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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, 2003
COMMISSION FILE NUMBER 1-15081
UNIONBANCAL CORPORATION
State of Incorporation: CALIFORNIA
I.R.S. Employer Identification No. 94-1234979
400 CALIFORNIA STREET
SAN FRANCISCO, CALIFORNIA 94104-1302
(Address and zip code of principal executive offices)
Registrant's telephone number: (415) 765-2969
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
Number of shares of Common Stock outstanding at July 31, 2003: 151,287,777
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UNIONBANCAL CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
NUMBER
------
PART I
FINANCIAL INFORMATION
Consolidated Financial Highlights....................................... 2
Item 1. Financial Statements:
Condensed Consolidated Statements of Income........................... 4
Condensed Consolidated Balance Sheets................................. 5
Condensed Consolidated Statements of Changes in Shareholders' Equity.. 6
Condensed Consolidated Statements of Cash Flows....................... 7
Notes to Condensed Consolidated Financial Statements.................. 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations:
Introduction.......................................................... 20
Summary............................................................... 21
Business Segments..................................................... 22
Net Interest Income................................................... 32
Noninterest Income.................................................... 35
Noninterest Expense................................................... 37
Income Tax Expense.................................................... 38
Loans................................................................. 39
Cross-Border Outstandings............................................. 40
Provision for Credit Losses........................................... 40
Allowance for Credit Losses........................................... 41
Nonperforming Assets.................................................. 45
Loans 90 Days or More Past Due and Still Accruing..................... 45
Quantitative and Qualitative Disclosure about Interest Rate Risk
Management (Other Than Trading)..................................... 46
Liquidity Risk........................................................ 49
Regulatory Capital.................................................... 50
Certain Business Risk Factors......................................... 51
Item 3. Quantitative and Qualitative Disclosure About Market Risk....... 55
Item 4. Controls and Procedures......................................... 55
PART II
OTHER INFORMATION
Item 1. Legal Proceedings............................................... 56
Item 4. Submission of Matters to a Vote of Security Holders............. 56
Item 6. Exhibits and Reports on Form 8-K................................ 57
Signatures.................................................................. 58
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) 2002 2003 CHANGE
- ------------------------------------------------------------ ----------- ----------- -------
RESULTS OF OPERATIONS:
Net interest income(1).................................... $ 386,298 $ 386,422 0.03%
Provision for credit losses............................... 50,000 25,000 (50.00)
Noninterest income........................................ 175,606 203,171 15.70
Noninterest expense....................................... 316,623 351,004 10.86
----------- -----------
Income before income taxes(1)............................. 195,281 213,589 9.38
Taxable-equivalent adjustment............................. 537 645 20.11
Income tax expense........................................ 64,802 68,186 5.22
----------- -----------
Net income................................................ $ 129,942 $ 144,758 11.40%
=========== ===========
PER COMMON SHARE:
Net income--basic......................................... $ 0.83 $ 0.96 15.66%
Net income--diluted....................................... 0.81 0.96 18.52
Dividends(2).............................................. 0.28 0.31 10.71
Book value (end of period)................................ 23.94 25.79 7.73
Common shares outstanding (end of period)................. 157,718,215 149,993,652 (4.90)
Weighted average common shares outstanding--basic......... 157,314,527 150,046,659 (4.62)
Weighted average common shares outstanding--diluted....... 159,675,924 151,489,337 (5.13)
BALANCE SHEET (END OF PERIOD):
Total assets.............................................. $36,136,725 $42,668,834 18.08%
Total loans............................................... 25,592,306 25,668,660 0.30
Nonaccrual loans.......................................... 414,482 379,487 (8.44)
Nonperforming assets...................................... 414,972 379,758 (8.49)
Total deposits............................................ 28,833,365 35,365,260 22.65
Medium and long-term debt................................. 406,869 420,853 3.44
Trust preferred securities................................ 366,265 360,166 (1.67)
Shareholders' equity...................................... 3,775,663 3,868,959 2.47
BALANCE SHEET (PERIOD AVERAGE):
Total assets.............................................. $35,730,492 $39,776,349 11.32%
Total loans............................................... 25,578,846 26,517,316 3.67
Earning assets............................................ 32,674,628 36,074,488 10.41
Total deposits............................................ 28,222,245 32,587,173 15.47
Shareholders' equity...................................... 3,749,035 3,919,276 4.54
FINANCIAL RATIOS:
Return on average assets(3)............................... 1.46% 1.46%
Return on average shareholders' equity(3)................. 13.90 14.81
Efficiency ratio(4)....................................... 56.35 59.53
Net interest margin(1).................................... 4.74 4.29
Dividend payout ratio..................................... 33.73 32.29
Tangible equity ratio..................................... 10.16 8.59
Tier 1 risk-based capital ratio........................... 11.90 11.44
Total risk-based capital ratio............................ 13.65 13.06
Leverage ratio............................................ 10.77 9.63
Allowance for credit losses to total loans................ 2.44 2.17
Allowance for credit losses to nonaccrual loans........... 150.78 147.11
Net loans charged off to average total loans(3)........... 0.90 0.80
Nonperforming assets to total loans and foreclosed assets. 1.62 1.48
Nonperforming assets to total assets...................... 1.15 0.89
- -------------------------------
<FN>
(1) Amounts are on a taxable-equivalent basis using the federal statutory tax
rate of 35 percent.
(2) Dividends per share reflect dividends declared on UnionBanCal Corporation's
common stock outstanding as of the declaration date.
(3) Annualized.
(4) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income
(taxable-equivalent basis) and noninterest income. Foreclosed asset expense
(income) was ($13) thousand for the second quarter of 2002 and nil for the
second quarter of 2003.
