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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 JUNE 30, 2005
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 Exchange Act). Yes X No
--- ---
Number of shares of Common Stock outstanding at July 29, 2005: 144,447,257
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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................................................ 26
Net Interest Income.................................................. 30
Noninterest Income................................................... 33
Noninterest Expense.................................................. 33
Income Tax Expense................................................... 34
Loans................................................................ 34
Cross-Border Outstandings............................................ 36
Reversal of Allowances for Credit Losses............................. 36
Allowances for Credit Losses......................................... 36
Nonperforming Assets................................................. 40
Loans 90 Days or More Past Due and Still Accruing.................... 41
Quantitative and Qualitative Disclosures About Market Risk........... 41
Liquidity Risk....................................................... 43
Regulatory Capital................................................... 43
Business Segments.................................................... 44
Regulatory Matters................................................... 52
Factors That May Affect Future Results............................... 53
Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 59
Item 4. Controls and Procedures........................................ 59
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 60
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.... 60
Item 4. Submission of Matters to a Vote of Security Holders............ 60
Item 6. Exhibits....................................................... 61
Signatures............................................................. 62
PART I. FINANCIAL INFORMATION
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL HIGHLIGHTS
(UNAUDITED)
AS OF AND FOR THE
THREE MONTHS ENDED
--------------------------
JUNE 30, JUNE 30, PERCENT
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2005 CHANGE
- -------------------------------------------------------------- ----------- ----------- ---------
RESULTS OF OPERATIONS:
Net interest income(1)..................................... $ 400,661 $ 464,874 16.03%
Reversal of allowance for loan losses...................... (10,000) (11,000) 10.00
Noninterest income......................................... 331,010 221,350 (33.13)
Noninterest expense(2)..................................... 376,402 409,190 8.71
----------- -----------
Income before income taxes(1).............................. 365,269 288,034 (21.14)
Taxable-equivalent adjustment.............................. 803 1,018 26.77
Income tax expense......................................... 133,369 99,834 (25.14)
----------- -----------
Net income................................................. $ 231,097 $ 187,182 (19.00)
=========== ===========
PER COMMON SHARE:
Net income--basic.......................................... $ 1.56 $ 1.29 (17.31)%
Net income--diluted........................................ 1.54 1.27 (17.53)
Dividends(3)............................................... 0.36 0.41 13.89
Book value (end of period)................................. 26.98 29.51 9.38
Common shares outstanding (end of period)(4)............... 147,845,160 144,205,458 (2.46)
Weighted average common shares outstanding--basic(4)....... 147,687,350 144,547,697 (2.13)
Weighted average common shares outstanding--diluted(4)..... 150,183,938 147,222,390 (1.97)
BALANCE SHEET (END OF PERIOD):
Total assets............................................... $46,295,831 $51,178,058 10.55%
Total loans................................................ 27,594,271 32,498,221 17.77
Nonaccrual loans........................................... 178,062 66,063 (62.90)
Nonperforming assets....................................... 183,913 68,945 (62.51)
Total deposits............................................. 39,367,911 42,730,027 8.54
Medium and long-term debt.................................. 800,988 821,664 2.58
Junior subordinated debt................................... 16,017 15,564 (2.83)
Stockholders' equity....................................... 3,988,676 4,254,991 6.68
BALANCE SHEET (PERIOD AVERAGE):
Total assets............................................... $44,611,351 $49,465,234 10.88%
Total loans................................................ 26,838,622 32,223,991 20.07
Earning assets............................................. 40,351,016 44,482,833 10.24
Total deposits............................................. 37,810,048 40,723,333 7.71
Stockholders' equity....................................... 3,933,788 4,145,150 5.37
FINANCIAL RATIOS:
Return on average assets(5)................................ 2.08% 1.52%
Return on average stockholders' equity(5).................. 23.63 18.11
Efficiency ratio(6)........................................ 51.44 60.59
Net interest margin(1)..................................... 3.98 4.18
Dividend payout ratio...................................... 23.08 31.78
Tangible equity ratio...................................... 7.88 7.41
Tier 1 risk-based capital ratio............................ 10.46 8.88
Total risk-based capital ratio............................. 13.07 11.01
Leverage ratio............................................. 8.36 7.77
Allowance for credit losses to total loans(7).............. 1.82 1.47
Allowance for credit losses to nonaccrual loans(7)......... 281.60 721.05
Net loans charged off (recovered) to average total loans(5) 0.15 (0.02)
Nonperforming assets to total loans and foreclosed assets.. 0.67 0.21
Nonperforming assets to total assets....................... 0.40 0.13
- ------------------------------------
<FN>
(1) Amounts are on a taxable-equivalent basis using the federal statutory tax
rate of 35 percent.
(2) Included in noninterest expense at June 30, 2005 was a $4 million reversal
of the allowance for losses on off-balance sheet commitments.
(3) Dividends per share reflect dividends declared on UnionBanCal Corporation's
common stock outstanding as of the declaration date.
(4) Common shares outstanding reflects common shares issued less treasury
shares.
(5) Annualized.
(6) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income) and the provision for losses on off-balance sheet
commitments, as a percentage of net interest income (taxable-equivalent
basis) and noninterest income.
(7) The allowance for credit losses ratios include the allowance for losses on
off-balance sheet commitments.
</FN>
2
PART I. FINANCIAL INFORMATION
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL HIGHLIGHTS
(UNAUDITED)
AS OF AND FOR THE
SIX MONTHS ENDED
--------------------------
JUNE 30, JUNE 30, PERCENT
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2005 CHANGE
- -------------------------------------------------------------- ----------- ----------- ---------
RESULTS OF OPERATIONS:
Net interest income(1)..................................... $ 801,884 $ 906,728 13.07%
Reversal of allowance for loan losses...................... (15,000) (19,000) 26.67
Noninterest income......................................... 542,215 444,111 (18.09)
Noninterest expense(2)..................................... 749,508 816,657 8.96
----------- -----------
Income before income taxes(1).............................. 609,591 553,182 (9.25)
Taxable-equivalent adjustment.............................. 1,605 2,073 29.16
Income tax expense......................................... 219,402 181,950 (17.07)
----------- -----------
Net income................................................. $ 388,584 $ 369,159 (5.00)
=========== ===========
PER COMMON SHARE:
Net income--basic.......................................... $ 2.63 $ 2.53 (3.80)%
Net income--diluted........................................ 2.59 2.49 (3.86)
Dividends(3)............................................... 0.67 0.77 14.93
Book value (end of period)................................. 26.98 29.51 9.38
Common shares outstanding (end of period)(4)............... 147,845,160 144,205,458 (2.46)
Weighted average common shares outstanding--basic(4)....... 147,543,824 145,765,905 (1.21)
Weighted average common shares outstanding--diluted(4)..... 149,991,567 148,412,390 (1.05)
BALANCE SHEET (END OF PERIOD):
Total assets............................................... $46,295,831 $51,178,058 10.55%
Total loans................................................ 27,594,271 32,498,221 17.77
Nonaccrual loans........................................... 178,062 66,063 (62.90)
Nonperforming assets....................................... 183,913 68,945 (62.51)
Total deposits............................................. 39,367,911 42,730,027 8.54
Medium and long-term debt.................................. 800,988 821,664 2.58
Junior subordinated debt................................... 16,017 15,564 (2.83)
Stockholders' equity....................................... 3,988,676 4,254,991 6.68
BALANCE SHEET (PERIOD AVERAGE):
Total assets............................................... $43,831,266 $48,874,761 11.51%
Total loans................................................ 26,490,239 31,765,930 19.92
Earning assets............................................. 39,613,622 43,974,939 11.01
Total deposits............................................. 36,874,787 40,198,996 9.01
Stockholders' equity....................................... 3,941,855 4,176,724 5.96
FINANCIAL RATIOS:
Return on average assets(5)................................ 1.78% 1.52%
Return on average stockholders' equity(5).................. 19.82 17.82
Efficiency ratio(6)........................................ 55.72 60.69
Net interest margin(1)..................................... 4.07 4.14
Dividend payout ratio...................................... 25.48 30.43
Tangible equity ratio...................................... 7.88 7.41
Tier 1 risk-based capital ratio............................ 10.46 8.88
Total risk-based capital ratio............................. 13.07 11.01
Leverage ratio............................................. 8.36 7.77
Allowance for credit losses to total loans(7).............. 1.82 1.47
Allowance for credit losses to nonaccrual loans(7)......... 281.60 721.05
Net loans charged off to average total loans(5)............ 0.17 (0.04)
Nonperforming assets to total loans and foreclosed assets.. 0.67 0.21
Nonperforming assets to total assets....................... 0.40 0.13
- -----------------------------------
<FN>
(1) Amounts are on a taxable-equivalent basis using the federal statutory tax
rate of 35 percent.
(2) Included in noninterest expense at June 30, 2005 was a $1 million reversal
of the allowance for losses on off-balance sheet commitments.
(3) Dividends per share reflect dividends declared on UnionBanCal Corporation's
common stock outstanding as of the declaration date.
(4) Common shares outstanding reflects common shares issued less treasury
shares.
(5) Annualized.
(6) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income) and the provision for losses on off-balance sheet
commitments, as a percentage of net interest income (taxable-equivalent
basis) and noninterest income.
(7) The allowance for credit losses ratios include the allowance for losses on
off-balance sheet commitments.
</FN>
3
ITEM 1. FINANCIAL STATEMENTS
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------- ------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2005 2004 2005
- ----------------------------------------------------- -------- -------- -------- ----------
INTEREST INCOME
Loans............................................. $328,372 $451,664 $663,701 $ 867,429
Securities........................................ 108,064 102,530 213,910 203,299
Interest bearing deposits in banks................ 1,121 1,892 2,029 3,994
Federal funds sold and securities purchased
under resale agreements......................... 2,928 5,256 4,887 7,629
Trading account assets............................ 861 998 1,418 1,840
-------- -------- -------- ----------
Total interest income........................... 441,346 562,340 885,945 1,084,191
-------- -------- -------- ----------
INTEREST EXPENSE
Domestic deposits................................. 32,123 64,792 65,733 119,354
Foreign deposits.................................. 2,761 8,154 4,893 14,330
Federal funds purchased and securities sold under
repurchase agreements........................... 552 8,217 1,233 15,672
Commercial paper.................................. 1,051 7,807 2,186 12,367
Medium and long-term debt......................... 3,693 7,459 6,832 13,991
Trust notes....................................... 130 238 2,311 476
Other borrowed funds.............................. 1,178 1,817 2,478 3,346
-------- -------- -------- ----------
Total interest expense.......................... 41,488 98,484 85,666 179,536
-------- -------- -------- ----------
NET INTEREST INCOME.................................. 399,858 463,856 800,279 904,655
Reversal of allowance for loan losses(1).......... (10,000) (11,000) (15,000) (19,000)
-------- -------- -------- ----------
Net interest income after reversal of allowance
for loan losses............................... 409,858 474,856 815,279 923,655
-------- -------- -------- ----------
NONINTEREST INCOME
Service charges on deposit accounts............... 90,031 80,757 171,127 161,212
Trust and investment management fees.............. 36,788 41,590 72,610 83,553
Insurance commissions............................. 18,652 19,340 40,387 41,357
International commissions and fees................ 18,102 18,326 35,647 36,000
Merchant banking fees............................. 7,714 18,114 15,181 24,380
Foreign exchange gains, net....................... 8,294 9,296 16,638 18,236
Brokerage commissions and fees.................... 8,023 8,605 16,320 17,577
Card processing fees, net......................... 15,456 6,464 24,248 12,071
Securities gains (losses), net.................... (4) (13,313) 1,618 (12,969)
Other............................................. 127,954 32,171 148,439 62,694
-------- -------- -------- ----------
Total noninterest income........................ 331,010 221,350 542,215 444,111
-------- -------- -------- ----------
NONINTEREST EXPENSE
Salaries and employee benefits.................... 217,597 241,653 437,020 481,133
Net occupancy..................................... 32,173 34,681 63,755 68,206
Outside services.................................. 17,406 27,320 33,865 49,216
Equipment......................................... 16,883 17,292 34,154 35,025
Professional services............................. 10,290 20,682 21,593 34,392
Software.......................................... 12,908 15,617 25,903 30,245
Communications.................................... 11,810 11,067 23,968 22,603
Foreclosed asset expense (income)................. 17 (2,577) 536 (2,171)
Reversal of allowance for losses on off-balance
sheet commitments(1)............................ -- (4,000) -- (1,000)
Other............................................. 57,318 47,455 108,714 99,008
-------- -------- -------- ----------
Total noninterest expense....................... 376,402 409,190 749,508 816,657
-------- -------- -------- ----------
Income before income taxes........................ 364,466 287,016 607,986 551,109
Income tax expense................................ 133,369 99,834 219,402 181,950
-------- -------- -------- ----------
NET INCOME........................................... $231,097 $187,182 $388,584 $ 369,159
======== ======== ======== ==========
NET INCOME PER COMMON SHARE--BASIC................... $ 1.56 $ 1.29 $ 2.63 $ 2.53
======== ======== ======== ==========
NET INCOME PER COMMON SHARE--DILUTED................. $ 1.54 $ 1.27 $ 2.59 $ 2.49
======== ======== ======== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--BASIC.... 147,687 144,548 147,544 145,766
======== ======== ======== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--DILUTED.. 150,184 147,222 149,992 148,412
======== ======== ======== ==========
- ----------------------------
<FN>
(1) Beginning in the quarter ended March 31, 2005, the net change in the
allowance for losses on off-balance sheet commitments was recognized
separately from the change in the allowance for loan losses. Prior periods
have not been restated.
</FN>
See accompanying notes to condensed consolidated financial statements.
4
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED) (UNAUDITED)
JUNE 30, DECEMBER 31, JUNE 30,
(DOLLARS IN THOUSANDS) 2004 2004 2005
- ---------------------------------------------------- ----------- ------------ -----------
ASSETS
Cash and due from banks............................. $ 2,287,708 $ 2,111,185 $ 2,339,527
Interest bearing deposits in banks.................. 630,451 491,905 279,555
Federal funds sold and securities purchased under
resale agreements................................. 1,156,650 944,950 2,782,105
----------- ------------ -----------
Total cash and cash equivalents................ 4,074,809 3,548,040 5,401,187
Trading account assets.............................. 307,334 236,331 321,134
Securities available for sale:
Securities pledged as collateral................. 77,532 144,240 443,717
Held in portfolio................................ 12,151,635 11,000,754 9,905,235
Loans (net of allowance for loan losses: June 30,
2004, $501,419; December 31, 2004, $407,156;
June 30, 2005, $394,972)(1)....................... 27,092,852 30,309,800 32,103,249
Due from customers on acceptances................... 52,867 55,914 54,189
Premises and equipment, net......................... 502,204 530,431 520,505
Intangible assets................................... 56,696 61,737 51,766
Goodwill............................................ 315,356 450,961 450,669
Other assets........................................ 1,664,546 1,759,813 1,926,407
----------- ------------ -----------
Total assets................................... $46,295,831 $ 48,098,021 $51,178,058
=========== ============ ===========
LIABILITIES
Domestic deposits:
Noninterest bearing.............................. $19,255,245 $ 19,205,596 $20,730,332
Interest bearing................................. 17,982,340 19,480,868 20,333,740
Foreign deposits:
Noninterest bearing.............................. 733,394 435,999 383,171
Interest bearing................................. 1,396,932 1,053,373 1,282,784
----------- ------------ -----------
Total deposits................................. 39,367,911 40,175,836 42,730,027
Federal funds purchased and securities sold under
repurchase agreements............................. 294,597 587,249 611,233
Commercial paper.................................... 552,038 824,887 1,102,042
Other borrowed funds................................ 180,426 172,549 132,368
Acceptances outstanding............................. 52,867 55,914 54,189
Other liabilities(1)................................ 1,042,311 1,157,439 1,455,980
Medium and long-term debt........................... 800,988 816,113 821,664
Junior subordinated debt payable to subsidiary
grantor trust..................................... 16,017 15,790 15,564
----------- ------------ -----------
Total liabilities.............................. 42,307,155 43,805,777 46,923,067
----------- ------------ -----------
Commitments and contingencies--See Note 9
STOCKHOLDERS' EQUITY
Preferred stock:
Authorized 5,000,000 shares, no shares issued
or outstanding as of June 30, 2004,
December 31, 2004, and June 30, 2005............ -- -- --
Common stock, par value $1 per share at June 30,
2004, December 31, 2004 and June 30, 2005:
Authorized 300,000,000 shares, issued 149,126,860
shares as of June 30, 2004, 152,191,818 shares
as of December 31, 2004, and 153,581,401 shares
as of June 30, 2005............................. 149,127 152,192 153,581
Additional paid-in capital.......................... 712,255 881,928 948,611
Treasury stock--1,281,700 shares as of June 30,
2004, 3,831,900 shares as of December 31, 2004
and 9,375,943 shares as of June 30, 2005.......... (68,557) (223,361) (552,786)
Retained earnings................................... 3,289,676 3,526,312 3,774,097
Accumulated other comprehensive loss................ (93,825) (44,827) (68,512)
----------- ------------ -----------
Total stockholders' equity..................... 3,988,676 4,292,244 4,254,991
----------- ------------ -----------
Total liabilities and stockholders' equity..... $46,295,831 $ 48,098,021 $51,178,058
=========== ============ ===========
- ----------------------------
<FN>
(1) On December 31, 2004, UnionBanCal Corporation transferred the allowance
related to losses on off-balance sheet commitments of $83 million from the
allowance for loan losses to other liabilities. At June 30, 2005, the
allowance related to losses on off-balance sheet commitments was $82
million. Periods prior to December 31, 2004 have not been restated.
</FN>
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 CAPITAL STOCK EARNINGS INCOME (LOSS) EQUITY
- ---------------------------------- ----------- -------- ---------- --------- ---------- ------------- ----------
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 six months
ended June 30, 2004........... 388,584 388,584
Other comprehensive income,
net of tax:
Net change in unrealized
gains on cash flow hedges... (37,753) (37,753)
Net change in unrealized
losses on securities
available for sale.......... (108,834) (108,834)
Foreign currency translation
adjustment.................. 520 520
----------
Total comprehensive income........ 242,517
Dividend reinvestment plan........ 308 17 17
Deferred compensation--restricted.
stock awards.................... 130 130
Stock options exercised........... 1,117,677 1,118 44,687 45,805
Stock issued in acquisitions...... 2,008,719 2,009 112,569 114,578
Common stock repurchased(1)....... (174) (55,711) (55,885)
Dividends declared on common
stock, $0.67 per share(2)....... (98,922) (98,922)
-------- ---------- --------- ---------- ------------- ----------
Net change........................ 3,127 157,099 (55,711) 289,792 (146,067) 248,240
----------- -------- ---------- --------- ---------- ------------- ----------
BALANCE JUNE 30, 2004............. 149,126,860 $149,127 $ 712,255 $ (68,557) $3,289,676 $ (93,825) $3,988,676
=========== ======== ========== ========= ========== ============= ==========
BALANCE DECEMBER 31, 2004......... 152,191,818 $152,192 $ 881,928 $(223,361) $3,526,312 $ (44,827) $4,292,244
-------- ---------- --------- ---------- ------------- ----------
Comprehensive income
Net income--For the six months
ended June 30, 2005........... 369,159 369,159
Other comprehensive income,
net of tax:
Net change in unrealized
losses on cash flow hedges.. (11,983) (11,983)
Net change in unrealized
losses on securities
available for sale.......... (11,949) (11,949)
Foreign currency translation
adjustment.................. 263 263
Minimum pension liability
adjustment.................. (16) (16)
----------
Total comprehensive income........ 345,474
Dividend reinvestment plan........ --
Deferred compensation--restricted
stock awards.................... 208,100 208 12,414 (9,976) 2,646
Stock options exercised........... 1,181,483 1,181 54,269 55,450
Common stock repurchased(1)....... (329,425) (329,425)
Dividends declared on common
stock, $0.77 per share(2)....... (111,398) (111,398)
-------- ---------- --------- ---------- ------------- ----------
Net change........................ 1,389 66,683 (329,425) 247,785 (23,685) (37,253)
----------- -------- ---------- --------- ---------- ------------- ----------
BALANCE JUNE 30, 2005............. 153,581,401 $153,581 $ 948,611 $(552,786) $3,774,097 $ (68,512) $4,254,991
=========== ======== ========== ========= ========== ============= ==========
- -------------------
<FN>
(1) Common stock repurchased includes commission costs.
