disclosure requirements that were effective
for fiscal years ending after December 15, 2003, EITF Issue No. 03-1 requires
that companies recognize impairment equal to the difference between the
investment's cost and fair value if the investor does not have the ability and
intent to hold the investment for a period of time sufficient for a forecasted
recovery of fair value up to or beyond the cost of the investment. EITF Issue
No. 03-1 is effective for interim periods beginning after June 15, 2004.
However, certain guidance contained in the EITF has been delayed by FASB Staff
Position (FSP) EITF Issue 03-1-1, "The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments." The Company adopted the
disclosure provisions of EITF Issue No. 03-1 on December 31, 2003 and any impact
arising from the reissuance of EITF No. 03-1 with respect to the recognition of
other-than-temporary impairment will be assessed at that time.
PRESCRIPTION DRUG BENEFITS
In May 2004, the FASB issued FSP Financial Accounting Standards (FAS) No.
106-2, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003." This FSP provides
guidance on the accounting for the effects of the Medicare prescription drug
benefit and the federal subsidy to sponsors of retiree healthcare benefit plans
that offer prescription drug coverage to retirees that is actuarially equivalent
to the Medicare benefit. In accordance with the FSP, sponsoring companies must
recognize the subsidy in the measurement of their plan's accumulated
postretirement benefit obligation (APBO) and net postretirement benefit cost.
The Company adopted FSP FAS No. 106-2 on July 1, 2004. For further information
on the impact of adoption and disclosure required under FSP FAS No. 106-2, see
Note 10 of the Notes to Condensed Consolidated Financial Statements included in
this Form 10-Q.
NOTE 3--EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
EPS incorporates the dilutive effect of common stock equivalents outstanding on
an average basis during the period. Stock options are a common stock equivalent.
The following table presents a reconciliation of basic and diluted EPS for the
three months and nine months ended September 30, 2003 and 2004.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------- -------------------------------------
2003 2004 2003 2004
------------------ ------------------ -------------------------------------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE DATA) BASIC DILUTED BASIC DILUTED BASIC DILUTED BASIC DILUTED
- --------------------------- -------- --------- -------- --------- -------- --------- -------- ---------
Net Income................. $155,045 $ 155,045 $163,438 $ 163,438 $435,320 $ 435,320 $552,022 $ 552,022
======== ========= ======== ========= ======== ========= ======== =========
Weighted average common
shares outstanding....... 149,528 149,528 147,555 147,555 150,060 150,060 147,548 147,548
Additional shares due to:
Assumed conversion of
dilutive stock options... -- 2,034 -- 2,824 -- 1,485 -- 2,479
-------- --------- -------- --------- -------- --------- -------- ---------
Adjusted weighted average
common shares outstanding 149,528 151,562 147,555 150,379 150,060 151,545 147,548 150,027
======== ========= ======== ========= ======== ========= ======== =========
Net income per share....... $ 1.04 $ 1.02 $ 1.11 $ 1.09 $ 2.90 $ 2.87 $ 3.74 $ 3.68
======== ========= ======== ========= ======== ========= ======== =========
12
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4--ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents the components of other comprehensive income
(loss) and the related tax effect allocated to each component.
BEFORE
TAX TAX NET OF
(DOLLARS IN THOUSANDS) AMOUNT EFFECT TAX
- ------------------------------------------------------- --------- -------- ---------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003:
Cash flow hedge activities:
Unrealized net gains on hedges arising during the
period............................................. $ 48,126 $(18,408) $ 29,718
Less: reclassification adjustment for net gains on
hedges included in net income.................. (109,485) 41,878 (67,607)
--------- -------- ---------
Net change in unrealized gains on hedges............... (61,359) 23,470 (37,889)
--------- -------- ----------
Securities available for sale:
Unrealized holding losses arising during the period
on securities available for sale................... (135,739) 51,920 (83,819)
Less: reclassification adjustment for net gains on
securities available for sale included in net
income......................................... (7,042) 2,694 (4,348)
--------- -------- ---------
Net change in unrealized gains on securities available
for sale............................................. (142,781) 54,614 (88,167)
--------- -------- ---------
Foreign currency translation adjustment................ 1,372 (525) 847
--------- -------- ---------
Net change in accumulated other comprehensive
income (loss)........................................ $(202,768) $ 77,559 $(125,209)
========= ======== =========
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004:
Cash flow hedge activities:
Unrealized net gains on hedges arising during the
period............................................. $ 12,680 $ (4,850) $ 7,830
Less: reclassification adjustment for net gains on
hedges included in net income.................. (61,725) 23,610 (38,115)
--------- -------- ---------
Net change in unrealized gains on hedges............... (49,045) 18,760 (30,285)
--------- -------- ---------
Securities available for sale:
Unrealized holding losses arising during the period
on securities available for sale................... (68,679) 26,270 (42,409)
Less: reclassification adjustment for net gains on
securities available for sale included in
net income..................................... (1,612) 617 (995)
--------- -------- ---------
Net change in unrealized losses on securities
available for sale................................... (70,291) 26,887 (43,404)
--------- -------- ---------
Foreign currency translation adjustment................ 1,025 (392) 633
--------- -------- ---------
Net change in accumulated other comprehensive
income (loss)........................................ $(118,311) $ 45,255 $ (73,056)
========= ======== =========
13
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4--ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (CONTINUED)
The following table presents accumulated other comprehensive income (loss)
balances.
NET NET
UNREALIZED UNREALIZED
GAINS (LOSSES) GAINS (LOSSES) FOREIGN MINIMUM ACCUMULATED
ON CASH ON SECURITES CURRENCY PENSION OTHER
FLOW AVAILABLE TRANSLATION LIABILITY COMPREHENSIVE
(DOLLARS IN THOUSANDS) HEDGES FOR SALE ADJUSTMENT ADJUSTMENT INCOME (LOSS)
- ----------------------------- -------------- -------------- ---------- ---------- -------------
BALANCE, DECEMBER 31, 2002... $104,368 $147,450 $(10,649) $(1,075) $240,094
Change during the period..... (37,889) (88,167) 847 -- (125,209)
-------- -------- -------- ------- --------
BALANCE, SEPTEMBER 30, 2003.. $ 66,479 $ 59,283 $ (9,802) $(1,075) $114,885
-------- -------- -------- ------- --------
BALANCE, DECEMBER 31, 2003... $ 43,786 $ 22,535 $(10,293) $(3,786) $ 52,242
Change during the period..... (30,285) (43,404) 633 -- (73,056)
-------- -------- -------- ------- --------
BALANCE, SEPTEMBER 30, 2004.. $ 13,501 $(20,869) $ (9,660) $(3,786) $(20,814)
======== ======== ======== ======= ========
NOTE 5--BUSINESS COMBINATIONS
The Company has regularly sought opportunities to acquire financial
services companies and businesses. Generally, the Company does not make a public
announcement about an acquisition opportunity until a definitive agreement has
been signed.
On January 16, 2004, we completed our acquisition of Business Bank of
California, a commercial bank headquartered in San Bernardino, California, with
$704 million in assets and fifteen full-service branches in the Southern
California Inland Empire and the San Francisco Bay Area. The core deposit
intangibles are being amortized on an accelerated basis over their economic
useful life of a weighted average 6 years.
On August 1, 2004, the Company's subsidiary, Union Bank of California, N.A.
(the Bank), completed its acquisition of the business portfolio of CNA Trust
Company (CNAT). The Company acquired total assets and assumed liabilities of
$173 million, each, for a cash consideration of $12 million. CNAT, based in
Costa Mesa, California, was a subsidiary of Chicago-based CNA Financial
Corporation. The identifiable intangibles are being amortized on an accelerated
basis over their economic useful life of a weighted average 7 years.
14
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 6--GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying amount of goodwill and intangible assets for
the nine months ended September 30, 2004 are as follows:
IDENTIFIABLE INTANGIBLE ASSETS
--------------------------------------------
CORE DEPOSIT RIGHTS-TO- TOTAL IDENTIFIABLE
GOODWILL INTANGIBLES EXPIRATION INTANGIBLE ASSETS
-------- ------------ ---------- ------------------
Balance, December 31, 2003......................... $226,556 $22,117 $27,475 $49,592
Amounts recorded during the year................. 94,279 25,167 0 25,167
Amortization expense............................. 0 (10,077) (3,706) (13,782)
-------- ------- ------- -------
Balance, September 30, 2004........................ $320,835 $37,207 $23,769 $60,977
======== ======= ======= =======
Estimated amortization expense for the years
ending:
Remaining 2004..................................... $ 4,104 $ 1,236 $ 5,340
2005............................................... 13,540 4,311 17,851
2006............................................... 8,201 3,672 11,873
2007............................................... 4,775 3,113 7,888
2008............................................... 2,821 2,622 5,443
thereafter......................................... 3,767 8,815 12,582
------- ------- -------
Total amortization expense after September 30, 2004 $37,208 $23,769 $60,977
======= ======= =======
NOTE 7--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 (California, Washington and
Oregon) network of branches and ATM's. These services include
commercial loans, mortgages, home equity lines of credit, consumer
loans, deposit services and cash management as well as fiduciary,
private banking, investment and asset management services for
individuals and institutions, and risk management and insurance
products for businesses and individuals.
o The Commercial Financial Services Group provides credit and cash
management services to large corporate and middle-market companies.
Services include commercial and project loans, real estate financing,
asset-based financing, trade finance and letters of credit, lease
financing, customized cash management services and selected capital
markets products.
o The International Banking Group primarily provides correspondent
banking and trade-finance products and services to financial
institutions. The group's revenue predominately relates to foreign
customers.
15
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7--BUSINESS SEGMENTS (CONTINUED)
o The Global Markets Group is responsible for the Company's market risk
management including liquidity, interest rate and price risks, and
offers a broad range of risk management and trading products and
services to the Company's clients through the groups 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 U.S. GAAP. Consequently, reported results
are not necessarily comparable with those presented by other companies. Included
in the total asset line of the table are the amounts of goodwill for each
reporting unit as of September 30, 2003 and 2004. Substantially all of the
goodwill reflected on the Consolidated Balance Sheet is attributed to the
Community Banking and Investment Services Group.
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" is comprised of certain parent company non-bank subsidiaries, the
elimination of the fully taxable-equivalent basis amount, the amount of the
(reversal of) provision for credit losses over/(under) the RAROC expected loss
for the period, the earnings associated with the unallocated equity capital and
allowance for credit losses, and the residual costs of support groups. In
addition, it includes the Pacific Rim Corporate Group, which offers financial
products to Japanese-owned subsidiaries located in the U.S. On an individual
basis, none of the items in "Other" are significant to the Company's business.
Included in noninterest income for the first nine months of 2004 is a $93.0
million gain resulting from the sale of the Company's merchant card portfolio,
which has not been included in the results of the Community Banking and
Investment Services Group.
The business units' results for the prior periods have been restated to
reflect changes in the transfer pricing methodology and any reorganization
changes that may have occurred.
16
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7--BUSINESS SEGMENTS (CONTINUED)
COMMUNITY BANKING
AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL
SERVICES GROUP SERVICES GROUP BANKING GROUP
------------------ ------------------- ------------------
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------------------
2003 2004 2003 2004 2003 2004
- -------------------------------------------- -------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income......................... $173,733 $203,040 $186,249 $203,288 $ 8,537 $ 9,802
Noninterest income.......................... 110,912 125,042 67,591 64,317 18,117 19,069
-------- -------- -------- -------- ------- -------
Total revenue............................... 284,645 328,082 253,840 267,605 26,654 28,871
Noninterest expense......................... 202,283 235,883 103,277 108,519 15,323 16,728
Credit expense (income)..................... 7,996 8,400 39,397 24,781 511 566
-------- -------- -------- -------- ------- -------
Income (loss) before income tax expense
(benefit)................................. 74,366 83,799 111,166 134,305 10,820 11,577
-------- -------- -------- -------- ------- -------
Income tax expense (benefit)................ 28,445 32,053 36,128 44,414 4,139 4,428
Net income (loss)........................... $ 45,921 $ 51,746 $ 75,038 $ 89,891 $ 6,681 $ 7,149
======== ======== ======== ========= ======= =======
TOTAL ASSETS, END OF PERIOD (dollars in
millions):................................ $ 12,958 $ 14,697 $ 14,255 $ 15,750 $ 2,012 $ 2,224
======== ======== ======== ========= ======= =======
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
------------------ ------------------- -------------------
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------------
2003 2004 2003 2004 2003 2004
- -------------------------------------------- -------- -------- -------- --------- -------- --------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income......................... $18,140 $(35,642) $ 14,430 $ 31,602 $401,089 $412,090
Noninterest income.......................... (1,097) 1,561 5,947 5,965 201,470 215,954
-------- -------- -------- --------- -------- --------
Total revenue............................... 17,043 (34,081) 20,377 37,567 602,559 628,044
Noninterest expense......................... 3,926 5,225 24,052 6,036 348,861 372,391
Credit expense (income)..................... 50 54 (27,954) (43,801) 20,000 (10,000)
-------- -------- -------- --------- -------- --------
Income (loss) before income tax expense
(benefit)................................. 13,067 (39,360) 24,279 75,332 233,698 265,653
Income tax expense (benefit)................ 4,998 (15,055) 4,943 36,375 78,653 102,215
-------- -------- -------- --------- -------- --------
Net income (loss)........................... $ 8,069 $(24,305) $ 19,336 $ 38,957 $155,045 $163,438
======== ======== ======== ========= ======== ========
TOTAL ASSETS, END OF PERIOD (dollars in
millions):................................ $ 12,046 $ 13,139 $ 1,332 $ 1,181 $ 42,603 $ 46,991
======== ======== ======== ========= ======== ========
COMMUNITY BANKING
AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL
SERVICES GROUP SERVICES GROUP BANKING GROUP
------------------ ------------------- -------------------
AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------------
2003 2004 2003 2004 2003 2004
- -------------------------------------------- -------- -------- -------- --------- -------- --------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income......................... $505,206 $571,536 $546,437 $ 578,265 $ 25,654 $ 26,832
Noninterest income.......................... 324,416 371,436 187,055 206,483 59,690 59,519
-------- -------- -------- --------- -------- --------
Total revenue............................... 829,622 942,972 733,492 784,748 85,344 86,351
Noninterest expense......................... 599,400 678,512 307,132 317,208 45,656 49,368
Credit expense (income)..................... 23,840 23,984 124,006 82,443 1,563 1,815
-------- -------- -------- --------- -------- --------
Income (loss) before income tax expense
(benefit)................................. 206,382 240,476 302,354 385,097 38,125 35,168
Income tax expense (benefit)................ 78,941 91,982 96,355 127,983 14,583 13,451
-------- -------- -------- --------- -------- --------
Net income (loss)........................... $127,441 $148,494 $205,999 $ 257,114 $ 23,542 $ 21,717
======== ======== ======== ========= ======== ========
TOTAL ASSETS, END OF PERIOD (dollars in
millions):................................ $ 12,958 $ 14,697 $ 14,255 $ 15,750 $ 2,012 $ 2,224
======== ======== ======== ========= ======== ========
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
------------------ ------------------- ---------------------
AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------
2003 2004 2003 2004 2003 2004
- -------------------------------------------- -------- -------- -------- --------- ---------- ----------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income......................... $ 56,371 $(50,293) $ 43,978 $ 86,029 $1,177,646 $1,212,369
Noninterest income.......................... 2,311 4,497 16,940 116,234 590,412 758,169
-------- -------- -------- --------- ---------- ----------
Total revenue............................... 58,682 (45,796) 60,918 202,263 1,768,058 1,970,538
Noninterest expense......................... 12,158 16,093 78,119 60,718 1,042,465 1,121,899
Credit expense (income)..................... 150 280 (74,559) (133,522) 75,000 (25,000)
-------- -------- -------- --------- ---------- ----------
Income (loss) before income tax expense
(benefit)................................. 46,374 (62,169) 57,358 275,067 650,593 873,639
Income tax expense (benefit)................ 17,738 (23,780) 7,656 111,981 215,273 321,617
-------- -------- -------- --------- ---------- ----------
Net income (loss)........................... $ 28,636 $(38,389) $ 49,702 $ 163,086 $ 435,320 $ 552,022
======== ======== ======== ========= ========== ==========
TOTAL ASSETS, END OF PERIOD (dollars in
millions):................................ $ 12,046 $ 13,139 $ 1,332 $ 1,181 $ 42,603 $ 46,991
======== ======== ======== ========= ========== ==========
17
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--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, medium-term notes and
subordinated debt.
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., U.S. 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, 2004, the
weighted average remaining life of the currently active (excluding any forward
positions) cash flow hedges was approximately 1.0 year.
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 floor strike rate
while net payments to be paid will reduce the increase in loan interest income
caused by the LIBOR index rising above the collar's cap strike rate.