</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) 2002 2003 CHANGE
- ------------------------------------------------------------ ----------- ----------- -------
RESULTS OF OPERATIONS:
Net interest income(1).................................... $ 767,271 $ 777,826 1.38%
Provision for credit losses............................... 105,000 55,000 (47.62)
Noninterest income........................................ 335,349 388,942 15.98
Noninterest expense....................................... 628,278 693,604 10.40
----------- -----------
Income before income taxes(1)............................. 369,342 418,164 13.22
Taxable-equivalent adjustment............................. 1,070 1,269 18.60
Income tax expense........................................ 123,553 136,620 10.58
----------- -----------
Net income................................................ $ 244,719 $ 280,275 14.53%
=========== ===========
PER COMMON SHARE:
Net income--basic......................................... $ 1.56 $ 1.86 19.23%
Net income--diluted....................................... 1.54 1.85 20.13
Dividends(2).............................................. 0.53 0.59 11.32
Book value (end of period)................................ 23.94 25.79 7.73
Common shares outstanding (end of period)................. 157,718,215 149,993,652 (4.90)
Weighted average common shares outstanding--basic......... 156,774,339 150,329,939 (4.11)
Weighted average common shares outstanding--diluted....... 158,534,791 151,746,328 (4.28)
BALANCE SHEET (END OF PERIOD):
Total assets.............................................. $36,136,725 $42,668,834 18.08%
Total loans............................................... 25,592,306 25,668,660 0.30
Nonaccrual loans.......................................... 414,482 379,487 (8.44)
Nonperforming assets...................................... 414,972 379,758 (8.49)
Total deposits............................................ 28,833,365 35,365,260 22.65
Medium and long-term debt................................. 406,869 420,853 3.44
Trust preferred securities................................ 366,265 360,166 (1.67)
Shareholders' equity...................................... 3,775,663 3,868,959 2.47
BALANCE SHEET (PERIOD AVERAGE):
Total assets.............................................. $35,408,797 $39,066,221 10.33%
Total loans............................................... 25,354,548 26,619,618 4.99
Earning assets............................................ 32,327,489 35,454,075 9.67
Total deposits............................................ 27,897,401 31,836,948 14.12
Shareholders' equity...................................... 3,687,244 3,896,909 5.69
FINANCIAL RATIOS:
Return on average assets(3)............................... 1.39% 1.45%
Return on average shareholders' equity(3)................. 13.38 14.50
Efficiency ratio(4)....................................... 56.97 59.44
Net interest margin(1).................................... 4.77 4.41
Dividend payout ratio..................................... 33.97 31.72
Tangible equity ratio..................................... 10.16 8.59
Tier 1 risk-based capital ratio........................... 11.90 11.44
Total risk-based capital ratio............................ 13.65 13.06
Leverage ratio............................................ 10.77 9.63
Allowance for credit losses to total loans................ 2.44 2.17
Allowance for credit losses to nonaccrual loans........... 150.78 147.11
Net loans charged off to average total loans(3)........... 0.93 0.80
Nonperforming assets to total loans and foreclosed assets. 1.62 1.48
Nonperforming assets to total assets...................... 1.15 0.89
- ------------------------------
<FN>
(1) Amounts are on a taxable-equivalent basis using the federal statutory tax
rate of 35 percent.
(2) Dividends per share reflect dividends declared on UnionBanCal Corporation's
common stock outstanding as of the declaration date.
(3) Annualized.
(4) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income
(taxable-equivalent basis) and noninterest income. Foreclosed asset expense
was $112 thousand and $51 thousand for the first six months of 2002 and
2003, respectively.
</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,
---------------------- ---------------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2003 2002 2003
- -------------------------------------------------------------- -------- -------- -------- --------
INTEREST INCOME
Loans....................................................... $378,572 $354,913 $754,370 $717,888
Securities.................................................. 78,244 78,036 159,580 157,899
Interest bearing deposits in banks.......................... 629 1,130 1,125 2,092
Federal funds sold and securities purchased under resale
agreements................................................ 4,828 4,001 8,887 5,678
Trading account assets...................................... 930 943 1,621 1,870
-------- -------- -------- --------
Total interest income..................................... 463,203 439,023 925,583 885,427
-------- -------- -------- --------
INTEREST EXPENSE
Domestic deposits........................................... 55,411 40,217 115,346 81,788
Foreign deposits............................................ 6,105 2,811 12,369 6,017
Federal funds purchased and securities sold under
repurchase agreements..................................... 1,396 747 3,345 2,074
Commercial paper............................................ 4,536 2,946 8,510 5,674
Medium and long-term debt................................... 2,411 1,818 4,823 3,684
UnionBanCal Corporation--obligated mandatorily
redeemable preferred securities of subsidiary
grantor trust............................................. 3,948 3,652 7,911 7,323
Other borrowed funds........................................ 3,635 1,055 7,078 2,310
-------- -------- -------- --------
Total interest expense.................................... 77,442 53,246 159,382 108,870
-------- -------- -------- --------
NET INTEREST INCOME........................................... 385,761 385,777 766,201 776,557
Provision for credit losses................................. 50,000 25,000 105,000 55,000
-------- -------- -------- --------
Net interest income after provision for credit
losses.................................................. 335,761 360,777 661,201 721,557
-------- -------- -------- --------
NONINTEREST INCOME
Service charges on deposit accounts......................... 69,869 77,942 136,012 150,229
Trust and investment management fees........................ 37,587 33,141 74,312 65,816
International commissions and fees.......................... 19,239 21,276 37,462 40,889
Insurance commissions....................................... 6,252 15,706 13,405 28,711
Card processing fees, net................................... 8,736 9,340 17,275 19,022
Brokerage commissions and fees.............................. 9,275 8,729 18,907 17,595
Foreign exchange trading gains, net......................... 7,011 6,958 13,459 13,892
Merchant banking fees....................................... 9,081 6,191 16,026 12,209
Securities gains, net....................................... 1,969 9,013 1,969 9,013
Other....................................................... 6,587 14,875 6,522 31,566
-------- -------- -------- --------
Total noninterest income.................................. 175,606 203,171 335,349 388,942
-------- -------- -------- --------
NONINTEREST EXPENSE
Salaries and employee benefits.............................. 186,100 198,929 364,976 397,036
Net occupancy............................................... 25,029 32,866 48,410 60,502
Equipment................................................... 15,967 16,354 32,307 33,025
Communications.............................................. 12,568 13,354 26,509 27,198
Professional services....................................... 10,936 13,566 20,439 25,580
Data processing............................................. 7,540 7,744 16,531 16,228
Foreclosed asset expense (income)........................... (13) -- 112 51
Other....................................................... 58,496 68,191 118,994 133,984
-------- -------- -------- --------
Total noninterest expense................................. 316,623 351,004 628,278 693,604
-------- -------- -------- --------
Income before income taxes.................................. 194,744 212,944 368,272 416,895
Income tax expense.......................................... 64,802 68,186 123,553 136,620
