SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended September 30, 1998 Commission File Number 1-10521
CITY NATIONAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 95-2568550
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
City National Center
400 North Roxbury Drive, Beverly Hills, California 90210
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (310) 888-6000
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
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Number of shares of common stock outstanding at October 31, 1998: 45,889,186
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CITY NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS 1998 1997 1997
- -------------------------------------------- ------------- ------------ -------------
A S S E T S
Cash and due from banks ................................................... $ 326,313 $ 327,398 $ 355,207
Interest-bearing deposits in other banks .................................. 343 301 309
Federal funds sold ........................................................ 122,000 150,000 150,000
Investment securities (fair value $195,844; $227,465 and $229,444 at
September 30, 1998, December 31, 1997 and September 30, 1997,
respectively) ......................................................... 192,771 225,934 228,452
Securities available-for-sale (cost $715,707; $597,910 and $582,134 at
September 30, 1998, December 31, 1997 and September 30, 1997,
respectively) ......................................................... 734,391 607,188 586,751
Trading account securities ................................................ 48,712 30,279 23,988
Loans ..................................................................... 4,343,796 3,825,224 3,530,122
Less allowance for credit losses .......................................... 135,486 137,761 137,850
----------- ----------- -----------
Net loans ............................................................. 4,208,310 3,687,463 3,392,272
Premises and equipment, net ............................................... 52,659 43,402 40,704
Customers' acceptance liability ........................................... 2,101 1,553 3,341
Deferred tax asset ........................................................ 43,005 58,815 55,838
Goodwill and core deposit intangibles ..................................... 63,867 54,921 58,122
Bank owned life insurance ................................................. 41,989 -- --
Other assets .............................................................. 70,847 64,778 79,675
----------- ----------- -----------
Total assets .......................................................... $ 5,907,308 $ 5,252,032 $ 4,974,659
----------- ----------- -----------
----------- ----------- -----------
L I A B I L I T I E S
Demand deposits ........................................................... $ 2,016,327 $ 2,027,014 $ 1,667,458
Interest checking deposits ................................................ 351,817 439,071 345,367
Money market deposits ..................................................... 926,592 773,291 799,488
Savings deposits .......................................................... 170,338 171,100 169,619
Time deposits-under $100,000 .............................................. 190,580 204,744 217,756
Time deposits-$100,000 and over ........................................... 793,018 613,128 614,489
----------- ----------- -----------
Total deposits ........................................................ 4,448,672 4,228,348 3,814,177
Federal funds purchased and securities sold under repurchase agreements ... 459,466 206,427 191,613
Other short-term borrowings ............................................... 77,059 212,575 415,047
Subordinated debt ......................................................... 123,217 -- --
Long-term debt ............................................................ 200,000 50,000 9,800
Other liabilities ......................................................... 55,160 44,459 53,781
Acceptances outstanding ................................................... 2,101 1,553 3,341
----------- ----------- -----------
Total liabilities ..................................................... 5,365,675 4,743,362 4,487,759
----------- ----------- -----------
COMMITMETS AND CONTINGENCIES
SUBSEQUENT EVENTS
SHAREHOLDERS' EQUITY
Preferred Stock authorized - 5,000,000 : none outstanding -- -- --
Common Stock-par value-$1.00; authorized - 75,000,000
Issued- 46,885,182; 46,700,891 and 46,700,891 shares at September 30,
1998, December 31, 1997 and September 30, 1997
respectively) ......................................................... 46,885 46,701 46,701
Additional paid-in capital ................................................ 289,508 297,654 298,724
Accumulated comprehensive income .......................................... 10,772 5,349 2,662
Retained earnings ......................................................... 224,932 173,089 156,474
Treasury shares, at cost - 896,907; 563,928 and 731,752 shares at
September 30, 1998, December 31, 1997 and September 30, 1997
respectively) ......................................................... (30,464) (14,123) (17,661)
----------- ----------- -----------
Total shareholders' equity ............................................ 541,633 508,670 486,900
----------- ----------- -----------
Total liabilities and shareholders' equity ............................ $ 5,907,308 $ 5,252,032 $ 4,974,659
----------- ----------- -----------
----------- ----------- -----------
See accompanying Notes to the Unaudited Consolidated Financial Statements.
2
CITY NATIONAL CORPORATION
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(UNAUDITED)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- --------------------------
IN THOUSANDS, EXCEPT PER SHARE AMOUNTS 1998 1997 1998 1997
- -------------------------------------- --------- --------- --------- ----------
I N T E R E S T I N C O M E
Loans.................................... $ 93,490 $ 78,651 $ 273,195 $ 223,679
Federal funds sold and securities
purchased under resale agreements..... 420 313 1,827 896
Investments securities................... 2,776 3,242 8,700 9,356
Securities available-for-sale............ 9,944 9,298 28,440 28,424
Trading account.......................... 880 691 2,155 1,843
--------- -------- --------- ---------
Total................................. 107,510 92,195 314,317 264,198
--------- -------- --------- ---------
I N T E R E S T E X P E N S E
Deposits................................. 22,786 19,081 65,111 53,607
Federal funds purchased and securities
sold under repurchase agreements...... 5,713 2,480 15,280 8,888
Other short-term borrowings.............. 690 5,247 4,027 12,080
Subordinated debt........................ 2,081 -- 5,873 --
Other long-term debt..................... 2,559 804 5,249 2,476
--------- -------- --------- ---------
Total................................. 33,829 27,612 95,540 77,051
--------- -------- --------- ---------
Net interest income...................... 73,681 64,583 218,777 187,147
PROVISION FOR CREDIT LOSSES................. -- -- -- --
--------- -------- --------- ---------
Net interest income after provision
for credit losses..................... 73,681 64,583 218,777 187,147
--------- -------- --------- ---------
N O N I N T E R E S T I N C O M E
Service charges on deposit accounts...... 3,821 3,256 13,031 9,885
Investment services...................... 4,482 3,511 11,900 9,655
Trust fees............................... 2,282 2,257 6,735 6,427
International services................... 2,206 1,912 5,929 5,279
Bank owned life insurance................ 546 -- 1,589 --
Gain on sale of assets................... 223 384 1,881 1,423
Gain (loss) on sale of securities........ 1,120 (224) 2,329 (763)
Other.................................... 2,118 1,952 7,115 7,181
--------- -------- --------- ---------
Total noninterest income.............. 16,798 13,048 50,509 39,087
--------- -------- --------- ---------
N O N I N T E R E S T E X P E N S E
Salaries and other employee benefits..... 29,489 25,308 87,072 73,421
Professional............................. 5,537 5,572 19,408 14,400
Net occupancy of premises................ 3,379 2,407 9,247 7,504
Data processing.......................... 1,125 2,393 3,454 7,199
Promotion................................ 1,784 1,938 7,138 5,660
Depreciation............................. 2,290 1,498 6,369 4,234
Office services.......................... 1,703 1,761 5,686 4,893
Equipment................................ 607 484 1,616 1,679
Amortization of goodwill and core
deposit intangibles................... 1,737 1,345 5,119 4,546
Other operating.......................... 3,380 3,038 13,346 11,480
Other real estate........................ (172) (797) (257) (830)
--------- -------- --------- ---------
Total noninterest expense............. 50,859 44,947 158,198 134,186
--------- -------- --------- ---------
INCOME BEFORE INCOME TAXES............... 39,620 32,684 111,088 92,048
Income taxes............................. 14,231 11,790 39,594 33,593
--------- -------- --------- ---------
NET INCOME............................... 25,389 20,894 71,494 58,455
--------- -------- --------- ---------
Other comprehensive income
Unrealized net gains on securities
available-for-sale.............. 5,693 6,069 11,735 7,581
Less: reclassification adjustment for
gains included in income........ (1,120) 224 (2,329) 763
Income taxes.......................... 2,163 2,673 3,983 3,533
--------- -------- --------- ---------
Other comprehensive income............... 2,410 3,620 5,423 4,811
--------- -------- --------- ---------
COMPREHENSIVE INCOME..................... $ 27,799 $ 24,514 $ 76,917 $ 63,266
--------- -------- --------- ---------
--------- -------- --------- ---------
NET INCOME PER SHARE, BASIC............. $ 0.55 $ 0.45 $ 1.54 $ 1.27
--------- -------- --------- ---------
--------- -------- --------- ---------
NET INCOME PER SHARE, DILUTED........... $ 0.53 $ 0.44 $ 1.48 $ 1.22
--------- -------- --------- ---------
--------- -------- --------- ---------
Shares used to compute income per
share, basic.......................... 46,230 45,993 46,504 46,009
--------- -------- --------- ---------
--------- -------- --------- ---------
Shares used to compute income per
share, diluted........................ 47,842 47,846 48,352 47,734
--------- -------- --------- ---------
--------- -------- --------- ---------
Dividends per share...................... $ 0.14 $ 0.11 $ 0.42 $ 0.33
--------- -------- --------- ---------
--------- -------- --------- ---------
See accompanying Notes to the Unaudited Consolidated Financial Statements.