The Company uses interest rate swaps to hedge the variable cash flows
associated with 1-month LIBOR or 3-month LIBOR indexed loans. Payments to be
received (or paid) under the swap contracts will offset the fluctuations in loan
interest income caused by changes in the relevant LIBOR index. As such, these
instruments hedge all fluctuations in the loans' interest income caused by
changes in the relevant LIBOR index.
The Company uses purchased interest rate caps to hedge the variable
interest cash flows associated with the forecasted issuance and rollover of
short-term, fixed rate, negotiable certificates of deposit (CDs). In these
hedging relationships, the Company hedges the LIBOR component of the CD rates,
which is either 3-month LIBOR or 6-month LIBOR, based on the CDs' original term
to maturity, which reflects their repricing frequency. Net payments to be
received under the cap contract offset the increase in interest expense caused
by the relevant LIBOR index rising above the cap's strike rate.
18
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
The Company uses interest rate cap corridors to hedge the variable cash
flows associated with the forecasted issuance and rollover of short-term, fixed
rate, negotiable CDs. In these hedging relationships, the Company hedges the
LIBOR component of the CD rates, either 1-month LIBOR, 3-month LIBOR, or 6-month
LIBOR, based on the original term to maturity of the CDs, which reflects their
repricing frequency. Net payments to be received under the cap corridor
contracts offset the increase in deposit interest expense caused by the relevant
LIBOR index rising above the corridor's lower strike rate, but only to the
extent the index rises to the upper strike rate. The corridor will not provide
protection from increases in the relevant LIBOR index to the extent it rises
above the 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 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 2004, the
Company recognized a net gain of $0.1 million due to ineffectiveness, which is
recognized in noninterest expense, compared to a net gain of less than $0.1
million in the third quarter of 2003.
FAIR VALUE HEDGES
HEDGING STRATEGY FOR UNIONBANCAL CORPORATION--JUNIOR SUBORDINATED DEBT
PAYABLE TO SUBSIDIARY GRANTOR TRUST (TRUST NOTES)
Prior to February 19, 2004, when the Company terminated its fair value
hedge and called its Trust Notes, the Company engaged in an interest rate
hedging strategy in which an interest rate swap was associated with a specific
interest bearing liability, UnionBanCal Corporation's Trust Notes, in order to
convert the liability from a fixed rate to a floating rate instrument. This
strategy mitigated the changes in fair value of the hedged liability caused by
changes in the designated benchmark interest rate, U.S. dollar LIBOR.
The fair value hedging transaction was structured at inception so that the
notional amount of the swap matched an associated principal amount of the Trust
Notes. The interest payment dates, the expiration date, and the embedded call
option of the swap matched those of the Trust Notes. Because the interest rate
swap was terminated in the first quarter of 2004, there was no ineffectiveness
on the fair value hedge during the third quarter of 2004 compared to a net gain
of less than $0.1 million in the third quarter of 2003.
HEDGING STRATEGY FOR MEDIUM-TERM NOTES
The Company engages in an interest rate hedging strategy in which an
interest rate swap is associated with a specified interest bearing liability,
UnionBanCal Corporation's five-year, medium-term debt issuance, in order to
convert the liability from a fixed rate to a floating rate instrument. This
strategy mitigates the changes in fair value of the hedged liability caused by
changes in the designated benchmark interest rate, U.S. 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.
19
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
HEDGING STRATEGY FOR SUBORDINATED DEBT
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 ten-year, subordinated debt issuance, in order to
convert the liability from a fixed rate to a floating rate instrument. This
strategy mitigates the changes in fair value of the hedged liability caused by
changes in the designated benchmark interest rate, U.S. dollar LIBOR.
The fair value hedging transaction for the subordinated debt was structured
at inception to mirror all of the provisions of the subordinated debt, which
allows the Company to assume that no ineffectiveness exists.
OTHER
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.
NOTE 9--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, 2004, the Company's
maximum exposure to loss for standby and commercial letters of credit was $3.0
billion and $297.8 million, respectively. At September 30, 2004, the carrying
value of the Company's standby and commercial letters of credit, which is
included in other liabilities on the consolidated balance sheet, totaled $5.3
million.
Principal investments include direct investments in private and public
companies and indirect investments in private equity funds. The Company issues
commitments to provide equity and mezzanine capital financing to private and
public companies through either direct investments in specific companies or
through investment funds and partnerships. The timing of future cash
requirements to fund such commitments is generally dependent on the investment
cycle. This cycle, the period over which privately-held companies are funded by
private equity investors and ultimately sold, merged, or taken public through an
initial offering, can vary based on overall market conditions as well as the
nature and type of industry in which the companies operate. At September 30,
2004, the Company had commitments to fund principal investments of $66.8
million.
The Company has contingent consideration agreements that guarantee
additional payments to acquired insurance agencies' stockholders 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 those former
stockholders. As of September 30, 2004, the Company had a maximum exposure of
$7.4 million for these agreements, the last of which expire in December 2006.
20
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 9--GUARANTEES (CONTINUED)
The Company is fund manager for limited liability corporations issuing
low-income housing credit (LIHC) investments. LIHC investments provide tax
benefits to investors in the form of tax deductions from operating losses and
tax credits. To facilitate the sale of these LIHC 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
LIHC investments that reduce the Company's ultimate exposure to loss. As of
September 30, 2004, the Company's maximum exposure to loss under these
guarantees was limited to a return of investor capital and minimum investment
yield, or $103.6 million. The Company maintains a reserve of $4.0 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 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, 2004, the Bank had a maximum
exposure to loss under these guarantees, which have an average term of less than
one year, of $627.5 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, 2004,
UnionBanCal Corporation had no material exposure to loss under these guarantees.
The Company conducts securities lending transactions for institutional
customers as a fully disclosed agent. At times, securities lending
indemnifications are issued to guarantee that a security lending customer will
be made whole in the event the borrower does not return the security subject to
the lending agreement and collateral held is insufficient to cover the market
value of the security. All lending transactions are collateralized, primarily by
cash. The amount of securities lent with indemnifications was $1.7 billion at
September 30, 2004. The market value of the associated collateral was $1.8
billion at September 30, 2004.
21
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10--PENSION AND OTHER POSTRETIREMENT BENEFITS
The following tables summarize the components of net periodic benefit costs
for the three months and nine months ended September 30, 2003 and 2004.
PENSION BENEFITS OTHER BENEFITS
-------------------- --------------------
FOR THE THREE MONTHS FOR THE THREE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- --------------------
(DOLLARS IN THOUSANDS) 2003 2004 2003 2004
- -------------------------------------------- -------- -------- ------- --------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost................................ $ 8,217 $ 9,415 $ 1,295 $ 849
Interest cost............................... 11,875 13,059 2,641 1,399
Expected return on plan assets.............. (18,203) (20,782) (1,687) (2,292)
Amortization of prior service cost.......... 267 266 (24) (24)
Amortization of transition amount........... -- -- 637 637
Recognized net actuarial loss (gain)........ 1,042 3,609 1,599 (539)
-------- -------- ------- --------
Total net periodic benefit cost............. $ 3,198 $ 5,567 $ 4,461 $ 30
======== ======== ======= ========
PENSION BENEFITS OTHER BENEFITS
-------------------- --------------------
FOR THE NINE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- --------------------
(DOLLARS IN THOUSANDS) 2003 2004 2003 2004
- -------------------------------------------- -------- -------- ------- --------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost................................ $ 24,650 $ 28,244 $ 3,885 $ 4,232
Interest cost............................... 35,625 39,179 7,921 7,079
Expected return on plan assets.............. (54,608) (62,347) (5,060) (6,759)
Amortization of prior service cost.......... 800 800 (72) (72)
Amortization of transition amount........... -- -- 1,912 1,912
Recognized net actuarial loss............... 3,127 10,826 4,796 2,997
-------- -------- ------- --------
Total net periodic benefit cost............. $ 9,594 $ 16,702 $13,382 $ 9,389
======== ======== ======= ========
In the third quarter of 2004, the Company recorded a $4.7 million reduction
in employee benefit expense associated with the remeasurement of our
postretirement benefits as a result of the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 ("The Act"). The reduction is
attributable to a federal subsidy provided by The Act to employers that sponsor
retiree health care plans with drug benefits that are equivalent to those
offered under Medicare Part D. The effect of the subsidy on the measurement of
net periodic postretirement benefit cost for the year-to-date period ending
September 30, 2004 includes a $2.3 million actuarial experience gain, a $0.9
million reduction in service cost, and a $1.5 million reduction in interest cost
on the accumulated postretirement benefit obligation (APBO). The effect of the
subsidy related to benefits attributed to past service in measuring the
Company's January 1, 2004 APBO was a reduction of $30.8 million related to
benefits attributed to past service.
As previously disclosed in its consolidated financial statements for the
year ended December 31, 2003, the Company expected to make discretionary cash
contributions of $80 million to its defined benefit plan in 2004. The Company
made cash contributions of $80 million and $20 million in March and June 2004,
respectively. The Company did not make any contributions to the plan in the
third quarter of 2004 and does not expect to make any further contributions for
the remainder of 2004.
22
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 11--SUBSEQUENT EVENTS
On October 27, 2004, the Company's Board of Directors declared a quarterly
cash dividend of $0.36 per share of common stock. The dividend will be paid on
January 7, 2005 to stockholders of record as of December 10, 2004.
On October 28, 2004, the Company's subsidiary, Union Bank of California,
N.A., completed its acquisition of Jackson Federal Bank, a savings bank
headquartered in Brea, California. The Company acquired approximately $1.4
billion in total assets and fourteen branches. The Company paid approximately
$305 million, consisting of $168 million in cash and $137 million in the
Company's common stock.
23
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 STOCKHOLDERS AND WHEN WE ARE SPEAKING ON BEHALF OF
UNIONBANCAL CORPORATION. FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY LOOKING
AT THE FACT THAT THEY DO NOT RELATE STRICTLY TO HISTORICAL OR CURRENT FACTS.
OFTEN, THEY INCLUDE THE WORDS "BELIEVE," "EXPECT," "ANTICIPATE," "INTEND,"
"PLAN," "ESTIMATE," "POTENTIAL," "PROJECT," OR WORDS OF SIMILAR MEANING, OR
FUTURE OR CONDITIONAL VERBS SUCH AS "WILL," "WOULD," "SHOULD," "COULD," OR
"MAY." THEY MAY ALSO CONSIST OF ANNUALIZED AMOUNTS BASED ON HISTORICAL INTERIM
PERIOD RESULTS. IN THIS DOCUMENT, FOR EXAMPLE, WE MAKE FORWARD-LOOKING
STATEMENTS DISCUSSING OUR EXPECTATIONS ABOUT THE IMPACT ON UNIONBANCAL
CORPORATION OF: RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS; BANK SECRECY
ACT-RELATED MATTERS; INCREASES IN BUSINESS ACTIVITY AND INTEREST RATES;
INVESTMENTS IN BANK ACQUISITIONS, DE NOVO BRANCHES AND TECHNOLOGY; MATURING
DERIVATIVE HEDGES; CHANGES IN OUR CALIFORNIA EFFECTIVE TAX RATE RELATED TO
PROJECTED PROFIT INCREASES FOR MITSUBISHI TOKYO FINANCIAL GROUP, INC.;
CREDIT-RELATED TRENDS REFLECTED IN THE UNALLOCATED PORTION OF OUR ALLOWANCE FOR
CREDIT LOSSES; CHANGES IN OUR NET INTEREST INCOME DUE TO POSSIBLE CHANGES IN
INTEREST RATES AND OTHER FACTORS; AND CERTAIN PENDING LEGAL ACTIONS. 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: FLUCTUATIONS IN INTEREST
RATES, GOVERNMENT POLICIES, REGULATIONS, AND THEIR ENFORCEMENT (INCLUDING
MONETARY AND FISCAL POLICIES AND BANK SECRECY ACT-RELATED MATTERS), LEGISLATION,
ECONOMIC CONDITIONS, CREDIT QUALITY OF BORROWERS, OPERATIONAL FACTORS,
COMPETITION IN THE GEOGRAPHIC AND BUSINESS AREAS IN WHICH THE COMPANY CONDUCTS
ITS OPERATIONS, GLOBAL POLITICAL CONDITIONS, 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. (MTFG), 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 "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS."
ALL REPORTS THAT WE FILE ELECTRONICALLY WITH THE SEC, INCLUDING ANNUAL
REPORTS ON FORM 10-K, QUARTERLY REPORTS ON FORM 10-Q, AND CURRENT REPORTS ON
FORM 8-K, AS WELL AS ANY AMENDMENTS TO THOSE REPORTS, ARE ACCESSIBLE AT NO COST
ON OUR INTERNET WEBSITE AT WWW.UBOC.COM AS SOON AS REASONABLY PRACTICABLE AFTER
WE ELECTRONICALLY FILE SUCH REPORTS WITH, OR FURNISH THEM TO, THE SEC. 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 $47.0 billion at September 30, 2004. During 2003,
UnionBanCal Corporation changed its state of incorporation from California to
Delaware. Our majority owner, BTM, owned approximately 62 percent of our
outstanding common stock at September 30, 2004.
EXECUTIVE OVERVIEW
We are providing you with an overview of what we believe are the most
significant events that impacted our results for the third quarter of 2004. You
should carefully read the rest of this document for
24
more detailed information that will assist your understanding of trends, events
and uncertainties that may impact us.
Our largest subsidiary is Union Bank of California, N.A., a commercial bank
that derives most of its revenues from lending, deposit taking and trust
services to customers primarily in California. We also service customers in the
western United States, nationally and internationally. Interest rates, business
conditions and customer confidence all affect our ability to generate revenues.
In addition, the regulatory environment and competition can challenge our
ability to generate those revenues.
Overall credit quality in the commercial lending area continued to improve
in the third quarter of 2004. The improvements came from positive financial
results and economic outlooks of our borrowers, as well as payoffs, partially
offset by a slight increase in our nonperforming assets. Nonaccrual loans
increased slightly from June 30, 2004 to $180 million, but have declined
significantly from December 31, 2003. With credit quality improvements partially
offset by growth in commercial lending, we recorded a reversal of provision for
credit losses of $10.0 million for the quarter.
Continuing low levels of interest rates have hampered growth in net
interest income, as our assets have continued to reprice at relatively low
levels. Significant contributors to the reduced asset yields were mortgage
refinancings, which further reduced our net interest income on our residential
mortgage loans and our mortgage-backed securities portfolio. Derivative
contracts, used to hedge the impact of falling interest rates on our lending
activities, began to expire in late 2003, further compressing our net interest
margin in the third quarter of 2004. A discussion of the impact of our hedges is
included in our detailed analysis of net interest income. Despite these
pressures, we have benefited from a higher level of earning assets, including a
significantly higher amount of securities, strong deposit growth, and changes in
our capital structure, including replacing higher cost debt with lower cost
funding. We expect that if business activity continues to pick up and interest
rates rise gradually, our net interest income will rise as well.
Growth in core deposits was particularly strong in the third quarter of
2004, compared to the third quarter of 2003, providing us with a low cost of
funding, which is a competitive advantage. Average demand deposits for the third
quarter of 2004 were 48 percent of average total deposits compared to 47 percent
for the third quarter of 2003, contributing to an average annualized all-in cost
of funds (interest expense divided by total interest bearing liabilities and
noninterest bearing deposits) of 0.49 percent and 0.50 percent in the third
quarters of 2004 and 2003, respectively. We attract deposits by offering a
variety of cash management products aimed at business clients, including web
cash management, check imaging, remittance and depository services and
disbursements. In addition, we made two acquisitions during the first nine
months of 2004 and opened a number of de novo branches, which further expanded
our business locations and deposits in California. A third acquisition, Jackson
Federal Bank, closed in October 2004.
Noninterest income rose in the third quarter of 2004, compared to the third
quarter of 2003, primarily as a result of higher service charges on deposits,
trust and investment management fees, letters of credit and international
commissions and fees. Increases in volumes, as well as our acquisitions, were
primarily responsible for the increases in our noninterest income.
Although noninterest expense rose in the third quarter of 2004, compared to
the third quarter of 2003, much of that increase related to investments that we
made in bank acquisitions, de novo branches and technology. We believe that
these investments will bring opportunities for growth in our business by
increasing our customer base and expanding the services we can provide.
CRITICAL ACCOUNTING POLICIES
UnionBanCal Corporation's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America (US GAAP) and the general practices of the banking industry.
25
The financial information contained within our statements is, to a
significant extent, financial information that is based on approximate measures
of the financial effects of transactions and events that have already occurred.