-------- -------- -------- --------
NET INCOME.................................................... $129,942 $144,758 $244,719 $280,275
======== ======== ======== ========
NET INCOME PER COMMON SHARE--BASIC............................ $ 0.83 $ 0.96 $ 1.56 $ 1.86
======== ======== ======== ========
NET INCOME PER COMMON SHARE--DILUTED.......................... $ 0.81 $ 0.96 $ 1.54 $ 1.85
======== ======== ======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--BASIC............. 157,315 150,047 156,774 150,330
======== ======== ======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--DILUTED........... 159,676 151,489 158,535 151,746
======== ======== ======== ========
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) 2002 2002 2003
- ------------------------------------------------------------------------- ----------- ----------- -----------
ASSETS
Cash and due from banks.................................................. $ 2,046,286 $ 2,823,573 $3,096,509
Interest bearing deposits in banks....................................... 153,423 278,849 212,746
Federal funds sold and securities purchased under resale agreements...... 640,500 1,339,700 1,624,552
----------- ----------- -----------
Total cash and cash equivalents........................................ 2,840,209 4,442,122 4,933,807
Trading account assets................................................... 365,784 276,021 387,928
Securities available for sale:
Securities pledged as collateral....................................... 133,219 157,823 154,961
Held in portfolio...................................................... 5,673,609 7,109,498 9,438,110
Loans (net of allowance for credit losses: June 30, 2002, $624,948;
December 31, 2002, $609,190; June 30, 2003, $558,282).................. 24,967,358 25,828,893 25,110,378
Due from customers on acceptances........................................ 119,072 62,469 81,560
Premises and equipment, net.............................................. 500,584 504,666 498,708
Intangible assets........................................................ 23,965 38,518 46,240
Goodwill................................................................. 92,924 150,542 178,591
Other assets............................................................. 1,420,001 1,599,221 1,838,551
----------- ----------- -----------
Total assets........................................................... $36,136,725 $40,169,773 $42,668,834
=========== =========== ===========
LIABILITIES
Domestic deposits:
Noninterest bearing.................................................... $12,938,634 $15,537,906 $17,198,024
Interest bearing....................................................... 14,267,606 15,258,479 16,494,167
Foreign deposits:
Noninterest bearing.................................................... 315,416 583,836 490,314
Interest bearing....................................................... 1,311,709 1,460,594 1,182,755
----------- ----------- -----------
Total deposits......................................................... 28,833,365 32,840,815 35,365,260
Federal funds purchased and securities sold under repurchase agreements.. 318,365 334,379 337,785
Commercial paper......................................................... 955,328 1,038,982 835,268
Other borrowed funds..................................................... 395,826 267,047 238,239
Acceptances outstanding.................................................. 119,072 62,469 81,560
Other liabilities........................................................ 965,972 1,083,836 1,160,744
Medium and long-term debt................................................ 406,869 418,360 420,853
UnionBanCal Corporation--obligated mandatorily redeemable preferred
securities of subsidiary grantor trust................................. 366,265 365,696 360,166
----------- ----------- -----------
Total liabilities...................................................... 32,361,062 36,411,584 38,799,875
----------- ----------- -----------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock:
Authorized 5,000,000 shares, no shares issued or outstanding as of June
30, 2002, December 31, 2002, and June 30, 2003......................... -- -- --
Common stock--no stated value:
Authorized 300,000,000 shares, issued 157,718,215 shares as of June 30,
2002, 150,702,363 shares as of December 31, 2002, and 149,993,652 shares
as of June 30, 2003.................................................... 1,222,571 926,460 894,979
Retained earnings........................................................ 2,393,132 2,591,635 2,783,314
Accumulated other comprehensive income................................... 159,960 240,094 190,666
----------- ----------- -----------
Total shareholders' equity............................................. 3,775,663 3,758,189 3,868,959
----------- ----------- -----------
Total liabilities and shareholders' equity............................. $36,136,725 $40,169,773 $42,668,834
=========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
5
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30,
-----------------------------------------------------
(DOLLARS IN THOUSANDS 2002 2003
- ------------------------------------------------------------ ----------------------- -----------------------
COMMON STOCK
Balance, beginning of period.............................. $1,181,925 $ 926,460
Dividend reinvestment plan................................ 72 24
Deferred compensation - restricted stock.................. (15) --
Stock options exercised................................... 70,564 13,324
Stock issued in bank acquisitions......................... 23,852 --
Common stock repurchased(1)............................... (53,827) (44,829)
---------- ----------
Balance, end of period.................................. $1,222,571 $ 894,979
---------- ----------
RETAINED EARNINGS
Balance, beginning of period.............................. $2,231,384 $2,591,635
Net income................................................ 244,719 $244,719 280,275 $280,275
Dividends on common stock(2).............................. (83,077) (88,707)
Deferred compensation - restricted stock.................. 106 111
---------- ----------
Balance, end of period.................................. $2,393,132 $2,783,314
---------- ----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of period.............................. $ 132,933 $ 240,094
Unrealized net gains on cash fllow hedges, net of tax
expense of $23,776 and $22,289 in the first six months
of 2002 and 2003, respectively........................... 38,383 35,983
Less: reclassification adjustment for net gains on
cash flow hedges included in net income, net of tax
expense of $21,285 and $27,236 in the first six
months of 2002 and 2003, respectively.................... (34,361) (43,968)
-------- --------
Net increase (reduction) in unrealized gains on cash
flow hedges.............................................. 4,022 (7,985)
Unrealized holding gains (losses) arising during the
period on securities available for sale, net of tax
expense (benefit) of $14,039 and $(22,296) in the
first six months of 2002 and 2003, respectively.......... 22,664 (35,995)
Less: reclassification adjustment for gains on
securities available for sale included in net income,
net of tax expense of $753 and $3,447 in the first
six months of 2002 and 2003, respectively................ (1,216) (5,566)
-------- --------
Net unrealized gains (losses) on securities available
for sale................................................. 21,448 (41,561)
Foreign currency translation adjustment, net of tax
expense of $964 and $73 in the first six months of
2002 and 2003, respectively.............................. 1,557 118
-------- --------
Other comprehensive income (loss)......................... 27,027 27,027 (49,428) (49,428)
---------- -------- ---------- --------
Total comprehensive income................................ $271,746 $230,847
======== ========
Balance, end of period.................................. $ 159,960 $ 190,666
---------- ----------
TOTAL SHAREHOLDERS' EQUITY............................ $3,775,663 $3,868,959
========== ==========
- ---------------------------------
<FN>
(1) Common stock repurchased includes commission costs.
(2) Dividends per share were $0.53 and $0.59 for the first six months of 2002
and 2003, respectively. Dividends are based on UnionBanCal Corporation's
shares outstanding as of the declaration date.
</FN>
See accompanying notes to condensed consolidated financial statements.