3
CITY NATIONAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
DOLLARS IN THOUSANDS 1998 1997
- -------------------- ----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ........................................................... $ 71,494 $ 58,455
Adjustments to net income:
Gain (loss) on sales of ORE....................................... 446 (1,556)
Depreciation...................................................... 6,369 4,234
Amortization of goodwill and core deposit intangibles ............ 5,119 4,546
Net (increase) decrease in trading securities..................... (18,433) 8,141
Deferred income tax benefit....................................... 16,695 5,919
Net increase in other liabilities ................................ 56 5,538
Other, net........................................................ 8,286 (7,291)
---------- ----------
Net cash provided by operating activites...................... 90,032 77,986
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Net (increase) decrease in short-term investments..................... (42) 10,669
Purchase of securities available-for-sale............................. (397,941) (288,767)
Sales of securities available-for-sale................................ 225,649 340,762
Maturities of securities available-for-sale........................... 64,334 40,635
Maturities of investment securities................................... 37,217 9,379
Purchase of investment securities..................................... (3,971) (41,996)
Purchase of residential mortgage loans................................ (32,396) (74,681)
Sale of residential mortgage loans.................................... - 47,513
(Loan originations) and principal collections, net.................... (351,441) (334,623)
Proceeds from sales of ORE............................................ 2,062 16,918
Purchase of premises and equipment ................................... (13,302) (13,087)
Net cash from acquisitions............................................ 43,622 42,876
Bank owned life insurance premium paid ............................... (40,399) -
Gain (loss) on sale of securities .................................... 2,329 (763)
Other, net............................................................ 668 1,227
---------- ----------
Net cash used by investing activities............................. (463,611) (243,938)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net decrease in federal funds purchased and securities sold under
repurchase agreements............................................. (71,961) (2,936)
Net increase (decrease) in deposits................................... 14,724 (23,525)
Net increase in short-term borrowings................................. 189,484 266,405
Net increase (decrease) in other long-term debt....................... 150,000 (25,000)
Net proceeds of subordinated debt .................................... 124,055 -
Proceeds from excercise of stock options.............................. 10,417 9,411
Stock repurchases..................................................... (55,711) (22,502)
Cash dividends paid................................................... (19,651) (15,247)
Other, net............................................................ 3,137 2,307
---------- ----------
Net cash provided by financing activities......................... 344,494 188,913
---------- ----------
Net (decrease) increase in cash and cash equivalents.................. (29,085) 22,961
Cash and cash equivalents at beginning of year........................ 477,398 482,246
---------- ----------
Cash and cash equivalents at end of period............................ $ 448,313 $ 505,207
---------- ----------
---------- ----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest ..................................................... $ 90,294 $ 73,866
Income taxes.................................................. 24,450 29,902
Non-cash investing activities:
Transfer from loans to foreclosed assets ..................... 2,445 11,433
See accompanying Notes to the Unaudited Consolidated Financial Statements.
4
CITY NATIONAL CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
Dollars in thousands 1998 1997
- -------------------------------- --------- ---------
Common Stock
Balance, beginning of period ....................... $ 46,701 $ 46,303
Stock issued for acquisitions ....................... 131 -
Stock options exercised ............................. 53 398
--------- ---------
Balance, end of period .............................. 46,885 46,701
--------- ---------
Additional paid-in capital
Balance, beginning of period ....................... 297,654 275,610
Stock options exercised ............................. - 2,620
Tax benefit from stock options ...................... 3,137 2,307
Excess of cost of treasury shares reissued
over stock option exercise amounts .............. (18,190) -
Excess of market value of shares issued
for acquisitions over historical cost ........... 6,907 18,187
--------- ---------
Balance, end of period .............................. 289,508 298,724
--------- ---------
Treasury shares
Balance, beginning of period ....................... (14,123) (32,283)
Purchase of shares ................................. (55,711) (22,502)
Issuance of shares for acquisitions ................. 10,817 30,643
Issuance of shares for stock options ................ 28,553 6,481
--------- ---------
Balance, end of period .............................. (30,464) (17,661)
--------- ---------
Accumulated comprehensive income
Balance, beginning of period ....................... 5,349 (2,149)
Unrealized net gains on securities
available-for-sale net of income taxes .......... 5,423 4,811
--------- ---------
Balance, end of period .............................. 10,772 2,662
--------- ---------
Retained earnings
Balance, beginning of period ...................... 173,089 113,266
Net income .......................................... 71,494 58,455
Dividends paid ...................................... (19,651) (15,247)
--------- ---------
Balance, end of period .............................. 224,932 156,474
--------- ---------
Total shareholders' equity ................................ $541,633 $486,900
--------- ---------
--------- ---------
See accompanying Notes to the Unaudited Consolidated Financial Statements.
5
CITY NATIONAL CORPORATION
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The results of operations reflect interim adjustments, all of which are of
a normal recurring nature and which, in the opinion of management, are
necessary for a fair presentation of the results for such interim periods.
These unaudited 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,
1997.
2. In June 1998, the Financial Accounting Standard Board "FASB" issued
Statement of Financial Accounting Standards "SFAS" No. 133, "Accounting for
Derivative Instruments and Hedging Activities". This Statement establishes
accounting and reporting standards for derivative instruments and for
hedging activities. This Statement is effective for fiscal years beginning
after June 15, 1999. Management of the Company uses interest rate swaps,
which are accounted for as hedging activities, to manage interest rate
exposure. Therefore, management is in the process of determining the impact
that this statement will have on the Company.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits". This Statement
standardizes the disclosure requirements for defined benefit plans and
recommends a parallel format for presenting information about pensions and
other postretirement benefits. This Statement is effective for fiscal years
beginning after December 15, 1997. Since the Company has no defined benefit
plans, it has determined that this Statement will have no significant
impact.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes
standards for the way in which public enterprises report information about
operating segments in annual financial statements and requires that
selected information about those operating segments be reported in interim
financial statements. This statement supersedes SFAS No. 14 "Financial
Reporting for Segments of a Business Enterprise". SFAS 131 requires that
all public enterprises report financial and descriptive information about
its reportable operating segments. Operating segments are defined as
components regularly evaluated by the chief operating decision maker in
deciding how to allocate resources and in assessing performance. This
statement is effective for fiscal years beginning after December 15, 1997.