(2) 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 SIX MONTHS
ENDED JUNE 30,
--------------------------
(DOLLARS IN THOUSANDS) 2004 2005
- ---------------------------------------------------------------------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................................... $ 388,584 $ 369,159
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Reversal of allowance for loan losses............................. (15,000) (19,000)
Reversal of allowance for losses on off-balance sheet commitments. -- (1,000)
Depreciation, amortization and accretion.......................... 66,191 67,862
Provision for deferred income taxes............................... 36,430 37,984
Losses (gains) on securities available for sale................... (1,618) 12,969
Net increase in prepaid expenses.................................. (85,933) (99,920)
Net (increase) decrease in fees and other charges receivable...... 40,498 (30,279)
Net increase (decrease) in accrued expenses....................... (5,032) 45,783
Net increase (decrease) in unearned and deferred income........... (11,035) 56,281
Net increase (decrease) in other liabilities...................... 108,699 149,265
Net (increase) decrease in other assets, net of acquisitions...... 255,613 (30,445)
Net (increase) decrease in trading account assets................. (54,405) (84,803)
Loans originated for resale....................................... (263,412) (90,109)
Net proceeds from sale of loans originated for resale............. 227,434 198,950
Other, net........................................................ 4,610 (4,952)
----------- -----------
Total adjustments................................................. 303,040 208,586
----------- -----------
Net cash provided by (used in) operating activities................. 691,624 577,745
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale.............. 9,970 505,937
Proceeds from matured and called securities available for sale.... 2,004,222 1,046,619
Purchases of securities available for sale, net of acquisitions... (3,664,523) (803,180)
Net (increase) decrease in loans, net of acquisitions............. (1,213,276) (1,870,930)
Net cash provided by (paid in) acquisitions....................... (2,287) --
Other, net........................................................ (36,533) (33,620)
----------- -----------
Net cash provided by (used in) investing activities............. (2,902,427) (1,155,174)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits, net of acquisitions.......... 3,255,271 2,554,191
Net increase (decrease) in federal funds purchased and securities
sold under repurchase agreements................................ 13,629 23,984
Net increase (decrease) in commercial paper and other borrowed
funds........................................................... (21,894) 236,974
Repayment of junior subordinated debt............................. (360,825) --
Common stock repurchased.......................................... (55,885) (329,425)
Payments of cash dividends........................................ (90,925) (105,750)
Other, net........................................................ 46,342 55,713
----------- -----------
Net cash provided by (used in) financing activities............. 2,785,713 2,435,687
----------- -----------
Net increase (decrease) in cash and cash equivalents.................. 574,910 1,858,258
Cash and cash equivalents at beginning of period...................... 3,499,005 3,548,040
Effect of exchange rate changes on cash and cash equivalents.......... 894 (5,111)
----------- -----------
Cash and cash equivalents at end of period............................ $ 4,074,809 $ 5,401,187
=========== ===========
CASH PAID DURING THE PERIOD FOR:
Interest............................................................ $ 88,860 $ 162,691
Income taxes........................................................ 95,764 92,654
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisitions:
Fair value of assets acquired..................................... $ 803,713 $ --
Purchase price:
Cash............................................................ (21,772) --
Stock issued.................................................... (114,578) --
----------- -----------
Liabilities assumed............................................... $ 667,363 $ --
=========== ===========
Loans transferred to foreclosed assets (OREO)....................... $ 1,057 $ 333
See accompanying notes to condensed consolidated financial statements.
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 (US
GAAP) for interim financial reporting and the instructions to Form 10-Q and Rule
10-01 of Regulation S-X of the Rules and Regulations of the Securities and
Exchange Commission (SEC). However, they do not include all of the disclosures
necessary for annual financial statements in conformity with US GAAP. The
results of operations for the period ended June 30, 2005 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 Annual Report on Form 10-K for the year ended December 31, 2004. The
preparation of financial statements in conformity with US GAAP also requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expense during the reporting period. Actual results could differ from those
estimates.
UnionBanCal Corporation is a commercial bank holding company and has, as
its major subsidiary, a banking subsidiary, Union Bank of California, N.A. (the
Bank). The Company provides a wide range of financial services to consumers,
small businesses, middle-market companies and major corporations, primarily in
California, Oregon, and Washington, but also nationally and internationally.
Since November 1999 through June 30, 2005, the Company has announced stock
repurchase plans totaling $900 million, and as of June 30, 2005, the Company was
authorized to repurchase $162 million of the Company's common stock under these
repurchase plans. The Company repurchased $210 million, $40 million and $89
million of common stock in 2004, the first quarter of 2005, and the second
quarter of 2005, respectively, as part of these repurchase plans (amounts
exclude commission costs). Under a separate stock repurchase agreement, the
Company repurchased $200 million of its common stock in February 2005, from its
majority owner, The Bank of Tokyo-Mitsubishi, Ltd. (BTM), which is a
wholly-owned subsidiary of Mitsubishi Tokyo Financial Group, Inc. At June 30,
2005, BTM owned approximately 61 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 June 30, 2005, the Company had two stock-based employee compensation
plans. For further discussion concerning the Company's stock-based employee
compensation plans see Note 15 of the Notes to Consolidated Financial Statements
included in the Annual Report on Form 10-K for the year ended December 31, 2004.
The 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
8
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
the underlying common stock on the date of grant and, therefore, were not
included in compensation expense as allowed by current US 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 purpose of this
disclosure, the Company has recognized compensation expense for graded vesting
on a straight-line basis and without regard for forfeitures.
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- ---------------------
(DOLLARS IN THOUSANDS) 2004 2005 2004 2005
- --------------------------------------------------- -------- -------- -------- --------
AS REPORTED NET INCOME............................. $231,097 $187,182 $388,584 $369,159
Stock option-based employee compensation expense
(determined under fair value based method for
all awards, net of taxes)........................ (6,683) (5,181) (13,215) (10,725)
-------- -------- -------- --------
Pro forma net income, after stock option-based
employee compensation expense.................... $224,414 $182,001 $375,369 $358,434
======== ======== ======== ========
EARNINGS PER SHARE--BASIC
As reported................................... $ 1.56 $ 1.29 $ 2.63 $ 2.53
Pro forma..................................... $ 1.52 $ 1.26 $ 2.54 $ 2.46
EARNINGS PER SHARE--DILUTED
As reported................................... $ 1.54 $ 1.27 $ 2.59 $ 2.49
Pro forma..................................... $ 1.49 $ 1.24 $ 2.50 $ 2.43
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 months
ended June 30, 2004 and 2005 were $0.1 million and $2.5 million, respectively.
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER
POSTRETIREMENT BENEFITS
In December 2003, the Financial Accounting Standards Board (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
periodic benefit costs of defined pension plans and other defined benefit
postretirement plans. The Statement was effective for financial statements with
fiscal years ending after December 15, 2003, with additional disclosure of
expected benefits to be paid in each of the next five years and in the aggregate
for the five years thereafter required for fiscal years ending after June 15,
2004. The disclosures required under SFAS No. 132R are contained in Note 10 of
these condensed consolidated financial statements.
9
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
ACCOUNTING FOR SHARE-BASED PAYMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment", a
revision of SFAS No. 123. This Statement requires that compensation costs
related to share-based payment transactions be recognized in the financial
statements. Measurement of the cost of employee service will be based on the
grant-date fair value of the equity or liability instruments issued. That cost
will be recognized over the period during which an employee is required to
provide service in exchange for the award. Additionally, liability awards will
be remeasured each reporting period. Statement 123R replaces SFAS No. 123, and
supersedes APB No. 25. This Statement requires adoption using a modified
prospective application or a modified retrospective application. The Statement
is effective for interim periods beginning after June 15, 2005. However, on
April 14, 2005, the SEC issued rule 2005-57, which allows companies to delay
implementation of the Statement to the beginning of the next fiscal year. The
Company has not yet concluded on the method of adoption allowed by the Statement
and is currently evaluating the impact of this accounting guidance on its
financial condition and results of operations. Disclosure required under SFAS
No. 123 is shown in Note 1 of these condensed consolidated financial statements.
EXCHANGES OF NONMONETARY ASSETS
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29." This Statement amends the principle
that exchanges of nonmonetary assets should be measured based on the fair value
of the assets exchanged and more broadly provides for exceptions regarding
exchanges of nonmonetary assets that do not have commercial substance. This
Statement specifies that a nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. The provisions of the Statement are effective for nonmonetary
asset exchanges occurring in the fiscal period beginning after June 15, 2005.
Management believes that adopting this Statement will not have a material impact
on the Company's financial position or results of operations.
ACCOUNTING CHANGES AND ERROR CORRECTIONS
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." The
Statement requires that a voluntary change in accounting principle be applied
retrospectively to all prior periods financial statements presented, unless
impracticable to do so. It also provides that a change in method of depreciation
or amortization for long-lived nonfinancial asset be accounted for as a change
in accounting estimate effected by a change in accounting principle, with the
change applied prospectively and that correction of errors in previously issued
financial statements should be termed a "restatement." The Statement is
effective for fiscal years beginning after December 15, 2005. Management
believes that adopting this Statement will 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 not sufficient to permit the entity to
finance its activities by itself, or the equity investors lack a controlling
10
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
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 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 beginning after December 15,
2004. At adoption, there was no impact on the Company's financial position or
results of operations.
NOTE 3--EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
EPS incorporates the dilutive effect of common stock equivalents outstanding on
an average basis during the period. Stock options are a common stock equivalent.
The following table presents a reconciliation of basic and diluted EPS for the
three and six months ended June 30, 2004 and 2005.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------------------- --------------------------------------
2004 2005 2004 2005
------------------ ------------------ ------------------ ------------------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE DATA) BASIC DILUTED BASIC DILUTED BASIC DILUTED BASIC DILUTED
- -------------------------- -------- -------- -------- -------- -------- -------- -------- --------
Net Income................ $231,097 $231,097 $187,182 $187,182 $388,584 $388,584 $369,159 $369,159
======== ======== ======== ======== ======== ======== ======== ========
Weighted average common
shares outstanding...... 147,687 147,687 144,548 144,548 147,544 147,544 145,766 145,766
Additional shares due to:
Assumed conversion of
dilutive stock options.. -- 2,497 -- 2,674 -- 2,448 -- 2,646
-------- -------- -------- -------- -------- -------- -------- --------
Adjusted weighted average
common shares
outstanding............. 147,687 150,184 144,548 147,222 147,544 149,992 145,766 148,412
======== ======== ======== ======== ======== ======== ======== ========
Net income per share...... $ 1.56 $ 1.54 $ 1.29 $ 1.27 $ 2.63 $ 2.59 $ 2.53 $ 2.49
======== ======== ======== ======== ======== ======== ======== ========
11
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 SIX MONTHS ENDED JUNE 30, 2004:
Cash flow hedge activities:
Unrealized net losses on hedges arising during the period. $ (15,832) $ 6,056 $ (9,776)
Reclassification adjustment for net gains on hedges
included in net income.................................. (45,307) 17,330 (27,977)
--------- ------- ---------
Net change in unrealized gains on hedges.................... (61,139) 23,386 (37,753)
--------- ------- ---------
Securities available for sale:
Unrealized holding losses arising during the period on
securities available for sale........................... (174,632) 66,797 (107,835)
Reclassification adjustment for net gains on securities
available for sale included in net income............... (1,618) 619 (999)
--------- ------- ---------
Net change in unrealized losses on securities available
for sale.................................................. (176,250) 67,416 (108,834)
--------- ------- ---------
Foreign currency translation adjustment..................... 842 (322) 520
--------- ------- ---------
Net change in accumulated other comprehensive income (loss). $(236,547) $90,480 $(146,067)
========= ======= =========
FOR THE SIX MONTHS ENDED JUNE 30, 2005:
Cash flow hedge activities:
Unrealized net losses on hedges arising during the period. $ (5,712) $ 2,185 $ (3,527)
Reclassification adjustment for net gains on hedges
included in net income.................................. (13,694) 5,238 (8,456)
--------- ------- ---------
Net change in unrealized losses on hedges................... (19,406) 7,423 (11,983)
--------- ------- ---------
Securities available for sale:
Unrealized holding losses arising during the period on
securities available for sale........................... (32,319) 12,362 (19,957)
Reclassification adjustment for net losses on securities
available for sale included in net income............... 12,969 (4,961) 8,008
--------- ------- ---------
Net change in unrealized losses on securities available for
sale...................................................... (19,350) 7,401 (11,949)
--------- ------- ---------
Foreign currency translation adjustment..................... 426 (163) 263
--------- ------- ---------
Minimum pension liability adjustment........................ (26) 10 (16)
--------- ------- ---------
Net change in accumulated other comprehensive income (loss). $ (38,356) $14,671 $ (23,685)
========= ======= =========
12
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) FOREIGN MINIMUM ACCUMULATED
GAINS (LOSSES) ON SECURITES CURRENCY PENSION OTHER
ON CASH AVAILABLE TRANSLATION LIABILITY COMPREHENSIVE
(DOLLARS IN THOUSANDS) FLOW HEDGES FOR SALE ADJUSTMENT ADJUSTMENT INCOME (LOSS)
- ------------------------------ ------------- ------------- ----------- ---------- -------------
BALANCE, DECEMBER 31, 2003.... $ 43,786 $ 22,535 $ (10,293) $ (3,786) $ 52,242
Change during the period...... (37,753) (108,834) 520 -- (146,067)
------------- ------------- ----------- ---------- -------------
BALANCE, JUNE 30, 2004........ $ 6,033 $ (86,299) $ (9,773) $ (3,786) $ (93,825)
============= ============= =========== ========== =============
BALANCE, DECEMBER 31, 2004.... $ 1,429 $ (31,696) $ (7,870) $ (6,690) $ (44,827)
Change during the period...... (11,983) (11,949) 263 (16) (23,685)
------------- ------------- ----------- ---------- -------------
BALANCE, JUNE 30, 2005........ $ (10,554) $ (43,645) $ (7,607) $ (6,706) $ (68,512)
============= ============= =========== ========== =============
NOTE 5--BUSINESS COMBINATIONS
The following describes the Company's most recent acquisitions:
On January 16, 2004, the Company completed its 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 an estimated life
of 6 years.
On August 1, 2004, the Company completed its acquisition of the business
portfolio of CNA Trust Company (CNAT). The Company acquired total assets and
assumed total liabilities of $173 million, each. 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 an
estimated life of 7 years.
On October 28, 2004, the Company 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
core deposit intangibles are being amortized on an accelerated basis over an
estimated life of 7 years.
13
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 six months ended June 30, 2004 and 2005 are reflected in the table below.
IDENTIFIABLE INTANGIBLE ASSETS
----------------------------------------------------
CORE DEPOSIT RIGHTS-TO- TOTAL IDENTIFIABLE
DOLLARS IN THOUSANDS GOODWILL INTANGIBLES EXPIRATION OTHER INTANGIBLE ASSETS
- ------------------------------------ -------- ------------ ---------- ------ ------------------
Balance, December 31, 2003.......... $226,556 $ 22,117 $ 27,475 $ -- $49,592
Amounts recorded during the six
months ended June 30, 2004...... 88,800 15,809 -- -- 15,809
Amortization expense.............. -- (6,269) (2,436) (8,705)
-------- ------------ ---------- ------ ------------------
Balance, June 30, 2004.............. $315,356 $ 31,657 $ 25,039 -- $56,696
Amounts recorded during the six
months ended December 31, 2004.. 135,605 13,707 -- 2,100 15,807
Amortization expense.............. -- (8,003) (2,506) (257) (10,766)
-------- ------------ ---------- ------ ------------------
Balance, December 31, 2004.......... $450,961 $ 37,361 $ 22,533 $1,843 $61,737
Amounts recorded during the six
months ended June 30, 2005...... -- -- -- -- --
Net adjustment arising during
contingent period............... (292) -- -- -- --
Amortization expense............ -- (7,548) (2,170) (253) (9,971)
-------- ------------ ---------- ------ ------------------
Balance, June 30, 2005.............. $450,669 $ 29,813 $ 20,363 $1,590 $51,766
======== ============ ========== ====== ==================
Estimated amortization expense for
the years ending:
Remaining 2005.................... $ 7,548 $ 2,141 $251 $9,940
2006.............................. 9,571 3,672 389 13,632
2007.............................. 5,471 3,113 299 8,883
2008.............................. 3,245 2,622 231 6,098
2009.............................. 1,764 2,188 178 4,130
2010.............................. 807 1,805 138 2,749
thereafter........................ 1,407 4,822 104 6,334
------------ ---------- ------ ------------------
Total amortization expense after
June 30, 2005................... $ 29,813 $ 20,363 $1,590 $51,766
============ ========== ====== ==================
14
The table below reflects the Company's intangible assets and accumulated
amortization at June 30, 2004 and 2005.
JUNE 30, 2004 JUNE 30, 2005
----------------------------------- -----------------------------------
GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
DOLLARS IN THOUSANDS AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT
- -------------------------- -------- ------------ -------- ------ ------------ ------
Core Deposit Intangibles.. $ 53,530 $ (21,873) $ 31,657 $ 67,237 $ (37,424) $ 29,813
Rights-to-Expiration...... 35,808 (10,769) 25,039 35,808 (15,445) 20,363
Other..................... -- -- -- 2,100 (510) 1,590
-------- ------------ -------- -------- ------------ --------
Total.................. $ 89,338 $ (32,642) $ 56,696 $105,145 $ (53,379) $ 51,766
======== ============ ======== ======== ============ ========
NOTE 7--BUSINESS SEGMENTS
In April 2005, the Company announced several organizational changes that
affected its business segments. The Global Markets Group has been eliminated and
the activities of this group have been transferred. Corporate Treasury which is
responsible for Asset-Liability Management (ALM) and the investment portfolio of
the Company, is now included in "Other". The trading of securities and foreign
exchange contracts, as well as the responsibilities for customer accommodated
derivative contracts, are now included in the "Global Markets Division" of the
Community Banking and Investment Services Group. The Company is now organized
around the target markets it serves and operates in three 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 ATMs. These services include
mortgages, home equity lines of credit, consumer and commercial 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. At June 30, 2004 and 2005, this Group had
$315.4 million and $326.2 million, respectively, of goodwill assigned
to its businesses.
o The Commercial Financial Services Group provides credit, depository
and cash management services to large corporate and middle-market
companies and numerous specialty niches. 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. At June 30,
2004, this Group had no goodwill assigned to its businesses compared
to $124.5 million of goodwill assigned to its businesses at June 30,
2005.
o The International Banking Group primarily provides correspondent
banking and trade-finance products and services to international
financial institutions. The Group's revenue predominantly relates to
foreign customers.