6
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS
ENDED JUNE 30,
-----------------------------
(DOLLARS IN THOUSANDS) 2002 2003
- ---------------------------------------------------------------------------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................ $ 244,719 $ 280,275
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses............................................. 105,000 55,000
Depreciation, amortization and accretion................................ 39,605 61,742
Provision for deferred income taxes..................................... 28,359 44,876
Gains on securities available for sale.................................. (1,969) (9,013)
Net increase in prepaid expenses........................................ (86,060) (83,845)
Net (increase) decrease in fees and other charges receivable............ 21,599 (94,140)
Net increase in trading account assets.................................. (136,087) (111,907)
Loans originated for resale............................................. (91,603) (55,608)
Net proceeds from sale of loans originated for resale................... 97,222 57,029
Other, net.............................................................. (165,258) (34,102)
---------- ----------
Total adjustments....................................................... (189,192) (169,968)
---------- ----------
Net cash provided by operating activities................................. 55,527 110,307
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale...................... 125,688 35,296
Proceeds from matured and called securities available for sale............ 584,878 1,506,572
Purchases of securities available for sale................................ (772,509) (3,907,936)
Net (increase) decrease in loans.......................................... (598,028) 643,659
Net cash received (paid) in acquisitions.................................. 64,689 (29,860)
Other, net................................................................ (29,140) (46,370)
---------- ----------
Net cash used in investing activities................................... (624,422) (1,798,639)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits.................................................. 72,541 2,524,445
Net increase (decrease) in federal funds purchased and securities
sold under repurchase agreements.... .................................... (100,449) 3,406
Net decrease in commercial paper and other borrowed funds................. (179,906) (232,522)
Common stock repurchased.................................................. (53,827) (44,829)
Payments of cash dividends................................................ (78,165) (84,413)
Stock options exercised................................................... 70,564 13,324
Other, net................................................................ 1,629 142
---------- ----------
Net cash provided by (used in) financing activities..................... (267,613) 2,179,553
---------- ----------
Net increase (decrease) in cash and cash equivalents........................ (836,508) 491,221
Cash and cash equivalents at beginning of period............................ 3,664,954 4,442,122
Effect of exchange rate changes on cash and cash equivalents................ 11,763 464
---------- ----------
Cash and cash equivalents at end of period.................................. $2,840,209 $4,933,807
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest.................................................................. $ 168,806 $ 117,463
Income taxes.............................................................. 73,098 51,197
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisitions:
Fair value of assets acquired........................................... $ 256,276 $ 47,988
Purchase price:
Cash.................................................................. (20,940) (40,300)
Stock issued.......................................................... (23,852) --
---------- ----------
Liabilities assumed..................................................... $ 211,484 $ 7,688
========== ==========
See accompanying notes to condensed consolidated financial statements.
7
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION AND NATURE OF OPERATIONS
The unaudited condensed consolidated financial statements of UnionBanCal
Corporation and subsidiaries (the Company) have been prepared in accordance with
accounting principles generally accepted in the United States of America (US
GAAP) for interim financial reporting and the instructions to Form 10-Q and Rule
10-01 of Regulation S-X of the Rules and Regulations of the Securities and
Exchange Commission. However, they do not include all of the disclosures
necessary for annual financial statements in conformity with US GAAP. The
results of operations for the period ended June 30, 2003 are not necessarily
indicative of the operating results anticipated for the full year. Accordingly,
these unaudited condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements included in the
Company's Form 10-K/A for the year ended December 31, 2002. The preparation of
financial statements in conformity with US GAAP also requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expense during
the reporting period. Actual results could differ from those estimates.
UnionBanCal Corporation is a commercial bank holding company and has, as
its major subsidiary, a banking subsidiary, Union Bank of California, N.A. (the
Bank). The Company provides a wide range of financial services to consumers,
small businesses, middle-market companies and major corporations, primarily in
California, Oregon, and Washington, but also nationally and internationally.
Since November 1999 through June 30, 2003, the Company has announced stock
repurchase plans totaling $500 million. The Company repurchased $86 million, $27
million, and $18 million of common stock in 2002, the first quarter of 2003, and
the second quarter of 2003, respectively, as part of these repurchase plans. As
of June 30, 2003, $115 million of the Company's common stock is authorized for
repurchase. In addition, on August 27, 2002, the Company announced that it
purchased $300 million of its common stock from its majority owner, The Bank of
Tokyo-Mitsubishi, Ltd. (BTM), which is a wholly-owned subsidiary of Mitsubishi
Tokyo Financial Group, Inc. At June 30, 2003, BTM owned approximately 66 percent
of the Company's outstanding common stock.
Certain amounts for prior periods have been reclassified to conform to
current financial statement presentation.
STOCK-BASED COMPENSATION-TRANSITION AND DISCLOSURE
In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure," which amends SFAS No. 123,
"Accounting for Stock-Based Compensation." This Statement provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. It also amends the disclosure
requirements to require prominent disclosure in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
disclosure requirements under this Statement are effective for financial
statements issued after December 15, 2002.
As allowed under the provisions of SFAS No. 123, as amended, the Company
has chosen to continue to recognize compensation expense using the intrinsic
value-based method of valuing stock options prescribed in Accounting Principles
Board Opinion (APB) No. 25, "Accounting for Stock Issued to
8
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION AND NATURE OF OPERATIONS (CONTINUED)
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, 2003, the Company has two stock-based employee compensation
plans. For further discussion concerning our stock-based employee compensation
plans see Note 14--"Management Stock Plan" of the Notes to Consolidated
Financial Statements included in the Form 10-K/A for the year ended December 31,
2002. Only restricted stock awards have been reflected in compensation expense,
while all options granted under those plans had an exercise price equal to the
market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ---------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003
- --------------------------------------------------------- -------- -------- -------- --------
AS REPORTED NET INCOME................................... $129,942 $144,758 $244,719 $280,275
Stock option-based employee compensation expense
(determined under fair value based method for
all awards, net of taxes)............................... (5,740) (6,527) (9,918) (12,483)
-------- -------- -------- --------
Pro forma net income, after stock option-based
employee compensation expense........................... $124,202 $138,231 $234,801 $267,792
======== ======== ======== ========
EARNINGS PER SHARE--BASIC
As reported.............................................. $ 0.83 $ 0.96 $ 1.56 $ 1.86
Pro forma................................................ $ 0.79 $ 0.92 $ 1.50 $ 1.78
EARNINGS PER SHARE--DILUTED
As reported.............................................. $ 0.81 $ 0.96 $ 1.54 $ 1.85
Pro forma................................................ $ 0.78 $ 0.91 $ 1.48 $ 1.76
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 second quarters
of 2002 and 2003 was not significant.
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The changes in
this Statement improve financial reporting by requiring that contracts with
comparable characteristics be accounted for similarly. SFAS No. 149 is
9
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
effective for contracts entered into or modified after June 30, 2003, except as
stated below, and for hedging relationships designated after June 30, 2003. All
provisions should be applied prospectively.