A variety of factors could affect the ultimate value that is obtained either
when earning income, recognizing an expense, recovering an asset or relieving a
liability. In many instances, we use a discount factor to determine the present
value of assets and liabilities. A change in the discount factor could increase
or decrease the values of those assets and liabilities and such a change would
result in either a beneficial or adverse impact to our financial results. We use
historical loss factors, adjusted for current conditions, to determine the
inherent loss that may be present in our loan and lease portfolio. Actual losses
could differ significantly from the loss factors that we use. Other estimates
that we use are employee turnover factors for pension purposes, residual values
in our leasing portfolio, fair value of our derivatives and securities, expected
useful lives of our depreciable assets and assumptions regarding our effective
income tax rates. We enter into derivative contracts to accommodate our
customers and for our own risk management purposes. The derivative contracts are
generally foreign exchange, interest rate swap and interest rate option
contracts, and we plan to offer energy-related derivatives to accommodate our
customers in the oil and gas industry. We value these contracts at fair value,
using either readily available, market quoted prices or from information that
can be extrapolated to approximate a market price. We have not historically
entered into derivative contracts for our customers or for ourselves, which
relate to credit, commodity or weather-related indices. We are subject to US
GAAP that may change from one previously acceptable method to another method.
Although the economics of our transactions would be the same, the timing of
events that would impact our transactions could change. Our most significant
estimates are approved by our Chief Executive Officer (CEO) Forum, which is
comprised of our most senior executives. At each financial reporting period, a
review of these estimates is then presented to the Audit Committee of our Board
of Directors.
Understanding our accounting policies is fundamental to understanding our
consolidated financial position and consolidated results of operations.
Accordingly, our significant accounting policies are discussed in detail in Note
1 in the "Notes to Consolidated Financial Statements" in our 2003 Annual Report
on Form 10-K filed with the Securities and Exchange Commission.
26
FINANCIAL PERFORMANCE
SUMMARY OF FINANCIAL PERFORMANCE
FOR THE THREE MONTHS INCREASE (DECREASE) FOR THE NINE MONTHS INCREASE (DECREASE)
-------------------- ------------------ ---------------------- ------------------
ENDED SEPTEMBER 30, 2004 VERSUS 2003 ENDED SEPTEMBER 30, 2004 VERSUS 2003
-------------------- ------------------ ---------------------- ------------------
(DOLLARS IN THOUSANDS) 2003 2004 AMOUNT PERCENT 2003 2004 AMOUNT PERCENT
- -------------------------------- -------- -------- ------- ------- ---------- ---------- -------- -------
RESULTS OF OPERATIONS
Net interest income(1).......... $401,089 $412,090 $11,001 2.7% $1,177,646 $1,212,369 $34,723 2.9%
Noninterest income
Service charges on deposit
accounts.................... 81,832 87,555 5,723 7.0 232,061 258,682 26,621 11.5
Trust and investment
management fees............. 35,429 39,089 3,660 10.3 101,245 111,699 10,454 10.3
Insurance commissions......... 15,814 17,463 1,649 10.4 45,056 57,850 12,794 28.4
International commissions and
fees........................ 17,380 18,906 1,526 8.8 49,581 54,553 4,972 10.0
Card processing fees, net..... 10,335 4,653 (5,682) (55.0) 29,357 28,901 (456) (1.6)
Gain on sale of merchant card
portfolio................... -- -- -- nm -- 93,000 93,000 nm
Other noninterest income...... 40,680 48,288 7,608 18.7 133,112 153,484 20,372 15.3
-------- -------- ------- ---------- ---------- --------
Total noninterest income........ 201,470 215,954 14,484 7.2 590,412 758,169 167,757 28.4
Total revenue................... 602,559 628,044 25,485 4.2 1,768,058 1,970,538 202,480 11.5
(Reversal of) provision for
credit losses................. 20,000 (10,000)(30,000) nm 75,000 (25,000) (100,000) nm
Noninterest expense
Salaries and employee benefits 205,302 216,767 11,465 5.6 602,338 653,787 51,449 8.5
Net occupancy................. 31,342 33,206 1,864 5.9 91,844 96,961 5,117 5.6
Intangible asset amortization. 2,587 5,077 2,490 96.3 8,291 13,783 5,492 66.2
Other noninterest expense..... 109,630 117,341 7,711 7.0 339,992 357,368 17,376 5.1
-------- -------- ------- ---------- ---------- --------
Total noninterest expense....... 348,861 372,391 23,530 6.7 1,042,465 1,121,899 79,434 7.6
Income before income tax........ 233,698 265,653 31,955 13.7 650,593 873,639 223,046 34.3
Income tax...................... 78,653 102,215 23,562 30.0 215,273 321,617 106,344 49.4
-------- -------- ------- ---------- ---------- --------
Net income...................... $155,045 $163,438 $ 8,393 5.4% $ 435,320 $ 552,022 $116,702 26.8%
======== ======== ======= ========== ========== ========
- ---------------------------------
<FN>
(1) Net interest income does not include any adjustments for fully taxable
equivalence.
</FN>
THE PRIMARY CONTRIBUTORS TO OUR FINANCIAL PERFORMANCE FOR THE THIRD QUARTER
OF 2004 COMPARED TO THE THIRD QUARTER OF 2003 ARE PRESENTED BELOW.
o We recorded a reversal of provision for credit losses in the third
quarter of 2004, which reflects continued improvement in credit
quality as discussed earlier in our executive overview. (See
additional discussion under "Allowance for Credit Losses.")
o Our net interest income was favorably influenced by higher earning
asset volumes, including a significantly higher amount of securities
and an increase in the average balances of our commercial loan and
residential real estate loan portfolios. Strong deposit growth,
including an attractive mix of average noninterest bearing deposits to
total deposits, also contributed favorably to our net interest income.
(See our discussion under "Net Interest Income.")
o Our noninterest income was attributable to several factors:
o Service charges on deposit accounts rose due to an 18 percent
increase in average retail demand deposits in the third quarter
of 2004 over the third quarter of 2003 and higher overdraft and
return fees of $5.2 million, primarily associated with changes in
our check processing introduced in April 2004;
o Trust and investment management fees increased from the third
quarter of 2003 primarily due to increased assets under
administration due to continued strong sales and the addition of
27
$3.7 billion from our acquisition of the business portfolio of
CNA Trust Company (CNAT). Year-to-date, trust fees have grown
approximately 10 percent from the first nine months of 2003.
Managed assets increased by approximately 9 percent and
non-managed assets increased by approximately 13 percent from the
third quarter of 2003 to the third quarter of 2004. Total assets
under administration increased by approximately 13 percent, to
$165.8 billion, for the same period;
o Insurance commissions increased primarily as a result of our
December 2003 acquisition of Knight Insurance Agency;
o International commissions and fees grew, reflecting strong growth
in the foreign remittances product in almost all of our markets,
from a combination of increased pricing, product enhancements and
higher market penetration;
o Card processing fees, net, decreased primarily due to the sale of
our merchant card portfolio to NOVA Information Systems (NOVA) in
the second quarter of 2004;
o In other income, the third quarter of 2004 included higher
merchant banking fees related to loan syndications.
o Our higher noninterest expense was attributable to several factors:
o Salaries and employee benefits increased primarily as a result
of:
o acquisitions and new branch openings, which accounted for 35
percent of the increase in our salaries and other
compensation;
o higher performance-related incentive expense from goal
achievements;
o annual merit increases; and
o decreased employee benefits expense due to:
o a $4.7 million reduction associated with the Medicare
Prescription Drug and Improvement Act of 2003. For a
further discussion regarding this reduction, see Note
10 of the Notes to Condensed Consolidated Financial
Statements included in this Form 10-Q; partly offset by
o increased employee benefits expense of approximately
$1.4 million associated with our acquisitions and new
branch openings;
o increasing healthcare costs for current employees and
retirees from rising insurance premiums and a greater
number of participants; and
o the impact of the lower discount rate we are using to
calculate our future pension and other postretirement
liabilities;
o Intangible asset amortization expense increased primarily as
a result of our recent acquisitions; and
o Other noninterest expense rose primarily as a result of
higher operational losses and litigation.
THE PRIMARY CONTRIBUTORS TO OUR FINANCIAL PERFORMANCE FOR THE FIRST NINE
MONTHS OF 2004 COMPARED TO THE FIRST NINE MONTHS OF 2003 ARE PRESENTED
BELOW.
o We recorded a reversal of provision for credit losses, which reflects
continued improvement in credit quality. (See additional discussion
under "Allowance for Credit Losses.")
28
o Our net interest income was favorably influenced by higher earning
asset volumes, including a significantly higher amount of securities.
Strong deposit growth, including an attractive mix of average
noninterest bearing deposits to total deposits, also contributed
favorably to our net interest income. (See our discussion under "Net
Interest Income.")
o Our noninterest income was attributable to several factors:
o Service charges on deposit accounts rose primarily due to a 20
percent increase in average retail demand deposits in the first
nine months of 2004 over the first nine months of 2003 and higher
overdraft and return fees of $15.3 million primarily associated
with changes in check processing introduced in April 2004;
o Trust and investment management fees increased from the first
nine months of 2003 primarily due to increased assets under
administration from continued strong sales and our acquisition of
the business portfolio of CNAT. Trust fees have grown steadily
since mid-2003 as the equity markets and the economy continued to
stabilize;
o Insurance commissions increased primarily as a result of our
April 2003 acquisition of Tanner Insurance Brokers and the
December 2003 acquisition of Knight Insurance Agency;
o International commissions and fees grew, reflecting strong growth
in the foreign remittances product in almost all of our markets,
from a combination of increased pricing, product enhancements and
higher market penetration;
o The first nine months of 2004 included a $93.0 million gain on
the sale of our merchant card portfolio, which was acquired by
NOVA. The sale of our merchant card portfolio reflects our
ongoing effort to sharpen our strategic focus. The long-term
marketing alliance we formed with NOVA will provide us with
marketing fees in the future;
o The first nine months of 2004 also included net gains in private
capital investment sales of $9.4 million, an $8.5 million gain on
the sale of real property, higher merchant banking fees of $5.3
million, and higher foreign exchange currency profits of $3.7
million. In addition, the first nine months of 2003 included a
$9.0 million gain on the redemption of a Mexican Brady Bond and
net gains in private capital investment sales of $1.5 million.
o Our higher noninterest expense was attributable to several factors:
o Salaries and employee benefits increased primarily as a result
of:
o acquisitions and new branch openings, which accounted for 40
percent of the increase in our salaries and other
compensation;
o higher performance-related incentive expense from goal
achievements;
o annual merit increases; and
o increased employee benefits expense due to:
o increased employee benefits expense of approximately
$4.9 million associated with our recent acquisitions
and new branch openings;
o increasing healthcare costs for current employees and
retirees from rising insurance premiums and a greater
number of participants;
o the impact of the lower discount rate we are using to
calculate our future pension and other postretirement
liabilities; and
29
o the impact of a higher state unemployment tax rate,
which rose from 2.0 percent in the first nine months of
2003 to 3.7 percent in the first nine months of 2004;
partly offset by
o a $4.7 million reduction associated with the Medicare
Prescription Drug and Improvement Act of 2003. For a
further discussion regarding this reduction, see Note
10 of the Notes to Condensed Consolidated Financial
Statements included in this Form 10-Q;
o Net occupancy costs increased primarily as a result of our
acquisitions and new branch openings, and reduced rental
income as we relocate personnel to previously
tenant-occupied premises, partially offset by a $4.2 million
write-off of leasehold improvements in the third quarter of
2003;
o Intangible asset amortization expense increased primarily as
a result of our recent acquisitions; and
o Other noninterest expense rose primarily as a result of
higher software expenses, resulting from increased software
purchases and development to support strategic technology
initiatives, and operational losses and litigation.
30
NET INTEREST INCOME
The following tables show the major components of net interest income and
net interest margin.
FOR THE THREE MONTHS ENDED
---------------------------------------------------------------- INCREASE (DECREASE) IN
SEPTEMBER 30, 2003 SEPTEMBER 30, 2004 ----------------------------------
------------------------------- -------------------------------- AVERAGE INCOME/
INTEREST AVERAGE INTEREST AVERAGE BALANCE EXPENSE(1)
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ ------------------ ---------------
(DOLLARS IN THOUSANDS) BALANCE EXPENSE(1)RATE(1)(2) BALANCE EXPENSE(1) RATE(1)(2) AMOUNT PERCENT AMOUNT PERCENT
- -------------------------------- ----------- --------- --------- ----------- --------- --------- ---------- ------- ------- -------
ASSETS
Loans:(3)
Domestic...................... $24,858,766 $342,629 5.48% $26,169,937 $ 340,401 5.18% $1,311,171 5.3% $(2,228) (0.7)%
Foreign(4).................... 1,473,220 7,581 2.04 1,977,356 10,588 2.13 504,136 34.2 3,007 39.7
Securities--taxable............. 9,928,708 92,553 3.73 11,912,985 105,256 3.53 1,984,277 20.0 12,703 13.7
Securities--tax-exempt.......... 40,592 1,015 10.00 68,884 1,416 8.22 28,292 69.7 401 39.5
Interest bearing deposits in
banks......................... 246,897 922 1.48 568,071 2,744 1.92 321,174 130.1 1,822 197.6
Federal funds sold and
securities purchased under
resale agreements............. 980,271 2,532 1.02 431,138 1,616 1.49 (549,133) (56.0) (916)(36.2)
Trading account assets.......... 327,415 909 1.10 299,238 1,250 1.66 (28,177) (8.6) 341 37.5
----------- -------- ----------- --------- ---------- --------
Total earning assets...... 37,855,869 448,141 4.71 41,427,609 463,271 4.46 3,571,740 9.4 $ 15,130 3.4%
-------- --------- ---------- --------
Allowance for credit losses..... (570,773) (501,259) 69,514 (12.2)
Cash and due from banks......... 2,324,389 2,229,980 (94,409) (4.1)
Premises and equipment, net..... 510,205 504,348 (5,857) (1.1)
Other assets.................... 1,793,825 2,052,602 258,777 14.4
----------- ----------- ----------
Total assets.............. $41,913,515 $45,713,280 $3,799,765 9.1%
=========== =========== ==========
LIABILITIES
Domestic deposits:
Interest bearing.............. $10,952,652 16,586 0.60 $11,807,430 18,603 0.63 $ 854,778 7.8% $ 2,017 12.2%
Savings and consumer time..... 4,116,669 9,990 0.96 4,383,745 9,029 0.82 267,076 6.5 (961 (9.6)
Large time.................... 2,303,754 8,408 1.45 1,986,815 7,244 1.45 (316,939) (13.8) (1,164)(13.8)
Foreign deposits(4)............. 1,200,668 1,991 0.66 1,729,290 5,007 1.15 528,622 44.0 3,016 151.5
----------- -------- ----------- --------- ---------- --------
Total interest bearing
deposits................ 18,573,743 36,975 0.79 19,907,280 39,883 0.80 1,333,537 7.2 2,908 7.9
----------- -------- ----------- --------- ---------- --------
Federal funds purchased and
securities sold under
repurchase agreements......... 393,772 689 0.69 867,988 2,861 1.31 474,216 120.4 2,172 315.2
Commercial paper................ 781,552 1,723 0.87 639,345 1,697 1.06 (142,207) (18.2) (26) (1.5)
Other borrowed funds............ 262,512 1,673 2.53 161,504 1,117 2.75 (101,008) (38.5) (556)(33.2)
Medium and long-term debt....... 399,761 1,738 1.73 792,083 4,369 2.19 392,322 98.1 2,631 151.4
Preferred securities and trust
notes(5)...................... 351,575 3,607 4.10 15,959 242 6.07 (335,616) (95.5) (3,365)(93.3)
----------- -------- ----------- --------- ---------- --------
Total borrowed funds...... 2,189,172 9,430 1.71 2,476,879 10,286 1.65 287,707 13.1 856 9.1
Total interest bearing
liabilities............. 20,762,915 46,405 0.89 22,384,159 50,169 0.89 1,621,244 7.8 $ 3,764 8.1%
-------- ----------- --------- ---------- --------
Noninterest bearing deposits.... 16,329,221 18,207,030 1,877,809 11.5
Other liabilities............... 986,545 1,054,138 67,593 6.9
----------- ----------- ----------
Total liabilities......... 38,078,681 41,645,327 3,566,646 9.4
----------- ----------- ----------
STOCKHOLDERS' EQUITY
Total stockholders' equity 3,834,834 4,067,953 233,119 6.1
----------- ----------- ----------
Total liabilities and
stockholders' equity.... $41,913,515 $45,713,280 $3,799,765 9.1%
=========== =========== ==========
Net interest income/margin
(taxable-equivalent basis).... 401,736 4.22% 413,102 3.98%
Less: taxable-equivalent
adjustment.................... 647 1,012
-------- ---------
Net interest income....... $401,089 $ 412,090
======== =========
- ----------------------
<FN>
(1) Yields and interest income are presented on a taxable-equivalent basis
using the federal statutory tax rate of 35 percent.
(2) Annualized
(3) 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.
(4) Foreign loans and deposits are those loans and deposits originated in
foreign branches.
(5) Includes interest expense for both trust preferred securities and trust
notes.