The information, set forth in the tables on the following page, reflects
selected income statement and balance sheet items by business segment. The
information presented does not necessarily represent the business units'
financial condition and results of operations were they independent entities.
Unlike
15
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7--BUSINESS SEGMENTS (CONTINUED)
financial accounting, there is no authoritative body of guidance for management
accounting equivalent to US GAAP. Consequently, reported results are not
necessarily comparable with those presented by other companies. Included in the
table within total assets are the amounts of goodwill for each business segment
as of June 30, 2004 and 2005.
The information in these tables are 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 transfer pricing
center, the amount of the provision for loan losses over/(under) the RAROC
expected loss for the period, the earnings associated with the unallocated
equity capital and allowances for credit losses, and the residual costs of
support groups. In addition, "Other" includes the Pacific Rim Corporate Group,
which offers financial products to Japanese-owned subsidiaries located in the
U.S. and Corporate Treasury, which manages the Company's wholesale funding
needs, securities portfolio, interest rate and liquidity risk and the funds
transfer pricing system. Except as discussed above, none of the items in "Other"
are significant to the Company's business.
16
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7--BUSINESS SEGMENTS (CONTINUED)
The business units' results for the prior periods have been restated to
reflect changes in the transfer pricing methodology and the organizational
changes that have occurred.
COMMUNITY BANKING
AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL
SERVICES GROUP SERVICES GROUP BANKING GROUP
------------------ -------------------- -----------------
AS OF AND FOR THE THREE MONTHS ENDED JUNE 30,
-------------------------------------------------------------
2004 2005 2004 2005 2004 2005
- -------------------------------------- -------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS (DOLLARS IN
THOUSANDS):
Net interest income................... $179,360 $234,031 $162,147 $220,713 $ 8,946 $ 7,608
Noninterest income (expense).......... 131,089 134,993 72,638 75,898 22,261 18,319
Total revenue......................... 310,449 369,024 234,785 296,611 31,207 25,927
Noninterest expense................... 226,090 256,022 103,680 116,280 16,957 15,859
Credit expense (income)............... 7,847 7,681 26,480 21,374 645 370
Income before income tax expense...... 76,512 105,321 104,625 158,957 13,605 9,698
Income tax expense.................... 29,266 40,285 34,265 53,252 5,204 3,709
Net income............................ $ 47,246 $ 65,036 $ 70,360 $105,705 $ 8,401 $ 5,989
-------- -------- -------- -------- ------- -------
TOTAL ASSETS, END OF PERIOD (dollars
in millions):....................... $ 14,254 $ 16,798 $ 14,852 $ 18,975 $ 2,379 $ 1,992
======== ======== ======== ======== ======= =======
UNIONBANCAL
OTHER CORPORATION
------------------ --------------------
AS OF AND FOR THE THREE MONTHS ENDED JUNE 30,
--------------------------------------------
2004 2005 2004 2005
- -------------------------------------- -------- -------- -------- --------
RESULTS OF OPERATIONS (DOLLARS IN
THOUSANDS):
Net interest income................... $ 49,405 $ 1,504 $399,858 $463,856
Noninterest income (expense).......... 105,022 (7,860) 331,010 221,350
Total revenue......................... 154,427 (6,356) 730,868 685,206
Noninterest expense................... 29,675 21,029 376,402 409,190
Credit expense (income)............... (44,972) (40,425) (10,000) (11,000)
Income before income tax expense...... 169,724 13,040 364,466 287,016
Income tax expense.................... 64,634 2,588 133,369 99,834
Net income............................ $105,090 $ 10,452 $231,097 $187,182
-------- -------- -------- --------
TOTAL ASSETS, END OF PERIOD (dollars
in millions):....................... $ 14,811 $ 13,413 $ 46,296 $ 51,178
======== ======== ======== ========
17
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 SIX MONTHS ENDED JUNE 30,
-------------------------------------------------------------
2004 2005 2004 2005 2004 2005
- -------------------------------------- -------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS (DOLLARS IN
THOUSANDS):
Net interest income................... $355,928 $456,579 $319,636 $418,862 $16,521 $15,031
Noninterest income (expense).......... 249,254 269,146 142,266 140,811 40,450 35,977
Total revenue......................... 605,182 725,725 461,902 559,673 56,971 51,008
Noninterest expense................... 447,646 514,566 208,415 225,356 32,640 31,326
Credit expense (income)............... 15,684 16,639 57,706 45,042 1,249 806
Income before income tax expense...... 141,852 194,520 195,781 289,275 23,082 18,876
Income tax expense.................... 54,258 74,404 62,526 96,300 8,829 7,220
Net income............................ $ 87,594 $120,116 $133,255 $192,975 $14,253 $11,656
-------- -------- -------- -------- ------- -------
TOTAL ASSETS, END OF PERIOD (dollars
in millions):....................... $ 14,254 $ 16,798 $ 14,852 $ 18,975 $ 2,379 $ 1,992
======== ======== ======== ======== ======= =======
UNIONBANCAL
OTHER CORPORATION
------------------ ----------------------
AS OF AND FOR THE SIX MONTHS ENDED JUNE 30,
-------------------------------------------
2004 2005 2004 2005
- -------------------------------------- -------- -------- ---------- ----------
RESULTS OF OPERATIONS (DOLLARS IN
THOUSANDS):
Net interest income................... $108,194 $ 14,183 $ 800,279 $ 904,655
Noninterest income (expense).......... 110,245 (1,823) 542,215 444,111
Total revenue......................... 218,439 12,360 1,342,494 1,348,766
Noninterest expense................... 60,807 45,409 749,508 816,657
Credit expense (income)............... (89,639) (81,487) (15,000) (19,000)
Income before income tax expense...... 247,271 48,438 607,986 551,109
Income tax expense.................... 93,789 4,026 219,402 181,950
Net income............................ $153,482 $ 44,412 $ 388,584 $ 369,159
-------- -------- ---------- ----------
TOTAL ASSETS, END OF PERIOD (dollars
in millions):....................... $ 14,811 $ 13,413 $ 46,296 $ 51,178
======== ======== ========== ==========
NOTE 8--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
Derivative positions are integral components of the Company's designated
ALM 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 and deposit interest
receipt and payments, and the hedged risk is the variability in those
receipts/payments due to changes in the designated benchmark rate, e.g., U.S.
dollar
18
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
(CONTINUED)
LIBOR. In these strategies, the hedging instruments are matched with groups of
variable rate loans or deposits such that the tenor of the variable rate
loans/deposits and that of the hedging instrument are aligned. Cash flow hedging
strategies include the utilization of purchased floor, cap, corridor options and
interest rate swaps. At June 30, 2005, the weighted average remaining life of
the currently active (excluding any forward positions) cash flow hedges was
approximately 1.2 years.
The Company uses purchased interest rate floors to hedge the variable cash
flows associated with 1-month to 6-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 to 6-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 to 6-month LIBOR indexed loans. Net payments to be
received under the collar contract 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 to 6-month LIBOR indexed loans. Payments to be received
(or paid) under the swap contract 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 certificates of deposit (CDs). In these hedging
relationships, the Company hedges the LIBOR component of the CD rates, which is
1-month to 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.
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 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 contract 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
19
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
(CONTINUED)
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 second quarter of 2005,
the Company recognized a net gain of $0.1 million due to ineffectiveness, which
is recognized in noninterest expense, compared to a net loss of $0.3 million in
the second quarter of 2004.
FAIR VALUE HEDGES
HEDGING STRATEGY FOR "MARKETPATH" CERTIFICATES OF DEPOSIT
The Company engages in a hedging strategy in which interest bearing CDs
issued to customers, which are tied to the changes in the Standard and Poor's
500 index, are exchanged for a fixed rate of interest. The Company accounts for
the embedded derivative in the CDs at fair value. A total return swap that
encompasses the value of a series of options that had individually hedged each
CD is valued at fair value and any ineffectiveness resulting from the hedge and
the hedged item are recognized in noninterest expense.
HEDGING STRATEGY FOR UNIONBANCAL CORPORATION--JUNIOR SUBORDINATED DEBT
PAYABLE TO SUBSIDIARY GRANTOR TRUST (TRUST NOTES)
On February 19, 2004, the Company terminated its fair value hedge and
called its Trust Notes. Prior to this date, 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. At the
termination date, the Company recognized a net gain of $1.6 million related to
hedge ineffectiveness.
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.
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.
20
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
(CONTINUED)
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 June 30, 2005, the Company's maximum
exposure to loss for standby and commercial letters of credit was $3.2 billion
and $174.2 million, respectively. At June 30, 2005, the carrying value of the
Company's standby and commercial letters of credit totaled $8.4 million.
Exposure to loss related to these commitments is covered by the allowance for
off-balance sheet commitments. Both of these amounts are included in other
liabilities on the consolidated balance sheet.
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 June 30, 2005,
the Company had commitments to fund principal investments of $119.1 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 June 30, 2005, the Company had a maximum exposure of $5.8
million for these agreements, the last of which expire in December 2006.
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.
21
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 9--GUARANTEES (CONTINUED)
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 June 30, 2005, the Company's
maximum exposure to loss under these guarantees was limited to a return of
investor capital and minimum investment yield, or $141.4 million. The Company
maintains a reserve of $5.9 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 June 30, 2005, the Bank had a maximum exposure
to loss under the commercial paper guarantees, which have an average term of
less than one year, of $1.1 billion. 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 June
30, 2005, 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 $2.0 billion at
June 30, 2005. The market value of the associated collateral was $2.1 billion at
June 30, 2005.
22
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 and six months ended June 30, 2004 and 2005.
PENSION BENEFITS OTHER BENEFITS
-------------------- --------------------
FOR THE THREE MONTHS FOR THE THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
(DOLLARS IN THOUSANDS) 2004 2005 2004 2005
- ---------------------------------------- -------- -------- ------- -------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost............................ $ 9,511 $ 11,373 $ 1,815 $ 1,553
Interest cost........................... 13,518 14,856 2,908 2,002
Expected return on plan assets.......... (20,778) (24,028) (2,370) (2,576)
Amortization of prior service cost...... 267 267 (24) (24)
Amortization of transition amount....... -- -- 638 509
Recognized net actuarial loss........... 4,395 7,211 1,950 429
-------- -------- ------- -------
Total net periodic benefit cost......... $ 6,913 $ 9,679 $ 4,917 $ 1,893
======== ======== ======= =======
PENSION BENEFITS OTHER BENEFITS
-------------------- --------------------
FOR THE SIX MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
(DOLLARS IN THOUSANDS) 2004 2005 2004 2005
- ---------------------------------------- -------- -------- ------- -------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost............................ $ 18,829 $ 22,765 $ 3,383 $ 3,102
Interest cost........................... 26,120 29,176 5,680 4,230
Expected return on plan assets.......... (41,565) (47,933) (4,467) (5,175)
Amortization of prior service cost...... 534 534 (48) (48)
Amortization of transition amount....... -- -- 1,275 1,018
Recognized net actuarial loss........... 7,217 13,312 3,536 1,397
-------- -------- ------- -------
Total net periodic benefit cost......... $ 11,135 $ 17,854 $ 9,359 $ 4,524
======== ======== ======= =======
In 2004, the Company recorded a $6.1 million reduction in employee benefit
expense associated with the remeasurement of 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 has been
recognized since the effective date of The Act, July 1, 2004. As a result, there
was no impact recognized in the first half of 2004.
At December 31, 2004, the Company expected to make cash contributions of
$125 million to the Pension Plan and $17 million to the Health Plan for pension
and postretirement benefits, respectively, in 2005. During the first six months
of 2005, the Company made those contributions.
NOTE 11--SUBSEQUENT EVENTS
On July 27, 2005, the Company's Board of Directors declared a quarterly
cash dividend of $0.41 per share of common stock. The dividend will be paid on
October 7, 2005 to stockholders of record as of September 9, 2005.
On July 28, 2005, the Company made an additional $57 million contribution
to the Pension Plan.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT INCLUDES FORWARD-LOOKING STATEMENTS, WHICH INCLUDE FORECASTS OF
OUR FINANCIAL RESULTS AND CONDITION, EXPECTATIONS FOR OUR OPERATIONS AND
BUSINESS, AND OUR ASSUMPTIONS FOR THOSE FORECASTS AND EXPECTATIONS. DO NOT RELY
UNDULY ON FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS MIGHT DIFFER SIGNIFICANTLY
FROM OUR FORECASTS AND EXPECTATIONS. PLEASE REFER TO "FACTORS THAT MAY AFFECT
FUTURE RESULTS" FOR A DISCUSSION OF SOME FACTORS THAT MAY CAUSE RESULTS TO
DIFFER.
You should read the following discussion and analysis of our consolidated
financial condition and results of our operations for the period ended June 30,
2005 in this quarterly report on Form 10-Q together with our Consolidated
Financial Statements and the Notes to Consolidated Financial Statements included
in our Annual Report on Form 10-K for the year ended December 31, 2004.
Averages, as presented in the following tables, are substantially all based upon
daily average balances.
INTRODUCTION
We are a California-based, commercial bank holding company with
consolidated assets of $51.2 billion at June 30, 2005. At June 30, 2005, The
Bank of Tokyo-Mitsubishi, Ltd., our majority owner, owned approximately 61
percent of our outstanding common stock.
EXECUTIVE OVERVIEW
We are providing you with an overview of what we believe are the most
significant factors and developments that impacted our second quarter 2005
results and that could impact our future results. We ask that you carefully read
the rest of this document for more detailed information that will complete your
understanding of trends, events and uncertainties that impact us.
Overall credit quality continued its improving trend during the second
quarter 2005. Our nonaccrual loan portfolio has reached a historical low of $66
million at June 30, 2005 compared to $157 million at December 31, 2004 and $178
million at June 30, 2004. This decline in nonaccrual loans resulted from loan
payoffs, upgrades and a low level of new inflows. We reversed $15 million of our
allowances for credit losses (an $11 million reversal related to loans and a $4
million reversal for losses on off-balance sheet commitments) in the second
quarter 2005, compared with a reversal of $10 million in the second quarter
2004.
Net interest income grew from $400 million for the three months ended June
30, 2004 to $464 million for the three months ended June 30, 2005. Our 16
percent growth in net interest income reflects the impact of higher interest
rates and increased average earning assets and noninterest bearing deposits,
offset by lower income from our derivative hedges. We believe that as interest
rates gradually rise and our commercial loan portfolio grows, our net interest
margin will be positively impacted throughout the remainder of 2005.
Noninterest income declined in the second quarter 2005 compared with the
second quarter 2004. Excluding the $93 million gain related to the sale of our
merchant card portfolio and a $9 million gain from the sale of a building in the
second quarter 2004, our noninterest income declined by $8 million due to lower
service charges on our deposit accounts, card processing fees and a $13 million
loss on sales of securities available for sale, offset by increases in trust and
investment management fees and merchant banking fees.
Noninterest expense grew in the second quarter 2005 compared with the
second quarter 2004, primarily from the investments we made in bank
acquisitions, de novo branches and technology in 2004. We believe that these
investments will bring opportunities for growth in our business by increasing
our customer base and expanding the services we provide.
24
In the second quarter 2005, we continued our practice of returning excess
capital to our stockholders by repurchasing $89 million of our common shares in
the open market and by increasing our quarterly cash dividend to $0.41 per
share.
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.
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 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, non-energy 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,
these estimates are then reviewed by the Audit Committee of our Board of
Directors.
Understanding our accounting policies is fundamental to understanding our
consolidated financial condition and consolidated results of operations.
Accordingly, except for an update to our pension obligations accounting policy
below, our significant accounting policies are discussed in detail in Note 1 in
the "Notes to Consolidated Financial Statements" in our 2004 Annual Report on
Form 10-K filed with the Securities and Exchange Commission.
In addition to information provided in our "Critical Accounting Policies"
in our 2004 Annual Report, we are providing the following information with
respect to our discount rate for determining our obligations for pension and
other post-retirement benefits. The discount rate assumed in measuring the plan
obligations is determined by selecting high quality investments rated Aa or
higher by a recognized rating agency corresponding to each year's future benefit
payments for the next 30 years. The discount rate is calculated based on the
weighted average investment yields as of December 31 and rounded to the nearest
0.25 percent. The reduction in the discount rate from 6.25 percent at December
31, 2003 to 5.75 percent at December 31, 2004, reported in our 2004 Annual
Report, reflects the annual evaluation of our discount rate assumptions.
25
FINANCIAL PERFORMANCE
SUMMARY OF FINANCIAL PERFORMANCE
FOR THE THREE FOR THE SIX
MONTHS INCREASE (DECREASE) MONTHS INCREASE (DECREASE)
ENDED JUNE 30, 2005 VERSUS 2004 ENDED JUNE 30, 2005 VERSUS 2004
------------------- ------------------- ----------------------- ------------------
(DOLLARS IN THOUSANDS) 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT
- ---------------------------------- -------- -------- --------- ------- ---------- ---------- -------- -------
RESULTS OF OPERATIONS
Net interest income(1)........... $399,858 $463,856 $ 63,998 16.0% $ 800,279 $ 904,655 $104,376 13.0%
Noninterest income
Service charges on deposit
accounts.................... 90,031 80,757 (9,274) (10.3) 171,127 161,212 (9,915) (5.8)
Trust and investment management
fees........................ 36,788 41,590 4,802 13.1 72,610 83,553 10,943 15.1
Merchant banking fees......... 7,714 18,114 10,400 nm 15,181 24,380 9,199 60.6
Card processing fees, net..... 15,456 6,464 (8,992) (58.2) 24,248 12,071 (12,177) (50.2)
Securities gains (losses), net (4) (13,313) (13,309) nm 1,618 (12,969) (14,587) nm
Gain on private capital
investments, net............ 4,017 5,261 1,244 31.0 7,331 13,196 5,865 80.0
Gain on sale of merchant card
portfolio................... 93,000 -- (93,000) nm 93,000 -- (93,000) nm
Other noninterest income...... 84,008 82,477 (1,531) (1.8) 157,100 162,668 5,568 3.5
-------- -------- --------- ---------- ---------- --------
Total noninterest income......... 331,010 221,350 (109,660) (33.1) 542,215 444,111 (98,104) (18.1)
Total revenue.................... 730,868 685,206 (45,662) (6.2) 1,342,494 1,348,766 6,272 0.5
Reversal of allowance for loan
losses(2)..................... (10,000) (11,000) (1,000) 10.0 (15,000) (19,000) (4,000) 26.7
Noninterest expense
Salaries and employee benefits 217,597 241,653 24,056 11.1 437,020 481,133 44,113 10.1
Net occupancy................. 32,173 34,681 2,508 7.8 63,755 68,206 4,451 7.0
Outside services.............. 17,406 27,320 9,914 57.0 33,865 49,216 15,351 45.3
Professional services......... 10,290 20,682 10,392 101.0 21,593 34,392 12,799 59.3
Software...................... 12,908 15,617 2,709 21.0 25,903 30,245 4,342 16.8
Foreclosed asset expense
(income).................... 17 (2,577) (2,594) nm 536 (2,171) (2,707) nm
Reversal of allowance for
losses on off-balance sheet
commitments(2).............. -- (4,000) (4,000) nm -- (1,000) (1,000) nm
Other noninterest expense..... 86,011 75,814 (10,197) (11.9) 166,836 156,636 (10,200) (6.1)
-------- -------- --------- ---------- ---------- --------
Total noninterest expense........ 376,402 409,190 32,788 8.7 749,508 816,657 67,149 9.0
Income before income tax......... 364,466 287,016 (77,450) (21.3) 607,986 551,109 (56,877) (9.4)
Income tax....................... 133,369 99,834 (33,535) (25.1) 219,402 181,950 (37,452) (17.1)
-------- -------- --------- ---------- ---------- --------
Net income....................... $231,097 $187,182 $ (43,915) (19.0)% $ 388,584 $ 369,159 $(19,425) (5.0)%
======== ======== ========= ========== ========== ========
- ---------------------
<FN>
(1) Net interest income does not include any adjustments for fully taxable
equivalence.