The provisions of SFAS No. 149 that relate to SFAS No. 133 implementation
issues that have been effective for fiscal quarters that began prior to June 15,
2003, will be applied in accordance with their respective effective dates. In
addition, the provisions of SFAS No. 149, which relate to forward purchases or
sales of when-issued securities or other securities that do not exist, will be
applied to both existing contracts and new contracts entered into after June 30,
2003. Management believes that adoption of the provisions of this Statement will
not have a material impact on the Company's financial position or results of
operations.
ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." The
Statement establishes standards for how the Company should classify and measure
certain financial instruments with characteristics of both liabilities and
equity. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The new standards for the
classification and measurement of financial instruments should be applied
retroactively. Any gain or loss resulting from the implementation of SFAS No.
150 will be reported as a cumulative effect of a change in accounting principle.
Management believes that adoption of the standards of this Statement will not
have a material impact on the Company's financial position or results of
operations.
ACCOUNTING FOR GUARANTORS AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 expands on the accounting
guidance of Statements No. 5, 57, and 107 and incorporates without change the
provisions of FIN 34, which is superseded. FIN 45 elaborates on the existing
disclosure requirements for most guarantees and requires that guarantors
recognize a liability for the fair value of guarantees at inception. The
disclosure requirements of FIN 45 are effective for financial statements periods
ending after December 15, 2002. The initial recognition and measurement
provisions of FIN 45 are applied on a prospective basis to guarantees issued or
modified after December 31, 2002. A complete description of significant
guarantees that have been entered into by the Company may be found in "Note
7--Guarantees." Adopting the measurement provisions of FIN 45 did not have a
material impact in the second quarter of 2003 and management believes that it
will not have a material impact on the Company's future financial position or
results of operations.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." The purpose of this interpretation is to provide guidance on
how to identify a variable interest entity (VIE) and determine when the assets,
liabilities, noncontrolling interests, and results of operations of a VIE need
to
10
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 2--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
be included in a company's consolidated financial statements. A company that
holds variable interests in an entity will need to consolidate that entity if
the company's interest in the VIE is such that the company will absorb a
majority of the VIE's expected losses and/or receive a majority of the VIE's
expected residual returns, if they occur. New disclosure requirements are also
prescribed by FIN 46. FIN 46 became effective upon its issuance. As of June 30,
2003, the Company does not believe it has any VIE's for which this
interpretation would require consolidation. However, under FIN 46, the Company's
subsidiary, which issued trust preferred securities, will be deconsolidated.
Deconsolidation of this entity in the third quarter of 2003 will cause total
assets and total liabilities to increase by approximately $10.8 million with no
change to the Company's results of operations.
For additional information on recently issued accounting pronouncements and
other significant accounting principles, see Note 1--"Summary of Significant
Accounting Policies and Nature of Operations" of the Notes to Consolidated
Financial Statements included in the Form 10-K/A for the year ended December 31,
2002.
NOTE 3--EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
EPS incorporates the dilutive effect of common stock equivalents outstanding on
an average basis during the period. Stock options are a common stock equivalent.
The following table presents a reconciliation of basic and diluted EPS for the
three months and six months ended June 30, 2002 and 2003.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------------------- -------------------------------------------------
2002 2003 2002 2003
---------------------- ---------------------- ---------------------- ---------------------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE
DATA) BASIC DILUTED BASIC DILUTED BASIC DILUTED BASIC DILUTED
- ------------------------- -------- -------- -------- -------- -------- -------- -------- --------
Net Income............... $129,942 $129,942 $144,758 $144,758 $244,719 $244,719 $280,275 $280,275
======== ======== ======== ======== ======== ======== ======== ========
Weighted average common
shares outstanding..... 157,315 157,315 150,047 150,047 156,774 156,774 150,330 150,330
Additional shares due to:
Assumed conversion
of dilutive stock
options................ -- 2,361 -- 1,442 -- 1,761 -- 1,416
-------- -------- -------- -------- -------- -------- -------- --------
Adjusted weighted average
common shares
outstanding............ 157,315 159,676 150,047 151,489 156,774 158,535 150,330 151,746
======== ======== ======== ======== ======== ======== ======== ========
Net income per share..... $ 0.83 $ 0.81 $ 0.96 $ 0.96 $ 1.56 $ 1.54 $ 1.86 $ 1.85
======== ======== ======== ======== ======== ======== ======== ========
11
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 4--ACCUMULATED OTHER COMPREHENSIVE INCOME
The following table presents a summary of the components of accumulated
other comprehensive income.
NET UNREALIZED GAINS
NET UNREALIZED GAINS ON SECURITIES FOREIGN CURRENCY
ON CASH FLOW HEDGES AVAILABLE FOR SALE TRANSLATION ADJUSTMENT
--------------------- --------------------- -----------------------
FOR THE SIX MONTHS ENDED JUNE 30,
-----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003 2002 2003
- ------------------------------- ------- -------- -------- -------- -------- --------
Beginning balance.............. $62,840 $104,368 $ 83,271 $147,450 $(12,205) $(10,649)
Change during the period....... 4,022 (7,985) 21,448 (41,561) 1,557 118
------- -------- -------- -------- -------- --------
Ending balance................. $66,862 $ 96,383 $104,719 $105,889 $(10,648) $(10,531)
======= ======== ======== ======== ======== ========
MINIMUM PENSION ACCUMULATED OTHER
LIABILITY ADJUSTMENT COMPREHENSIVE INCOME
-------------------- ---------------------
FOR THE SIX MONTHS ENDED JUNE 30,
-----------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003
- --------------------------------------------------------- ------- -------- -------- --------
Beginning balance........................................ $ (973) $(1,075) $132,933 $240,094
Change during the period................................. -- -- 27,027 (49,428)
------- -------- -------- --------
Ending balance........................................... $ (973) $(1,075) $159,960 $190,666
======= ======== ======== ========
NOTE 5--BUSINESS SEGMENTS
The Company is organized based on the products and services that it offers
and operates in four principal areas:
o The Community Banking and Investment Services Group offers a range of
banking services, primarily to individuals and small businesses,
delivered generally through a tri-state network of branches and ATM's.
These services include commercial loans, mortgages, home equity lines
of credit, consumer loans, cash management and deposit services, as
well as fiduciary, private banking, investment and asset management
services for individuals and institutions, and risk management and
insurance products for businesses and individuals.
o The Commercial Financial Services Group provides credit and cash
management and deposit services to large corporate and middle market
companies. Services include commercial and project loans, real estate
financing, asset-based financing, trade finance and letters of credit,
lease financing, cash management services and selected capital markets
products.
o The International Banking Group provides correspondent banking and
trade-finance products and services to financial institutions, and
extends primarily short-term credit to corporations engaged in
international business. The group's revenue predominately relates to
foreign customers.
o The Global Markets Group manages the Company's wholesale funding
needs, securities portfolio, and interest rate and liquidity risks.