</FN>
31
FOR THE NINE MONTHS ENDED
----------------------------------------------------------------- INCREASE (DECREASE) IN
SEPTEMBER 30, 2003 SEPTEMBER 30, 2004 ----------------------------------
-------------------------------- -------------------------------- AVERAGE INCOME/
INTEREST AVERAGE INTEREST AVERAGE BALANCE EXPENSE(1)
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ ------------------ ---------------
(DOLLARS IN THOUSANDS) BALANCE EXPENSE(1) RATE(1)(2) BALANCE EXPENSE(1) RATE(1)(2) AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------- ----------- ---------- --------- ----------- ---------- --------- --------- ------- ------- -------
ASSETS
Loans:(3)
Domestic..................... $24,986,259 $1,043,906 5.58% $25,226,482 $ 988,164 5.23% $ 240,223 1.0% $(55,742) (5.3)%
Foreign(4)................... 1,536,428 24,742 2.15 1,819,780 27,083 1.99 283,352 18.4 2,341 9.5
Securities--taxable............ 8,220,231 249,073 4.04 11,669,470 317,395 3.63 3,449,239 42.0 68,322 27.4
Securities--tax-exempt......... 41,168 3,045 9.86 68,120 4,175 8.17 26,952 65.5 1,130 37.1
Interest bearing deposits in
banks........................ 223,937 3,014 1.80 353,060 4,773 1.81 129,123 57.7 1,759 58.4
Federal funds sold and
securities purchased under
resale agreements............ 932,496 8,210 1.18 786,045 6,503 1.11 (146,451) (15.7) (1,707) (20.8)
Trading account assets......... 322,952 2,847 1.18 299,381 2,728 1.22 (23,571) (7.3) (119) (4.2)
----------- ---------- ----------- ---------- --------- -------
Total earning assets..... 36,263,471 1,334,837 4.92 40,222,338 1,350,821 4.49 3,958,867 10.9 $15,984 1.2%
---------- ---------- --------- -------
Allowance for credit losses.... (586,418) (520,219) 66,199 (11.3)
Cash and due from banks........ 2,173,775 2,246,479 72,704 3.3
Premises and equipment, net.... 508,859 512,780 3,921 0.8
Other assets................... 1,666,062 2,001,805 335,743 20.2
----------- ----------- ----------
Total assets............. $40,025,749 $44,463,183 $4,437,434 11.1%
=========== =========== ==========
LIABILITIES
Domestic deposits:
Interest bearing............. $10,087,830 54,194 0.72 $11,566,270 51,357 0.59 $1,478,440 14.7% $(2,837) (5.2)%
Savings and consumer time.... 3,937,051 33,583 1.14 4,249,118 26,288 0.83 312,067 7.9 (7,295) (21.7)
Large time................... 2,416,606 28,995 1.60 2,238,352 22,964 1.37 (178,254) (7.4) (6,031) (20.8)
Foreign deposits(4)............ 1,269,010 8,008 0.84 1,478,573 9,900 0.89 209,563 16.5 1,892 23.6
----------- ---------- ----------- ---------- --------- -------
Total interest bearing
deposits............... 17,710,497 124,780 0.94 19,532,313 110,509 0.76 1,821,816 10.3 (14,271) (11.4)
----------- ---------- ----------- ---------- --------- -------
Federal funds purchased and
securities sold under
repurchase agreements........ 414,446 2,763 0.89 537,169 4,094 1.02 122,723 29.6 1,331 48.2
Commercial paper............... 899,456 7,397 1.10 566,776 3,883 0.92 (332,680) (37.0) (3,514) (47.5)
Other borrowed funds........... 191,480 3,983 2.78 175,211 3,595 2.74 (16,269) (8.5) (388) (9.7)
Medium and long-term debt...... 399,745 5,422 1.81 805,863 11,201 1.86 406,118 101.6 5,779 106.6
Preferred securities and trust
notes(5)..................... 351,594 10,930 4.15 78,139 2,553 4.36 (273,455) (77.8) (8,377) (76.6)
----------- ---------- ----------- ---------- --------- -------
Total borrowed funds..... 2,256,721 30,495 1.80 2,163,158 25,326 1.56 (93,563) (4.1) (5,169) (17.0)
----------- ---------- ----------- ---------- --------- -------
Total interest bearing
liabilities............ 19,967,218 155,275 1.04 21,695,471 135,835 0.84 1,728,253 8.7 $(19,440)(12.5)%
---------- ---------- --------- --------
Noninterest bearing deposits... 15,159,687 17,758,663 2,598,976 17.1
Other liabilities.............. 1,022,854 1,024,855 2,001 0.2
----------- ----------- ---------
Total liabilities........ 36,149,759 40,478,989 4,329,230 12.0
----------- ----------- ---------
STOCKHOLDERS' EQUITY
Common equity.................. 3,875,990 3,984,194 108,204 2.8
----------- ----------- ---------
Total stockholders'
equity................. 3,875,990 3,984,194 108,204 2.8
----------- ----------- ---------
Total liabilities and
stockholders' equity... $40,025,749 $44,463,183 $4,437,434 11.1%
=========== =========== ==========
Net interest income/margin
(taxable-equivalent basis)... 1,179,562 4.35% 1,214,986 4.03%
Less: taxable-equivalent
adjustment................... 1,916 2,617
---------- ----------
Net interest income...... $1,177,646 $1,212,369
========== ==========
- ---------------------
<FN>
(1) Yields and interest income are presented on a taxable-equivalent basis
using the federal statutory tax rate of 35 percent.
(2) Annualized
(3) 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.
(4) Foreign loans and deposits are those loans and deposits originated in
foreign branches.
(5) Includes interest expense for both trust preferred securities and trust
notes.
</FN>
32
Net interest income in the third quarter of 2004, on a taxable-equivalent
basis, increased 3 percent, from the third quarter of 2003. Our results were
attributable to the following factors:
o The growth in average earning assets was primarily attributable to an
increase in average securities and in average loans. The increase in
average securities, which was comprised primarily of fixed rate
securities, reflected liquidity and interest rate risk management
actions. Securities held for Asset and Liability Management (ALM)
purposes were $11.1 billion at September 30, 2004, compared to $10.4
billion at December 30, 2003. For further information on securities
held for ALM purposes, see the section, "Quantitative and Qualitative
Disclosures About Market Risk" included in this Form 10-Q. The
increase in average loans was largely due to a $1.4 billion increase
in average residential mortgages, resulting from a strategic portfolio
shift from more volatile commercial loans, which we feel we have
achieved.
o Deposit growth has contributed significantly to our lower cost of
funds in the third quarter of 2004, compared to the third quarter of
2003. Average noninterest bearing deposits were higher in the third
quarter of 2004, compared to the third quarter of 2003, mainly
attributable to higher average business demand deposits of $1.5
billion, despite declines in demand deposits from our title and escrow
clients, which decreased by $0.4 billion, and higher consumer demand
deposit growth. We anticipate that the growth rates in average
noninterest bearing deposits will decline in 2005 as rising interest
rates will cause our customers to divert those deposits to more
attractive interest bearing investments and will slow the activity in
mortgage loan refinancings, which will impact our title and escrow
deposits;
o Yields on our earning assets were negatively impacted by the
generally, lower level of interest rates, resulting in a lower average
yield of 25 basis points on average earning assets, which was also
negatively impacted by lower hedge income of $21.9 million;
o Although market rates on our interest bearing deposits were
unfavorably impacted by increasing interest rates and lower hedge
income of $0.9 million, the redemption of our higher yielding trust
preferred securities in February 2004 contributed to our market rates
on interest bearing liabilities remaining relatively unchanged; and
o During 2004, our strategy has been to take advantage of our higher
noninterest bearing deposit balances by reducing our balances in
higher interest rate liabilities such as large certificates of
deposit, foreign deposits, commercial paper and other borrowed funds.
As a result of these changes and as long-term interest rates declined, our
net interest margin decreased by 24 basis points.
We use derivatives to hedge expected changes in the yields on our variable
rate loans and term certificates of deposit (CDs), and to convert our long-term,
fixed-rate borrowings to floating rate. During 2004, these derivative positions
will provide less in net interest income, than in 2003, as positions mature and,
to a lesser extent, as interest rates rise. However, we expect the declines in
hedge income to be partially offset by increased yields on the underlying
variable rate loans. For the quarters ended September 30, 2003 and 2004, we had
hedge income of $43.2 million and $20.4 million, respectively.
Net interest income in the first nine months of 2004, on a
taxable-equivalent basis, increased 3 percent, from the first nine months of
2003. Our results were attributable to the following factors:
o The growth in average earning assets was primarily attributable to an
increase in average securities and in average loans. The increase in
average securities, which was comprised primarily of fixed rate
securities, reflected liquidity and interest rate risk management
actions. The increase in average loans was largely due to a $1.1
billion increase in average residential mortgages and a decrease of
$0.6 billion in average commercial loans;
33
o Deposit growth has contributed significantly to our lower cost of
funds in the first nine months of 2004, compared to the first nine
months of 2003. Average noninterest bearing deposits were higher in
the first nine months of 2004, compared to the first nine months of
2003, mainly attributable to higher average business demand deposits
of $6.5 billion, including demand deposits from our title and escrow
clients which increased less than $0.1 billion, and higher consumer
demand deposit growth;
o Yields on our earning assets were negatively impacted by decreasing
interest rates for much of the period, resulting in a lower average
yield of 43 basis points on average earning assets, which was also
negatively impacted by lower hedge income of $46.2 million;
o Market rates on our interest bearing liabilities were favorably
impacted by the decreasing interest rate environment resulting in a
lower cost of funds on interest bearing liabilities of 20 basis
points, which included higher hedge income of $1.0 million; and
o During 2004, our strategy has been to take advantage of our higher
noninterest bearing deposit balances by reducing our balances in
higher interest rate liabilities such as large certificates of
deposit, foreign deposits, commercial paper and other borrowed funds.
As a result of these changes and as long-term interest rates declined, our
net interest margin decreased by 32 basis points.
As explained previously, derivative hedges will provide less net interest
income than in 2003, as positions mature and, to a lesser extent, as interest
rates rise. For the nine months ended September 30, 2003 and 2004, we had hedge
income of $124.6 million and $79.4 million, respectively.
NONINTEREST INCOME
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
--------------------------------------------- ---------------------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
SEPTEMBER 30, SEPTEMBER 30, ---------------- SEPTEMBER 30, SEPTEMBER 30, ----------------
(DOLLARS IN THOUSANDS) 2003 2004 AMOUNT PERCENT 2003 2004 AMOUNT PERCENT
- ------------------------------- ------------- ------------- ------- ------- ------------- ------------- -------- -------
Service charges on deposit
accounts..................... $ 81,832 $87,555 $ 5,723 7.0% $232,061 $258,682 $ 26,621 11.5%
Trust and investment management
fees......................... 35,429 39,089 3,660 10.3 101,245 111,699 10,454 10.3
Insurance commissions.......... 15,814 17,463 1,649 10.4 45,056 57,850 12,794 28.4
International commissions and
fees......................... 17,380 18,906 1,526 8.8 49,581 54,553 4,972 10.0
Card processing fees, net...... 10,335 4,653 (5,682) (55.0) 29,357 28,901 (456) (1.6)
Merchant banking fees.......... 9,312 11,682 2,370 25.5 21,521 26,863 5,342 24.8
Foreign exchange gains, net.... 7,574 8,548 974 12.9 21,466 25,186 3,720 17.3
Brokerage commissions and fees. 7,549 8,527 978 13.0 24,614 24,847 233 0.9
Securities gains (losses), net. (2,618) (6) 2,612 (99.8) 7,042 1,612 (5,430)(77.1)
Gain on sale of merchant card
portfolio.................... -- -- -- -- -- 93,000 93,000 nm
Other.......................... 18,863 19,537 674 3.6 58,469 74,976 16,507 28.2
-------- -------- ------- -------- -------- --------
Total noninterest income..... $201,470 $215,954 $14,484 7.2% $590,412 $758,169 $167,757 28.4%
======== ======== ======= ======== ======== ========
- --------------------
<FN>
nm--not meaningful
</FN>
34
NONINTEREST EXPENSE
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
--------------------------------------------- ---------------------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
SEPTEMBER 30, SEPTEMBER 30, ---------------- SEPTEMBER 30, SEPTEMBER 30, ----------------
(DOLLARS IN THOUSANDS) 2003 2004 AMOUNT PERCENT 2003 2004 AMOUNT PERCENT
- ------------------------------- ------------- ------------- ------- ------- ------------- ------------- -------- -------
Salaries and other compensation $169,705 $181,497 $11,792 6.9% $ 484,333 $ 526,821 $42,488 8.8%
Employee benefits.............. 35,597 35,270 (327) (0.9) 118,005 126,966 8,961 7.6
Salaries and employee benefits 205,302 216,767 11,465 5.6 602,338 653,787 51,449 8.5
Net occupancy.................. 31,342 33,206 1,864 5.9 91,844 96,961 5,117 5.6
Equipment...................... 15,680 16,289 609 3.9 48,705 50,443 1,738 3.6
Software....................... 11,996 13,560 1,564 13.0 34,921 39,463 4,542 13.0
Communications................. 12,661 12,850 189 1.5 39,859 39,295 (564) (1.4)
Professional services.......... 12,676 12,375 (301) (2.4) 38,256 33,968 (4,288) (11.2)
Advertising and public relations 9,227 7,954 (1,273) (13.8) 28,587 27,495 (1,092) (3.8)
Data processing................ 7,659 8,364 705 9.2 23,887 23,648 (239) (1.0)
Intangible asset amortization.. 2,587 5,077 2,490 96.3 8,291 13,783 5,492 66.2
Foreclosed asset expense....... (79) (10) 69 nm (28) 526 554 nm
Other.......................... 39,810 45,959 6,149 15.4 125,805 142,530 16,725 13.3
-------- -------- ------- ---------- ---------- -------
Total noninterest expense.... $348,861 $372,391 $23,530 6.7% $1,042,465 $1,121,899 $79,434 7.6%
======== ======== ======= ========== ========== =======
- ---------------------
<FN>
nm--not meaningful
</FN>
INCOME TAX EXPENSE
Income tax expense in the third quarter of 2004 resulted in a 38 percent
effective income tax rate compared with an effective tax rate of 34 percent for
the third quarter of 2003. The increase in the effective tax rate was due to
higher California state taxes in 2004 and an adjustment of $7.8 million in the
third quarter of 2004 for 2003 state taxes. The adjustment was due primarily to
the difference between our estimate of California state tax expense for last
year and the taxes reported in our 2003 tax return. Income tax expense in the
first nine months of 2004 resulted in a 37 percent effective income tax rate
compared with an effective tax rate of 33 percent for the first nine months of
2003.
The State of California requires us to file our franchise tax returns as a
member of a unitary group that includes MTFG and either all worldwide affiliates
or only U.S. affiliates. The unitary method of taxation requires us to
incorporate MTFG's financial results, adjusted to reflect income tax reporting
standards, in determining our California tax. Changes between MTFG's estimated
and actual income for the fiscal year ended March 31, 2004, as reported in Form
20-F, filed with the SEC on September 28, 2004, affected our California taxes
for the 2003 tax year.
We have filed our California tax returns on the worldwide unitary basis
since 1996. The inclusion of MTFG's financial results, which in some years were
net losses, has partially offset our net profits subject to California income
tax. The inclusion of MTFG's worldwide property, payroll and sales in the
calculation of the California apportionment factor has also reduced the
percentage of our income subject to California income tax. As a result, our
effective tax rate for California has been significantly lower than the
statutory rate, net of federal benefit, of 7.05 percent.
We review MTFG's financial information on a quarterly basis in order to
determine the rate at which to recognize our California income taxes. However,
all of the information relevant to determining the effective tax rate, including
MTFG's results on a U.S. GAAP basis, may not be available until after the end of
the period to which the tax relates. The determination of the California
effective tax rate involves management judgment and estimates, and can change
during the calendar year or between calendar years, as additional information
becomes available. Our effective tax rates in the third quarter and the first
nine
35
months of 2004, when compared to the same periods in 2003, are higher partially
as a result of increased profits reported by MTFG for its most recent reporting
period, as well as projected profit increases for MTFG due to improving economic
conditions in Japan.
LOANS
The following table shows loans outstanding by loan type.