(2) Beginning in the quarter ended March 31, 2005, the net change in the
allowance for losses on off-balance sheet commitments was recognized
separately from the change in the allowance for loan losses. Prior periods
have not been restated.
nm = not meaningful
</FN>
THE PRIMARY CONTRIBUTORS TO OUR FINANCIAL PERFORMANCE FOR THE SECOND
QUARTER OF 2005 COMPARED TO THE SECOND QUARTER OF 2004 ARE PRESENTED BELOW.
o The reversal of our allowance for loan losses in the second quarter of
2005 is primarily attributable to the improvement in the loan
portfolio and to the net recoveries during the quarter. Credit quality
continued to improve in our commercial loan portfolio evidenced by the
significant reductions in nonperforming assets. However, this trend is
balanced by increasing uncertainty in the economic outlook coupled
with indications that the improvement in credit quality could be
reaching its peak. (See our discussion under "Allowances for Credit
Losses.")
o Our net interest income was favorably influenced by higher earning
asset volumes (including higher volume for residential mortgages,
commercial loans and commercial mortgages), higher average
26
yields on our earning assets, strong deposit growth (including an
attractive mix of average noninterest bearing deposits to total
deposits) and higher interest recoveries. Offsetting these positive
influences to our net interest margin were higher rates on interest
bearing liabilities and lower hedge income (See our discussion under
"Net Interest Income.")
o The decrease in our noninterest income was due to several factors:
o In the second quarter 2004, we sold our merchant card portfolio
to NOVA Information Systems (NOVA). In addition, card processing
fees, net, decreased in the current year as a result of this
sale;
o In the second quarter 2005, service charges on deposits decreased
primarily due to lower account analysis fees, stemming from an
increase in the earnings credit rate on commercial deposit
balances;
o In the second quarter 2005, we sold $475 million of U.S.
government agency securities for a loss of approximately $13.3
million; partly offset by
o Higher trust and investment management fees primarily due to
continued strong sales, solid organic growth and the acquisition
of the business portfolio of CNA Trust Company (renamed
TruSource) and the corporate trust business of the BTM Trust
Company, New York. Managed assets increased by approximately 6
percent and non-managed assets increased by approximately 35
percent from the second quarter 2004 to the second quarter 2005.
Total assets under administration increased by approximately 32
percent, to $209.8 billion, for the same period; and
o Higher merchant banking fees due to an increased number of
completed syndication deals in the current quarter compared to
the prior year quarter.
o Our higher noninterest expense was due to several factors:
o Salaries and employee benefits increased primarily as a result
of:
o acquisitions and new branch openings, which accounted for
approximately 27 percent of the increase in our salaries and
other compensation;
o higher performance-related incentive expense from goal
achievements and the issuance of higher levels of restricted
stock in the second quarter of 2005;
o annual merit increases; and
o higher employee benefits expense mainly due to the impact of
the lower discount rate we used to calculate our future
pension and other postretirement liabilities (reduced from
6.25 percent at December 31, 2003 to 5.75 percent at
December 31, 2004);
o Net occupancy expense increased mainly from acquisitions, new
branch openings, the payment of a lease termination fee in the
second quarter of 2004 and the impact of lower rental income from
non-bank tenants due to bank employee occupancy as we migrate our
operations into fewer downtown San Francisco locations;
o Outside services expense increased mainly as a result of higher
vendor billings stemming from a higher earnings credit rate in
the second quarter of 2005 primarily related to title and escrow
balances;
o Professional services expenses increased mainly as a result of a
$7.4 million increase in compliance-related expenses;
o Software expense increased mainly from the purchase and
development of software to support key technology initiatives;
27
o Foreclosed asset income in the second quarter of 2005 was
primarily due to a gain on the sale of a foreclosed commercial
property;
o Provision for losses on off-balance sheet commitments, which was
previously included in the provision for loan losses, was reduced
due to improving credit quality, which favorably impacted
noninterest expense in the second quarter of 2005; and
o Other noninterest expense declined mainly due to lower reserve
expenses for litigation, partly offset by higher
acquisition-related expenses, including amortization of
intangibles.
THE PRIMARY CONTRIBUTORS TO OUR FINANCIAL PERFORMANCE FOR THE FIRST SIX
MONTHS OF 2005 COMPARED TO THE FIRST SIX MONTHS OF 2004 ARE PRESENTED
BELOW.
o The reversal of our allowance for loan losses in the first six months
of 2005 is primarily attributable to improving credit quality and
year-to-date net recoveries. Credit quality continued to improve in
our commercial loan portfolio evidenced by reductions in nonperforming
assets. However, this trend is balanced by increasing uncertainty in
the economic outlook coupled with indications that the improvement in
credit quality could be reaching its peak. (See our discussion under
"Allowances for Credit Losses.")
o Our net interest income was favorably influenced by higher earning
asset volumes (including a higher mix of residential mortgages,
commercial loans, and commercial mortgages), higher average yields on
our earning assets and strong deposit growth (including an attractive
mix of average noninterest bearing deposits to total deposits).
Offsetting these positive influences to our net interest margin were
higher rates on interest bearing liabilities and lower hedge income
(See our discussion under "Net Interest Income.")
o The decrease in our noninterest income was attributable to several
factors:
o In the second quarter 2004, we sold our merchant card portfolio
to NOVA. In addition, card processing fees, net, decreased in the
current year as result of this sale;
o In the first six months of 2005, service charges on deposits
decreased primarily due to lower account analysis fees, stemming
from an increase in the earnings credit rate on commercial
deposit balances;
o In the second quarter 2005, we sold $475 million of U.S.
government agency securities for a loss of approximately $13.3
million; partly offset by
o Trust and investment management fees increased from the first six
months 2004 primarily due to continued strong sales, solid
organic growth and the acquisition of the business portfolio of
CNA Trust Company (renamed TruSource) and the corporate trust
business of the BTM Trust Company, New York;
o Higher merchant banking fees attributable to an increased number
of completed syndication deals in the current year compared to
the prior year;
o Higher gains on the sales and capital distributions on private
capital investments compared to the prior year.
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
approximately 24 percent of the increase in our salaries and
other compensation;
28
o higher performance-related incentive expense from goal
achievements and the amortization of restricted stock in the
second quarter of 2005;
o annual merit increases; and
o higher employee benefits expense mainly attributable to the
impact of the lower discount rate we used to calculate our
future pension and other postretirement liabilities (reduced
from 6.25 percent at December 31, 2003 to 5.75 percent at
December 31, 2004) and a $3.2 million reclassification of
COLI income to other noninterest income (previously reported
as employee benefits expense in the prior year);
o Net occupancy expense increased mainly from acquisitions, new
branch openings, the payment of a lease termination fee in the
second quarter of 2004 and the impact of lower rental income from
non-bank tenants due to bank employee occupancy as we migrate our
operations into fewer downtown San Francisco locations;
o Outside services expense increased primarily as a result of
higher vendor billings stemming from a higher earnings credit
rate in the first six months of 2005 primarily related to title
and escrow balances;
o Professional services expenses increased mainly due to a $9.3
million increase in compliance-related expenses;
o Software expense increased mainly from the purchase and
development of software to support key technology initiatives;
o Foreclosed asset income in the second quarter of 2005 was
primarily attributable to a gain on the sale of a foreclosed
commercial property; and
o Other noninterest expense declined primarily as a result of lower
reserve expenses for litigation, partly offset by higher expenses
related to the Jackson Federal Bank acquisition, including
amortization of intangibles.
29
NET INTEREST INCOME
The following table shows the major components of net interest income and
net interest margin.
FOR THE THREE MONTHS ENDED
------------------------------------------------------------------ INCREASE (DECREASE) IN
JUNE 30, 2004 JUNE 30, 2005 -----------------------------------
-------------------------------- -------------------------------- 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................. $24,967,825 $ 319,829 5.14% $30,412,677 $ 436,339 5.75% $5,444,852 21.8% $116,510 36.4%
Foreign(4)............... 1,870,797 8,818 1.90 1,811,314 15,803 3.50 (59,483) (3.2) 6,985 79.2
Securities--taxable......... 11,696,096 107,146 3.66 10,964,803 101,672 3.71 (731,293) (6.3) (5,474) (5.1)
Securities--tax-exempt...... 69,654 1,424 8.18 66,207 1,347 8.14 (3,447) (4.9) (77) (5.4)
Interest bearing deposits
in banks.................. 280,892 1,121 1.61 275,472 1,892 2.75 (5,420) (1.9) 771 68.8
Federal funds sold and
securities purchased
under resale agreements... 1,143,901 2,928 1.03 696,177 5,256 3.03 (447,724) (39.1) 2,328 79.5
Trading account assets...... 321,851 883 1.10 256,183 1,049 1.64 (65,668) (20.4) 166 18.8
----------- --------- ----------- --------- ---------- --------
Total earning assets.... 40,351,016 442,149 4.40 44,482,833 563,358 5.07 4,131,817 10.2 121,209 27.4
--------- --------- --------
Allowance for loan
losses(5)................. (525,435) (402,207) 123,228 (23.5)
Cash and due from banks..... 2,233,586 2,404,587 171,001 7.7
Premises and equipment, net. 514,122 524,941 10,819 2.1
Other assets................ 2,038,062 2,455,080 417,018 20.5
----------- ----------- ----------
Total assets............ $44,611,351 $49,465,234 $4,853,883 10.9%
=========== =========== ==========
LIABILITIES
Domestic deposits:
Interest bearing.......... $11,498,694 16,198 0.57 $12,462,267 32,055 1.03 $ 963,573 8.4% 15,857 97.9
Savings and consumer time. 4,225,435 8,540 0.81 4,704,180 14,132 1.20 478,745 11.3 5,592 65.5
Large time................ 2,298,403 7,385 1.29 3,029,992 18,605 2.46 731,589 31.8 11,220 nm
Foreign deposits(4)......... 1,476,095 2,761 0.75 1,193,958 8,154 2.74 (282,137) (19.1) 5,393 nm
----------- --------- ----------- --------- ---------- --------
Total interest bearing
deposits.............. 19,498,627 34,884 0.72 21,390,397 72,946 1.37 1,891,770 9.7 38,062 nm
----------- --------- ----------- --------- ---------- --------
Federal funds purchased
and securities sold
under repurchase
agreements................ 344,416 552 0.64 1,160,373 8,217 2.84 815,957 nm 7,665 nm
Commercial paper............ 517,333 1,051 0.82 1,158,630 7,807 2.70 641,297 nm 6,756 nm
Other borrowed funds........ 176,449 1,178 2.69 197,918 1,817 3.68 21,469 12.2 639 54.2
Medium and long-term debt... 819,595 3,693 1.81 799,514 7,459 3.74 (20,081) (2.5) 3,766 nm
Trust notes................. 16,119 130 3.23 15,619 238 6.10 (500) (3.1) 108 83.1
----------- --------- ----------- --------- ---------- --------
Total borrowed funds.... 1,873,912 6,604 1.42 3,332,054 25,538 3.07 1,458,142 77.8 18,934 nm
----------- --------- ----------- --------- ---------- --------
Total interest bearing
liabilities........... 21,372,539 41,488 0.78 24,722,451 98,484 1.60 3,349,912 15.7 56,996 nm
--------- --------- --------
Noninterest bearing deposits 18,311,421 19,332,936 1,021,515 5.6
Other liabilities(5)........ 993,603 1,264,697 271,094 27.3
----------- ----------- ----------
Total liabilities....... 40,677,563 45,320,084 4,642,521 11.4
STOCKHOLDERS' EQUITY
Common equity............... 3,933,788 4,145,150 211,362 5.4
----------- ----------- ----------
Total stockholders'
equity................ 3,933,788 4,145,150 211,362 5.4
----------- ----------- ----------
Total liabilities and
stockholders' equity.. $44,611,351 $49,465,234 $4,853,883 10.9%
=========== =========== ==========
Net interest income/margin
(taxable-equivalent basis) 400,661 3.98% 464,874 4.18% 64,213 16.0
Less: taxable-equivalent
adjustment............ 803 1,018 215 26.8
--------- --------- --------
Net interest income. $ 399,858 $ 463,856 $ 63,998 16.0%
========= ========= ========
- ----------------
<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) The average allowance for losses on off-balance sheet commitments was
included in other liabilities for the quarter ended June 30, 2005. Periods
prior to December 31, 2004 have not been restated.
nm--not meaningful
</FN>
30
FOR THE SIX MONTHS ENDED
------------------------------------------------------------------ INCREASE (DECREASE) IN
JUNE 30, 2004 JUNE 30, 2005 -----------------------------------
-------------------------------- -------------------------------- 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................. $24,750,113 $ 647,762 5.26% $29,969,569 $ 838,966 5.63% $5,219,456 21.1% $191,204 29.5%
Foreign(4)............... 1,740,126 16,496 1.91 1,796,361 29,436 3.30 56,235 3.2 12,940 78.4
Securities--taxable......... 11,546,375 212,139 3.67 11,043,518 201,611 3.65 (502,857) (4.4) (10,528) (5.0)
Securities--tax-exempt...... 67,733 2,759 8.15 66,673 2,672 8.02 (1,060) (1.6) (87) (3.2)
Interest bearing deposits
in banks.................. 244,373 2,029 1.67 317,204 3,994 2.54 72,831 29.8 1,965 96.8
Federal funds sold and
securities purchased
under resale agreements... 965,448 4,887 1.02 537,615 7,629 2.86 (427,833)(44.3) 2,742 56.1
Trading account assets...... 299,454 1,478 0.99 243,999 1,957 1.62 (55,455)(18.5) 479 32.4
----------- --------- ----------- --------- ---------- --------
Total earning assets.... 39,613,622 887,550 4.50 43,974,939 1,086,265 4.96 4,361,317 11.0 198,715 22.4
--------- --------- --------
Allowance for loan losses(5) (529,803) (406,798) 123,005 (23.2)
Cash and due from banks..... 2,254,820 2,349,782 94,962 4.2
Premises and equipment, net. 517,042 526,528 9,486 1.8
Other assets................ 1,975,585 2,430,310 454,725 23.0
----------- ----------- ----------
Total assets.......... $43,831,266 $48,874,761 $5,043,495 11.5%
=========== =========== ==========
LIABILITIES
Domestic deposits:
Interest bearing.......... $11,444,746 32,755 0.58 $12,359,316 57,523 0.94 $ 914,570 8.0% 24,768 75.6
Savings and consumer time. 4,181,065 17,258 0.83 4,741,366 27,180 1.16 560,301 13.4 9,922 57.5
Large time................ 2,365,502 15,720 1.34 2,898,489 34,652 2.41 532,987 22.5 18,932 nm
Foreign deposits(4)......... 1,351,457 4,893 0.73 1,184,439 14,330 2.44 (167,018)(12.4) 9,437 nm
----------- --------- ----------- --------- ---------- --------
Total interest bearing
deposits.............. 19,342,770 70,626 0.73 21,183,610 133,685 1.27 1,840,840 9.5 63,059 89.3
----------- --------- ----------- --------- ---------- --------
Federal funds purchased and
securities sold under
repurchase agreements..... 369,941 1,233 0.67 1,219,788 15,672 2.59 849,847 nm 14,439 nm
Commercial paper............ 530,093 2,186 0.83 1,012,855 12,367 2.46 482,762 91.1 10,181 nm
Other borrowed funds........ 182,139 2,478 2.74 189,278 3,346 3.56 7,139 3.9 868 35.0
Medium and long-term debt... 812,829 6,832 1.69 804,154 13,991 3.51 (8,675) (1.1) 7,159 nm
Trust notes................. 109,571 2,311 4.22 15,676 476 6.08 (93,895)(85.7) (1,835)(79.4)
----------- --------- ----------- --------- ---------- --------
Total borrowed funds.... 2,004,573 15,040 1.51 3,241,751 45,852 2.85 1,237,178 61.7 30,812 nm
----------- --------- ----------- --------- ---------- --------
Total interest bearing
liabilities........... 21,347,343 85,666 0.81 24,425,361 179,537 1.48 3,078,018 14.4 93,871 nm
--------- --------- --------
Noninterest bearing deposits 17,532,017 19,015,386 1,483,369 8.5
Other liabilities(5)........ 1,010,051 1,257,290 247,239 24.5
----------- ----------- ----------
Total liabilities..... 39,889,411 44,698,037 4,808,626 12.1
STOCKHOLDERS' EQUITY
Common equity............... 3,941,855 4,176,724 234,869 6.0
----------- ----------- ----------
Total stockholders'
equity.............. 3,941,855 4,176,724 234,869 6.0
----------- ----------- ----------
Total liabilities and
stockholders' equity $43,831,266 $48,874,761 $5,043,495 11.5%
=========== =========== ==========
Net interest income/margin
(taxable-equivalent basis) 801,884 4.07% 906,728 4.14% 104,844 13.1
Less: taxable-equivalent
adjustment............ 1,605 2,073 468 29.2
--------- --------- --------
Net interest income... $ 800,279 $ 904,655 $104,376 13.0%
========= ========= ========
- --------------
<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) The average allowance for losses on off-balance sheet commitments was
included in other liabilities for the six months ended June 30, 2005.