In the initial year of application, comparative information for earlier
years should be restated. Management is in the process of determining the
impact, if any, this statement will have on the Company.
3. Securities held-for-investment are classified as investment securities.
Because the Company has the ability and management has the intent to hold
investment securities until maturity, investment securities are stated at
cost, adjusted for amortization of premiums and accretion of discounts.
Trading account securities are stated at market value. Investments not
classified as trading securities nor as investment securities are
classified as securities available-for-sale and recorded at fair value.
Unrealized holding gains or losses on securities available-for-sale are
excluded from net income and are reported as comprehensive income included
as a separate component of shareholders' equity, net of taxes.
4. On January 9, 1998, the Company completed its acquisition of Harbor Bancorp
(HB), a one-bank holding company with six branches, one of which was
subsequently closed. The total purchase price was approximately $34.5
million. The Company issued approximately 540,000 shares, primarily from
treasury, with an aggregate market value of $17.9 million and paid the
remainder in cash. This acquisition was accounted for under the purchase
method of accounting and resulted in the recording of goodwill and core
deposit intangibles of approximately $24.0 million. The results of HB's
operations are included in those reported by the Company beginning on
January 10, 1998.
On February 27, 1998, the Company sold its Wilmington branch, which had
been acquired as part of the acquisition of Ventura County National Bancorp
to Banco Popular, N.A. (California). With the sale, the purchaser received
approximately $40 million of deposits.
On May 15, 1998, the Company closed its Magnolia branch, which was acquired
in the Company's acquisition of Riverside National Bank.
6
5. On January 12, 1998, City National Bank issued $125 million of 6 3/8%
Subordinated Notes due 2008. The net proceeds from the sale are being used
for general corporate purposes in the ordinary course of its banking
business.
6. For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, and overnight federal funds sold.
7. Certain prior periods' data have been reclassified to conform to current
period presentation.
8. In September, the Company completed a 1.0 million common shares stock
buyback program that had been announced in April, at a cost of $34.3
million or an average price of $34.27 per share. Concurrently, a new 1.0
million-share common stock buyback program was announced. Shares are
repurchased from time to time in open market transactions. As of October
31, 1998, the Company had repurchased 128,000 shares under this program at
a total cost of $3.5 million, or an average price of $27.38 per share.
Shares purchased under the buyback program will be reissued upon the
exercise of stock options and for other general corporate purposes.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
City National Corporation (the Corporation) is the holding Company for City
National Bank (the Bank). Because the Bank comprises substantially all of the
business of the Corporation, references to the "Company" in this Item 2 reflect
the consolidated activities of the Corporation and the Bank.
See "Cautionary Statement for Purposes of the `Safe Harbor' Provision of the
Private Securities Litigation Reform Act of 1995", below in connection with
"forward looking" statements included in the Overview section of Results of
Operations and in the Loan Portfolio section of the Balance Sheet Analysis.
The Company regularly evaluates, and holds discussions with, various potential
acquisition candidates. As a general rule the Company does not publicly announce
such acquisitions until after a definitive agreement has been reached, as in the
September 24, 1998 announcement of the acquisition of North American Trust
Company, an independent trust company and subsidiary of London Pacific Group,
for $11.5 million in an all cash transaction. North American Trust Company has
approximately $4 billion in total assets under management or administration.
Also as a matter of policy, the Company generally does not make any specific
projections as to future earnings nor does it endorse any projections regarding
future performance which may be made by others.
RESULTS OF OPERATIONS
OVERVIEW
The Company recorded consolidated net income of $25.4 million, or $.53 per
diluted common share, in the third quarter of 1998, compared to $20.9 million,
or $.44 per diluted common share, in the third quarter of 1997. Increased net
income was primarily due to $9.1 million higher net interest income, and $3.8
million higher noninterest income, partially offset by $5.9 million in higher
noninterest expense.
Net income for the first nine months of 1998 totaled $71.5 million, or $1.48 per
diluted common share compared with $58.5 million, or $1.22 per diluted common
share in the 1997 period. The nine month increase resulted largely from a $31.6
million increase in net interest income and a $11.4 million increase in
noninterest income, partially offset by a $24.0 million increase in noninterest
expense.
Returns on average assets for the third quarter and first nine months of 1998
were 1.78% and 1.74% respectively compared with 1.74% and 1.69% for the
corresponding periods of 1997. Returns on average equity for the third quarter
and first nine months of 1998 increased to 18.70% and 17.86% respectively from
17.26% and 16.80% in 1997.
Earnings before the amortization of goodwill and core deposits intangibles (net
of applicable taxes) ("cash" earnings) for the quarter and nine months ended
September 30, 1998 were $26.6 million or $.56 per diluted common share and $75.6
million or $1.56 per diluted common share, respectively compared to $21.9
million or $.46 per diluted common share and $61.6 million or $1.29 per diluted
common share in the corresponding periods of 1997. On the same basis, the
returns on average assets were 1.88% and 1.86% for the quarter and nine months
ended September 30, 1998, respectively compared to 1.84% and 1.80% in the 1997
periods. Cash returns on average common equity were 21.91% and 20.98% for the
quarter and nine months ended September 30, 1998, respectively compared to
20.04% and 19.69% for the year ago periods. "Cash" earnings are presented
because they measure the Company's ability to support growth, pay dividends and
repurchase stock. The Company's "cash" earnings per share and other ratios are
not necessarily comparable to similarly titled measures reported by other
companies.
Taxable equivalent net interest income was $76.3 million in the third quarter of
1998, up 13.7% from the year ago quarter. The increase resulted from a 20.3%
increase in average interest earning assets between quarters. The net interest
spread and the net interest margin decreased to 4.16% and 5.79%, respectively
for the third quarter from 4.61% and 6.13%, for the comparable period a year
ago. Management expects net interest income to be essentially flat for the
remainder of the year reflecting higher loan balances but lower rates. Actual
results may vary if the assumption proves to be incorrect.
8
Average loans increased $848.4 million (24.6%) between third quarters to
$4,302.8 million for quarter ended September 30, 1998. This increase reflected
higher average commercial, construction, real estate commercial mortgage and
residential first mortgage loans outstanding, up $588.4 million (35.6%), $90.1
million (67.7%), $85.1 million (12.8%) and $79.1 million (8.3%), respectively.
The increase in commercial loans resulted from the Bank's internal loan
generation, the acquisition of HB in January 1998 and purchases of corporate
syndicated loans. The increase in real estate commercial mortgage loans was
primarily from the acquisition of HB. The increases in construction loans and
residential first mortgage loans resulted from the Bank's internal loan
generation.
Total average deposits increased $672.6 million (18.6%) between third quarters
due primarily to the acquisition of HB as well as increased deposit levels
generated by the Bank's specialty deposit department and existing branches.