INCREASE (DECREASE)
SEPTEMBER 30, 2004 FROM:
--------------------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31,
2003 2003 2004 2003 2003
------------------ ------------------
(DOLLARS IN THOUSANDS) ------------- ------------ ------------- AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------ ---------- ------- ---------- -------
Domestic:
Commercial, financial and
industrial...................... $ 9,277,969 $8,817,679 $9,555,618 $277,649 3.0% $ 737,939 8.4%
Construction...................... 1,127,915 1,101,166 1,103,970 (23,945) (2.1) 2,804 0.3
Mortgage:
Residential..................... 7,095,436 7,463,538 8,821,566 1,726,130 24.3 1,358,028 18.2
Commercial...................... 4,310,957 4,195,178 4,356,052 45,095 1.0 160,874 3.8
------------- ------------ ------------- ---------- ----------
Total mortgage................ 11,406,393 11,658,716 13,177,618 1,771,225 15.5 1,518,902 13.0
Consumer:
Installment..................... 867,133 818,746 779,857 (87,276) (10.1) (38,889) (4.7)
Revolving lines of credit....... 1,168,374 1,222,220 1,496,584 328,210 28.1 274,364 22.4
------------- ------------ ------------- ---------- ----------
Total consumer................ 2,035,507 2,040,966 2,276,441 240,934 11.8 235,475 11.5
Lease financing................... 668,074 663,632 612,054 (56,020) (8.4) (51,578) (7.8)
------------- ------------ ------------- ---------- ----------
Total loans in domestic
offices..................... 24,515,858 24,282,159 26,725,701 2,209,843 9.0 2,443,542 10.1
Loans originated in foreign branches 1,520,856 1,650,204 1,897,091 376,235 24.7 246,887 15.0
------------- ------------ ------------- ---------- ----------
Total loans held to maturity.. 26,036,714 25,932,363 28,622,792 2,586,078 9.9 2,690,429 10.4
Total loans held for sale..... 10,662 12,265 2,294 (8,368) (78.5) (9,971) (81.3)
------------- ------------ ------------- ---------- ----------
Total loans................. $26,047,376 $25,944,628 $28,625,086 $2,577,710 9.9% $2,680,458 10.3%
============= ============ ============= ========== ==========
COMMERCIAL, FINANCIAL AND INDUSTRIAL LOANS
Commercial, financial and industrial 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 U.S.
Our commercial market lending originates primarily through our commercial
banking offices. These offices, which rely extensively on relationship-oriented
banking, provide a variety of services including cash management services, lines
of credit, accounts receivable and inventory financing. Separately, we originate
or participate in a wide variety of financial services to major corporations.
These services include traditional commercial banking and specialized financing
tailored to the needs of each customer's specific industry. Presently, we are
active in, among other sectors, the oil and gas, communications, media,
entertainment, retailing and financial services industries.
As of September 30, 2004, the increase in the commercial, financial and
industrial loan portfolio compared to September 30, 2003, was primarily
attributable to an increase in loan demand in the third quarter of 2004 much of
which was in our energy portfolio.
CONSTRUCTION AND COMMERCIAL MORTGAGE LOANS
We engage in non-residential real estate lending that includes commercial
mortgage loans and construction loans secured by deeds of trust. Construction
loans are made primarily to commercial property developers and to residential
builders.
36
As of September 30, 2004, the construction loan portfolio increased from
December 31, 2003, mainly reflecting growth in the demand for new single family
homes, and decreased from September 30, 2003. The growth in new single family
homes has been offset by slowing growth in capital assets and employment and
higher office vacancy rates in our markets, which were factors that impacted the
level of development and construction projects we financed.
The commercial mortgage loan portfolio consists of loans on commercial and
industrial projects primarily in California. As of September 30, 2004, the
increase in the commercial mortgage portfolio compared to September 30, 2003 was
primarily attributable to our acquisition of Business Bank of California in the
first quarter of 2004.
RESIDENTIAL MORTGAGE LOANS
We originate residential mortgage loans, secured by one-to-four family
residential properties, through our multiple channel network (including
branches, mortgage brokers, and loan-by-phone) throughout California, Oregon and
Washington, and we periodically purchase loans in our market area.
As of September 30, 2004, the increase in the residential mortgage
portfolio compared to September 30, 2003, was primarily attributable to an
active refinance market driven by low interest rates throughout the period.
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. Third
quarter 2004 growth was driven by our broker channel contributing approximately
two-thirds of the growth and the remaining growth attributable to retail,
loan-by-phone and internet channels. Purchase money loans accounted for 50
percent of this third quarter 2004 growth with the remaining growth attributable
to refinancings.
CONSUMER LOANS
We originate consumer loans, such as auto loans and home equity loans and
lines, through our branch network. As of September 30, 2004, the consumer loan
portfolio increased compared to September 30, 2003, primarily as a result of an
increase in home equity loans and partially offset by pay-offs related to the
run-off of the automobile dealer lending business that we exited in the third
quarter of 2000. The indirect automobile dealer lending portfolio at September
30, 2004 was $23.7 million.
LEASE FINANCING
We offer primarily two types of leases to our customers: direct financing
leases, where the assets leased are acquired without additional financing from
other sources; and leveraged leases, where a substantial portion of the
financing is provided by debt with no recourse to us. As of September 30, 2004,
the decrease in the lease financing portfolio compared to September 30, 2003,
was primarily attributable to our announced discontinuance of our auto leasing
activity, effective April 20, 2001. At September 30, 2004, our auto lease
portfolio had declined to $32.9 million. Included in our lease portfolio are
leveraged leases of $566.7 million, which are net of non-recourse debt of
approximately $1.3 billion. We utilize a number of special purpose entities for
our leveraged leases. These entities serve legal and tax purposes and do not
function as vehicles to shift liabilities to other parties or to deconsolidate
affiliates for financial reporting purposes. As allowed by U.S. GAAP and by law,
the gross lease receivable is offset by the qualifying non-recourse debt. In
leveraged lease transactions, the third-party lender may only look to the
collateral value of the leased assets for repayment.
LOANS ORIGINATED IN FOREIGN BRANCHES
Our loans originated in foreign branches consist primarily of short-term
extensions of credit to financial institutions. As of September 30, 2004, the
increase in loans originated in foreign branches, compared to September 30,
2003, was primarily borrowings from financial institutions related to an
increase in trade financing activity and increased energy-related lending in
Canada.
37
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, 2003, December 31, 2003 and September 30, 2004, 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 OUSTANDINGS
- ------------------------------------ ------------- -------- ------------ -----------
September 30, 2003
Korea............................... $636 $-- $42 $678
December 31, 2003
Korea............................... $630 $-- $28 $658
September 30, 2004
Korea............................... $623 $-- $4 $627
PROVISION FOR CREDIT LOSSES
We recorded a reversal of provision for credit losses of $10 million in the
third quarter of 2004, compared with a $20 million provision for credit losses
in the third quarter of 2003. 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. Reversals of provisions for credit losses increase our income and reduce
the allowance.
ALLOWANCE FOR CREDIT LOSSES
ALLOWANCE POLICY AND METHODOLOGY
We maintain an allowance for credit losses to absorb losses inherent in the
loan portfolio. Understanding our policies on allowance for credit losses is
fundamental to understanding our consolidated financial position and
consolidated results of operations. Accordingly, our significant policies and
methodology on allowance for credit losses are discussed in detail in Note 1 in
the "Notes to Consolidated Financial Statements" and in the section "Allowance
for Credit Losses" included in our "Management's Discussion and Analysis of
Financial Conditions and Results of Operation" in our 2003 Annual Report on Form
10-K, which was filed with the Securities and Exchange Commission.
COMPARISON OF THE TOTAL ALLOWANCE AND RELATED PROVISION FOR CREDIT LOSSES
FROM DECEMBER 31, 2003
At December 31, 2003, our total allowance for credit losses was $533
million, or 2.05 percent of the total loan portfolio and 190 percent of total
nonaccrual loans. At September 30, 2004, our total allowance for credit losses
was $483 million (consisting of $407 million and $76 million of allocated and
unallocated allowance, respectively), or 1.69 percent of the total loan
portfolio and 268 percent of total nonaccrual loans. In addition, the allowance
incorporates the results of measuring impaired loans as provided in 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." These accounting standards prescribe the measurement methods,
income recognition and disclosures related to impaired loans. At December 31,
2003, total impaired loans were $230 million, and the associated impairment
38
allowance was $55 million, compared with $126 million and $29 million,
respectively, at September 30, 2004. On September 30, 2004 and December 31,
2003, the total allowance for credit losses for off-balance sheet commitments,
which is included within our total allowance for credit losses, was $50 million
and $86 million, respectively. In the second quarter of 2004, we made some
adjustments on how we allocate our allowance for credit losses between
off-balance sheet commitments and loans. These adjustments, offset by the
increases in our loss factors, contributed to the decline in that allocation
from December 31, 2003. These adjustments had no impact on the allowance as a
whole, since commitments and funded loans are considered together in determining
the adequacy of our allowance for credit losses.
During 2004, there were no material 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 the following
refinements: we refined our loss factors for commercial real estate and
construction lending in order to more accurately capture probable loss inherent
in the portfolio, we adjusted the period used to calculate the cumulative loss
rates on criticized loans from 12 to 24 quarters to better estimate losses over
the life of the loans and we revised our method of estimating our expected
losses based on a loss confirmation period. The loss confirmation period is the
estimated average period of time between a material adverse event affecting the
credit-worthiness of a borrower and the subsequent recognition of a loss. Based
upon our evaluation process, we believe that, for our risk-graded loans, on
average, losses are sustained approximately 10 quarters after an adverse event
in the creditor's financial condition has taken place. Similarly, for retail,
pool-managed credits, the loss confirmation period varies by product, but ranges
between one and two years.
During 2004, changes in estimates and assumptions regarding the effects of
economic and business conditions on borrowers and other factors also affected
the assessment of the unallocated allowance. As a result of management's
assessment of factors, including the continued improvement in the U.S. economy,
improving conditions in the communications/media, power, and other sectors in
domestic markets in which we operate, and growth and changes in the composition
of the loan portfolio, offset by the adverse impact of increasing fuel costs
across the whole economy, we recorded a reversal of provision for credit losses
of $10 million in the third quarter of 2004. The refinements we made in the
manner in which we segment our allowance for credit losses, as previously
described, had no impact on the overall level of the allowance.
CHANGES IN THE ALLOCATED (FORMULA AND SPECIFIC) ALLOWANCE
At September 30, 2004, the formula allowance increased to $354 million,
compared to $280 million at December 31, 2003. The increase was due primarily to
the impact of the introduction in the second quarter of 2004 of the loss
confirmation period into the determination of our loan loss factors, which was
approximately $125 million, the modifications to the commercial real estate and
construction loss factors, which was approximately $18 million, the expansion of
the period used to calculate cumulative loss rates on criticized credits, which
was $9 million, and growth in our commercial loan portfolio, offset by
significant improvements in the credit quality of our loan portfolio. Since a
portion of the impact for the use of the loss confirmation period had already
been considered in our attributions in the unallocated allowance, a reallocation
between the formula and unallocated portions of the allowance was made.
The specific allowance decreased to $53 million at September 30, 2004,
compared to $80 million at December 31, 2003. This decrease is reflective of
decreases in impaired loans and the renegotiation of terms for certain aircraft
leases that are now reported as operating leases.
CHANGES IN THE UNALLOCATED ALLOWANCE
At September 30, 2004, the unallocated allowance decreased to $76 million
from $173 million at December 31, 2003. The reasons for the decrease, and for
which an unallocated allowance is warranted, are detailed below.
39
In our assessment as of September 30, 2004, management focused, in
particular, on the factors and conditions set out below. 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.
Although in certain instances the downgrading of a loan resulting from the
effects of the conditions described below has been reflected in the formula
allowance, management believes that 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 to
such loans. In addition, our formula allowance does not take into consideration
a sector-specific change in the severity of losses that are expected to arise
from current economic conditions compared with our historical losses.
Accordingly, our evaluation of the probable losses related to the impact of
these factors was reflected in the unallocated allowance. The evaluations of the
inherent losses with respect to these factors are subject to higher degrees of
uncertainty because they are not identified with specific problem credits. As
previously mentioned, we refined our formula allowance to include certain losses
based upon a loss confirmation period, which has eliminated the need to consider
those losses in the attributions of our unallocated allowance.
In evaluating the results of this methodology change, we considered the
effect of underlying conditions on expected future credit migration for each of
our lending segments. In several cases, we concluded that this experience is not
likely to be more severe than the long-run average embedded in the loss factors
that drive the formula allowance calculation. In these cases, we determined that
our attribution, previously established for the retail, technology and consumer
sectors, was no longer required.
Similarly, in certain cases, we believe that credit migration is likely to
be somewhat more severe than the long-run average, but a greater share of the
inherent probable loss associated with this credit migration is now captured in
the allocated allowance as a result of the previously mentioned refinement in
methodology. In these cases, we have reduced certain unallocated allowance
attributions.
o With respect to fuel prices, we considered the sustained high prices
of oil and petroleum products, and the impact across virtually all
sectors of the economy, and established an attribution for probable
losses, which could be in the range of $10 million to $35 million.
o With respect to commercial real estate, we considered slightly
improving vacancy rates and stagnant rent growth being experienced
nationally, with specific weakness in Northern California, which could
be in the range of $10 million to $20 million, a reduction from the
December 31, 2003 level of $16 million to $32 million.
o With respect to leasing, we considered the worsening situation for
some electric service providers, combined with continued weakness in
the airline industry in the wake of surging fuel prices, which could
be in the range of $10 million to $20 million, an increase from the
December 31, 2003 level of $5 million to $11 million.
o With respect to cross-border exposures in certain foreign countries,
we considered the improving economic performances in many countries of
our key international markets, as well as better financial results of
our customers, and reduced the attribution range, which provides for
certain weaknesses in the banking sector of some of our markets, to $4
million to $8 million.
o With respect to power companies/utilities, we considered the effects
of lower excess capacity and evidence that a slow recovery is
beginning in this industry. We reduced the attribution for probable
losses from a range of $13 million to $27 million at December 31, 2003
to a range of $4 million to $8 million at September 30, 2004.
Accordingly, our evaluation of the probable losses related to the impact of
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.
40
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, INCREASE (DECREASE) ENDED SEPTEMBER 30, INCREASE (DECREASE)
-------------------- ------------------ ------------------- ------------------
(DOLLARS IN THOUSANDS) 2003 2004 AMOUNT PERCENT 2003 2004 AMOUNT PERCENT
- ---------------------- -------- -------- -------- -------- -------- -------- -------- --------
Balance, beginning of
period.............. $558,282 $501,419 $(56,863) (10.2)% $609,190 $532,970 $(76,220) (12.5)%
Loans charged off:
Commercial,
financial and
industrial........ 41,457 15,358 (26,099) (63.0) 130,413 55,868 (74,545) (57.2)
Construction........ -- 200 200 nm -- 200 200 nm
Commercial mortgage. 7,286 -- (7,286) 100.0) 7,286 43 (7,243) (99.4)
Consumer............ 2,058 1,520 (538) (26.1) 7,143 4,795 (2,348) (32.9)
Lease financing..... 518 183 (335) (64.7) 32,726 2,207 (30,519) (93.3)
Foreign(1).......... 2,220 -- (2,220) (100.0) 2,220 -- (2,220) (100.0)
-------- -------- -------- -------- -------- --------
Total loans
charged off..... 53,539 17,261 (36,278) (67.8) 179,788 63,113 (116,675) (64.9)
Recoveries of loans
previously charged
off:
Commercial,
financial and
industrial........ 13,845 8,216 (5,629) (40.7) 32,432 29,127 (3,305) (10.2)
Commercial mortgage -- -- -- nm 150 1,571 1,421 nm
Consumer............ 1,276 350 (926) (72.6) 2,695 1,241 (1,454) (54.0)
Lease financing..... 183 41 (142) (77.6) 352 191 (161) (45.7)
-------- -------- -------- -------- -------- --------
Total recoveries
of loans
previously
charged off..... 15,304 8,607 (6,697) (43.8) 35,629 32,130 (3,499) (9.8)
-------- -------- -------- -------- -------- --------
Net loans
charged off... 38,235 8,654 (29,581) (77.4) 144,159 30,983 (113,176) (78.5)
(Reversal of)
provision for
credit losses....... 20,000 (10,000) (30,000) (150.0) 75,000 (25,000) (100,000) (133.3)
Foreign translation
adjustment and
other net additions
(deductions)(2)..... 10,503 (3) (10,506) (100.0) 10,519 5,775 (4,744) (45.1)
-------- -------- -------- -------- -------- --------
Balance, end of period $550,550 $482,762 $(67,788) (12.3)% $550,550 $482,762 $(67,788) (12.3)%
======== ======== ======== ======== ======== ========
Allowance for credit
losses to total
loans............... 2.11% 1.69% 2.11% 1.69%
(Reversal of) provision
for credit losses to
net loans charged off 52.31 nm 52.03 nm
Net loans charged off
to average loans
outstanding for the
period(3)........... 0.58 0.12 0.73 0.15
- ---------------
<FN>
(1) Foreign loans are those loans originated in foreign branches.
(2) Includes $10.3 million related to the Monterey Bay Bank acquisition in the
third quarter of 2003 and $5.7 million related to the Business Bank of
California acquisition in the first quarter of 2004.
(3) Annualized.