Periods prior to December 31, 2004 have not been restated.
nm--not meaningful
</FN>
31
Net interest income in the second quarter 2005, on a taxable-equivalent
basis, increased 16 percent, from the second quarter 2004. Our results were
primarily attributable to the following:
o The growth in average earning assets was primarily attributable to an
increase in average loans. The increase in average loans was largely
due to a $2.6 billion increase in average residential mortgages, a
$1.3 billion increase in average commercial loans and a $1.1 billion
increase in average commercial mortgages;
o Deposit growth contributed favorably to net interest margin in the
second quarter 2005. Average noninterest bearing deposits were higher
in the second quarter 2005, compared to the second quarter 2004,
mainly attributable to higher average business demand deposits,
despite a slight decline in demand deposits from our title and escrow
clients and higher consumer demand deposit growth;
o Yields on our earning assets were favorably impacted by the increasing
interest rate environment and higher cash basis recoveries, resulting
in a higher average yield of 67 basis points on average earning
assets, despite being negatively impacted by lower hedge income, which
decreased by $18.7 million; and
o In the second quarter 2005, we continued to take advantage of our
ability to attract lower cost of funds interest-bearing core and
noninterest-bearing deposit balances, which represented approximately
47.5 percent and 48.4 percent of total deposits, in the second quarter
2005 and 2004, respectively. However, our cost of funds on interest
bearing liabilities was negatively impacted by the increasing rate
environment, resulting in a higher average cost of interest-bearing
liabilities of 82 basis points, which included lower hedge income,
which decreased by $0.7 million.
As a result of these changes, our net interest margin increased by 20 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. Throughout 2005, these derivative
positions will provide less net interest income than in 2004, 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 June 30, 2004 and 2005,
we had hedge income of $26.8 million and $7.4 million, respectively.
Net interest income in the first six months 2005, on a taxable-equivalent
basis, increased 13 percent, from the first six months 2004. Our results were
primarily attributable to the following:
o The growth in average earning assets was primarily attributable to an
increase in average loans. The increase in average loans was largely
due to a $2.5 billion increase in average residential mortgages, a
$1.3 billion increase in average commercial loans and a $1.1 billion
increase in average commercial mortgages;
o Deposit growth contributed favorably to net interest margin in the
first six months 2005. Average noninterest bearing deposits were
higher in the first six months 2005, compared to the first six months
2004, mainly attributable to higher average business demand deposits,
including demand deposits from our title and escrow clients which
remained relatively unchanged from the prior year, and higher consumer
demand deposit growth;
o Yields on our earning assets were favorably impacted by the increasing
interest rate environment and higher cash basis recoveries, resulting
in a higher average yield of 46 basis points on average earning
assets, despite being negatively impacted by lower hedge income, which
decreased by $37.4 million; and
o In the first six months 2005, we continued to take advantage of our
ability to attract lower cost of funds interest-bearing core and
noninterest-bearing deposit balances, which represented approximately
47.3 percent and 47.5 percent of total deposits, in the first six
months 2005 and 2004,
32
respectively. However, our cost of funds on interest bearing
liabilities was negatively impacted by the increasing rate
environment, resulting in a higher average cost of interest-bearing
liabilities of 67 basis points, which included lower hedge income,
which decreased by $4.7 million.
As a result of these changes, our net interest margin increased by 7 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 2005, we expect our derivative
positions will provide less in net interest income than in 2004, 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 six months ended June 30, 2004 and 2005,
we had hedge income of $59.0 million and $16.9 million, respectively.
NONINTEREST INCOME
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------------- --------------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
JUNE 30, JUNE 30, ------------------ JUNE 30, JUNE 30, ------------------
(DOLLARS IN THOUSANDS) 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT
- --------------------------- -------- -------- -------- ------- -------- -------- -------- -------
Service charges on deposit
accounts................. $ 90,031 $ 80,757 $ (9,274) (10.3)% $171,127 $161,212 $ (9,915) (5.8)%
Trust and investment
management fees.......... 36,788 41,590 4,802 13.1 72,610 83,553 10,943 15.1
Insurance commissions...... 18,652 19,340 688 3.7 40,387 41,357 970 2.4
International commissions
and fees................. 18,102 18,326 224 1.2 35,647 36,000 353 1.0
Merchant banking fees...... 7,714 18,114 10,400 nm 15,181 24,380 9,199 60.6
Foreign exchange gains, net 8,294 9,296 1,002 12.1 16,638 18,236 1,598 9.6
Brokerage commissions and
fees..................... 8,023 8,605 582 7.3 16,320 17,577 1,257 7.7
Card processing fees, net 15,456 6,464 (8,992) (58.2) 24,248 12,071 (12,177) (50.2)
Securities gains (losses),
net...................... (4) (13,313) (13,309) nm 1,618 (12,969) (14,587) nm
Gain on private capital
investments, net......... 4,017 5,261 1,244 31.0 7,331 13,196 5,865 80.0
Gain on sale of merchant
card portfolio........... 93,000 -- (93,000) nm 93,000 -- (93,000) nm
Other...................... 30,937 26,910 (4,027) (13.0) 48,108 49,498 1,390 2.9
-------- -------- -------- -------- -------- --------
Total noninterest
income............... $331,010 $221,350 $109,660 (33.1)% $542,215 $444,111 $ 98,104 (18.1)%
======== ======== ======== ======== ======== ========
- -------------
<FN>
nm--not meaningful
</FN>
NONINTEREST EXPENSE
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
-------------------------------------- --------------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
JUNE 30, JUNE 30, ------------------ JUNE 30, JUNE 30, ------------------
(DOLLARS IN THOUSANDS) 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT
- --------------------------- -------- -------- -------- ------- -------- -------- -------- -------
Salaries and other
compensation............. $174,894 $193,256 $ 18,362 10.5% $345,324 $378,450 $ 33,126 9.6%
Employee benefits.......... 42,703 48,397 5,694 13.3 91,696 102,683 10,987 12.0
-------- -------- -------- -------- -------- --------
Salaries and employee
benefits............... 217,597 241,653 24,056 11.1 437,020 481,133 44,113 10.1
Net occupancy.............. 32,173 34,681 2,508 7.8 63,755 68,206 4,451 7.0
Outside services........... 17,406 27,320 9,914 57.0 33,865 49,216 15,351 45.3
Equipment.................. 16,883 17,292 409 2.4 34,154 35,025 871 2.6
Professional services...... 10,290 20,682 10,392 101.0 21,593 34,392 12,799 59.3
Software................... 12,908 15,617 2,709 21.0 25,903 30,245 4,342 16.8
Communications............. 11,810 11,067 (743) (6.3) 23,968 22,603 (1,365) (5.7)
Data processing............ 8,409 8,663 254 3.0 16,826 17,752 926 5.5
Advertising and public
relations................ 10,814 9,022 (1,792) (16.6) 19,541 16,773 (2,768) (14.2)
Intangible asset
amortization............. 4,485 4,985 500 11.1 8,705 9,971 1,266 14.5
Foreclosed asset expense
(income)................. 17 (2,577) (2,594) nm 536 (2,171) (2,707) nm
Reversal of allowance for
losses on off-balance
sheet commitments(1)..... -- (4,000) (4,000) nm -- (1,000) (1,000) nm
Other...................... 33,610 24,785 (8,825) (26.3) 63,642 54,512 (9,130) (14.3)
-------- -------- -------- -------- -------- --------
Total noninterest
expense.............. $376,402 $409,190 $ 32,788 8.7% $749,508 $816,657 $ 67,149 9.0%
======== ======== ======== ======== ======== ========
- ----------------
<FN>
(1) Beginning in the quarter ended March 31, 2005, the net change in the
allowance for losses on off-balance sheet commitments was recognized
separately from the change in the allowance for loan losses. Prior periods
have not been restated.
nm--not meaningful
</FN>
33
INCOME TAX EXPENSE
Income tax expense in the second quarter of 2005 resulted in a 35 percent
effective income tax rate compared with an effective tax rate of 37 percent for
the second quarter of 2004. The decrease in the effective tax rate was due
primarily to increased tax credits and lower state taxes.
Income tax expense in the first six months of 2005 resulted in a 33 percent
effective tax rate compared with an effective tax rate of 36 percent for the
first six months of 2004. The decrease in the year-to-date tax rate was due
primarily to a reduction in reserves of $10.0 million in the first quarter of
2005 for estimated amounts owed to the Internal Revenue Service with respect to
certain leveraged leasing transactions.
For further information regarding income tax expense, see our Annual Report
on Form 10-K for the year ended December 31, 2004.
LOANS
The following table shows loans outstanding by loan type.
INCREASE (DECREASE)
JUNE 30, 2005 FROM:
----------------------------------------
JUNE 30, DECEMBER 31, JUNE 30, JUNE 30, DECEMBER 31,
2004 2004 2005 2004 2004
----------- ------------ ----------- ------------------- -------------------
(DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------ ---------- ------- ---------- -------
Domestic:
Commercial, financial and
industrial................ $ 9,237,338 $ 9,761,096 $10,353,000 $1,115,662 12.1% $ 591,904 6.1%
Construction................ 1,078,630 1,130,070 1,240,752 162,122 15.0 110,682 9.8
Mortgage:
Residential............... 8,224,715 9,538,150 10,457,449 2,232,734 27.1 919,299 9.6
Commercial................ 4,288,867 5,409,029 5,538,578 1,249,711 29.1 129,549 2.4
----------- ------------ ----------- ---------- ----------
Total mortgage.......... 12,513,582 14,947,179 15,996,027 3,482,445 27.8 1,048,848 7.0
Consumer:
Installment............... 794,428 767,767 790,963 (3,465) (0.4) 23,196 3.0
Revolving lines of credit. 1,379,751 1,581,866 1,676,703 296,952 21.5 94,837 6.0
----------- ------------ ----------- ---------- ----------
Total consumer.......... 2,174,179 2,349,633 2,467,666 293,487 13.5 118,033 5.0
Lease financing............. 605,358 609,090 594,952 (10,406) (1.7) (14,138) (2.3)
----------- ------------ ----------- ---------- ----------
Total loans in domestic
offices............... 25,609,087 28,797,068 30,652,397 5,043,310 19.7 1,855,329 6.4
Loans originated in foreign
branches.................... 1,981,815 1,801,988 1,830,313 (151,502) (7.6) 28,325 1.6
----------- ------------ ----------- ---------- ----------
Total loans held to
maturity................ 27,590,902 30,599,056 32,482,710 4,891,808 17.7 1,883,654 6.2
Total loans held for sale. 3,369 117,900 15,511 12,142 nm (102,389) (86.8)
----------- ------------ ----------- ---------- ----------
Total loans........... $27,594,271 $ 30,716,956 $32,498,221 $4,903,950 17.8% $1,781,265 5.8%
=========== ============ =========== ========== ==========
- ---------------
<FN>
nm--not meaningful
</FN>
COMMERCIAL, FINANCIAL AND INDUSTRIAL LOANS
Commercial, financial and industrial loans represent one of the largest
categories in the loan portfolio. These loans are extended principally to
corporations, middle-market businesses, and small businesses, with no industry
concentration exceeding 10 percent of total loans. In addition, we believe our
geographic diversification based upon our customers' revenue bases lowers our
vulnerability to changes in the regional and national outlook for the U.S
economy.
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 depository and 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
34
customer's specific industry. Presently, we are active in, among other sectors,
the oil and gas, entertainment, retailing, power and utilities and financial
services industries.
The commercial, financial and industrial loan portfolio increase in the
second quarter of 2005 from the second quarter of 2004 was mainly attributable
to increased loan demand in the California middle market and specialty segments,
which reflected the improving economy in those markets and an increase in loans
extended to our title company clients.
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.
The construction loan portfolio increase in the second quarter of 2005 from
the second quarter of 2004 was attributable to increased demand for new
single-family homes, as well as apartment, retail building and REIT financing.
This growth occurred despite continued high office vacancy rates in our markets,
which was a factor 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. The increase in commercial
mortgages in the second quarter of 2005 from the second quarter of 2004 was
mainly attributable to our acquisition of Jackson Federal Bank in the fourth
quarter of 2004, offset by substantial commercial mortgage refinancings with
other lenders.
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. At June 30,
2005, 55 percent of our residential mortgage loans were interest only. At
origination, these interest only loans had high credit scores and below 80
percent loan-to-value (LTV) ratios. The remainder of the portfolio consists of
balloon or regular amortizing loans, of which none are negative amortizing.
The increase in residential mortgages in the second quarter of 2005
compared to second quarter of 2004 was primarily driven by adjustable rate
mortgages (ARMs). Contributing to this increase were very attractive mortgage
rates in the latter half of 2004 and higher home prices. We hold most of the
loans we originate, selling only our 30-year, fixed rate loans, except for
Community Reinvestment Act (CRA) loans.
CONSUMER LOANS
We originate consumer loans, such as auto loans and home equity loans and
lines, through our branch network. The primary driver of the increase in
consumer loans was our "Flex Equity Line/Loan" product. The "Flex Equity
Line/Loan" allows our customers the flexibility to manage a line of credit and
as many as four fixed rate loans under a single product.
LEASE FINANCING
We primarily offer 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. The lease financing
decrease from June 30, 2004 was attributable to the run-off of our discontinued
auto leasing activity. At June 30, 2005, our auto lease portfolio had declined
to $9.3 million and will fully mature by mid-year 2006. Included in our lease
portfolio are leveraged leases of $577 million, which are net of non-recourse
debt of approximately $1.2 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
35
deconsolidate affiliates for financial reporting purposes. As allowed by US 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 located primarily in Asia and
energy-related lending in Canada.
CROSS-BORDER OUTSTANDINGS
Our cross-border outstandings reflect certain additional economic and
political risks that are not reflected in domestic outstandings. These risks
include those arising from exchange rate fluctuations and restrictions on the
transfer of funds. The following table sets forth our cross-border outstandings
as of June 30, 2004, December 31, 2004 and June 30, 2005, 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. For any country shown in the table below, any significant local
currency outstandings are either hedged or funded by local currency borrowings.
PUBLIC CORPORATIONS
FINANCIAL SECTOR AND OTHER TOTAL
(DOLLARS IN MILLIONS) INSTITUTIONS ENTITIES BORROWERS OUTSTANDINGS
- --------------------------- ------------ -------- ------------ ------------
June 30, 2004
Korea...................... $769 $-- $4 $773
December 31, 2004
Korea...................... $615 $-- $3 $618
June 30, 2005
Korea...................... $626 $-- $7 $633
REVERSAL OF ALLOWANCES FOR CREDIT LOSSES
We recorded a reversal of the allowance for loan losses of $11 million in
the second quarter of 2005, compared with a reversal of allowance for loan
losses of $10 million in the second quarter of 2004. Provisions for loan losses
are charged to income to bring our allowance for loan losses to a level deemed
appropriate by management based on the factors discussed under "Allowances for
Credit Losses" below. Beginning with first quarter 2005, changes in the
allowance for losses related to off-balance sheet commitments are recognized in
noninterest expense. The change in the allowance for losses on off-balance sheet
commitments in the second quarter 2005 was a reversal of $4 million.
ALLOWANCES FOR CREDIT LOSSES
ALLOWANCE POLICY AND METHODOLOGY
We maintain allowances for credit losses to absorb losses inherent in the
loan portfolio as well as for leases and off-balance sheet commitments.
Understanding our policies on allowances for credit losses is fundamental to
understanding our consolidated financial condition and consolidated results of
operations. Accordingly, our significant policies and methodology on allowances
for credit losses are discussed in detail in Note 1 in the "Notes to
Consolidated Financial Statements" and in the section "Allowances for Credit
Losses" included in our "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in our 2004 Annual Report on Form 10-K,
which was filed with the Securities and Exchange Commission.
36
COMPARISON OF THE TOTAL ALLOWANCE AND RELATED PROVISION FOR CREDIT LOSSES
FROM DECEMBER 31, 2004
At June 30, 2005, our total allowances for credit losses was $477 million,
which consisted of $395 million related to loans and $82 million related to
off-balance sheet commitments. The allowances for credit losses consisted of
$384 million and $93 million of allocated and unallocated allowance,
respectively. At June 30, 2005, our allowance for credit loss coverage ratios
were 1.47 percent of total loans and 721 percent of total nonaccrual loans. At
December 31, 2004, our total allowances for credit losses was at $490 million,
or 1.59 percent of the total loan portfolio and 313 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 June 30, 2005, total impaired loans were $48 million, and the
associated impairment allowance was $10 million, compared with $102 million and
$32 million, respectively, at December 31, 2004.
At June 30, 2005 and December 31, 2004, the allowances for losses related
to off-balance sheet commitments included within our total allowances for credit
losses, were $82 million and $83 million, respectively. In determining the
adequacy of our allowances for credit losses, we consider both the allowance for
loan losses and for losses on off-balance sheet commitments.
During the second quarter of 2005, 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.
As a result of management's assessment of factors, including improvements
in the quality of our loan portfolio, the continued improvement in the U.S.
economy and improving conditions in domestic markets in which we operate, offset
by the growth in the loan portfolio and the adverse impact of increasing fuel
costs across the whole economy, we recorded a total reversal of our allowances
for credit losses of $15 million in the second quarter 2005.
CHANGES IN THE ALLOCATED (FORMULA AND SPECIFIC) ALLOWANCE
At June 30, 2005, the formula allowance increased to $365 million, compared
to $361 million at December 31, 2004. The increase was due primarily to the
impact of increases in both the loss factors and growth in our pass-graded and
homogeneous pooled loans.
At June 30, 2005, the specific allowance decreased to $19 million, compared
to $46 million at December 31, 2004. This decrease is primarily reflective of
lower nonaccrual loans and leases.
CHANGES IN THE UNALLOCATED ALLOWANCE
At June 30, 2005, the unallocated allowance increased to $93 million from
$83 million at December 31, 2004, reflecting the heightened uncertainties
surrounding the economy and some indications that the improvement in credit
quality could be reaching its peak. Additionally, the reasons for which an
unallocated allowance is warranted are detailed below.
In our assessment as of June 30, 2005, 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
sector-specific changes in the severity of losses that are
37
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.
The following describes the specific conditions we considered.
o With respect to fuel prices, we considered the high and increasing
prices of oil and petroleum products, and the impact across virtually
all sectors of the economy, which could be in the range of $10 million
to $39 million.
o With respect to leasing, we considered a slight improvement for some
electric service providers and the continued weakness in the airline
industry, which could be in the range of $12 million to $23 million.
o With respect to commercial real estate, we considered slightly
improved 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 $22 million.
o With respect to concentrated sales (which include suppliers of "big
box" stores like Costco, Wal-Mart, Home Depot, Lowe's and other
companies that generate 15 percent or more of their revenues from one
customer), we considered the potential negative impact competitive
market pricing would have on their profit margins, which could be in
the range of $3 million to $6 million.
o With respect to cross-border exposures in certain foreign countries,
we considered the positive effect that the inflow of funds and
reconstruction efforts resulting from the December 26, 2004 tsunami
are having on certain Southeast Asian economies, the elimination of
our exposure in Eastern Europe, and the political and national debt
situation in the Philippines, which could be in the range of $2
million to $4 million.
Accordingly, our evaluation of the probable losses related to the impact of
these factors was reflected in the unallocated allowance.