The group also offers a broad range of risk management and
12
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 5--BUSINESS SEGMENTS (CONTINUED)
trading products to institutional and business clients of the Company
through the businesses described above.
The information, set forth in the tables on the following pages, reflects
selected income statement and balance sheet items by business unit. The
information presented does not necessarily represent the business units'
financial condition and results of operations were they independent entities.
Unlike financial accounting, there is no authoritative body of guidance for
management accounting equivalent to US GAAP. Consequently, reported results are
not necessarily comparable with those presented by other companies.
The information in these tables is derived from the internal management
reporting system used by management to measure the performance of the business
segments and the Company overall. The management reporting system assigns
balance sheet and income statement items to each business segment based on
internal management accounting policies. Net interest income is determined by
the Company's internal funds transfer pricing system, which assigns a cost of
funds or a credit for funds to assets or liabilities based on their type,
maturity or repricing characteristics. Noninterest income and expense directly
attributable to a business segment are assigned to that business. Certain
indirect costs, such as operations and technology expense, are allocated to the
segments based on studies of billable unit costs for product or data processing.
Other indirect costs, such as corporate overhead, are allocated to the business
segments based on a predetermined percentage of usage. Under the Company's
risk-adjusted return on capital (RAROC) methodology, credit expense is charged
to business segments based upon expected losses arising from credit risk. In
addition, the attribution of economic capital is related to unexpected losses
arising from credit, market and operational risks.
"Other" includes the following items:
o corporate activities that are not directly attributable to one of the
four major business units. Included in this category are certain other
nonrecurring items such as merger and integration expense, certain
parent company non-bank subsidiaries, and the elimination of the fully
taxable-equivalent basis amount;
o the adjustment between the credit expense under RAROC and the
provision for credit losses under US GAAP and earnings associated with
unallocated equity capital;
o the Pacific Rim Corporate Group, with assets at June 30, 2003 of
$342.4 million, which offers a range of credit, deposit, and
investment management products and services to companies in the US,
which are affiliated with companies headquartered in Japan; and
o the residual costs of support groups.
13
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 5--BUSINESS SEGMENTS (CONTINUED)
The business units' results for the prior periods have been restated to
reflect transfer pricing changes and any reorganization changes that may have
occurred.
COMMUNITY BANKING
AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL
SERVICES GROUP SERVICES GROUP BANKING GROUP
--------------------- ---------------------- -------------------
AS OF AND FOR THE THREE MONTHS ENDED JUNE 30,
-------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- --------------------------------------------------- -------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income................................ $191,739 $212,859 $165,463 $204,011 $ 9,366 $ 9,829
Noninterest income................................. 94,305 111,872 54,474 61,552 16,632 26,090
-------- -------- -------- -------- ------- -------
Total revenue...................................... 286,044 324,731 219,937 265,563 25,998 35,919
Noninterest expense................................ 172,781 197,037 95,017 105,134 15,266 15,258
Credit expense (income)............................ 8,911 8,064 47,487 42,145 460 547
-------- -------- -------- -------- ------- -------
Income before income tax expense (benefit)......... 104,352 119,630 77,433 118,284 10,272 20,114
Income tax expense (benefit)....................... 39,915 45,758 24,331 38,351 3,929 7,693
-------- -------- -------- -------- ------- -------
Net income (loss).................................. $ 64,437 $ 73,872 $ 53,102 $ 79,933 $ 6,343 $12,421
======== ======== ======== ======== ======= =======
TOTAL ASSETS, END OF PERIOD (dollars in millions):. $ 10,929 $ 12,248 $ 15,932 $ 14,976 $ 1,467 $ 1,937
======== ======== ======== ======== ======= =======
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
--------------------- ---------------------- -------------------
AS OF AND FOR THE THREE MONTHS ENDED JUNE 30,
-------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- -------------------------------------------------- -------- -------- -------- ------- -------- --------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income............................... $ 12 $(60,157) $ 19,181 $19,235 $385,761 $385,777
Noninterest income................................ 4,708 1,882 5,487 1,775 175,606 203,171
-------- -------- -------- ------- -------- --------
Total revenue..................................... 4,720 (58,275) 24,668 21,010 561,367 588,948
Noninterest expense............................... 4,007 3,687 29,552 29,888 316,623 351,004
Credit expense (income)........................... 50 50 (6,908) (25,806) 50,000 25,000
-------- -------- -------- ------- -------- --------
Income (loss) before income tax expense (benefit). 663 (62,012) 2,024 16,928 194,744 212,944
Income tax expense (benefit)...................... 254 (23,719) (3,627) 103 64,802 68,186
-------- -------- -------- ------- -------- --------
Net income (loss)................................. $ 409 $(38,293) $ 5,651 $16,825 $129,942 $144,758
======== ======== ======== ======= ======== ========
TOTAL ASSETS, END OF PERIOD (dollars in millions): $ 6,868 $ 11,824 $ 941 $ 1,684 $ 36,137 $ 42,669
======== ======== ======== ======= ======== ========
14
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 5--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,
-------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- --------------------------------------------------- -------- -------- -------- -------- -------- --------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income................................ $370,758 $418,550 $325,617 $396,362 $ 18,871 $ 20,048
Noninterest income................................. 183,409 213,469 102,978 119,462 32,720 41,573
-------- -------- -------- -------- -------- --------
Total revenue...................................... 554,167 632,019 428,595 515,824 51,591 61,621
Noninterest expense................................ 348,148 396,255 186,551 204,532 30,409 30,182
Credit expense (income)............................ 17,891 15,782 94,520 84,607 954 1,052
-------- -------- -------- -------- -------- --------
Income before income tax expense (benefit)......... 188,128 219,982 147,524 226,685 20,228 30,387
Income tax expense (benefit)....................... 71,959 84,143 47,038 73,804 7,737 11,623
-------- -------- -------- -------- -------- --------
Net income (loss).................................. $116,169 $135,839 $100,486 $152,881 $ 12,491 $ 18,764
======== ======== ======== ======== ======== ========
TOTAL ASSETS, END OF PERIOD (dollars in millions):. $ 10,929 $ 12,248 $ 15,932 $ 14,976 $ 1,467 $ 1,937
======== ======== ======== ======== ======== ========
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
--------------------- ---------------------- ---------------------
AS OF AND FOR THE SIX MONTHS ENDED JUNE 30,
--------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- ---------------------------------------------- -------- -------- -------- -------- --------- ---------
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS):
Net interest income........................ $ 12,718 $(93,775) $ 38,237 $ 35,372 $ 766,201 $ 776,557
Noninterest income......................... 6,226 3,408 10,016 11,030 335,349 388,942
-------- -------- -------- -------- --------- ---------
Total revenue.............................. 18,944 (90,367) 48,253 46,402 1,101,550 1,165,499
Noninterest expense........................ 7,921 7,800 55,249 54,835 628,278 693,604
Credit expense (income).................... 100 100 (8,465) (46,541) 105,000 55,000
-------- -------- -------- -------- --------- ---------
Income (loss) before income tax expense
(benefit)................................ 10,923 (98,267) 1,469 38,108 368,272 416,895
Income tax expense (benefit)............... 4,178 (37,587) (7,359) 4,637 123,553 136,620
-------- -------- -------- -------- --------- ---------
Net income (loss).......................... $ 6,745 $(60,680) $ 8,828 $ 33,471 $ 244,719 $ 280,275
======== ======== ======== ======== ========= =========
TOTAL ASSETS, END OF PERIOD (dollars in
millions):............................... $ 6,868 $ 11,824 $ 941 $ 1,684 $ 36,137 $ 42,669
======== ======== ======== ======== ========= =========
NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
Derivative positions are integral components of the Company's designated
asset and liability management activities. The Company uses interest rate
derivatives to manage the sensitivity of the Company's net interest income to
changes in interest rates. These instruments are used to manage interest rate
risk relating to specified groups of assets and liabilities, primarily
LIBOR-based commercial loans, certificates of deposit, trust preferred
securities and medium-term notes.