</FN>
Total loans charged off in the third quarter of 2004 decreased from the
third quarter of 2003, as problem loans in the commercial, financial and
industrial industries declined. Charge offs reflect the realization of losses in
the portfolio that were recognized previously through provisions for credit
losses. In addition, third quarter 2004 recoveries of loans previously charged
off decreased from the third quarter of 2003.
At September 30, 2004, the allowance for credit losses exceeded the
annualized net loans charged off during the third quarter of 2004, 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
Nonperforming assets consist of nonaccrual loans and foreclosed assets.
Nonaccrual loans are those for which management has discontinued accrual of
interest because there exists significant uncertainty as to the full and timely
collection of either principal or interest or such loans have become
contractually past
41
due 90 days with respect to principal or interest. For a more detailed
discussion of the accounting for nonaccrual loans, see Note 1 in the "Notes to
Consolidated Financial Statements" included in our 2003 Annual Report on Form
10-K.
Foreclosed assets include property where we acquired title through
foreclosure or "deed in lieu" of foreclosure.
The following table sets forth an analysis of nonperforming assets.
INCREASE (DECREASE)
SEPTEMBER 30, 2004 FROM:
-------------------------------------
SEPTEMBER 30, DECEMBER 31,
2004 2003
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, ------------------ -----------------
(DOLLARS IN THOUSANDS) 2003 2003 2004 AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------ ------------- ------------ ------------- --------- ------- -------- -------
Commercial, financial and
industrial.................. $243,877 $190,404 $91,612 $(152,265) (62.4)% $(98,792) (51.9)%
Construction.................. 1,554 -- 6,180 4,626 297.7 6,180 na
Commercial mortgage........... 42,758 38,354 28,396 (14,362) (33.6) (9,958) (26.0)
Lease financing............... 52,085 51,603 53,758 1,673 3.2 2,155 4.2
Loan originated in foreign
branches.................... 765 840 210 (555) (72.5) (630) (75.0)
------------- ------------ ------------- --------- --------
Total nonaccrual loans.... 341,039 281,201 180,156 (160,883) (47.2) (101,045) (35.9)
Foreclosed assets............. 3,308 5,689 10,607 7,299 220.6 4,918 86.4
------------- ------------ ------------- --------- --------
Total nonperforming assets $344,347 $286,890 $190,763 $(153,584) (44.6) $(96,127) (33.5)
============= ============ ============= ========= ========
Allowance for credit losses... $550,550 $532,970 $482,762 $(67,788) (12.3)% $(50,208) (9.4)%
============= ============ ============= ========= ========
Nonaccrual loans to total
loans....................... 1.31% 1.08% 0.63%
Allowance for credit losses
to nonaccrual loans......... 161.43 189.53 267.97
Nonperforming assets to total.
loans and foreclosed assets. 1.32 1.11 0.67
Nonperforming assets to total
assets...................... 0.81 0.68 0.41
As of September 30, 2004, our nonperforming assets included approximately
$55.1 million in aircraft leases and $52.4 million in acquired syndicated loans.
The decrease in nonaccrual loans was primarily due to pay-downs, charge-offs,
and loan sales, coupled with significantly reduced inflows. During the third
quarter of 2004, we had no sales of nonperforming loans compared to $67 million
of loan commitments sold in the third quarter of 2003, which reduced our credit
exposures. Losses from these sales were reflected in our charge-offs.
42
LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING
INCREASE (DECREASE)
SEPTEMBER 30, 2004 FROM:
-----------------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31,
2003 2003 2004 2003 2003
------------- ------------ ------------- ----------------- ----------------
(DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT
- --------------------- -------- ------- ------- -------
Commercial, financial
and industrial..... $21,598 $893 $1,892 $(19,706) (91.2)% $ 999 111.9%
Construction......... -- -- 2,137 2,137 na 2,137 na
Mortgage:
Residential........ 1,777 1,878 3,353 1,576 88.7 1,475 78.5
Commercial......... 982 -- -- (982) (100.0) -- na
------- ------ ------ -------- -------
Total mortgage... 2,759 1,878 3,353 594 21.5 1,475 78.5
Consumer and other... 1,706 1,123 1,249 (457) (26.8) 126 11.2
------- ------ ------ -------- -------
Total loans 90 days
or more past due
and still accruing. $26,063 $3,894 $8,631 $(17,432) (66.9)% $ 4,737 121.6%
======= ====== ====== ======== =======
QUANTITATIVE AND QUALITATIVE DISCLOSURES 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 mitigate an undue adverse impact on
earnings and capital arising from changes in interest rates and prices of
financial instruments. This risk management objective supports our broad
objective of preserving shareholder value, which encompasses earnings growth
over time and capital stability.
The Board of Directors, through its Finance and Capital Committee,
establishes the Bank's ALM Policy, which governs the management of market risk.
In the administration of market risk management, the Chief Executive Officer
(CEO) Forum provides broad and strategic guidance to the Asset & Liability
Management Committee (ALCO). ALCO is a committee comprised of senior executives,
with the chairman designated by the Chief Executive Officer. ALCO is responsible
for management of liquidity, interest rate and price risks in the implementation
of ALM Policy, including formulation of risk management strategies, guidelines
and trading policy limits, in accordance with the CEO Forum's directives. The
Treasurer of the Bank is primarily responsible for the implementation of risk
management strategies approved by ALCO and for operating management of market
risk through the funding, investment, derivatives hedging, and trading functions
of the Bank's Global Markets Group (GMG).
The Market Risk Monitoring (MRM) unit is structured as an independent unit
responsible for the measurement and monitoring of market risk, including the
preparation of reports in sufficient detail to ensure that ALCO, the Bank's
senior management and the Board are kept fully informed as to the Bank's market
risk profile and compliance with applicable limits, guidelines and policies. MRM
functions independently of all operating and management units and reports
directly to the ALCO Chairman.
43
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 ALM Policy approved by our Board's Finance and Capital Committee
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 non-interest
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 over various time horizons.
Our unhedged NII remains 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 investment portfolio are used to manage this risk. In the third quarter
of 2004, we modestly decreased the size of our securities portfolio from June
30, 2004, due to run-off of maturing securities combined with slower purchases,
reducing average balances by approximately $105 million from the second quarter
of 2004. Effective duration was reduced from 2.7 to 2.4, both of which are
relatively short. In addition during the third quarter of 2004, we entered into
$300 million of interest rate cap corridors to offset the potential adverse
impact that rising short-term interest rates could have on our cost of deposit
funding. We also entered into $200 million of interest rate floors during the
third quarter of 2004 to hedge some of our variable rate loans. For a further
discussion of derivative instruments and our hedging strategies, see Note 8 to
our Notes to Condensed Consolidated Financial Statements included in this Form
10-Q.
Together, our hedging and investment activities resulted in an essentially
neutral interest rate risk profile for the hedged balance sheet with respect to
parallel yield curve shifts in terms of simulated NII versus the no rate change
base case scenario. However, our NII is also sensitive to non-parallel shifts in
the yield curve. In general, our adjusted 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 adjusted
NII. In this respect, our adjusted NII is asset sensitive when measured against
changes in long rates and slightly liability sensitive when measured against
changes in short rates.
In the current, still low rate environment, run off of fixed rate assets,
including prepayments, depresses 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.
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
44
no change, scenario. The following table sets forth the simulation results in
both the up and down 200 basis point ramp scenarios as of December 31, 2003 and
September 30, 2004(1):
DECEMBER 31, SEPTEMBER 30,
(DOLLARS IN MILLIONS) 2003 2004
- ---------------------- ------------ -------------
+ 200 basis points........................ $ 17.2 $ 13.1
as a percentage of base case NII.......... 1.20% 0.81%
- - 200 basis points........................ $(19.8) $(27.6)
as a percentage of base case NII.......... 1.38% 1.70%
- ------------------
(1) For these policy simulations, NII is adjusted to incorporate the effect of
certain noninterest expense items related to demand deposits that are
nevertheless sensitive to changes in interest rates.
EaR in the down 200 basis point scenario was a negative $27.6 million, or
1.70 percent of adjusted NII in the base case scenario, well within the Board's
guidelines.
However, with Federal Funds and LIBOR rates currently close to two percent,
a downward ramp scenario of 200 basis points would result in short-term rate
levels near 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, 2004, the difference
between adjusted NII in the base case and adjusted NII after a gradual 100 basis
point downward ramp was a negative $3.7 million, or 0.23 percent of the base
case scenario.
In order to reflect more fully and accurately the anticipated NII impact of
interest rate shocks at a specified future point in time, we have over the past
quarter made a transition from a constant to a projected balance sheet as the
basis for our EaR simulations. Such an approach aligns our interest rate risk
analysis with the Bank's management goals and processes. 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. This
includes alternate scenarios for volume growth for key balance sheet items.
In addition to EaR, we measure the sensitivity of Economic Value of Equity
(EVE) to interest rate shocks. Limits on EVE-at-Risk are set by ALCO and
monitored monthly for compliance.
We believe that, together, our NII and EVE simulations provide management
with a reasonably comprehensive view of the sensitivity of our operating results
and value profile 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 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.
At December 31, 2003 and September 30, 2004, our securities available for
sale portfolio included $10.4 billion and $11.1 billion, respectively, of
securities for ALM purposes with an estimated effective duration of 2.4,
compared to 2.5 at December 31, 2003. Effective duration is a measure of price
sensitivity of a bond portfolio to immediate changes in interest rates. An
effective duration of 2.4 suggests an expected price change of approximately 2.4
percent for an immediate one percent change in interest rates. At September 30,
2004, the ALM portfolio included $6.1 billion in mortgage-backed securities with
an estimated effective duration of 2.8. The ALM portfolio's effective duration,
in the context of our total
45
balance sheet, after giving consideration to the composition of our core
deposits, contributes to the maintenance of our interest rate risk profile as
near-neutral for NII over the next 12 months.
TRADING ACTIVITIES
We enter into trading account activities primarily as a financial
intermediary for customers, and, to a minor extent, for our own account. By
acting as a financial intermediary, we are able to provide our customers with
access to a wide range of products from the securities, foreign exchange, and
derivatives markets. In acting for our own account, we may take positions in
some of these instruments with the objective of generating trading profits.
These activities expose us to two primary types of market risk: interest rate
and foreign currency exchange risk.
In order to manage interest rate and foreign currency exchange risk
associated with the securities and foreign exchange trading activities for our
own account, we utilize a variety of non-statistical methods including: position
limits for each trading activity, daily marking of all positions to market,
daily profit and loss statements, position reports, and independent verification
of all inventory pricing. Additionally, MRM reports positions and profits and
losses daily to the Treasurer and trading managers and weekly to the ALCO
Chairman. ALCO is provided reports on a monthly basis. We believe that these
procedures, which stress timely communication between MRM and senior management,
are the most important elements of the risk management process.
We use a form of Value at Risk (VaR) methodology to measure the overall
market risk inherent in our trading account activities. Under this methodology,
management statistically calculates, with 97.5 percent confidence, the potential
loss in fair value that we might experience if an adverse shift in market prices
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 stockholders' equity. The VaR model incorporates a number of key
assumptions, including assumed holding period and historical volatility based on
3 years of historical market data updated quarterly.
The following table sets forth the average, high and low VaR for our
trading activities for the year ended December 31, 2003 and the quarter ended
September 30, 2004.
DECEMBER 31, 2003 SEPTEMBER 30, 2004
--------------------- ---------------------
AVERAGE HIGH LOW AVERAGE HIGH LOW
(DOLLARS IN THOUSANDS) VAR VAR VAR VAR VAR VAR
- --------------------------- ------- ---- --- ------- ---- ---
Foreign exchange........... $143 $428 $57 $119 $173 $64
Securities................. 206 463 97 407 484 322
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 Finance and Capital Committee of 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 our 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 and Institutional Sales department serves the fixed
income needs of our institutional clients and acts as the fixed income
wholesaler for our broker/dealer subsidiary, UnionBanc Investment Services LLC.
As with our foreign exchange business, we continue to generate the vast majority
of our securities trading income from customer-related transactions.
Our interest rate derivative contracts included, as of September 30, 2004,
$4.1 billion notional amount of derivative contracts entered into as an
accommodation for customers. We act as an intermediary and
46
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 Finance and Capital Committee of the Board requires
regular 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 company-wide basis, encompassing all major
business units. The operating management of liquidity is implemented through the
funding and investment functions of the Global Markets Group. Our liquidity
management draws upon the strengths of our extensive retail and commercial core
deposit franchise, coupled with the ability to obtain funds for various terms in
a variety of domestic and international money markets. Our securities portfolio
represents a significant source of additional liquidity.
Core deposits provide us with a sizable source of relatively stable and
low-cost funds. Our average core deposits, which include demand deposits, money
market demand accounts, and savings and consumer time deposits, combined with
average common stockholders' equity, funded 84 percent of average total assets
of $45.7 billion in the third quarter of 2004. 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. In the fourth quarter of 2003, we issued $400 million in long-term
subordinated debt. In February 2004, we used a portion of the net proceeds
(approximately $350 million) from the sale of these securities to redeem our
Trust Notes that were outstanding as of December 31, 2003. The remainder of the
net proceeds from this offering is for general corporate purposes, which may
include extending credit to or funding investments in our subsidiaries,
repurchasing shares of our common stock, reducing our existing indebtedness or
financing possible acquisitions.
The securities portfolio provides additional enhancement to our liquidity
position, which may be created through repurchase agreements. At September 30,
2004, a liquidity need could have been met by transferring under repurchase
agreements a substantial portion of our unencumbered available for sale
securities, which totaled approximately $8.8 billion. Liquidity may also be
provided by the sale or maturity of other assets such as interest-bearing
deposits in banks, federal funds sold, and trading account securities. The
aggregate balance of these assets averaged approximately $1.3 billion in the
third quarter of 2004. Additional liquidity may be provided through loan
maturities and sales. In the third quarter of 2003, we terminated the issuance
of commercial paper under UnionBanCal Corporation's commercial paper program.
UnionBanCal Commercial Funding Corporation (a UnionBanCal Corporation
subsidiary) continues to issue commercial paper under another commercial paper
program. The proceeds of this commercial paper program are deposited in Union
Bank of California, N.A. and used to fund our Bank operations.
47
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) 2003 2003 2004 REQUIREMENT
- ----------------------- ---------------- ---------------- ---------------- -----------------
CAPITAL COMPONENTS
Tier 1 capital......... $ 3,632,898 $ 3,747,884 $ 3,760,291
Tier 2 capital......... 537,737 936,189 949,091
---------------- ---------------- ----------------
Total risk-based
capital.............. $ 4,170,635 $ 4,684,073 $ 4,709,382
================ ================ ================
Risk-weighted assets... $33,144,336 $33,133,407 $37,622,266
================ ================ ================
Quarterly average
assets............... $41,624,946 $41,506,828 $45,444,623
================ ================ ================
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ----------------------- ---------- ----- ---------- ----- ------ ----- ---------- -----
Total capital (to risk-
weighted assets)..... $4,170,635 12.58% $4,684,073 14.14% $4,709,382 12.52% >$3,009,781 8.0%
Tier 1 capital (to -
risk-weighted assets) 3,632,898 10.96 3,747,884 11.31 3,760,291 9.99 >1,504,891 4.0
-
Leverage(1)............ 3,632,898 8.73 3,747,884 9.03 3,760,291 8.27 >1,817,785 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) 2003 2003 2004 REQUIREMENT REQUIREMENT
- ----------------------- ---------------- ---------------- ---------------- ----------------- -------------------
CAPITAL COMPONENTS
Tier 1 capital......... $ 3,306,884 $ 3,395,519 $ 3,791,489
Tier 2 capital......... 467,814 467,619 487,480
---------------- ---------------- ----------------
Total risk-based
capital.............. $ 3,774,698 $ 3,863,138 $ 4,278,969
================ ================ ================
Risk-weighted assets... $32,520,713 $32,526,017 $36,919,037
================ ================ ================
Quarterly average
assets............... $41,044,744 $40,921,517 $44,943,543
================ ================ ================
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ----------------------- ---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to risk-
weighted assets...... $3,774,698 11.61% $3,863,138 11.88% $4,278,969 11.59% >$2,953,523 8.0% >$3,691,904 10.0
Tier 1 capital (to - -
risk-weighted
assets).............. 3,306,884 10.17 3,395,519 10.44 3,791,489 10.27 > 1,476,761 4.0 > 2,215,142 6.0
- -
Leverage(1)............ 3,306,884 8.06 3,395,519 8.30 3,791,489 8.44 > 1,797,742 4.0 > 2,247,177 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).