38
CHANGE IN THE TOTAL ALLOWANCES FOR CREDIT LOSSES
The following table sets forth a reconciliation of changes in our
allowances for credit losses:
FOR THE
THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, INCREASE (DECREASE) ENDED JUNE 30, INCREASE (DECREASE)
------------------ ------------------ ------------------ ------------------
(DOLLARS IN THOUSANDS) 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT
- ------------------------------- -------- -------- --------- ------- -------- -------- --------- -------
Balance, beginning of period... $521,111 $404,231 $(116,880) (22.4)% $532,970 $407,156 $(125,814) (23.6)%
Loans charged off:
Commercial, financial and
industrial................. 20,721 9,936 (10,785) (52.0) 40,510 22,436 (18,074) (44.6)
Construction................. -- -- -- -- -- 118 118 nm
Commercial mortgage.......... 43 11 (32) (74.4) 43 1,307 1,264 nm
Consumer..................... 1,460 1,018 (442) (30.3) 3,275 2,101 (1,174) (35.8)
Lease financing.............. 1,666 71 (1,595) (95.7) 2,024 201 (1,823) (90.1)
-------- -------- --------- -------- -------- ---------
Total loans charged off.... 23,890 11,036 (12,854) (53.8) 45,852 26,163 (19,689) (42.9)
Recoveries of loans previously
charged off:
Commercial, financial and
industrial................. 12,091 12,232 141 1.2 20,911 31,832 10,921 52.2
Construction................. -- 34 34 nm -- 34 34 nm
Commercial mortgage.......... 1,571 25 (1,546) (98.4) 1,571 48 (1,523) (96.9)
Consumer..................... 456 411 (45) (9.9) 891 1,000 109 12.2
Lease financing.............. 77 119 42 54.5 150 136 (14) (9.3)
-------- -------- --------- -------- -------- ---------
Total recoveries of loans
previously charged off... 14,195 12,821 (1,374) (9.7) 23,523 33,050 9,527 40.5
-------- -------- --------- -------- -------- ---------
Net loans charged off
(recovered)............ 9,695 (1,785) (11,480) (118.4) 22,329 (6,887) (29,216) (130.8)
Reversal of allowance for loan
losses....................... (10,000) (11,000) (1,000) 10.0 (15,000) (19,000) (4,000) 26.7
Foreign translation adjustment
and other net additions
(deductions)(1).............. 3 (44) (47) nm 5,778 (71) (5,849) (101.2)
-------- -------- --------- -------- -------- ---------
Ending balance of allowance
for loan losses(2)........... $501,419 $394,972 $(106,447) (21.2)% $501,419 $394,972 $(106,447) (21.2)%
Allowance for losses on off-
balance sheet commitments(2). -- 81,375 81,375 nm -- 81,375 81,375 nm
-------- -------- --------- -------- -------- ---------
Allowance for credit losses.... $501,419 $476,347 $(25,072) (5.0)% $501,419 $476,347 $(25,072) (5.0)%
======== ======== ========= ======== ======== =========
Allowance for credit losses to
total loans................. 1.82% 1.47% 1.82% 1.47%
Reversal of allowance for loan
losses to net loans charged
off (recovered).............. nm 616.25 nm 275.88
Net loans charged off
(recovered) to average loans
outstanding for the period(3) 0.15 (0.02) 0.17 (0.04)
- ------------------
<FN>
(1) Includes $5.7 million related to the Business Bank of California
acquisition in the first quarter of 2004.
(2) On December 31, 2004, UnionBanCal Corporation transferred the allowance for
losses on off-balance sheet commitments of $83 million from allowance for
loan losses to other liabilities. At June 30, 2005, the allowance for
losses on off-balance commitments was $82 million. Periods prior to
December 31, 2004 have not been restated.
(3) Annualized.
nm--not meaningful
</FN>
Total loans charged off in the second quarter 2005 decreased from the
second quarter 2004, primarily attributable to improvements in loan quality.
Charge-offs reflect the realization of losses in the portfolio that were
recognized previously through provisions for credit losses. In addition, second
quarter 2005 recoveries of loans previously charged off decreased from the
second quarter of 2004, primarily attributable to higher recoveries of
commercial mortgages in the second quarter of 2004. Such fluctuations
39
in loan recoveries from year-to-year are due to variability in timing of
recoveries and tend to trail the periods in which charge-offs are recorded.
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 due 90 days with respect to principal or interest. For a more
detailed discussion of the accounting for nonaccrual loans, see Note 1 to our
Consolidated Financial Statements in our 2004 Annual Report on Form 10-K, which
has been filed with the Securities and Exchange Commission.
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)
JUNE 30, 2005 FROM:
---------------------------------------
JUNE 30, DECEMBER 31,
2004 2004
JUNE 30, DECEMBER 31, JUNE 30, ------------------ ------------------
(DOLLARS IN THOUSANDS) 2004 2004 2005 AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------- -------- ------------ -------- --------- ------- -------- -------
Commercial, financial and
industrial................... $111,015 $ 72,600 $ 35,510 $ (75,505) (68.0)% $(37,090) (51.1)%
Construction................... 5,401 2,622 1,425 (3,976) (73.6) (1,197) (45.7)
Commercial mortgage............ 22,717 26,520 11,168 (11,549) (50.8) (15,352) (57.9)
Lease financing................ 36,719 54,894 17,960 (18,759) (51.1) (36,934) (67.3)
Loan originated in foreign
branches..................... 2,210 -- -- (2,210) (100.0) -- --
-------- ------------ -------- --------- --------
Total nonaccrual loans..... 178,062 156,636 66,063 (111,999) (62.9) (90,573) (57.8)
Foreclosed assets.............. 5,851 7,282 2,882 (2,969) (50.7) (4,400) (60.4)
-------- ------------ -------- --------- --------
Total nonperforming assets. $183,913 $ 163,918 $ 68,945 $(114,968) (62.5) $(94,973) (57.9)
======== ============ ======== ========= ========
Allowances for credit losses(1) $501,419 $ 489,531 $476,347 $ (25,072) (5.0)% $(13,184) (2.7)%
======== ============ ======== ========= ========
Nonaccrual loans to total loans 0.65% 0.51% 0.20%
Allowances for credit losses to
nonaccrual loans............. 281.60 312.53 721.05
Nonperforming assets to total
loans and foreclosed assets.. 0.67 0.53 0.21
Nonperforming assets to total
assets....................... 0.40 0.34 0.13
- --------------------
<FN>
(1) Includes allowance for losses on off-balance sheet commitments.
</FN>
At June 30, 2005, our nonperforming assets included approximately $18.0
million in aircraft leases and $15.3 million in acquired syndicated loans. The
decrease in nonaccrual lease financings was primarily due to the return to
accrual status of an aircraft lease. During the second quarter 2005, we had no
sales of nonperforming loans compared to approximately $8 million in the second
quarter 2004. Losses from these sales were reflected in our charge-offs.
40
LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING
INCREASE (DECREASE)
JUNE 30, 2005 FROM:
---------------------------------------
JUNE 30, DECEMBER 31, JUNE 30, JUNE 30, DECEMBER 31,
2004 2004 2005 2004 2004
-------- ------------ -------- ------------------ ------------------
(DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------- --------- ------- -------- -------
Commercial, financial and
industrial................... $ 798 $ 1,315 $ 578 $ (220) (27.6)% $ (737) (56.0)%
Construction................... 2,919 -- 1,180 (1,739) (59.6) 1,180 nm
Mortgage:
Residential.................. 4,588 1,385 1,929 (2,659) (58.0) 544 39.3
Commercial................... -- -- 30 30 nm 30 nm
-------- ------------ -------- --------- --------
Total mortgage............. 4,588 1,385 1,959 (2,629) (57.3) 574 41.4
Consumer and other............. 1,535 1,157 643 (892) (58.1) (514) (44.4)
-------- ------------ -------- --------- --------
Total loans 90 days or more
past due and still accruing.. $ 9,840 $ 3,857 $ 4,360 $ (5,480) (55.7)% $ 503 13.0%
======== ============ ======== ========= ========
- ------------------
<FN>
nm = not meaningful
</FN>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk exists primarily in interest rate risk in our
non-trading balance sheet and to a much lesser degree in price risk in our
trading portfolio for our customer-focused trading and sales activities. The
objective of market risk management is to mitigate an undue adverse impact on
earnings and capital arising from changes in interest rates and other market
variables. 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, approves
our Asset-Liability Management (ALM) Policy, which governs the management of
market risk and liquidity. In the administration of market risk management, the
Chief Executive Officer (CEO) Forum provides broad and strategic guidance and,
as appropriate, specific direction to the Asset & Liability Management Committee
(ALCO) whose voting members are comprised of senior executives. ALCO is
responsible for ongoing management of interest rate and price risks as well as
liquidity risk, including formulation of risk management strategies, in
accordance with the CEO Forum's directives. The Treasurer is primarily
responsible for the implementation of risk management strategies approved by
ALCO and for operating management of market risk through the funding, investment
and derivatives hedging activities of Corporate Treasury.
The Market Risk Monitoring (MRM) unit is responsible for the monitoring and
reporting of market risk, including ensuring that ALCO, our senior management
and the Board are kept fully informed as to our market risk profile and
compliance with applicable limits, guidelines and policies. MRM functions
independently of all operating and management units.
We have separate and distinct methods for managing the market risk
associated with our ALM activities and our trading activities.
INTEREST RATE RISK MANAGEMENT (OTHER THAN TRADING)
During the second quarter 2005, our asset-sensitivity continued to
increase. This reflected the strategic decision to allow maturing ALM securities
and derivative positions to run-off. These actions were
41
complemented by changes in the core balance sheet that tended to promote
increased asset-sensitivity. For additional information, see--"ALM Activities"
section below.
The increase in our asset-sensitivity is evidenced in the table below. A
+200 basis points parallel rate shift at June 30, 2005 would have produced an
estimated 2.7 percent increase in Economic NII (net interest income), while a
- -200 basis points shift would have lowered Economic NII by an estimated 3.5
percent. This compares with an estimated 1.1 percent and 1.5 percent,
respectively, at June 30, 2004. We caution, however, that modeling changes
implemented over this period may make year-over-year comparisons misleading.
Economic NII adjusts our reported NII for the effect of certain non-interest,
DDA-related, fee and expense items. Those adjustment items are innately
liability-sensitive, meaning that reported NII is more asset-sensitive than is
Economic NII.
ECONOMIC NII
JUNE 30, JUNE 30,
(DOLLARS IN MILLIONS) 2004 2005
- ------------------------------------------------------ -------- ---------
+200 basis points..................................... $17.2 $51.3
as a percentage of base case NII...................... 1.13% 2.68%
- -200 basis points..................................... $(23.1) $(66.5)
as a percentage of base case NII...................... 1.52% 3.48%
In the case of non-parallel yield curve changes, we remain asset-sensitive
both to changes in long-term rates (with short-term rates held constant) and to
the converse.
ALM ACTIVITIES
In general, our unhedged, core balance sheet is asset sensitive, meaning
that our loans generally re-price more quickly than our core deposits. In
managing the interest sensitivity of our balance sheet, we use the ALM
securities portfolio and derivatives positions as our primary tools. During the
second quarter, we continued to allow maturations in our relatively short
duration ALM securities to help support loan growth. Together with the continued
maturation of our existing derivative hedges, this had the effect of increasing
our asset-sensitivity during the course of the second quarter.
ALM INVESTMENTS
At June 30, 2005, our securities available for sale portfolio included $9.0
billion of securities for ALM purposes, compared with $11.7 billion at June 30,
2004. During the second quarter 2005, in addition to allowing our ALM fixed rate
portfolio to run off as part of our strategy to allow our core asset sensitivity
to increase, we sold $475 million of low-yielding Agency securities to fund loan
growth. The estimated ALM portfolio effective duration was 1.9 at June 30, 2005,
compared to 2.7 at June 30, 2004.
Effective duration is a measure of price sensitivity of a bond portfolio to
immediate parallel shifts in interest rates. An effective duration of 1.9
suggests an expected price change of approximately minus 1.9 percent for an
immediate one percent rise in interest rates.
ALM DERIVATIVES
We also continued to allow our ALM derivatives to mature and reduced the
net level of interest rate derivatives by $830 million during the quarter. This
strategy further contributed to our rising core asset-sensitivity. For
additional discussion of derivative instruments and our hedging strategies, see
Note 8 to our Condensed Consolidated Financial Statements included in this
report and Note 18 to our Consolidated Financial Statements included in our
Annual Report on Form 10-K for the year ended December 31, 2004.
42
TRADING ACTIVITIES
Effective January 1, 2005, the Securities Trading and Institutional Sales
department, which serves the fixed-income needs of our institutional clients,
was combined with the retail brokerage operations of our broker/dealer
subsidiary, UnionBanc Investment Services LLC. The vast majority of our
securities trading income comes from customer-related transactions. UnionBanc
Investment Services LLC's trading risk is closely monitored and tightly
controlled using the existing Value-at-Risk methodology.
We began marketing energy derivatives contracts to existing energy industry
customers, primarily oil and gas producers, in late 2004, in order to meet their
hedging needs. Volume increased from $42 million in notional amount of contracts
outstanding as of December 31, 2004 to $650 million as of June 30, 2005.
Consistent with our customer interest rate derivatives business, all
transactions are fully matched to remove our exposure to market risk, with
income produced from the credit spread earned.
For information about the market risk in our trading activities, please see
"Quantitative and Qualitative Disclosures about Market Risk" in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in our
Annual Report on Form 10-K for the year ended December 31, 2004.
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. ALCO conducts monthly ongoing reviews
of our liquidity situation as well as regular updates to our CEO Forum who
approve our liquidity contingency plan. Liquidity is managed through this ALCO
coordination process on an entity-wide basis, encompassing all major business
units. The operating management of liquidity is implemented through the funding
and investment functions. 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 time deposits (of $100 thousand or
less), combined with average common stockholders' equity, funded over 82 percent
of average total assets of $49 billion in the second quarter of 2005. Most of
the remaining funding was provided by short-term borrowings in the form of
negotiable certificates of deposit, large time deposits, foreign deposits,
federal funds purchased, securities sold under repurchase agreements, commercial
paper, and other borrowings.
The securities portfolio provides additional enhancement to our liquidity
position, which may be created through either securities sales or repurchase
agreements. At June 30, 2005, we could have sold or transferred under repurchase
agreements almost $7 billion of our available for sale securities. 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 $1 billion during the
quarter. Additional liquidity may be provided through loan maturities and sales.
REGULATORY CAPITAL
The following tables summarize our risk-based capital, risk-weighted
assets, and risk-based capital ratios.
43
UNIONBANCAL CORPORATION
MINIMUM
JUNE 30, DECEMBER 31, JUNE 30, REGULATORY
(DOLLARS IN THOUSANDS) 2004 2004 2005 REQUIREMENT
- ------------------------ ---------------- ---------------- ---------------- ----------------
CAPITAL COMPONENTS
Tier 1 capital.......... $ 3,706,202 $ 3,817,698 $ 3,814,576
Tier 2 capital.......... 922,122 968,294 915,081
---------------- ---------------- ----------------
Total risk-based capital $ 4,628,324 $ 4,785,992 $ 4,729,657
================ ================ ================
Risk-weighted assets.... $ 35,422,904 $ 39,324,859 $ 42,958,478
================ ================ ================
Quarterly average assets $ 44,339,052 $ 47,168,683 $ 49,123,946
================ ================ ================
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------ ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to
risk-weighted assets). $4,628,324 13.07% $4,785,992 12.17% $4,729,657 11.01%>$3,436,678 8.0%
Tier 1 capital (to
risk-weighted assets). 3,706,202 10.46 3,817,698 9.71 3,814,576 8.88 > 1,718,339 4.0
Leverage(1)............. 3,706,202 8.36 3,817,698 8.09 3,814,576 7.77 > 1,964,958 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"
JUNE 30, DECEMBER 31, JUNE 30, REGULATORY REGULATORY
(DOLLARS IN THOUSANDS) 2004 2004 2005 REQUIREMENT REQUIREMENT
- ------------------------ ---------------- ---------------- ---------------- ---------------- ----------------
CAPITAL COMPONENTS
Tier 1 capital.......... $ 3,695,565 $ 3,597,738 $ 3,844,620
Tier 2 capital.......... 476,900 493,756 457,607
---------------- ---------------- ----------------
Total risk-based capital $ 4,172,465 $ 4,091,494 $ 4,302,227
================ ================ ================
Risk-weighted assets.... $ 34,925,361 $ 38,711,682 $ 42,299,041
================ ================ ================
Quarterly average assets $ 43,688,650 $ 46,588,762 $ 48,528,048
================ ================ ================
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------ ---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to risk-
weighted assets).. $4,172,465 11.95% $4,091,494 10.57% $4,302,227 10.17%>$3,383,923 8.0% >$4,229,904 10.0%
Tier 1 capital (to risk-
weighted assets)...... 3,695,565 10.58 3,597,738 9.29 3,844,620 9.09 > 1,691,962 4.0 > 2,537,942 6.0
Leverage(1)............. 3,695,565 8.46 3,597,738 7.72 3,844,620 7.92 > 1,941,122 4.0 > 2,426,402 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).
The decrease in our capital ratios from June 30, 2004, was attributable to
higher risk-weighted assets. Our Leverage ratio decrease was primarily
attributable to a $5 billion, or 11 percent, increase in quarterly average
assets, which was substantially the result of increases in both our residential
mortgage and commercial loan portfolios.
As of June 30, 2005, 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
In April 2005, we announced several organizational changes that affected
our business segments. The Global Markets Group has been eliminated and the
activities of this group have been transferred. Corporate Treasury, which is
responsible for ALM and the investment portfolio, is now included in "Other."
The trading of securities and foreign exchange contracts, as well as the
responsibilities for customer accommodated derivative contracts are now included
in the "Global Markets Division" of the Community Banking and Investment
Services Group. We are now organized around the target markets we serve and
operate in three principal areas, as shown in the table that follows. The
results show the financial performance of our major business units.
44
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, market and operational. 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 all other factors, such as
failures in internal control, system failures, or external events. RAROC is one
of several measures that is used to measure business unit compensation.
The following tables reflect the condensed income statements, selected
average balance sheet items, and selected financial ratios, including changes
from the prior year, for each of our primary business units. The information
presented does not necessarily represent the business units' financial condition
and results of operations as if they were independent entities. Also, the table
has been expanded to include performance center earnings. A performance center
is a special unit 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 Securities Trading and Sales unit within the Global
Markets Division, is a performance center that manages the fixed income
securities activities. Unlike financial accounting, there is no authoritative
body of guidance for management accounting equivalent to US GAAP. Consequently,
reported results are not necessarily comparable with those presented by other
companies.
The RAROC measurement methodology recognizes credit expense for expected
losses arising from credit risk and attributes economic capital related to
unexpected losses arising from credit, market and operational risks. As a result
of the methodology used by the RAROC model to calculate expected losses,
differences between the provision for credit losses and credit expense in any
one period could be significant. However, over an economic cycle, the cumulative
provision for credit losses and credit expense for expected losses should be
substantially the same. Business unit results are based on an internal
management reporting system used by management to measure the performance of the
units and UnionBanCal Corporation as a whole. Our management reporting system
identifies balance sheet and income statement items for 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 allocated
to the business units based on a predetermined percentage of usage.
45
The business units' results for the prior periods have been restated to
reflect changes in the transfer pricing methodology and the organizational
changes that have occurred.