15
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
(CONTINUED)
CASH FLOW HEDGES
HEDGING STRATEGIES FOR VARIABLE RATE LOANS AND CERTIFICATES OF DEPOSIT
The Company engages in several types of cash flow hedging strategies for
which the hedged transactions are forecasted future loan interest payments, and
the hedged risk is the variability in those payments due to changes in the
designated benchmark rate, e.g., US dollar LIBOR. In these strategies, the
hedging instruments are matched with groups of variable rate loans such that the
tenor of the variable rate loans and that of the hedging instrument is
identical. Cash flow hedging strategies include the utilization of purchased
floor, cap, corridor options and interest rate swaps. The maximum length of time
over which the Company is hedging these exposures is 6.14 years.
The Company uses purchased interest rate floors to hedge the variable cash
flows associated with 1-month LIBOR or 3-month LIBOR indexed loans. Payments
received under the floor contract offset the decline in loan interest income
caused by the relevant LIBOR index falling below the floor's strike rate.
The Company uses interest rate floor corridors to hedge the variable cash
flows associated with 1-month LIBOR or 3-month LIBOR indexed loans. Net payments
to be received under the floor corridor contracts offset the decline in loan
interest income caused by the relevant LIBOR index falling below the corridor's
upper strike rate, but only to the extent the index falls to the lower strike
rate. The corridor will not provide protection from declines in the relevant
LIBOR index to the extent it falls below the corridor's lower strike rate.
The Company uses interest rate collars to hedge the variable cash flows
associated with 1-month LIBOR or 3-month LIBOR indexed loans. Net payments to be
received under the collar contracts offset the decline in loan interest income
caused by the relevant LIBOR index falling below the collar's strike rate while
net payments to be paid will reduce the increase in loan interest income caused
by the LIBOR index rising above the collar's cap strike rate.
The Company uses interest rate swaps to hedge the variable cash flows
associated with 1-month LIBOR or 3-month LIBOR indexed loans. Payments to be
received (or paid) under the swap contracts will offset the fluctuations in loan
interest income caused by changes in the relevant LIBOR index. As such, these
instruments hedge all fluctuations in the loans' interest income caused by
changes in the relevant LIBOR index.
The Company uses purchased interest rate caps to hedge the variable
interest cash flows associated with the forecasted issuance and rollover of
short-term, fixed rate negotiable certificates of deposit (CDs). In these
hedging relationships, the Company hedges the LIBOR component of the CD rates,
which is either 3-month LIBOR or 6-month LIBOR, based on the CD's original term
to maturity, which reflects their repricing frequency. Net payments to be
received under the cap contract offset the increase in interest expense caused
by the relevant LIBOR index rising above the cap's strike rate.
Hedging transactions are structured at inception so that the notional
amounts of the hedge are matched with an equal principal amount of loans or CDs,
the index and repricing frequencies of the hedge matches those of the loans or
CDs, and the period in which the designated hedged cash flows occurs is equal to
the term of the hedge. As such, most of the ineffectiveness in the hedging
relationship results from
16
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 6--DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
(CONTINUED)
the mismatch between the timing of reset dates on the hedge versus those of the
loans or CDs. In the second quarter of 2003, the Company recognized a net gain
of $0.3 million due to ineffectiveness, which is recognized in noninterest
expense, compared to a net loss of $0.1 million in the second quarter of 2002.
FAIR VALUE HEDGES
HEDGING STRATEGY FOR UNIONBANCAL CORPORATION--OBLIGATED MANDATORILY
REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY GRANTOR TRUST (TRUST PREFERRED
SECURITIES)
The Company engages in an interest rate hedging strategy in which an
interest rate swap is associated with a specific interest bearing liability,
UnionBanCal Corporation's Trust Preferred Securities, in order to convert the
liability from a fixed rate to a floating rate instrument. This strategy
mitigates the changes in fair value of the hedged liability caused by changes in
the designated benchmark interest rate, US dollar LIBOR.
Fair value hedging transactions are structured at inception so that the
notional amounts of the swap match an associated principal amount of the Trust
Preferred Securities. The interest payment dates, the expiration date, and the
embedded call option of the swap match those of the Trust Preferred Securities.
The ineffectiveness on the fair value hedges in the second quarter of 2003 was a
net loss of less than $0.1 million, compared to a net gain of $0.5 million in
the second quarter of 2002.
HEDGING STRATEGY FOR MEDIUM-TERM NOTES
The Company engages in an interest rate hedging strategy in which an
interest rate swap is associated with a specified interest bearing liability,
UnionBanCal Corporation's five-year, medium-term debt issuance, in order to
convert the liability from a fixed rate to a floating rate instrument. This
strategy mitigates the changes in fair value of the hedged liability caused by
changes in the designated benchmark interest rate, US dollar LIBOR.
The fair value hedging transaction for the medium-term notes was structured
at inception to mirror all of the provisions of the medium-term notes, which
allows the Company to assume that no ineffectiveness exists.