Included in Tier 1 capital at year-end 2003 was $350 million in Trust
Preferred Securities, which we redeemed on February 19, 2004, resulting in a
decrease in our Tier 1 capital ratio at September 30, 2004, compared with
September 30, 2003 and December 31, 2003. In December 2003, we issued $400
million of long-term subordinated debt, which is included in Tier 2 capital as
of December 31, 2003 (further discussion of our subordinated debt can be found
in Note 11 in the "Notes to Consolidated Financial Statements" included in our
2003 Annual Report on Form 10-K).
Compared with September 30, 2003, in addition to the changes to our capital
structure mentioned in the above paragraph, the decrease in our capital ratios
was also attributable to higher risk-weighted assets. Our leverage ratio
decrease was primarily attributable to a $4 billion, or 9 percent, increase in
quarterly average assets, which was substantially the result of increases in
both our securities and residential mortgage loan portfolios.
48
As of September 30, 2004, 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.
BUSINESS SEGMENTS
We segregate our operations into four primary business units for the
purpose of management reporting, as shown in the table that follows. The results
show the financial performance of our major business units.
The risk-adjusted return on capital (RAROC) methodology used seeks to
attribute economic capital to business units consistent with the level of risk
they assume. These risks are primarily credit risk, market risk and operational
risk. Credit risk is the potential loss in economic value due to the likelihood
that the obligor will not perform as agreed. Market risk is the potential loss
in fair value due to changes in interest rates, currency rates and equity
prices. Operational risk is the potential loss due to failures in internal
control, system failures, or external events.
The tables on the following pages 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. In addition, the tables include performance
center earnings. A performance center is a special unit 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 U.S. 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.
49
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 COMMERCIAL
AND INVESTMENT FINANCIAL SERVICES INTERNATIONAL
SERVICES GROUP SERVICES GROUP BANKING GROUP
------------------ ------------------ -----------------
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------
2003 2004 2003 2004 2003 2004
-------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS AFTER PERFORMANCE
CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income............................ $173,733 $203,040 $186,249 $203,288 $ 8,537 $ 9,802
Noninterest income............................. 110,912 125,042 67,591 64,317 18,117 19,069
-------- -------- -------- -------- ------- -------
Total revenue.................................. 284,645 328,082 253,840 267,605 26,654 28,871
Noninterest expense............................ 202,283 235,883 103,277 108,519 15,323 16,728
Credit expense (income)........................ 7,996 8,400 39,397 24,781 511 566
-------- -------- -------- -------- ------- -------
Income (loss) before income tax
expense (benefit)............................ 74,366 83,799 111,166 134,305 10,820 11,577
Income tax expense (benefit)................... 28,445 32,053 36,128 44,414 4,139 4,428
-------- -------- -------- -------- ------- -------
Net income (loss).............................. $ 45,921 $ 51,746 $ 75,038 $ 89,891 $ 6,681 $ 7,149
======== ======== ======== ======== ======= =======
PERFORMANCE CENTER EARNINGS (DOLLARS
IN THOUSANDS):
Net interest income............................ $ 186 $ 67 $ (99) $ (26) $ 10 $ 17
Noninterest income............................. (9,835) (2,631) 16,697 10,383 305 258
Noninterest expense............................ (8,904) (2,760) 9,513 4,063 59 2
Net income (loss).............................. (477) 103 4,412 3,961 158 169
Total loans (dollars in millions).............. 24 21 (43) (42) -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................. $ 11,801 $ 13,105 $ 12,483 $ 12,712 $ 1,457 $ 1,883
Total assets................................... 12,904 14,386 14,347 15,381 1,913 2,281
Total deposits(1).............................. 17,463 19,355 13,767 14,344 1,555 2,259
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............. 25% 30% 19% 24% 43% 44%
Return on average assets(2).................... 1.41 1.43 2.08 2.33 1.39 1.25
Efficiency ratio(3)............................ 71.1 71.9 40.7 40.6 57.5 57.9
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
------------------ ------------------ ------------------
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------
2003 2004 2003 2004 2003 2004
-------- -------- -------- -------- -------- --------
RESULTS OF OPERATIONS AFTER PERFORMANCE
CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income............................ $ 18,140 $(35,642) $ 14,430 $ 31,602 $401,089 $412,090
Noninterest income............................. (1,097) 1,561 5,947 5,965 201,470 215,954
-------- -------- -------- -------- -------- --------
Total revenue.................................. 17,043 (34,081) 20,377 37,567 602,559 628,044
Noninterest expense............................ 3,926 5,225 24,052 6,036 348,861 372,391
-------- -------- -------- -------- -------- --------
Credit expense (income)........................ 50 54 (27,954) (43,801) 20,000 (10,000)
Income (loss) before income tax
expense (benefit)............................ 13,067 (39,360) 24,279 75,332 233,698 265,653
Income tax expense (benefit)................... 4,998 (15,055) 4,943 36,375 78,653 102,215
-------- -------- -------- -------- -------- --------
Net income (loss).............................. $ 8,069 $(24,305) $ 19,336 $ 38,957 $155,045 $163,438
======== ======== ======== ======== ======== ========
PERFORMANCE CENTER EARNINGS (DOLLARS
IN THOUSANDS):
Net interest income............................ $ (203) $ (176) $ 106 $ 118 $ -- $--
Noninterest income............................. (10,605) (11,294) 3,438 3,284 -- --
Noninterest expense............................ (2,123) (1,989) 1,455 684 -- --
Net income (loss).............................. (5,362) (5,854) 1,269 1,621 -- --
Total loans (dollars in millions).............. -- -- 19 21 -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................. $ 333 $ 192 $ 258 $ 255 $ 26,332 $ 28,147
Total assets................................... 11,506 12,544 1,244 1,121 41,914 45,713
Total deposits(1).............................. 837 737 1,281 1,419 34,903 38,114
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............. 3% (15)% na na na na
Return on average assets(2).................... 0.28 (0.77) na na 1.47% 1.42%
Efficiency ratio(3)............................ 23.0 (15.3) na na 57.9 59.2
- --------------------------
<FN>
(1) Represents loans and deposits for each business segment after allocation
between the segments of loans and deposits originated in one segment but
managed by another segment.
(2) Annualized.
(3) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income and noninterest
income. Foreclosed asset expense (income) was ($79 thousand) and ($10
thousand) in the third quarters of 2003 and 2004, respectively.
na = not applicable
</FN>
50
COMMUNITY BANKING COMMERCIAL
AND INVESTMENT FINANCIAL SERVICES INTERNATIONAL
SERVICES GROUP GROUP BANKING GROUP
AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------
2003 2004 2003 2004 2003 2004
-------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER
EARNINGS (DOLLARS IN THOUSANDS):
Net interest income............................ $505,206 $571,536 $546,437 $578,265 $25,654 $26,832
Noninterest income............................. 324,416 371,436 187,055 206,483 59,690 59,519
-------- -------- -------- -------- ------- -------
Total revenue.................................. 829,622 942,972 733,492 784,748 85,344 86,351
Noninterest expense............................ 599,400 678,512 307,132 317,208 45,656 49,368
Credit expense (income)........................ 23,840 23,984 124,006 82,443 1,563 1,815
-------- -------- -------- -------- ------- -------
Income (loss) before income tax
expense (benefit)............................ 206,382 240,476 302,354 385,097 38,125 35,168
Income tax expense (benefit)................... 78,941 91,982 96,355 127,983 14,583 13,451
-------- -------- -------- -------- ------- -------
Net income (loss).............................. $127,441 $148,494 $205,999 $257,114 $23,542 $21,717
======== ======== ======== ======== ======= =======
PERFORMANCE CENTER EARNINGS (DOLLARS
IN THOUSANDS):
Net interest income............................ $ 589 $ 388 $ (500) $(231) $ 24 $52
Noninterest income............................. (28,245) (22,804) 46,112 42,273 887 874
Noninterest expense............................ (25,458) (19,262) 26,706 21,654 393 67
Net income (loss).............................. (1,414) (2,000) 11,799 12,737 320 531
Total loans (dollars in millions).............. 25 25 (45) (44) -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................. $ 11,383 $ 12,486 $ 13,025 $ 12,314 $ 1,529 $1,757
Total assets................................... 12,392 13,722 15,028 14,683 1,948 2,180
Total deposits(1).............................. 16,568 19,105 12,461 14,022 1,515 1,989
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............. 25% 29% 16% 23% 50% 47%
Return on average assets(2).................... 1.37 1.45 1.83 2.34 1.62 1.33
Efficiency ratio(3)............................ 72.2 72.0 41.9 40.4 53.5 57.2
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
------------------ ------------------ ----------------------
AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------------------
2003 2004 2003 2004 2003 2004
-------- -------- -------- -------- ---------- ----------
RESULTS OF OPERATIONS AFTER PERFORMANCE
CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income............................ $ 56,371 $(50,293) $ 43,978 $ 86,029 $1,177,646 $1,212,369
Noninterest income............................. 2,311 4,497 16,940 116,234 590,412 758,169
Total revenue.................................. 58,682 (45,796) 60,918 202,263 1,768,058 1,970,538
Noninterest expense............................ 12,158 16,093 78,119 60,718 1,042,465 1,121,899
Credit expense (income)........................ 150 280 (74,559) (133,522) 75,000 (25,000)
Income (loss) before income tax expense
(benefit).................................... 46,374 (62,169) 57,358 275,067 650,593 873,639
Income tax expense (benefit)................... 17,738 (23,780) 7,656 111,981 215,273 321,617
Net income (loss).............................. $ 28,636 $(38,389) $ 49,702 $163,086 $ 435,320 $ 552,022
PERFORMANCE CENTER EARNINGS (DOLLARS IN
THOUSANDS):
Net interest income............................ $ (433) $ (531) $ 320 $ 322 $ -- $ --
Noninterest income............................. (28,553) (31,012) 9,799 10,669 -- --
Noninterest expense............................ (5,776) (5,741) 4,135 3,282 -- --
Net income (loss).............................. (14,332) (15,933) 3,627 4,665 -- --
Total loans (dollars in millions).............. -- -- 20 19 -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................. $ 279 $ 228 $ 307 $ 261 $ 26,523 $ 27,046
Total assets................................... 9,655 12,732 1,003 1,146 40,026 44,463
Total deposits(1).............................. 1,037 838 1,289 1,337 32,870 37,291
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............. 4% (6)% na na na na
Return on average assets(2).................... 0.40 (0.40) na na 1.45% 1.66%
Efficiency ratio(3)............................ 20.7 (35.1) na na 58.9 56.8
- --------------------------
<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. Foreclosed asset and noninterest income. Foreclosed asset expense
(income) was ($28 thousand) and $526 thousand in the first nine months of
2003 and 2004, respectively.
na = not applicable
</FN>
51
COMMUNITY BANKING AND INVESTMENT SERVICES GROUP
In the third quarter of 2004, net income increased $5.8 million, or 13
percent, compared to the third quarter of 2003. In the third quarter of 2004,
total revenue increased $43.4 million, or 15 percent, compared to the third
quarter of 2003. Increased asset and deposit volumes, partly offset by the
effect of a lower interest rate environment led to an increase of $29.3 million,
or 17 percent, in net interest income over the third quarter of 2003. In the
third quarter of 2004, noninterest income was $14.1 million, or 13 percent,
higher than the third quarter of 2003 primarily due to higher deposit fees and
trust fees. Noninterest expense increased $33.6 million, or 17 percent, in the
third quarter of 2004 compared to the third quarter of 2003, with the majority
of that increase being attributable to higher staff expenses related to our
acquisitions and de novo branches, as well as increased deposit volumes and
residential loan growth.
In 2004, 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, 2004, residential mortgages grew by $1.7 billion, or 24
percent, from September 30, 2003. 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. On January 16, 2004, we completed our
acquisition of Business Bank of California, a commercial bank headquartered in
San Bernardino, California, with $704 million in assets and fifteen full-service
branches in the Southern California Inland Empire and the San Francisco Bay
Area. On October 28, 2004, we completed our acquisition of Jackson Federal Bank,
a savings bank headquartered in Brea, California, with $1.4 billion in assets
and fourteen full-service branches in Southern California.
The Community Banking and Investment Services Group is comprised of six
major divisions: Community Banking, Wealth Management, Institutional Services
and Asset Management, Consumer Asset Management, UBOC Markets and Insurance
Services.
COMMUNITY BANKING serves its customers through 301 full-service branches in
California, Washington and Oregon and a network of 571 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
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 and business financing, brokerage products and
services, and insurance services;
o through on-line access to our internet banking services, which augment
our physical delivery channels by providing an array of customer
transaction, bill payment and loan payment services;
o through branches and business banking centers, which serve businesses
with annual sales up to $5 million; and
o through in-store branches in supermarkets, which also serve consumers
and businesses.
52
WEALTH MANAGEMENT provides private banking services to our affluent
clientele.
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 locations in California, Oregon and
Washington, The Private Bank relationship managers offer all of our
available products and services.
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 expanding
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. Our recent acquisition of the business
portfolio of CNAT, which was completed on August 1, 2004, added
outsourcing capability for direct distributors of retirement products
and strengthened capacity to support smaller plans. The newly acquired
products and services of CNAT will be marketed under the name
"TruSource." 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 its position in our target markets.
CONSUMER ASSET MANAGEMENT provides the centralized underwriting,
processing, servicing, collection and administration for consumer assets
including residential loans. On May 31, 2004, we completed the sale of our
merchant card portfolio and formed a long-term marketing alliance with NOVA
Information Systems (NOVA). NOVA acquired our merchant accounts and will provide
processing services, customer service and support operations to our merchant
locations. We will market merchant services through our branch network in
California, Oregon and Washington.
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.
UBOC MARKETS. In May 2004, the Bank announced a strategic move to realign
the Bank's wholly owned brokerage subsidiary, UnionBanc Investment Services LLC
and Personal Trust Sales with Securities Trading and Institutional Sales. The
realignment advances our goals of leveraging and anchoring client relationships
by enhancing the Bank's cross sell culture.
o Our brokerage products and services are provided through UnionBanc
Investment Services LLC, a registered broker/dealer offering
investment products to individuals and institutional clients, whose
primary strategy is to further penetrate our existing client base.
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
53
2002 acquisition of John Burnham and Company, and our 2003 acquisitions of
Tanner Insurance Brokers, Inc. and Knight Insurance Agency, offers its risk
management and insurance products through offices in California and Oregon.
OTHER SERVICES
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 2004, net income increased $14.9 million, or 20
percent, compared to the third quarter of 2003. In the third quarter of 2004,
net interest income increased $17.0 million, or 9 percent, compared to the third
quarter of 2003, partially attributable to the impact of increasing deposit
balances. Noninterest income decreased $3.3 million, or 5 percent, mainly
attributable to lower deposit-related service fees related to a higher earning
credit rates in the current quarter on customer deposits used to pay for banking
services. In the third quarter of 2004, noninterest expense increased $5.2
million, or 5 percent, mainly attributed higher expenses to support increased
product sales and deposit volumes. Credit expense decreased $14.6 million mainly
as a result of improving credit quality.
The group's initiatives during 2004 continue to 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 and cash vault services.
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;
54
o the Corporate Deposit and Treasury Management Division, which provides
deposit and cash management expertise to middle-market and large
corporate clients, 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'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 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 also 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.
The Check Clearing for the 21st Century Act (Check 21) was signed into law
on October 28, 2003, and became effective on October 28, 2004. Check 21 is
designed to foster innovation in the payments system and to enhance its
efficiency by reducing some of the legal impediments to check truncation (that
is, the banking process by which cancelled original checks are not returned to
the customer with the customer's regular bank statement). The law facilitates
check truncation by creating a new negotiable instrument called a substitute
check, which would permit banks to truncate original checks, to process check
information electronically, and to deliver substitute checks to banks that want
to continue receiving paper checks. A substitute check will be the legal
equivalent of the original check and will include all the information contained
on the original check. The law does not require banks to accept checks in
electronic form nor does it require banks to use the new authority granted by
Check 21 to create substitute checks. The final regulations regarding Check 21
were published in July 2004. In order to manage and control the changes which
may be necessitated by Check 21, we have established a "Check 21 Initiative
Project Management Structure," composed of representatives from many of our
operating and support units. The objective of this initiative is to allow us to
prioritize and allocate our resources and mitigate risk to our ongoing
operations. It is not possible at this time to predict the long-term financial
impact of Check 21, and regulations thereunder, on our business.
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
providing short-term financing. The majority of the revenue generated by the
International Banking Group is from financial institutions domiciled outside of
the U.S.
In the third quarter of 2004, net income increased $0.5 million, or 7
percent, compared to the third quarter of 2003. Total revenue increased $2.2
million or 8 percent, compared to the third quarter of 2003. Net interest income
increased $1.3 million, or 15 percent, compared to the third quarter of 2003
mainly attributable to higher demand deposit balances. Noninterest income was
$1.0 million, or 5 percent, higher compared to the third quarter of 2003
primarily attributable to higher payment and trade activities in the current
quarter. Noninterest expense increased $1.4 million, or 9 percent, compared to
the third quarter of
55
2003 primarily due to incremental costs associated with strengthening our Bank
Secrecy Act controls and processes in our Union Bank of California,
International--New York subsidiary. In the third quarter of 2004, credit expense
of $0.1 million was slightly higher compared to the third quarter of 2003. The
International Banking Group's business revolves around short-term financing,
mostly to 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 offices in Asia, Latin America and Europe; and an
international banking subsidiary in New York.