For the first nine months of 1998, average loans increased $834.1 million
(25.2%) and total average investment and available-for-sale securities decreased
$18.8 million (2.3%) over the same period of 1997. Total deposits for the nine
months ended September 30, 1998 increased $658.0 million (18.6%) compared to the
1997 period. The change in the nine month average balance resulted from the same
factors that caused the change between the third quarter average balances.
The provision for credit losses was zero for the quarters and nine months ended
September 30, 1998 and 1997. Loans charged off in the third quarter of 1998 were
$3.1 million, compared to $3.4 million in the third quarter of 1997. Recoveries
were $2.8 million and $8.3 million in the quarters ended September 30, 1998 and
1997, respectively. The allowance for credit losses was 3.12% of total loans at
September 30, 1998 compared to 3.90% at September 30, 1997 and 3.60% at December
31, 1997. The provision for credit losses is expected to remain at reduced
levels for the remainder of 1998. This assumes that general economic conditions
in Southern California will not deteriorate materially during the balance of
1998, and if this assumption proves to be inaccurate, a higher provision for
credit losses may be required.
Noninterest income excluding gains and losses on the sale of securities and
assets totaled $15.5 million for the third quarter of 1998, up $2.6 million
(19.9%) from a year earlier. For the nine months ended September 30, 1998,
noninterest income, excluding gains and losses on sale of securities and
assets, totaled $46.3 million, an increase of $7.9 million (20.5%) from last
year's total of $38.4 million. Service charges on deposit accounts increased
$0.6 million (17.4%) and $3.1 million (31.8%), respectively, for the quarter
and nine months ended September 30, 1998 due primarily to increases in
service charge fee schedules effective during the fourth quarter of 1997 and
the acquisition of HB. Investment services income increased $1.0 million
(27.7%) and $2.2 million (23.3%) compared to the same periods a year ago due
to new customers and new investment products offered to customers. During the
first quarter of 1998, the company invested in bank owned life insurance that
generated $0.5 million and $1.6 million in noninterest income in the third
quarter and first nine months of 1998, respectively. Noninterest income is
expected to continue to grow during the remainder of 1998 and will benefit
from the acquisition of North American Trust Company when the transaction is
completed.
Noninterest expense totaled $50.9 million in the third quarter of 1998, an
increase of $5.9 million (13.2%) from the third quarter of 1997. For the nine
months of 1998, noninterest expense totaled $158.2 million, an increase of
$24.0 million (17.9%) from the same period last year. Salaries and other
employee benefits increased $4.2 million (16.5%) and $13.7 million (18.6%)
for the quarter and nine months ended September 30, 1998 from the comparable
periods in 1997, due primarily to the additional personnel added as a result
of the acquisition of HB, the hiring of additional personnel to pursue other
opportunities, and moving to a more performance-based compensation structure.
The expense categories, other than staff, increased $1.7 million (8.8 %) and
$10.4 million (17.1%) for the quarter and nine months ended September 30,
1998 from the comparable periods in 1997. For the quarter increases in net
occupancy of premises ($1.0 million), due to the HB acquisition, and
depreciation ($0.8 million), due to capital expenditures in 1997, were the
major contributors to higher expenses. In addition to the year to date
increases in these categories, increases in professional expenses resulted
primarily from higher customer service expense due to increased volumes and
higher consulting fees, and higher promotion expense resulted from the
Company's increased advertising program. Amortization of goodwill and core
deposit intangibles for the third quarter was $1.7 million and increased to
$5.1 million for the first nine months of 1998 from $4.5 million in the same
period of 1997, reflecting primarily the
9
acquisition of HB. Lower data processing expense is attributable to savings
from the conversion of core operating systems to a new data processing
provider. Other increases are attributable primarily to the acquisition of
HB. Noninterest expense levels for the remainder of 1998 are expected to be
higher than in 1997 reflecting the growth of the Company and the acquisition
of HB.
The Year 2000 issue is the result of computer programs written using two
digits (rather than four) to define years. Computers or other equipment with
date-sensitive software may recognize "00" as 1900 rather than 2000. This
could result in system failure or miscalculations. If the Company or
significant customers, suppliers or other third parties fail to correct Year
2000 issues, the Company's ability to operate could be affected.
During the third quarter, efforts continued to address Year 2000 matters in
accordance with the Company's five-phase project plan which covers
information technology as well as embedded systems. The five phases are
awareness, assessment, renovation, validation and implementation with
contingency planning as a part of the validation phase. As previously
reported, the first two phases of awareness and assessment have been
completed. The Company has now completed approximately 80% of its renovation
phase. The renovation phase pertains to internal programs and applications
that are not mission critical. As part of the validation phase, the Company
has completed development of its test lab and has already certified as Year
2000 compliant 80% of its hardware, and software applications. On October 4,
1998, M&I, the Bank's core processing provider, successfully completed the
Year 2000 upgrade of its software. The upgrade had no production impact on
either Bank customers or the Bank. Final Year 2000 certification will be
completed with M&I by the end of the first quarter of 1999. In accordance
with the Federal Financial Institution Examination Council's latest guidance,
the Company expects to complete its implementation of mission critical
internal and external systems and applications by June 30, 1999. The Company
has developed a contingency plan for each of its mission critical business
functions. The plan establishes trigger dates by which the contingency plan
will be implemented for each vendor who is not Year 2000 compliant. However,
these plans do not guarantee that circumstances beyond the Company's control
will not adversely impact operations. At this time based on assessments and
testing to date, the Company does not foresee any Year 2000 issues that would
materially impair the Bank's ability to conduct business.
The Company is engaged in the ongoing process of considering and examining
whether or not there would be a material effect on its business, net income
or balance sheet if its vendors, suppliers and customers do not become Year
2000 compliant in a timely manner. With regard to customer readiness the
Company has queried all borrowers with loans of $1.0 million and over. For
those customers having responded, it has been determined that the customer
base would either be only slightly impacted by Year 2000 matters or the
customer's compliance efforts at this time are satisfactory to the point
where the Company has determined there would not be a material effect on the
Company. In addition, there is a group of customers that have indicated that
their compliance will be in the future and the Company continues to monitor
their progress. Wherein the Company is a third party vendor, as in the area
of cash management, it is believed at this time, that the Company will reach
compliance by March 31, 1999. However, if the Company is not compliant, the
customer will be allowed to terminate their contract. The loss of revenue
from this type of relationship would not be material. In terms of our
corporate counterparts for Asset/Liability Management and the International
Department, the Company's analysis of the corporate counterparts is underway
and the effect if any should be finalized by March 31, 1999.
In the third quarter of 1998, approximately $0.5 million was spent on Year 2000
matters, bringing the nine months total expenditures to approximately $1.2
million.
The Company's effective tax rate of 35.9% in the third quarter of 1998 was
slightly higher than the previous quarter and essentially unchanged from the
previous year's third quarter.
10
The following table presents the components of net interest income on a fully
taxable equivalent basis for the three months ended September 30, 1998 and 1997.