COMMUNITY BANKING COMMERCIAL INTERNATIONAL
AND INVESTMENT FINANCIAL BANKING
SERVICES GROUP SERVICES GROUP GROUP
----------------- ----------------- ---------------
AS OF THE THREE 2005 VS. 2004 AS OF THE THREE 2005 VS. 2004 AS OF THE THREE 2005 VS. 2004
MONTHS ENDED INCREASE MONTHS ENDED INCREASE MONTHS ENDED INCREASE
JUNE 30, (DECREASE) JUNE 30, (DECREASE) JUNE 30, (DECREASE)
----------------- --------------- ----------------- --------------- --------------- ---------------
2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT
-------- -------- ------- ------- -------- -------- ------- ------- ------- ------- ------- -------
RESULTS OF OPERATIONS
AFTER PERFORMANCE
CENTER EARNINGS
(DOLLARS IN THOUSANDS):
Net interest income.. $179,360 $234,031 $54,671 30% $162,147 $220,713 $58,566 36% $ 8,946 $ 7,608 $(1,338) (15)%
Noninterest income
(expense).......... 131,089 134,993 3,904 3 72,638 75,898 3,260 4 22,261 18,319 (3,942) (18)
-------- -------- ------- -------- -------- ------- ------- ------- -------
Total revenue........ 310,449 369,024 58,575 19 234,785 296,611 61,826 26 31,207 25,927 (5,280) (17)
Noninterest expense.. 226,090 256,022 29,932 13 103,680 116,280 12,600 12 16,957 15,859 (1,098) (6)
Credit expense....... 7,847 7,681 (166) (2) 26,480 21,374 (5,106) (19) 645 370 (275) (43)
-------- -------- ------- -------- -------- ------- ------- ------- -------
Income before income
tax expense........ 76,512 105,321 28,809 38 104,625 158,957 54,332 52 13,605 9,698 (3,907) (29)
Income tax expense... 29,266 40,285 11,019 38 34,265 53,252 18,987 55 5,204 3,709 (1,495) (29)
-------- -------- ------- -------- -------- ------- ------- ------- -------
Net income........... $ 47,246 $ 65,036 $17,790 38 $ 70,360 $105,705 $35,345 50 $ 8,401 $ 5,989 $(2,412) (29)
======== ======== ======= ======== ======== ======= ======= ======= =======
PERFORMANCE CENTER
EARNINGS
(DOLLARS IN THOUSANDS):
Net interest income.. $ 156 $ 54 $ (102) (65) $ (110) $(81)$ 29 26 $ 26 $ 17 $ (9) (35)
Noninterest income... (19,143) (15,721) 3,422 18 15,271 11,590 (3,681) (24) 343 568 225 66
Noninterest expense.. (9,068) (5,661) 3,407 38 8,015 4,786 (3,229) (40) 22 247 225 1,023
Net income (loss).... (6,143) (6,187) (44) (1) 4,450 4,298 (152) (3) 215 208 (7) (3)
Total loans (dollars
in millions)....... 28 24 (4) (14) (46) (48) (2) (4) -- -- -- na
AVERAGE BALANCES
(DOLLARS IN MILLIONS):
Total loans(1)....... $ 12,256 $ 15,046 $ 2,790 23 $ 12,140 $15,331 $ 3,191 26 $ 1,820 $ 1,644 $ (176) (10)
Total assets......... 13,609 16,470 2,861 21 14,467 18,753 4,286 30 2,254 2,007 (247) (11)
Total deposits(1).... 19,332 20,366 1,034 5 14,380 15,527 1,147 8 2,041 1,412 (629) (31)
FINANCIAL RATIOS:
Risk adjusted return
on capital(2)...... 26% 34% 19% 26% 54% 43%
Return on average
assets(2).......... 1.40 1.58 1.96 2.26 1.50 1.20
Efficiency ratio(3).. 72.83 69.38 44.16 39.20 54.34 61.17
UNIONBANCAL
OTHER CORPORATION
----------------- -----------------
AS OF THE THREE 2005 VS. 2004 AS OF THE THREE 2005 VS. 2004
MONTHS ENDED INCREASE MONTHS ENDED INCREASE
JUNE 30, (DECREASE) JUNE 30, (DECREASE)
----------------- ----------------- ----------------- ------------------
2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT
-------- -------- -------- ------- -------- -------- --------- -------
RESULTS OF OPERATIONS
AFTER PERFORMANCE
CENTER EARNINGS
(DOLLARS IN THOUSANDS):
Net interest income.. $ 49,405 $ 1,504 $(47,901) (97)% $399,858 $463,856 $ 63,998 16%
Noninterest income
(expense)........... 105,022 (7,860)(112,882) (107) 331,010 221,350 (109,660) (33)
-------- -------- -------- -------- -------- ---------
Total revenue........ 154,427 (6,356)(160,783) (104) 730,868 685,206 (45,662) (6)
Noninterest expense.. 29,675 21,029 (8,646) (29) 376,402 409,190 32,788 9
Credit expense....... (44,972) (40,425) 4,547 10 (10,000) (11,000) (1,000) (10)
-------- -------- -------- -------- -------- ---------
Income before income
tax expense........ 169,724 13,040 (156,684) (92) 364,466 287,016 (77,450) (21)
Income tax expense... 64,634 2,588 (62,046) (96) 133,369 99,834 (33,535) (25)
-------- -------- -------- -------- -------- ---------
Net income........... $105,090 $ 10,452 $(94,638) (90) $231,097 $187,182 $ (43,915) (19)
======== ======== ======== ======== ======== =========
PERFORMANCE CENTER
EARNINGS (DOLLARS IN
THOUSANDS):
Net interest income.. $ (72)$ 10 $ 82 114 $ -- $ -- $ -- na
Noninterest income... 3,529 3,563 34 1 -- -- -- na
Noninterest expense.. 1,031 628 (403) (39) -- -- -- na
Net income (loss).... 1,478 1,681 203 14 -- -- -- na
Total loans (dollars
in millions)....... 18 24 6 33 -- -- -- na
AVERAGE BALANCES
(DOLLARS IN MILLIONS):
Total loans(1)....... $ 623 $ 203 $ (420) (67) $ 26,839 $ 32,224 $ 5,385 20
Total assets......... 14,281 12,235 (2,046) (14) 44,611 49,465 4,854 11
Total deposits(1).... 2,057 3,418 1,361 66 37,810 40,723 2,913 8
FINANCIAL RATIOS:
Risk adjusted return
on capital(2)...... na na na na
Return on average
assets(2).......... na na 2.08% 1.52%
Efficiency ratio(3).. na na 51.44 60.59
- ------------------
<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) and provision for losses on off-balance sheet commitments,
as a percentage of net interest income and noninterest income.
na = not applicable
</FN>
46
COMMUNITY BANKING COMMERCIAL INTERNATIONAL
AND INVESTMENT FINANCIAL BANKING
SERVICES GROUP SERVICES GROUP GROUP
----------------- ----------------- ---------------
AS OF THE SIX 2005 VS. 2004 AS OF THE SIX 2005 VS. 2004 AS OF THE SIX 2005 VS. 2004
MONTHS ENDED INCREASE MONTHS ENDED INCREASE MONTHS ENDED INCREASE
JUNE 30, (DECREASE) JUNE 30, (DECREASE) JUNE 30, (DECREASE)
----------------- ---------------- ----------------- --------------- --------------- ---------------
2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT
-------- -------- -------- ------- -------- -------- ------- ------- ------- ------- ------- -------
RESULTS OF OPERATIONS
AFTER PERFORMANCE
CENTER EARNINGS
(DOLLARS IN
THOUSANDS):
Net interest income.. $355,928 $456,579 $100,651 28% $319,636 $418,862 $99,226 31% $16,521 $15,031 $(1,490) (9)%
Noninterest income
(expense).......... 249,254 269,146 19,892 8 142,266 140,811 (1,455) (1) 40,450 35,977 (4,473) (11)
-------- -------- -------- -------- -------- ------- ------- ------- -------
Total revenue........ 605,182 725,725 120,543 20 461,902 559,673 97,771 21 56,971 51,008 (5,963) (10)
Noninterest expense.. 447,646 514,566 66,920 15 208,415 225,356 16,941 8 32,640 31,326 (1,314) (4)
Credit expense....... 15,684 16,639 955 6 57,706 45,042 (12,664) (22) 1,249 806 (443) (35)
-------- -------- -------- -------- -------- ------- ------- ------- -------
Income before income
tax expense........ 141,852 194,520 52,668 37 195,781 289,275 93,494 48 23,082 18,876 (4,206) (18)
Income tax expense... 54,258 74,404 20,146 37 62,526 96,300 33,774 54 8,829 7,220 (1,609) (18)
-------- -------- -------- -------- -------- ------- ------- ------- -------
Net income........... $ 87,594 $120,116 $ 32,522 37 $133,255 $192,975 $59,720 45 $14,253 $11,656 $(2,597) (18)
======== ======== ======== ======== ======== ======= ======= ======= =======
PERFORMANCE CENTER
EARNINGS
(DOLLARS IN THOUSANDS):
Net interest income.. $ 327 $ 152 $ (175) (54) $ (238)$ (246)$ (8) (3) $ 35 $ 31 $ (4) (11)
Noninterest income... (39,892) (29,809) 10,083 25 31,889 22,014 (9,875) (31) 616 1,116 500 81
Noninterest expense.. (20,095) (10,690) 9,405 47 17,591 8,973 (8,618) (49) 65 451 386 594
Net income (loss).... (12,058) (11,731) 327 3 8,755 8,134 (621) (7) 362 430 68 19
Total loans (dollars
in millions)....... 28 25 (3) (11) (45) (52) (7) (16) -- -- -- na
AVERAGE BALANCES
(DOLLARS IN MILLIONS):
Total loans(1)....... $ 12,174 $ 14,782 $ 2,608 21 $ 12,112 $ 15,092 $ 2,980 25 $ 1,692 $ 1,636 $ (56) (3)
Total assets......... 13,512 16,214 2,702 20 14,330 18,384 4,054 28 2,129 2,012 (117) (5)
Total deposits(1).... 19,021 20,354 1,333 7 13,858 15,203 1,345 10 1,853 1,497 (356) (19)
FINANCIAL RATIOS:
Risk adjusted return
on capital(2)...... 24% 31% 18% 24% 47% 41%
Return on average
assets(2).......... 1.30 1.49 1.87 2.12 1.35 1.17
Efficiency ratio(3).. 73.97 70.90 45.12 40.27 57.29 61.41
UNIONBANCAL
OTHER CORPORATION
----------------- ---------------------
AS OF THE SIX 2005 VS. 2004 AS OF THE SIX 2005 VS. 2004
MONTHS ENDED INCREASE MONTHS ENDED INCREASE
JUNE 30, (DECREASE) JUNE 30, (DECREASE)
----------------- ----------------- --------------------- ------------------
2004 2005 AMOUNT PERCENT 2004 2005 AMOUNT PERCENT
-------- -------- --------- ------- ---------- ---------- -------- -------
RESULTS OF OPERATIONS
AFTER PERFORMANCE
CENTER EARNINGS
(DOLLARS IN THOUSANDS):
Net interest income.. $108,194 $ 14,183 $ (94,011) (87)% $ 800,279 $ 904,655 $104,376 13%
Noninterest income
(expense)........... 110,245 (1,823) (112,068) (102) 542,215 444,111 (98,104) (18)
-------- -------- --------- ---------- ---------- --------
Total revenue........ 218,439 12,360 (206,079) (94) 1,342,494 1,348,766 6,272 0
Noninterest expense.. 60,807 45,409 (15,398) (25) 749,508 816,657 67,149 9
Credit expense....... (89,639) (81,487) 8,152 9 (15,000) (19,000) (4,000) (27)
-------- -------- --------- ---------- ---------- --------
Income before income
tax expense........ 247,271 48,438 (198,833) (80) 607,986 551,109 (56,877) (9)
Income tax expense... 93,789 4,026 (89,763) (96) 219,402 181,950 (37,452) (17)
-------- -------- --------- ---------- ---------- --------
Net income........... $153,482 $ 44,412 $(109,070) (71) $ 388,584 $ 369,159 $(19,425) (5)
======== ======== ========= ========== ========== ========
PERFORMANCE CENTER
EARNINGS (DOLLARS IN
THOUSANDS):
Net interest income.. $ (124)$ 63 $ 187 151 $ -- $ -- $ -- na
Noninterest income... 7,387 6,679 (708) (10) -- -- -- na
Noninterest expense.. 2,439 1,266 (1,173) (48) -- -- -- na
Net income (loss).... 2,941 3,167 226 8 -- -- -- na
Total loans (dollars
in millions)....... 17 27 10 59 -- -- -- na
AVERAGE BALANCES
(DOLLARS IN MILLIONS):
Total loans(1)....... $ 512 $ 256 $ (256) (50) $ 26,490 $ 31,766 $ 5,276 20
Total assets......... 13,860 12,265 (1,595) (12) 43,831 48,875 5,044 12
Total deposits(1).... 2,143 3,145 1,002 47 36,875 40,199 3,324 9
FINANCIAL RATIOS:
Risk adjusted return
on capital(2)...... na na na na
Return on average
assets(2).......... na na 1.78% 1.52%
Efficiency ratio(3).. na na 55.72 60.69
- ----------------
<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) and the provision for losses on off-balance sheet
commitments, as a percentage of net interest income and noninterest income.
na = not applicable
</FN>
47
COMMUNITY BANKING AND INVESTMENT SERVICES GROUP
The Community Banking and Investment Services Group provides financial
products including a set of credit, deposit, trust, risk management, and
insurance products delivered through branches, relationship managers, private
bankers, trust administrators, and insurance agents to individuals and small
businesses.
During the second quarter 2005, net income increased by 38 percent over the
same period in 2004, reflecting the group's continued focus on growing the
consumer asset portfolio and attracting retail and small business deposits.
The group's strategy is to grow assets through an expanded small business
sales force, increased emphasis on real estate secured and Small Business
Administration (SBA) guaranteed loans to small business, and a stronger network
of residential real estate brokers. Increasing demand for home equity loans and
more effective cross-selling tactics have led to an overall growth in consumer
loans, despite run-off of discontinued auto dealer and auto lease lines of
business. In addition, the group expects a larger branch network, created from
new branches and acquired branches, to improve growth prospects when combined
with more robust efforts in the telephone and internet channels.
Total core deposit growth demonstrates the group's continued success in
attracting mass retail, affluent consumers and small business deposits through
marketing activities, relationship management, increased and improved sales
resources, new locations, and new products. These activities, in the aggregate,
have resulted in a year-over-year increase of approximately 8 percent in core
deposits. Among the more successful marketing activities has been the "Power
Bank" network, in Fresno, California and in the Central Coast region of
California. These branches offer an expanded set of service options, extended
hours and have been remodeled to improve the customer experience with facility
enhancements. We do not, however, intend to expand the "Power Bank" to
additional markets in 2005 until we better understand the return on our
investment in facilities and improved service. The focus on enterprise-wide
cross-sell has been particularly effective in our affluent market where a key
strategy of The Private Bank is to expand its business by leveraging existing
Bank client relationships.
The largest portion of the 3 percent increase in noninterest income was due
to an increase in deposit fees and trust fees, which were attributable to the
recently acquired portfolios from CNA Trust (renamed TruSource) and the BTM
Trust Company, New York. Overall, total revenues for the second quarter 2005
increased by over 19 percent compared to the second quarter 2004.
The Community Banking and Investment Services Group is comprised of five
major divisions: Community Banking, Wealth Management, Institutional Services
and Asset Management, Consumer Asset Management, and Global Markets.
COMMUNITY BANKING serves its customers through 314 full-service branches in
California, 4 full-service branches in Oregon and Washington, and a network of
594 proprietary ATMs. Customers may also access our services 24 hours a day by
telephone or through our WEBSITE at WWW.UBOC.COM. In addition, the division
offers automated teller and point-of-sale merchant services.
This division is organized by service delivery method, by markets and by
geography. We serve our customers in the following ways:
o through community banking branches, which serve consumers and
businesses with checking and deposit services, as well as various
types of consumer financing;
o through 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 small
businesses with annual sales up to $5 million; and
o through in-store branches, which also serve consumers and small
businesses.
48
WEALTH MANAGEMENT provides comprehensive 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 existing locations, 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, administration and support services to
institutional clients and our proprietary mutual funds, the affiliated
HighMark Funds. It also provides advisory services to most Union Bank
of California, N.A. trust and agency clients, including corporations,
pension funds and individuals. HighMark Capital Management, Inc.'s
strategy is to increase assets under management by broadening its
client base and helping to expand the distribution of shares of its
mutual fund clients.
o Institutional Services provides custody, corporate trust, and
retirement plan services. Custody Services provides both domestic and
international safekeeping/settlement services in addition to
securities lending. Corporate Trust acts as trustee for corporate and
municipal debt issues and provides escrow services. Retirement
Services provides a full range of defined benefit and defined
contribution administrative services, including trustee services,
administration, investment management, and 401(k) valuation services.
The client base of Institutional Services includes financial
institutions, corporations, government agencies, unions, insurance
companies, mutual funds, investment managers, and non-profit
organizations. Institutional Services' strategy is to continue to
leverage and expand its position in our target markets. The
acquisition of CNA Trust Company (renamed TruSource) expanded our
retirement processing capability by providing outsourcing services for
direct distributors of retirement products, and strengthened capacity
to support smaller plans. The acquisition of the corporate trust
portfolio of the BTM Trust Company, New York enhanced our capability
in the areas of municipal and project finance trustee and agent
services.
CONSUMER ASSET MANAGEMENT provides the centralized underwriting,
processing, servicing, collection and administration for consumer assets
including residential mortgages.
GLOBAL MARKETS serves our customers with their insurance, foreign exchange
and interest rate risk management and investment needs. Since the fourth quarter
2004, Global Markets Division has been offering energy derivative contracts, on
a limited basis, to serve our energy sector client base. The division takes
market risk when buying and selling securities and foreign exchange contracts
for its own account, but takes no market risk when providing insurance or
derivative contracts, since the market risk for these products is offset with
third parties. Insurance products are sold through UBOC Insurance Services and
securities are sold through UnionBanc Investment Services LLC, both of which are
subsidiaries of Union Bank of California, N.A.
Through alliances with other financial institutions, the Community Banking
and Investment Services Group offers additional products and services, such as
credit cards, merchant bank 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
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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.
COMMERCIAL FINANCIAL SERVICES GROUP
The Commercial Financial Services Group offers financing, depository and
cash management services to middle market and large corporate businesses
primarily headquartered in the western United States. The group has continued to
focus on specific geographic markets and industry segments such as energy,
entertainment, and real estate. Relationship managers 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 cash management services delivered
through deposit managers with significant industry expertise and experience in
cash management solutions for businesses, correspondent banks and government
entities.
In the second quarter 2005, the increase in net income was due to
significant growth in both loans and deposits. Net interest income increased by
36 percent due to higher demand deposits and a higher margin on deposits,
resulting in a $58 million improvement over the prior year. Deposit growth came
primarily from sales successes in middle market, corporate and real estate
industries. In addition to new sales, pricing strategies to retain volume helped
to offset the disintermediation associated with a rising interest rate
environment. Our title/escrow deposits were not a significant source of growth
in the second quarter.