GLOBAL MARKETS GROUP
The Global Markets Group conducts business to support all of our business
groups and their customers. This group is responsible for our treasury
management, which encompasses wholesale funding, liquidity management, interest
rate risk management, including the ALM securities portfolio management and
derivatives hedging activities. Associated with this function, this group's
results include the transfer pricing activity for us, which allocates to the
other business segments their cost of funds on all asset categories and credit
for funds on all liability categories. Another important function of the Global
Markets Group is the offering of a broad range of risk management products, such
as foreign exchange contracts and interest rate derivative hedge products for
our client's risk management needs. It also trades fixed income securities to
meet investment needs of our institutional and business clients. In May 2004,
with a strategic realignment of the market and investment product offering
functions, the UBOC Markets unit was formed, encompassing the risk management
and fixed income products offerings of the Global Markets Group and UnionBanc
Investment Services LLC, the Bank's brokerage subsidiary. The UnionBanc
Investment Services' management dually reports to the Global Markets Group and
the Community Banking and Investment Services Group. UBOC Markets' income
attributable to business with our clients is allocated, through performance
centers, to the business units.
In the third quarter of 2004, net loss was $24.3 million compared to net
income of $8.1 million in the third quarter of 2003. Total revenue in the third
quarter of 2004 decreased by $51.1 million, compared to the third quarter of
2003, resulting from a $53.8 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 2004 resulting from the continuing
growth in core deposits, which are priced on longer-term liability rates,
compared to our portfolio of relatively short-term loans and securities, which
are credited at shorter-term lending and investment rates. Noninterest income
increased $2.7 million compared to the third quarter of 2003. Noninterest
expense in the third quarter of 2004 increased $1.3 million, or 33 percent,
compared to the previous year's quarter as we incurred costs for technology
improvements and added to our staff.
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 the results of operations of 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 U.S. GAAP and earnings associated
with unallocated equity capital;
56
o the adjustment between the tax expense reported 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 of $279 million at
September 30, 2004, which offers a range of credit, deposit, and
investment management products and services to companies in the U.S.
which are affiliated with companies headquartered in Japan; and
o the residual costs of support groups.
Net income for "Other" in the third quarter of 2004 was $39.0 million. The
results were impacted by the following factors:
o Credit expense (income) of ($43.8) million was due to the difference
between the $10.0 million reversal of provision for credit losses
calculated under our U.S. GAAP methodology and the $33.8 million in
expected losses for the reportable business segments, which utilizes
the RAROC methodology;
o Net interest income of $31.6 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 $6.0 million compared with $24.1 million for
the quarter ending September 30, 2003. The decline resulted from
decreases in post-retirement healthcare expense, technology,
consulting, and marketing expenses.
Net income for "Other" in the third quarter of 2003 was $19.3 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 provision for credit losses calculated under
our U.S. 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 $14.4 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 $5.9 million; and
o Noninterest expense of $24.1 million.
REGULATORY MATTERS
Union Bank of California International has entered into a written agreement
with the Federal Reserve Bank of New York relating to Union Bank of California
International's Bank Secrecy Act controls and processes. Union Bank of
California International is wholly owned by Union Bank of California, N.A.,
which is wholly owned by UnionBanCal Corporation. Union Bank of California
International is headquartered in New York City and, as an Edge Act subsidiary,
is limited to engaging in international banking activities. Union Bank of
California International is implementing a plan to strengthen its Bank Secrecy
Act controls and processes. UnionBanCal Corporation filed a Form 8-K containing
Union Bank of California International's agreement with the Federal Reserve Bank
of New York.
The banking industry, including Union Bank of California, N.A., is subject
to significantly increased regulatory scrutiny and enforcement regarding Bank
Secrecy Act matters. Union Bank of California International's agreement with the
Federal Reserve Bank of New York and this general increase in regulatory
scrutiny and enforcement of Bank Secrecy Act matters have resulted in Union Bank
of California, N.A. initiating enhanced efforts to strengthen its Bank Secrecy
Act controls and processes.
57
The increased regulatory scrutiny and enforcement of Bank Secrecy Act
matters and Union Bank of California International's agreement with the Federal
Reserve Bank of New York will adversely affect Union Bank of California
International's, and may adversely affect UnionBanCal Corporation's and Union
Bank of California, N.A.'s, ability to obtain regulatory approvals for future
initiatives requiring regulatory approval, including acquisitions. However,
neither this effect, nor the terms of Union Bank of California International's
agreement with the Federal Reserve Bank of New York, nor the financial impact of
enhanced Bank Secrecy Act controls and processes, are expected to have a
material adverse impact on the financial condition or results of operations of
Union Bank of California, N.A. or UnionBanCal Corporation.
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 pace and scope of the recovery
in the technology sector, the California state government's budgetary
difficulties and continuing fiscal difficulties. We have various banking
relationships with the California State government, including credit and deposit
relationships and funds transfer arrangements. If economic conditions in
California decline, we expect that our level of problem assets could increase
and our prospects for growth could be impaired. On March 2, 2004, the California
electorate approved certain ballot measures, including a one-time economic
recovery bond issue of up to $15 billion to pay off the State's accumulated
general fund deficit. While these measures have provided near-term relief for
the State government's fiscal situation, the State of California continues to
face fiscal challenges, the long-term impact of which, on the State's economy,
cannot be predicted with any certainty.
THE CONTINUING WAR ON TERRORISM COULD ADVERSELY AFFECT U.S. ECONOMIC
CONDITIONS
Acts or threats of terrorism and actions taken by the U.S. or other
governments as a result of such acts or threats may result in a downturn in U.S.
economic conditions and could adversely affect business and economic conditions
in the U.S. generally and in our principal markets.
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 and the
quality of our real estate loan portfolio. Increases in residential mortgage
loan interest rates could also have an adverse effect on our operations by
depressing new mortgage loan originations. 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. Recent increases in fuel prices have adversely affected
businesses in several of these industries. 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.
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, 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
58
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.
STOCKHOLDER VOTES ARE CONTROLLED BY THE BANK OF TOKYO-MITSUBISHI, LTD.; OUR
INTERESTS MAY NOT BE THE SAME AS THE BANK OF TOKYO-MITSUBISHI, LTD.'S
INTERESTS
The Bank of Tokyo-Mitsubishi, Ltd., a wholly owned subsidiary of Mitsubishi
Tokyo Financial Group, Inc., owns a majority of the outstanding shares of our
common stock. As a result, The Bank of Tokyo-Mitsubishi, Ltd. can elect all of
our directors and 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
stockholders; 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 The Bank of Tokyo-Mitsubishi, Ltd.
A majority of our directors are independent of The Bank of
Tokyo-Mitsubishi, Ltd. and are not officers or employees of UnionBanCal
Corporation or any of our affiliates, including The Bank of Tokyo-Mitsubishi,
Ltd. However, because of The Bank of Tokyo-Mitsubishi, Ltd.'s control over the
election of our directors, we could designate ourselves as a "controlled
company" under the New York Stock Exchange Rules and could change the
composition of our Board of Directors so that the Board would not have a
majority of independent directors. The Bank of Tokyo-Mitsubishi, Ltd.'s ability
to prevent an unsolicited bid for us or any other change in control could have
an adverse effect on the market price for our common stock.
POSSIBLE FUTURE SALES OF SHARES BY THE BANK OF TOKYO-MITSUBISHI, LTD. COULD
ADVERSELY AFFECT THE MARKET FOR OUR STOCK
The Bank of Tokyo-Mitsubishi, Ltd. may sell shares of our common stock in
compliance with the federal securities laws. By virtue of The Bank of
Tokyo-Mitsubishi, Ltd.'s current control of us, The Bank of Tokyo-Mitsubishi,
Ltd. could sell large amounts of shares of our common stock by causing us to
file a registration statement that would allow them to sell shares more easily.
In addition, The Bank of Tokyo-Mitsubishi, Ltd. could sell shares of our common
stock without registration. Although we can make no prediction as to the effect,
if any, that such sales would have on the market price of our common stock,
sales of substantial amounts of our common stock, or the perception that such
sales could occur, could adversely affect the market price of our common stock.
If The Bank of Tokyo-Mitsubishi, Ltd. sells or transfers shares of our common
stock as a block, another person or entity could become our controlling
stockholder.
THE BANK OF TOKYO-MITSUBISHI, LTD.'S FINANCIAL CONDITION COULD ADVERSELY
AFFECT OUR OPERATIONS
We fund our operations independently of The Bank of Tokyo-Mitsubishi, Ltd.
and believe our business is not necessarily closely related to The Bank of
Tokyo-Mitsubishi, Ltd.'s business or outlook, including the proposed merger of
Mitsubishi Tokyo Financial Group, Inc. with UFJ Holdings, Inc. However, The Bank
of Tokyo-Mitsubishi, Ltd.'s credit ratings may affect our credit ratings. The
Bank of
59
Tokyo-Mitsubishi, Ltd. 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 The Bank of Tokyo-Mitsubishi, Ltd., and other
developments concerning The Bank of Tokyo-Mitsubishi, Ltd. including the
proposed merger with UFJ Holdings, Inc.
POTENTIAL CONFLICTS OF INTEREST WITH THE BANK OF TOKYO-MITSUBISHI, LTD.
COULD ADVERSELY AFFECT US
The Bank of Tokyo-Mitsubishi, Ltd.'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 The Bank of Tokyo-Mitsubishi, Ltd.'s normal risk
management processes, The Bank of Tokyo-Mitsubishi, Ltd. manages global credit
exposures and concentrations on an aggregate basis, including UnionBanCal
Corporation. Therefore, at certain levels or in certain circumstances, our
ability to approve certain credits or other banking transactions and categories
of customers is subject to the concurrence of The Bank of Tokyo-Mitsubishi, Ltd.
We may wish to extend credit or furnish other banking services to the same
customers as The Bank of Tokyo-Mitsubishi, Ltd. Our ability to do so may be
limited for various reasons, including The Bank of Tokyo-Mitsubishi, Ltd.'s
aggregate credit exposure and marketing policies.
Certain directors' and officers' ownership interests in The Bank of
Tokyo-Mitsubishi, Ltd.'s common stock or service as a director or officer or
other employee of both us and The Bank of Tokyo-Mitsubishi, Ltd. could create or
appear to create potential conflicts of interest, especially since both of us
compete in the U.S. 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, credit unions and major
foreign-affiliated or foreign banks, as well as many financial and nonfinancial
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 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 U.S., further
increasing competition in the U.S. 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.
60
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 or regulatory
approaches to compliance and enforcement, 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 U.S.
corporate bankruptcies and reports of accounting irregularities at U.S. 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
The Bank of Tokyo-Mitsubishi, Ltd.'s controlling ownership of us, laws,
regulations and policies adopted or enforced by the Government of Japan may
adversely affect our activities and investments and those of our subsidiaries in
the future.
In addition, our business model relies, in part, upon cross-marketing the
services offered by UnionBanCal Corporation and our subsidiaries to our
customers. Laws that restrict our ability to share information about customers
within our corporate organization could adversely affect our business, results
of operations and financial condition.
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, which
regulates the supply of money and credit in the U.S. Under long-standing policy
of the Federal Reserve Board, 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 Federal Reserve Board are (a)
conducting open market operations in U.S. 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
Federal Reserve Board may have a material effect on our business, results of
operations and financial condition.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR DIVESTITURES OR
RESTRUCTURINGS MAY ADVERSELY AFFECT US
We may seek to acquire or invest in financial and non-financial 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
opportunities 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 restructurings 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, results of operations and financial condition. Acquisitions,
divestitures or restructurings 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),
61
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 addressing these or any other significant risks encountered.
SIGNIFICANT LEGAL ACTIONS COULD SUBJECT US TO SUBSTANTIAL UNINSURED
LIABILITIES
We may be subject to claims related to our operations. Such legal actions
could involve large claims and significant defense costs. To protect ourselves
from the cost of these claims, we maintain insurance coverage in amounts and
with deductibles that we believe are appropriate for our operations. However,
our insurance coverage may not cover all claims against us or continue to be
available to us at a reasonable cost. As a result, we may be exposed to
substantial uninsured liabilities, which could adversely affect our business,
results of operations and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A complete explanation concerning our market risk exposure is incorporated
by reference to Part I, Item 2 of this document under the captions "Quantitative
and Qualitative Disclosures about Market Risk," "Liquidity Risk," and "Certain
Business Risk Factors."
ITEM 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer (principal executive officer) and Chief
Financial Officer (principal financial officer) have concluded that the design
and operation of our disclosure controls and procedures are effective as of
September 30, 2004. This conclusion is based on an evaluation conducted under
the supervision and with the participation of management. Disclosure controls
and procedures are those controls and procedures which ensure that information
required to be disclosed in this filing is accumulated and communicated to
management and is recorded, processed, summarized and reported in a timely
manner and in accordance with Securities and Exchange Commission rules and
regulations.
During the quarter ended September 30, 2004, there were no changes in our
internal controls over financial reporting that materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.
62
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to various pending and threatened legal actions that arise
in the normal course of business. We maintain reserves for losses from legal
actions that are both probable and estimable.
Union Bank of California, N.A., our major subsidiary (the Bank), was named
in a suit pending in the United States District Court for the Central District
of California, Neilson v. Union Bank of California et al (filed September 4,
2002). The plaintiffs in this suit sought in excess of $250 million, which was
alleged to have been lost by those who invested money in various investment
arrangements conducted by an individual named Reed Slatkin. We have reached an
agreement to resolve the Nielson matter, which calls for a payment by the
Company of $10 million, $6 million of which will be paid by the Company's
insurance carrier. This agreement has been submitted to the court for approval.
The disposition of this claim will not have a material adverse effect on our
financial position or results of operations, since a reserve has been
established for the loss.
Another suit, Grafton Partners LP v. Union Bank of California, is pending
in Alameda County Superior Court (filed March 12, 2003). That suit concerns a
"Ponzi" scheme perpetrated by PinnFund, USA, located in San Diego, California.
The victims of this scheme seek $235 million from the Bank. They assert that the
Bank improperly opened and administered a deposit account, which was used by
PinnFund in furtherance of the fraud.
The Bank has numerous legal defenses to the Grafton case. Based on our
evaluation to date of this claim, management believes that this matter will not
result in a material adverse effect on our financial position or results of
operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Repurchases of equity securities are presented in the table below.
TOTAL NUMBER OF MAXIMUM NUMBER (OR
SHARES (OR UNITS) APPROXIMATE DOLLAR VALUE)
TOTAL NUMBER OF PURCHASED AS PART OF OF SHARES (OR UNITS) THAT
SHARES (OR UNITS) AVERAGE PRICE PAID PUBLICLY ANNOUNCED MAY YET BE PURCHASED UNDER
PERIOD PURCHASED PER SHARE (OR UNIT) PLANS OR PROGRAMS THE PLANS OR PROGRAMS
- --------------------------- ----------------- ------------------- -------------------- --------------------------
JULY 2004
(July 23 - 30, 2004)....... 274,200 $57.28 274,200 $230,443,532
AUGUST 2004
(August 2 - 31, 2004)...... 530,000 $58.09 530,000 $199,653,218
SEPTEMBER 2004
(September 1 - 30, 2004)... 280,000 $58.42 280,000 $183,294,679(1)
--------- ---------
Total...................... 1,084,200 $57.97 1,084,200
========= =========
- --------------------
<FN>
(1) In the third quarter of 2004, we used the remaining $46 million from the
$200 million repurchase program announced on April 22, 2003. In addition,
$183 million is available from a $200 million repurchase program announced
on April 28, 2004.
</FN>
63
ITEM 6. EXHIBITS
NO. DESCRIPTION
--- ----------------------------------------------------------------------
2.1 Agreement and Plan of Merger by and among UnionBanCal Corporation,
Union Bank of California, N.A., Jackson National Insurance Company and
Jackson Federal Bank dated as of July 1, 2004(1)
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14a/15d-14(a) of the Exchange Act, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14a/15d-14(a) of the Exchange Act, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
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
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
- -------------------------------
<FN>
(1) Incorporated by reference to the UnionBanCal Corporation current
report on Form 8-K, dated July 1, 2004
</FN>
64
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)
Date: November 5, 2004 By: /S/ NORIMICHI KANARI
----------------------------------------
Norimichi Kanari
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
Date: November 5, 2004 By: /S/ DAVID I. MATSON
-----------------------------------------
David I. Matson
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(Principal Financial Officer)
Date: November 5, 2004 By: /S/ DAVID A. ANDERSON
-----------------------------------------
David A. Anderson
SENIOR VICE PRESIDENT AND CONTROLLER
(Principal Accounting Officer)
65