NET INTEREST INCOME SUMMARY
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------------------- ------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
Dollars in thousands BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- -------------------- ------- -------- -------- ------- ------- --------
A S S E T S
Earning assets(1)
Loans:
Commercial $ 2,241,282 $ 49,867 8.83% $ 1,652,857 $ 39,342 9.44%
Residential first mortgages 1,035,779 19,966 7.65 956,729 18,477 7.66
Real estate - construction 223,136 6,543 11.63 133,054 4,084 12.18
Real estate - commercial mortgage 751,291 17,369 9.17 666,195 16,373 9.75
Installment 51,345 958 7.40 45,550 1,295 11.28
-------------- ---------- ------------- ----------
Total loans(2) 4,302,833 94,703 8.73 3,454,385 79,571 9.14
Due from banks-interest bearing 9,282 144 6.15 413 2 1.92
State and municipal investment securities 103,175 1,799 6.92 108,715 1,916 6.99
Taxable investment securities 95,005 1,477 6.17 122,231 2,010 6.52
Securities available for sale 620,063 10,601 6.78 586,648 10,143 6.86
Federal funds sold and securities
purchased under resale agreements 31,067 420 5.36 21,918 313 5.67
Trading account securities 63,555 951 5.94 49,455 763 6.12
-------------- ---------- ------------- ----------
Total earning assets 5,224,980 110,095 8.36 4,343,765 94,718 8.65
---------- ----------
Allowance for credit losses (136,083) (135,597)
Cash and due from banks 304,435 337,037
Other nonearning assets 275,427 224,273
-------------- -------------
Total assets $ 5,668,759 $ 4,769,478
-------------- -------------
-------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
Interest checking accounts $ 372,978 929 0.99 $ 347,785 881 1.01
Money market accounts 917,014 7,128 3.08 804,442 6,163 3.04
Savings deposits 166,525 1,542 3.67 167,650 1,433 3.39
Time deposits - under $100,000 193,123 2,584 5.31 223,996 2,909 5.15
Time deposits - $100,000 and over 780,447 10,603 5.39 561,287 7,695 5.44
-------------- ---------- ------------- ----------
Total interest - bearing deposits 2,430,087 22,786 3.72 2,105,160 19,081 3.60
Federal funds purchased and securities
sold under repurchase agreements 414,103 5,713 5.47 183,749 2,480 5.35
Other borrowings 350,958 5,330 6.03 422,808 6,051 5.68
-------------- ---------- ------------- ----------
Total interest - bearing liabilities 3,195,148 33,829 4.20 2,711,717 27,612 4.04
---------- ----------
Noninterest - bearing deposits 1,866,634 1,518,937
Other liabilities 68,467 58,524
Shareholders' equity 538,510 480,300
-------------- -------------
Total liabilities and shareholders'
equity $ 5,668,759 $ 4,769,478
-------------- -------------
-------------- -------------
Net interest spread 4.16% 4.61%
---- ----
---- ----
Fully taxable equivalent net interest income $ 76,266 $ 67,106
---------- ----------
---------- ----------
Net interest margin 5.79% 6.13%
---- ----
---- ----
(1) Includes average nonaccrual loans of $31,239 and $36,483 for 1998 and
1997, respectively.
(2) Loan income includes loan fees of $3,116 and
$2,630 for 1998 and 1997, respectively.
11
The following table presents the components of net interest income on a fully
taxable equivalent basis for the nine months ended September 30, 1998 and 1997.
NET INTEREST INCOME SUMMARY
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------------------------- ----------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
Dollars in thousands BALANCE EXPENSE RATE BALANCE EXPENSE RATE
- -------------------- ------- -------- -------- ------- -------- --------
A S S E T S
Earning assets (1)
Loans:
Commercial $ 2,128,408 $144,618 9.08% $ 1,570,668 $110,040 9.34%
Residential first mortgages 1,028,118 58,684 7.63 935,067 54,584 7.80
Real estate - construction 174,332 14,763 11.32 122,766 10,766 11.72
Real estate - commercial mortgage 760,594 54,768 9.63 633,082 46,848 9.89
Installment 51,340 3,808 9.92 47,075 3,780 10.74
------------- ----------- ------------ ---------
Total loans (2) 4,142,792 276,641 8.93 3,308,658 226,018 9.13
Due from banks-interest bearing 6,391 283 5.92 2,825 100 4.73
State and municipal investment securities 104,942 5,313 6.77 104,547 5,500 7.03
Taxable investment securities 105,488 5,006 6.34 117,123 5,725 6.54
Securities available for sale 601,186 30,727 6.83 608,742 30,840 6.77
Federal funds sold and securities
purchased under resale agreements 43,850 1,827 5.57 22,012 896 5.44
Trading account securities 52,650 2,349 5.97 46,004 2,000 5.81
------------- ----------- ------------ ---------
Total earning assets 5,057,299 322,146 8.52 4,209,911 271,079 8.60
----------- ---------
Allowance for credit losses (137,742) (136,123)
Cash and due from banks 309,709 334,080
Other nonearning assets 273,766 220,145
------------- ------------
Total assets $ 5,503,032 $ 4,628,013
------------- ------------
------------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
Interest checking accounts $ 384,482 2,850 0.99 $ 366,036 2,757 1.01
Money market accounts 870,405 19,865 3.05 793,900 17,952 3.02
Savings deposits 167,688 4,520 3.60 169,210 4,216 3.33
Time deposits - under $100,000 204,683 8,050 5.26 226,787 8,672 5.11
Time deposits - $100,000 and over 749,724 29,826 5.32 506,560 20,010 5.28
------------- ----------- ------------ ---------
Total interest - bearing deposits 2,376,982 65,111 3.66 2,062,493 53,607 3.48
Federal funds purchased and securities
sold under repurchase agreements 375,071 15,280 5.45 225,770 8,888 5.26
Other borrowings 335,240 15,149 6.04 348,533 14,556 5.58
------------- ----------- ------------ ---------
Total interest - bearing liabilities 3,087,293 95,540 4.14 2,636,796 77,051 3.91
----------- ---------
Noninterest - bearing deposits 1,815,518 1,471,934
Other liabilities 65,010 54,218
Shareholders' equity 535,211 465,065
------------- ------------
Total liabilities and shareholders'
equity $ 5,503,032 $ 4,628,013
------------- ------------
------------- ------------
Net interest spread 4.38% 4.69%
---- ----
---- ----
Fully taxable equivalent net interest income $226,606 $194,028
----------- ---------
----------- ---------
Net interest margin 5.99% 6.16%
---- ----
---- ----
(1) Includes average nonaccrual loans of $33,833 and $40,922 for 1998 and
1997, respectively.
(2) Loan income includes loan fees of $8,814 and $6,516
for 1998 and 1997, respectively.
12
The following tables set forth the changes in net interest income on a
fully taxable equivalent basis broken down by volume and rates. The change in
interest due to both volume and rate has been allocated to change due to
volume and rate in proportion to the relationship of the absolute dollar
amounts of the change in each.