Second quarter 2005 average loans increased by 26 percent over the same
period last year. This was primarily due to the acquisition of Jackson Federal
and continued improvement in our approach to the commercial real estate market.
The margin on deposits improved through a combination of increased volume and
higher internal valuation rates.
The decrease in noninterest income was mainly attributable to lower deposit
fees due to an increase in the earnings credit available to our wholesale
customers; lower credit card fees as a result of the sale of the merchant
portfolio; however, these decreases were partly offset by higher syndication
fees. The increase in noninterest expense during the second quarter 2005,
compared to the second quarter 2004, was mainly due to outside services expense
from vendor bills paid primarily for title and escrow customers.
The group's initiatives during 2005 will 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, corporate banking,
commercial real estate, energy, entertainment, equipment leasing and commercial
finance. The group is particularly strong in processing services, including
services such as Automated Clearing House (ACH), 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;
o the Commercial Deposit and Treasury Management Division, which
provides deposit and cash management expertise to middle-market and
large corporate clients, government agencies and specialized
industries. This division also manages the Bank's web strategies for
retail, small business, wealth management and commercial clients, as
well as product development and management for the Bank as a whole.
o the Real Estate Industries Division, which provides real estate
lending products such as construction loans, commercial mortgages and
bridge financing;
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o the Energy Capital Services Division, which provides corporate
financing and project financing to oil and gas companies, as well as
power and utility companies, nationwide; and
o the Corporate Capital Markets Division, which provides 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
level of industry expertise, 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.
INTERNATIONAL BANKING GROUP
Our 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 is from
financial institutions domiciled outside the U.S.
The group's business revolves around providing international correspondent
banking services and short-term financing, mostly to international financial
institutions. Net interest income in the second quarter 2005 declined due to
lower demand for loans and tightening spreads in our major markets as well as
our decision to exit from the Russian and former Soviet bloc markets in 2004.
Lower sweep balances also contributed to the lower net interest income, again
due to the decision to exit the Russian and former Soviet bloc markets.
Noninterest income declined mainly due to a $3.9 million insurance recovery in
the second quarter 2004 relating to the World Trade Center disaster. Noninterest
expense declined primarily due to reduced overhead allocations based on lower
asset balances.
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 markets, but there are certain trends in these markets
that could materially and adversely affect our international correspondent
banking business. These trends include heightened regulatory burdens related to
the Bank Secrecy Act and other anti-money laundering laws and regulations, as
well as consolidation of banks in key international markets, increased
technological investments and competition from major banks that are active in
international correspondent banking. The International Banking Group,
headquartered in San Francisco, also maintains offices in Asia and Latin America
and an international banking subsidiary in New York.
OTHER
"Other" includes the following items:
o corporate activities that are not directly attributable to one of the
three 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 US GAAP and earnings associated with
unallocated equity capital;
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o the adjustment between the tax expense calculated under RAROC using a
tax rate of 38.25 percent and our effective tax rates;
o the Pacific Rim Corporate Group, with assets of $215 million at June
30, 2005, 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;
o Corporate Treasury, which is responsible for our ALM, wholesale
funding, and the investment and derivatives portfolios. These treasury
management activities are carried out to counter-balance the residual
risk positions of our core balance sheet and to manage those risks
within conservative guidelines. (For additional discussion regarding
these risk management activities, see "Quantitative and Qualitative
Disclosures About Market Risk.") The funds transfer pricing results
for the entire company, which allocates to the other business segments
their cost of funds on all asset categories and credit for funds on
all liability categories; and
o the residual costs of support groups.
The second quarter 2005 financial results were impacted by the following
factors:
o Credit expense (income) of ($40.4) million was due to the difference
between the $11.0 million reversal of provision for loan losses
calculated under our US GAAP methodology and the $29.4 million in
expected losses for the reportable business segments, which utilizes
the RAROC methodology;
o Net interest income included the result of differences between the
credit for equity for the reportable segments under RAROC and the net
interest income earned by UnionBanCal Corporation, a credit for
deposits in the Pacific Rim Corporate Group and transfer pricing
results. Net interest income declined $47.9 million primarily as a
result of a decrease in income from ALM derivatives hedges and from
the net impact of changes in transfer pricing rates over prior period
as market rates increased;
o Noninterest income of ($7.9) million included a $13.3 million loss on
the sale of $475 million of securities in support of loan growth
during the quarter; and
o Noninterest expense of $21.0 million declined partially as a result of
lower litigation expenses and refinements in our overhead allocations
in the second quarter of 2005.
The second quarter 2004 financial results were impacted by the following
factors:
o Credit expense (income) of ($45.0) million was due to the difference
between the $10.0 million reversal in provision for loan losses
calculated under our US GAAP methodology and the $35.0 million in
expected losses for the reportable business segments, which utilizes
the RAROC methodology;
o Net interest income is the result of differences between the credit
for equity for the reportable segments under RAROC and the net
interest income earned by UnionBanCal Corporation, a credit for
deposits in the Pacific Rim Corporate Group and net transfer pricing
results reported by Corporate Treasury;
o Noninterest income of $105.0 million, which included a $93.0 million
gain on the sale of our merchant card portfolio and an $8.5 million
gain on the sale of real property; and
o Noninterest expense of $29.7 million.
REGULATORY MATTERS
On October 18, 2004, Union Bank of California International entered into a
written agreement with the Federal Reserve Bank of New York relating to Union
Bank of California International's Bank Secrecy
52
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. On March 23, 2005, Union Bank of California,
N.A., received from the Office of the Comptroller of the Currency, its principal
regulator, a memorandum of understanding, which requires Union Bank of
California, N.A. to strengthen its Bank Secrecy Act and anti-money laundering
controls and processes. Management is committed to resolving the issues raised
by the regulators and is continuing to take action aimed at resolving these
matters.
These regulatory matters 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, the regulatory agreements, nor the financial
impact of enhanced Bank Secrecy Act and anti-money laundering 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.
FACTORS THAT MAY AFFECT FUTURE RESULTS
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 our Securities and Exchange Commission (SEC)
filings, press releases, news articles, conference calls with analysts and
stockholders and when we are speaking on behalf of UnionBanCal Corporation.
Forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts. Often, they include the words
"believe," "expect," "target," "anticipate," "intend," "plan," "estimate,"
"potential," "project," or words of similar meaning, or future or conditional
verbs such as "will," "would," "should," "could," or "may." These
forward-looking statements are intended to provide investors with additional
information with which they may assess our future potential. All of these
forward-looking statements are based on assumptions about an uncertain future
and are based on information available to us at the date of these statements. 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.
In this document, for example, we make forward-looking statements, which
discuss our expectations about:
o Pending legal actions
o Credit quality and provision for credit losses
o Net interest income including income from derivative hedges
o The impact of increases in interest rates and growth in our commercial
loan portfolio on our net interest margin
o The impact of strategic investments on our business
o The unallocated portion of our allowances for credit losses
o Our sensitivity to changes in interest rates
o The asset sensitivity of our balance sheet
o Increased regulatory controls and processes regarding Bank Secrecy Act
and anti-money laundering matters
o Trends in international markets, which could adversely affect our
international correspondent banking business
53
o Future legislative and regulatory developments
o The costs and effects of litigation, investigations, or similar
matters, or adverse facts and developments related thereto
o Decisions to downsize, sell or close units or otherwise change the
business mix of any of the company
o Potential dividend restrictions
o Integration of acquired companies
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 those listed below in "Industry Factors" and
"Company Factors."
Readers of this document should not rely solely on forward-looking
information and should consider all uncertainties and risks disclosed throughout
this document and in our other reports to the SEC, including, but not limited
to, those discussed below. Any factor described in this report could by itself,
or together with one or more other factors, adversely affect our business,
future prospects, results of operations or financial condition. There are also
other factors that we have not described in this report and our other reports
that could cause our results to differ from our expectations.
INDUSTRY FACTORS
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 of loan prepayments. An increase in market interest
rates could also adversely affect the ability of our floating-rate borrowers to
meet their higher payment obligations. If this occurred, it could cause an
increase in nonperforming assets and charge-offs, which could adversely affect
our business.
FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR MARGIN SPREAD
Changes in market interest rates, including changes in the relationship
between short-term and long-term market interest rates or between different
interest rate indices, can impact our margin spread, that is, the difference
between the interest rates we charge on interest earning assets, such as loans,
and the interest rates we pay on interest bearing liabilities, such as deposits
or other borrowings. The impact could result in a decrease in our interest
income relative to interest expense.
THE CONTINUING WAR ON TERRORISM COULD ADVERSELY AFFECT U.S. AND GLOBAL
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 disruption of
U.S. and global economic and financial conditions and could adversely affect
business and economic and financial conditions in the U.S. and globally
generally and in our principal markets.
54
SUBSTANTIAL COMPETITION COULD ADVERSELY AFFECT US
Banking is a highly competitive business. We compete actively for loan,
deposit, and other financial services business in California, Oregon and
Washington, 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, including
many large securities firms. Some of our competitors are community or regional
banks that have strong local market positions. Other competitors include large
financial institutions that have substantial capital, technology and marketing
resources that are well in excess of ours. 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.
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 will likely 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 future changes in laws,
regulations, policies or interpretations or regulatory approaches to compliance
and enforcement. Additionally, our international activities may be subject to
the laws and regulations of the jurisdiction in which 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 and the Federal Reserve Board may adversely
affect our activities and investments and those of our subsidiaries in the
future.
Additionally, our business is affected significantly by the fiscal and
monetary policies of the U.S. 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 on 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, prospects,
results of operations and financial condition.
Refer to "Supervision and Regulation" in our Annual Report on Form 10-K for
the year ended December 31, 2004, and "Regulatory Matters" for discussion of
other laws and regulations, including the Bank Secrecy Act and other anti-money
laundering laws and regulations that may have a material effect on our business,
prospects, results of operations and financial condition.
CHANGES IN ACCOUNTING STANDARDS COULD MATERIALLY IMPACT OUR FINANCIAL
STATEMENTS
From time to time the Financial Accounting Standards Board, the SEC and
bank regulators change the financial accounting and reporting standards that
govern the preparation of our financial statements. These changes can be very
difficult to predict and can materially impact how we record and report our
55
financial condition and results of operations. In some cases, we could be
required to apply a new or revised standard retroactively, resulting in our
restating prior period financial statements.
THERE ARE AN INCREASING NUMBER OF NON-BANK COMPETITORS PROVIDING FINANCIAL
SERVICES
Technology and other changes increasingly allow parties to complete
financial transactions electronically, and in many cases, without banks. For
example, consumers can pay bills and transfer funds over the internet and by
telephone without banks. Many non-bank financial service providers have lower
overhead costs and are subject to fewer regulatory constraints. If consumers do
not use banks to complete their financial transactions, we could potentially
lose fee income, deposits and income generated from those deposits.
COMPANY 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, and the California state government's continuing
budgetary and fiscal difficulties. If economic conditions in California decline,
we expect that our level of problem assets could increase and our prospects for
growth could be impaired. 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.
ADVERSE ECONOMIC FACTORS AFFECTING CERTAIN INDUSTRIES WE SERVE 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, especially in California. 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
commercial real estate industry, the communications / media industry, the retail
industry, the power industry and the technology industry. Recent increases in
fuel prices and energy costs 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 and a slowing of growth or reduction in our
loan portfolio.
WE ARE NOT ABLE TO OFFER ALL OF THE FINANCIAL SERVICES AND PRODUCTS OF A
FINANCIAL HOLDING COMPANY
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. Many of our competitors
have elected to become financial holding companies. Recently, a number of
foreign banks have acquired financial holding companies in the U.S., further
increasing competition in the U.S. market. Under current regulatory
interpretations, Mitsubishi Tokyo Financial Group, Inc. would be required to
make a financial holding company election in order for us to have the benefits
of their status. We do not expect that Mitsubishi Tokyo Financial Group, Inc.
will make such an election in the near future.
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OUR STOCKHOLDER VOTES ARE CONTROLLED BY THE BANK OF TOKYO-MITSUBISHI, LTD.;
OUR INTERESTS AND THOSE OF OUR MINORITY STOCKHOLDERS MAY NOT BE THE SAME AS
THOSE OF THE BANK OF TOKYO-MITSUBISHI, LTD.
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: approval of
mergers or other business combinations; a sale of all or substantially all of
our assets; 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
our 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 also have an adverse effect on the market price for our common stock.
POSSIBLE FUTURE SALES OF OUR 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 it to sell shares more easily. In
addition, The Bank of Tokyo-Mitsubishi, Ltd. could sell shares of our common
stock without registration under certain circumstances, such as in a "private
placement." 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 AND MITSUBISHI TOKYO FINANCIAL GROUP,
INC.'S FINANCIAL CONDITION COULD ADVERSELY AFFECT OUR OPERATIONS
We fund our operations independently of The Bank of Tokyo-Mitsubishi, Ltd.
and Mitsubishi Tokyo Financial Group, Inc. and believe our business is not
necessarily closely related to the business or outlook of The Bank of
Tokyo-Mitsubishi, Ltd. or Mitsubishi Tokyo Financial Group, Inc. However, The
Bank of Tokyo-Mitsubishi, Ltd.'s and Mitsubishi Tokyo Financial Group, Inc.'s
credit ratings may affect our credit ratings. The Bank of Tokyo-Mitsubishi, Ltd.
and Mitsubishi Tokyo Financial Group, Inc. are also subject to regulatory
oversight and review by Japanese and U.S. regulatory authorities. Our business
operations and expansion plans could be negatively affected by regulatory
concerns related to the Japanese financial system, The Bank of Tokyo-Mitsubishi,
Ltd. or Mitsubishi Tokyo Financial Group, Inc., and other developments
concerning The Bank of Tokyo-Mitsubishi, Ltd. or Mitsubishi Tokyo Financial
Group, Inc., including the proposed merger with UFJ Holdings, Inc., which may
result in capital constraints as well as additional Japanese and U.S. regulatory
constraints.
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.
57
Also, as part of The Bank of Tokyo-Mitsubishi, Ltd.'s normal risk
management processes, The Bank of Tokyo-Mitsubishi, Ltd. manages global credit
and other types of exposures and concentrations on an aggregate basis, including
exposures and concentrations at 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 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 U.S. banking markets.
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 were
to 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.
OUR ABILITY TO MAKE ACQUISITIONS IS SUBJECT TO REGULATORY CONSTRAINTS AND
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR DIVESTITURES OR
RESTRUCTURINGS MAY ADVERSELY AFFECT US
Our ability to obtain regulatory approval of acquisitions is subject to
constraints related to the Bank Secrecy Act, as described in "Supervision and
Regulation" in our Annual Report on Form 10-K for the year ended December 31,
2004, and above in "Regulatory Matters." Subject to our ability to address
successfully these regulatory concerns, we may seek to acquire or invest in
financial and non-financial companies 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 parties. 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), 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.
PRIVACY RESTRICTIONS COULD ADVERSELY AFFECT OUR BUSINESS
Our business model relies, in part, upon cross-marketing the services
offered by us 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.
58
WE RELY ON THIRD PARTIES FOR IMPORTANT PRODUCTS AND SERVICES
Third party vendors provide key components of our business infrastructure
such as internet connections, network access and mutual fund distribution. While
we have selected these third party vendors carefully, we do not control their
actions. Any problems caused by these third parties, including as a result of
their not providing us their services for any reason or their performing their
services poorly, could adversely affect our ability to deliver products and
services to our customers and otherwise to conduct our business. Replacing these
third party vendors could also entail significant delay and expense.
SIGNIFICANT LEGAL ACTIONS COULD SUBJECT US TO SUBSTANTIAL UNINSURED
LIABILITIES
We are from time to time subject to claims related to our operations. These
claims and legal actions, including supervisory actions by our regulators, could
involve large monetary 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,
prospects, results of operations and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A discussion of 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 "Factors That May Affect
Future Results."
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 June
30, 2005. 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 June 30, 2005, 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.
59
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.
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. We have
reached an agreement in principle to resolve the Grafton matter, which calls for
a payment of $22 million, $15.8 million of which will be paid by the Company's
insurance carriers. This agreement in principle is in the process of being
documented, and will thereafter require court approval. The disposition of this
claim, on the basis described above, assuming that the settlement becomes final
and approved, will not have a material adverse effect on our financial condition
or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
REPURCHASES OF EQUITY SECURITIES
The following table presents repurchases by us of our equity securities
during the second quarter 2005:
TOTAL NUMBER OF SHARES APPROXIMATE DOLLAR VALUE
PURCHASED AS PART OF OF SHARES THAT
TOTAL NUMBER OF AVERAGE PRICE PAID PUBLICLY ANNOUNCED MAY YET BE PURCHASED
PERIOD SHARES PURCHASED PER SHARE PROGRAMS UNDER THE PROGRAMS
- -------------------------- ---------------- ------------------ ---------------------- ------------------------
APRIL 2005
(April 25 - 29, 2005)..... 227,000 $60.33 227,000 $237,600,475(1)
MAY 2005
(May 2 - 31, 2005)........ 615,000 $62.34 615,000 $199,258,735
JUNE 2005
(June 1 - 30, 2005)....... 579,100 $64.20 579,100 $162,078,928(2)
--------- ---------
TOTAL.................. 1,421,100 $62.78 1,421,100
- ---------------
<FN>
(1) On April 21, 2005, UnionBanCal Corporation announced the Board of Directors
authorization of an additional $200 million repurchase of the Company's
common stock.
(2) In the second quarter of 2005, UnionBanCal Corporation used the remaining
$51.3 million from the $200 million repurchase program announced on April
28, 2004 and $37.9 million from the $200 million repurchase program
announced April 21, 2005.
</FN>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
For information regarding matters submitted to a vote at the Annual Meeting
of Stockholders on April 27, 2005, see Part II, Item 4 of our Report on Form
10-Q for the quarter ended March 31, 2005, incorporated by reference herein.
60
ITEM 6. EXHIBITS
NO. DESCRIPTION
---- --------------------------------------------------------------------
10.1 Philip B. Flynn Amendment of Employment Agreement (Effective May 1,
2005)(1)
10.2 David I. Matson Amendment of Employment Agreement (Effective May 1,
2005)(1)
10.3 Year 2000 UnionBanCal Corporation Management Stock Plan(2)
31.1 Certification of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002(1)
31.2 Certification of the Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002(1)
32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002(1)
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002(1)
- -------------------------
<FN>
(1) Filed herewith.
(2) Filed as Appendix A to UnionBanCal Corporation's Proxy Statement on
Schedule 14A for its 2005 Annual Meeting of Stockholders and incorporated
by reference herein.
</FN>
61
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
UNIONBANCAL CORPORATION
(Registrant)
Date: August 5, 2005 By: /S/TAKASHI MORIMURA
--------------------------------------
Takashi Morimura
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
Date: August 5, 2005 By: /S/DAVID I. MATSON
--------------------------------------
David I. Matson
VICE CHAIRMAN AND
CHIEF FINANCIAL OFFICER
(Principal Financial Officer)
Date: August 5, 2005 By: /S/DAVID A. ANDERSON
--------------------------------------
David A. Anderson
SENIOR VICE PRESIDENT AND CONTROLLER
(Chief Accounting Officer)
62