CHANGES IN NET INTEREST INCOME
FOR THE THREE FOR THE THREE
MONTHS ENDED SEPTEMBER 30, MONTHS ENDED SEPTEMBER 30,
DOLLARS IN THOUSANDS 1998 VS 1997 1997 VS 1996
- --------------------------- ---------------------------------------- -------------------------------------------
INCREASE (DECREASE) NET INCREASE (DECREASE) NET
DUE TO INCREASE DUE TO INCREASE
---------------------- ------------------------
VOLUME RATE (DECREASE) VOLUME RATE (DECREASE)
---------- --------- -------------- ----------- --------- --------------
Interest earned on:
Interest-bearing deposits
in other banks $ 130 $ 12 $ 142 $ (191) $ (117) $ (308)
Loans 18,832 (3,700) 15,132 18,994 2,059 21,053
Investment securities (547) (103) (650) 691 81 772
Securities available for sale 576 (118) 458 (1,204) 487 (717)
Trading account securities 211 (23) 188 150 10 160
Federal funds sold and
securities purchased
under resale agreements 125 (18) 107 (492) 12 (480)
-------- ------- -------- -------- -------- --------
Total interest-earning assets 19,327 (3,950) 15,377 17,948 2,532 20,480
-------- ------- -------- -------- -------- --------
Interest paid on:
Interest checking 66 (18) 48 117 -- 117
Money market deposits 882 83 965 498 96 594
Savings deposits (10) 119 109 302 75 377
Other time deposits 2,563 20 2,583 3,793 416 4,209
Other borrowings 2,278 234 2,512 (420) 389 (31)
-------- ------- -------- -------- -------- --------
Total interest-bearing liabilities 5,779 438 6,217 4,290 976 5,266
-------- ------- -------- -------- -------- --------
$ 13,548 $(4,388) $ 9,160 $ 13,658 $ 1,556 $ 15,214
-------- ------- -------- -------- -------- --------
-------- ------- -------- -------- -------- --------
FOR THE NINE FOR THE NINE
MONTHS ENDED SEPTEMBER 30, MONTHS ENDED SEPTEMBER 30,
DOLLARS IN THOUSANDS 1998 VS 1997 1997 VS 1996
- ----------------------------- ---------------------------------------- -------------------------------------------
INCREASE (DECREASE) NET INCREASE (DECREASE) NET
DUE TO INCREASE DUE TO INCREASE
---------------------- ------------------------
VOLUME RATE (DECREASE) VOLUME RATE (DECREASE)
---------- --------- -------------- ----------- --------- --------------
Interest earned on:
Interest-bearing deposits
in other banks $ 153 $ 30 $ 183 $ (892) $ (154) $ (1,046)
Loans 55,683 (5,060) 50,623 56,583 3,016 59,599
Investment securities (562) (344) (906) 2,742 86 2,828
Securities available for sale (385) 272 (113) (3,242) 1,754 (1,488)
Trading account securities 293 56 349 512 (55) 457
Federal funds sold and
securities purchased
under resale agreements 910 21 931 (1,999) (63) (2,062)
-------- -------- -------- -------- -------- --------
Total interest-earning assets 56,092 (5,025) 51,067 53,704 4,584 58,288
-------- -------- -------- -------- -------- --------
Interest paid on:
Interest checking 145 (52) 93 387 -- 387
Money market deposits 1,734 179 1,913 1,499 276 1,775
Savings deposits (38) 342 304 907 220 1,127
Other time deposits 8,750 444 9,194 9,421 488 9,909
Other borrowings 5,778 1,207 6,985 2,088 553 2,641
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities 16,369 2,120 18,489 14,302 1,537 15,839
-------- -------- -------- -------- -------- --------
$ 39,723 $ (7,145) $ 32,578 $ 39,402 $ 3,047 $ 42,449
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
13
BALANCE SHEET ANALYSIS
SECURITY PORTFOLIO
Comparative period-end security portfolio balances are presented below:
INVESTMENT SECURITIES
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1998 1997 1997
---------------------- ----------------------- -----------------------
DOLLARS IN THOUSANDS COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
- -------------------- ---- ---------- ---- ---------- ---- ----------
Mortgage-backed $ 87,456 $ 88,406 $107,386 $107,728 $110,913 $110,985
State and Municipal 102,148 104,272 107,567 108,756 107,804 108,724
Other debt 3,155 3,154 3,216 3,201 3,215 3,215
-------- -------- -------- -------- -------- --------
Total debt securities 192,759 195,832 218,169 219,685 221,932 222,924
Equity 12 12 7,765 7,780 6,520 6,520
-------- -------- -------- -------- -------- --------
Total securities $192,771 $195,844 $225,934 $227,465 $228,452 $229,444
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
AVAILABLE-FOR-SALE SECURITIES
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1998 1997 1997
---------------------- ----------------------- -----------------------
DOLLARS IN THOUSANDS COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
- -------------------- ---- ---------- ---- ---------- ---- ----------
U.S. Gov. and federal agency $270,032 $279,521 $255,552 $257,057 $259,859 $260,246
Mortgage-backed 189,559 193,225 171,439 172,075 153,697 152,930
State and Municipal 2,179 2,195 5,911 5,997 5,920 5,983
Other debt 136,870 138,942 23,928 25,920 24,131 24,979
-------- -------- -------- -------- -------- --------
Total debt securities 598,640 613,883 456,830 461,049 443,607 444,138
Marketable equity securities 117,067 120,508 141,080 146,139 138,527 142,613
-------- -------- -------- -------- -------- --------
Total securities $715,707 $734,391 $597,910 $607,188 $582,134 $586,751
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
The following tables provide the expected remaining maturities and
yields (taxable-equivalent basis) of debt securities within the securities
portfolio as of September 30, 1998.
INVESTMENT DEBT SECURITIES
ONE YEAR OVER 1 YEAR OVER 5 YEARS
OR LESS THRU 5 YEARS THRU 10 YEARS OVER 10 YEARS TOTAL
---------------- --------------- --------------- --------------- ---------------
DOLLARS IN THOUSANDS AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- -------------------- ------ ----- ------ ----- ----- ----- ------ ----- ------ -----
Mortgage-backed $28,686 6.77% $ 48,908 6.49% $ 9,862 7.12% $ -- -- % $ 87,456 6.66%
State and Municipal 24,922 6.60 64,064 6.73 13,162 7.03 -- -- 102,148 6.74
Other debt 1,000 8.00 2,155 7.14 -- -- -- -- 3,155 7.41
------- ----- -------- ----- ------- ----- ------- ---- -------- -----
Total debt securities $54,608 6.71% $115,127 6.64% $23,024 7.07% $ -- -- % $192,759 6.71%
------- -------- ------- ------- --------
------- -------- ------- ------- --------
Fair value $54,651 $117,314 $23,867 $ -- $195,832
------- -------- ------- ------- --------
------- -------- ------- ------- --------
AVAILABLE-FOR-SALE DEBT SECURITIES
ONE YEAR OVER 1 YEAR OVER 5 YEARS
OR LESS THRU 5 YEARS THRU 10 YEARS OVER 10 YEARS TOTAL
---------------- --------------- --------------- --------------- ---------------
DOLLARS IN THOUSANDS AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
- -------------------- ------ ----- ------ ----- ----- ----- ------ ----- ------ -----
U.S. Gov. and
federal agency........ $12,489 5.74% $235,751 6.12% $ 31,281 6.26% $ -- -- % $279,521 6.12%
Mortgage-backed........ -- -- -- -- -- -- 193,225 6.75 193,225 6.75
State and Municipal.... -- -- 2,195 5.92 -- -- -- -- 2,195 5.92
Other debt............. -- -- -- -- 95,842 7.71 43,100 8.07 138,942 7.82
------- ---- -------- ----- -------- ----- -------- ----- -------- -----
Total debt securities. $12,489 5.74% $237,946 6.12% $127,123 7.35% $236,325 6.99% $613,883 6.70%
------- -------- -------- -------- --------
------- -------- -------- -------- --------
Amortized cost.... $12,464 $229,868 $124,830 $231,478 $598,640
------- -------- -------- -------- --------
------- -------- -------- -------- --------
Dividend income included in interest income on securities in the
Consolidated Statement of Income and Comprehensive Income in the third quarter
of 1998 and 1997 was $1.9 million and $2.4 million, respectively and for the
nine months of 1998 and 1997 was $6.5 million and $6.3 million, respectively.
14
LOAN PORTFOLIO
A comparative period-end loan table is presented below:
LOANS
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
DOLLARS IN THOUSANDS 1998 1997 1997
- ----------------------------- ------------- ------------ -------------
Commercial $ 2,280,202 $ 1,972,232 $ 1,694,859
Residential first mortgage 1,033,799 980,040 951,688
Real estate - construction 234,519 144,558 144,989
Real estate - mortgage 744,265 686,188 695,434
Installment 51,011 42,206 43,152
------------- ------------ -------------
Total loans, gross 4,343,796 3,825,224 3,530,122
Less: Allowance for credit losses (135,486) (137,761) (137,850)
------------- ------------ -------------
Total loans, net $ 4,208,310 $ 3,687,463 $ 3,392,272
------------- ------------ -------------
------------- ------------ -------------
Gross loans at September 30, 1998 amounted to $4,343.8 million, up
$813.7 million (23.0%) from September 30, 1997 and up $518.6 million (13.6%)
from December 31, 1997. Approximately $152.2 million of the increase was due
to the acquisition of HB. Also contributing to the $585.3 million increase in
commercial loans from September 30, 1997 were loan originations and the
purchase of syndicated corporate loans. The $82.1 million increase in
residential first mortgage loans from the year ago quarter resulted from the
Bank's own originations. Construction loans also increased by $89.5 million
from September 30, 1997 as the Company continued to expand its lending for
residential construction development. The Company expects that the Bank's
loan portfolio will continue to increase from third quarter 1998 levels.
The following table presents information concerning nonaccrual loans,
ORE, and restructured loans.
NONACCRUAL LOANS, ORE AND RESTRUCTURED LOANS
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
DOLLARS IN THOUSANDS 1998 1997 1997
- ----------------------------- ------------- ------------ -------------
Nonaccrual loans:
Commercial $ 10,200 $ 6,589 $ 11,443
Real estate 19,664 19,243 19,594
Installment 2,642 1,734 --
------------- ------------ -------------
Total 32,506 27,566 31,037
ORE: 2,148 2,126 7,433
------------- ------------ -------------
Total nonaccrual loans and ORE $ 34,654 $ 29,692 $ 38,470
------------- ------------ -------------
------------- ------------ -------------
Restructured loans, accruing $ 1,766 $ 2,813 $ 4,165
------------- ------------ -------------
------------- ------------ -------------
Total non accrual loans as a
percentage of total loans................... 0.75% 0.72% 0.88%
Total non accrual loans and ORE as a
percentage of total loans and ORE........... 0.80 0.78 1.09
Allowance for credit losses to total loans..... 3.12 3.60 3.90
Allowance for credit losses
to nonaccrual loans........................ 416.80 499.75 444.15
15
The table below summarizes the approximate changes in nonaccrual loans for
the quarters and nine months ended September 30, 1998 and September 30, 1997.
CHANGES IN NONACCRUAL LOANS
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- -------------------------
DOLLARS IN MILLIONS 1998 1997 1998 1997
- ------------------- ---- ---- ---- ----
Balance, beginning of period $33.2 $40.8 $27.6 $41.5
Additions from acquisitions -- -- 3.1 2.4
Loans placed on nonaccrual 5.4 5.2 30.2 25.7
Charge offs (1.9) (2.2) (9.5) (11.0)
Loans returned to accrual status -- (6.8) -- (9.9)
Repayments (including interest
applied to principal) (4.2) (5.5) (18.9) (14.6)
Transfer to ORE -- (0.5) -- (3.1)
----- ----- ----- -----
Balance, end of period $32.5 $31.0 $32.5 $31.0
----- ----- ----- -----
----- ----- ----- -----
At September 30, 1998, in addition to loans disclosed above as nonaccrual
or restructured, management had also identified $3.5 million of problem loans
about which the ability of the borrowers to comply with the present loan
repayment terms in the future is questionable.
ALLOWANCE FOR CREDIT LOSSES
The following table summarizes average loans outstanding and changes in the
allowance for credit losses for the periods presented:
CHANGES IN ALLOWANCE FOR CREDIT LOSSES
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- -------------------------
DOLLARS IN MILLIONS 1998 1997 1998 1997
- ------------------- ---- ---- ---- ----
Average amount of loans outstanding $4,302.8 $3,454.4 $4,142.8 $3,308.7
-------- -------- -------- --------
-------- -------- -------- --------
Balance of allowance for credit losses,
beginning of period $ 135.8 $ 132.9 $ 137.8 $ 130.1
Loans charged off:
Commercial 1.9 2.7 12.9 10.9
Real estate 1.2 0.7 2.1 4.2
-------- -------- -------- --------
Total loans charged off 3.1 3.4 15.0 15.1
-------- -------- -------- --------
Less recoveries of loans previously charged off:
Commercial 2.4 2.4 9.5 8.7
Real estate 0.4 5.9 0.5 7.1
-------- -------- -------- --------
Total recoveries 2.8 8.3 10.0 15.8
-------- -------- -------- --------
Net loans (charged off) recovered (0.3) 4.9 (5.0) 0.7
Additions to allowance from provisions -- -- -- --
Additions to allowance from acquisitions -- -- 2.7 7.0
-------- -------- -------- --------
Balance, end of period $ 135.5 $ 137.8 $ 135.5 $ 137.8
-------- -------- -------- --------
-------- -------- -------- --------
Ratio of net charge-offs
to average loans 0.01% * 0.12% *
-------- -------- -------- --------
-------- -------- -------- --------
Ratio of allowance for credit losses
to total period end loans 3.12% 3.90%
-------- -------
-------- -------
* Not meaningful
16
CAPITAL ADEQUACY REQUIREMENT
The following table presents the regulatory standards for "well capitalized"
institutions and the capital ratios for the Company and the Bank at September
30, 1998, December 31, 1997 and September 30, 1997.
Regulatory
Well Capitalized September 30, December 31, September 30,
Standards 1998 1997 1997
---------------- ------------- ------------ -------------
CITY NATIONAL CORPORATION
Tier 1 leverage 4.00% 8.33% 9.19% 9.09%
Tier 1 risk-based capital 6.00 9.81 10.99 11.43
Total risk-based capital 10.00 13.69 12.27 12.71
CITY NATIONAL BANK
Tier 1 leverage 5.00 7.90 7.93 7.86
Tier 1 risk-based capital 6.00 9.28 9.50 9.92
Total risk-based capital 10.00 13.17 10.78 11.20
In September, the Company completed a 1.0 million-share common stock buyback
program that had been announced in April, at a cost of $34.3 million or an
average price of $34.27 per share. Concurrently, a new 1.0 million-share
common stock buyback program was announced. Shares are repurchased from time
to time in open market transactions. As of October 31, 1998 the Company had
repurchased 128,000 shares under this program at a total cost of $3.5
million, or an average price of $27.38 per share. Shares purchased under the
buyback program will be reissued upon the exercise of stock options and for
other general corporate purposes.
On October 28, 1998, the Company declared a regular quarterly dividend of
$.14 per share, payable November 12, 1998 to shareholders of record as of
November 3, 1998.
ASSET/LIABILITY MANAGEMENT
The principal objectives of asset/liability management are to maximize net
interest margin subject to margin volatility and liquidity constraints.
Margin volatility results when the rate reset (or repricing) characteristics
of assets are materially different from those of the Company's liabilities.
Liquidity risk results from the mismatching of asset and liability cash
flows. Management chooses asset/liability strategies that promote stable
earnings and reliable funding. Interest rate risk and funding positions are
kept within limits established by the Company's board of directors to ensure
that risk-taking is not excessive and that liquidity is properly managed.
The Company has established three measurement process to quantify and manage
exposure to interest rate risk: net interest income simulation modeling, gap
analysis, and present value of equity analysis. Net interest income
simulations are used to identify the direction and severity of interest rate
risk exposure across a twelve month forecast horizon. Gap analysis provides
insight into structural mismatches of assets and liability repricing
characteristics. Present value of equity calculations are used to estimate
the theoretical price sensitivity of shareholder equity to changes in
interest rates.
Generally, an asset sensitive gap indicates that net interest income will
improve during a period of rising interest rates. The gap report is based on
the contractual cash flows of all asset and liability balances on the
Company's books. The contractual life of those balances may differ
substantially from their expected lives however. For example, checking
accounts are all subject to immediate withdrawal. Experience suggests that
these accounts will
17
have an average life of several years. Also, certain loans (such as first
mortgages) are subject to prepayment. The cash flows shown in the gap report
are adjusted to reflect these behaviors. The gap report also shows the
effects that interest rate swaps have had on the repricing profile of the
Company.
The use of interest rate swaps to manage interest rate exposure involves the
risk of dealing with counterparties and their ability to meet contractual
terms. These counterparties must receive appropriate credit approval before
the Company enters into an interest rate contract. Notional principal amounts
express the volume of these transactions, although the amounts potentially
subject to credit and market risks are much smaller. At September 30, 1998,
almost all of the Company's interest rate swaps were entered into as hedges
against a decrease in interest income generated from prime based loans if the
prime decreased. The Company has not entered into transactions involving any
other interest rate derivative financial instruments, such as interest rate
floors, caps and interest rate futures contracts.
At September 30, 1998, the under-one-year cumulative gap was a $63.2 million
(1.1% of total assets) net asset position compared with a net asset position
of $132 million (3% of total assets) at December 31, 1997. The decrease
resulted from an increase in interest rate risk mitigation activities and
relatively low holdings of short-term rate-sensitive assets. As of September
30, 1998, the Company has $610.0 million of notional principal in receive
fixed-pay LIBOR interest rate swaps, of which $420.0 million have maturities
greater than one year. The Company's interest-rate risk-management
instruments had a fair value of $9.9 million and $1.7 million and an exposure
to credit risk of $2.2 million and $1.8 million at September 30, 1998 and
December 31, 1997, respectively. The credit exposure represents the cost to
replace, on a present value basis and at current market rates, all profitable
contracts outstanding at the end of the period. The Company's swap agreements
require the deposit of collateral to mitigate the amount of credit risk if
certain thresholds are exceeded. No amounts were required to be deposited by
the Company or its counterparties as of September 30, 1998.
Since interest rate changes do not affect all categories of assets and
liabilities equally or simultaneously, a cumulative gap analysis alone cannot
be used to evaluate the Company's interest rate sensitivity position. To
supplement traditional gap analysis, the Company uses simulation modeling to
estimate the potential effects of changing interest rates. This process
allows the Company to fully explore the complex relationships within the gap
over time and various interest rate scenarios.
At September 30, 1998, the Company's outstanding foreign exchange contracts
totaled $20.3 million. The Company enters into foreign exchange contracts
with its customers and counterparty banks solely for the purpose of
offsetting or hedging transaction and economic exposures arising out of
commercial transactions. The Company's policies prohibit outright speculation
by the Company and its employees. The Company actively manages its foreign
exchange exposures within prescribed risk limits and controls. All foreign
exchange contracts outstanding at September 30, 1998 had remaining maturities
of six months or less with the exception of $8.9 million which had remaining
maturities ranging between six months and 24 months.
LIQUIDITY MANAGEMENT
The Company continues to manage its liquidity through the combination of core
deposits, federal funds purchased, repurchase agreements, collateralized
borrowing lines at the Federal Reserve Bank and the Federal Home Loan Bank of
San Francisco, and a portfolio of securities availabie-for-sale. Liquidity is
also provided by maturing investment securities and loans.
Average core deposits and shareholders' equity comprised 71.5% of total
funding in the third quarter of 1998, compared to 74.3% in the third quarter
of 1997. This decrease has required that the Company increase its use of more
costly alternative funding sources. Despite the decrease in percentage of
funding derived from core deposits and shareholders' equity, the Company has
not faced any liquidity constraints.
18
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company wishes to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 as to "forward looking"
statements in this Quarterly Report which are not historical facts. The
Company cautions readers that the following important factors could affect
the Company's business and cause actual results to differ materially from
those expressed in any forward looking statement made by, or on behalf of,
the Company.
- --Economic conditions. The Company's results are strongly influenced by
general economic conditions in its market area, Southern California, and a
deterioration in these conditions could have a material adverse impact on the
quality of the Bank's loan portfolio and the demand for its products and
services. In particular, changes in economic conditions in the real estate
and entertainment industries may affect the Company's performance.
- --Interest rates. Management anticipates that the recent easing of interest
rates may continue. If interest rates vary substantially from present levels,
this may cause the Company's results to differ materially.
- --Government regulation and monetary policy. All forward looking statements
presume a continuation of the existing regulatory environment and U.S.
Government policies. The banking industry is subject to extensive federal and
state regulations, and significant new laws or changes in, or repeal of,
existing laws may cause results to differ materially. Further, federal
monetary policy, particularly as implemented through the Federal Reserve
System, significantly affects credit conditions for the Bank, primarily
through open market operations in U.S. Government securities, the discount
rate for member bank borrowing and bank reserve requirements, and a material
change in these conditions would be likely to have an impact on results.
- --Competition. The Bank competes with numerous other domestic and foreign
financial institutions and non-depository financial intermediaries. Results
may differ if circumstances affecting the nature or level of competitive
change, such as the merger of competing financial institutions.
- --Credit quality. A significant source of risk arises from the possibility
that losses will be sustained because borrowers, guarantors and related
parties may fail to perform in accordance with the terms of their loans. The
Bank has adopted underwriting and credit monitoring procedures and credit
policies, including the establishment and review of the allowance for credit
losses, that management believes are appropriate to minimize this risk. These
procedures and policies assess the likelihood of nonperformance, track loan
performance and diversify the Bank's credit portfolio, but may not prevent
unexpected losses that could adversely affect the Company's results.
- --Other risks. From time to time, the Company details other risks to its
businesses and/or its financial results in its filings with the Securities
and Exchange Commission.
While management believes that its assumptions regarding these and other
factors on which forward looking statements are based are reasonable, such
assumptions are necessarily speculative in nature, and actual outcomes can be
expected to differ to some degree. Consequently, there can be no assurance
that the results described in such forward looking statements will, in fact,
be achieved.
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PART 11. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None
ITEM 5. OTHER INFORMATION
(a) Exhibits
10.22.2 Employment agreement dated as of July 15, 1998,
between Russell Goldsmith and City National Bank
(b) Reports on Form 8-K
None
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.
CITY NATIONAL CORPORATION
(Registrant)
DATE: November 16, 1998 /s/ FRANK P. PEKNY
------------------------- -------------------------------
FRANK P. PEKNY
Executive Vice President
and Chief Financial Officer
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