OTHER
The Company uses foreign currency forward contracts as a means of managing
foreign exchange rate risk associated with assets and/or liabilities denominated
in foreign currencies. The Company values the forward contracts, the assets
and/or the liabilities at fair value, with the resultant gain or loss recognized
in noninterest income.
The Company uses To-Be-Announced (TBA) contracts to fix the price and yield
of anticipated purchases or sales of mortgage-backed securities that will be
delivered at an agreed upon date. This strategy hedges the risk of variability
in the cash flows to be paid or received upon settlement of the TBA contract.
17
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 7--GUARANTEES
Standby and commercial letters of credit are conditional commitments issued
to guarantee the performance of a customer to a third party. Standby letters of
credit generally are contingent upon the failure of the customer to perform
according to the terms of the underlying contract with the third party, while
commercial letters of credit are issued specifically to facilitate foreign or
domestic trade transactions. The majority of these types of commitments have
terms of one year or less. Collateral may be obtained based on management's
credit assessment of the customer. As of June 30, 2003, the Company's maximum
exposure to loss for standby and commercial letters of credit is $3.0 billion
and $280.1 million, respectively.
The Company has contingent consideration agreements that guarantee
additional payments to acquired insurance agencies' shareholders based on the
agencies future performance in excess of established revenue and/or earnings
before interest, taxes, depreciation and amortization (EBITDA) thresholds. If
the insurance agencies' future performance exceeds these thresholds during a
three-year period, the Company will be liable to make payments to former
shareholders. As of June 30, 2003, the Company has a maximum exposure of $12.0
million for these agreements, which expire December 2005.
The Company is fund manager for limited liability corporations issuing
low-income housing investments. Low-income housing investments provide tax
benefits to investors in the form of tax deductions from operating losses and
tax credits. To facilitate the sale of these investments, the Company guarantees
the timely completion of projects and delivery of tax benefits throughout the
investment term. Guarantees may include a minimum rate of return, the
availability of tax credits, and operating deficit thresholds over a ten-year
average period. Additionally, the Company receives project completion and tax
credit guarantees from the limited liability corporations issuing the
investments that reduce the Company's ultimate exposure to loss. As of June 30,
2003, the Company's maximum exposure to loss under these guarantees is limited
to a return of investor capital and minimum investment yield, or $77.0 million.
The Company maintains a liability of $3.0 million for these guarantees.
The Company has guarantees that obligate it to perform if its affiliates
are unable to discharge their obligations. These obligations include guarantee
of trust preferred securities, commercial paper obligations and leveraged lease
transactions. Guarantees issued by the Bank for an affiliate's commercial paper
program are done in order to facilitate their sale. As of June 30, 2003, the
Bank had a maximum exposure to loss under these guarantees, which have an
average term of less than one year, of $842.1 million. The Bank's guarantee is
fully collateralized by a pledged deposit. UnionBanCal Corporation guarantees
its subsidiaries' leveraged lease transactions, which have terms ranging from 15
to 30 years. Following the original funding of the leveraged lease transactions,
UnionBanCal Corporation has no material obligation to be satisfied. As of June
30, 2003, UnionBanCal Corporation had no exposure to loss for these agreements.
NOTE 8--ACQUISITIONS
On April 1, 2003, the Company completed its acquisition of Tanner Insurance
Brokers, Inc., and recorded approximately $31 million of goodwill and $9 million
of rights-to-expiration. The rights-to-expiration will be amortized on an
accelerated basis over its useful economic life.
18
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
NOTE 9--SUBSEQUENT EVENTS
On July 1, 2003, the Company completed its acquisition of Monterey Bay
Bank, a savings and loan association based in Watsonville, California. As a
result, the Company acquired $632 million in total assets and eight branches.
The Company paid $96.7 million in cash and common stock.
On July 23, 2003, the Board of Directors declared a quarterly cash dividend
of $0.31 per share of common stock. The dividend will be paid on October 3, 2003
to shareholders of record as of September 5, 2003.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS DOCUMENT INCLUDES FORWARD-LOOKING INFORMATION, WHICH IS SUBJECT TO THE
"SAFE HARBOR" CREATED BY SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED,
AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. WE MAY MAKE
FORWARD-LOOKING STATEMENTS IN OTHER UNITED STATES SECURITIES AND EXCHANGE
COMMISSION (SEC) FILINGS, PRESS RELEASES, NEWS ARTICLES, CONFERENCE CALLS WITH
WALL STREET ANALYSTS AND SHAREHOLDERS AND WHEN WE ARE SPEAKING ON BEHALF OF
UNIONBANCAL CORPORATION. FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY THE
FACT THAT THEY DO NOT RELATE STRICTLY TO HISTORICAL OR CURRENT FACTS. OFTEN,
THEY INCLUDE THE WORDS "BELIEVE," "EXPECT," "ANTICIPATE," "INTEND," "PLAN,"
"ESTIMATE," "PROJECT," OR WORDS OF SIMILAR MEANING, OR FUTURE OR CONDITIONAL
VERBS SUCH AS "WILL," "WOULD," "SHOULD," "COULD," OR "MAY." THESE
FORWARD-LOOKING STATEMENTS ARE INTENDED TO PROVIDE INVESTORS WITH ADDITIONAL
INFORMATION WITH WHICH THEY MAY ASSESS OUR FUTURE POTENTIAL. ALL OF THESE
FORWARD-LOOKING STATEMENTS ARE BASED ON ASSUMPTIONS ABOUT AN UNCERTAIN FUTURE
AND ARE BASED ON INFORMATION AVAILABLE AT THE DATE SUCH STATEMENTS ARE ISSUED.
WE DO NOT UNDERTAKE TO UPDATE FORWARD-LOOKING STATEMENTS TO REFLECT FACTS,
CIRCUMSTANCES, ASSUMPTIONS OR EVENTS THAT OCCUR AFTER THE DATE THE
FORWARD-LOOKING STATEMENTS ARE MADE.
THERE ARE NUMEROUS RISKS AND UNCERTAINTIES THAT COULD AND WILL CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN OUR FORWARD-LOOKING
STATEMENTS. MANY OF THESE FACTORS ARE BEYOND OUR ABILITY TO CONTROL OR PREDICT
AND COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR STOCK PRICE, FINANCIAL
CONDITION, AND RESULTS OF OPERATIONS OR PROSPECTS. SUCH RISKS AND UNCERTAINTIES
INCLUDE, BUT ARE NOT LIMITED TO, THE FOLLOWING FACTORS: ADVERSE ECONOMIC
CONDITIONS IN CALIFORNIA, GLOBAL POLITICAL AND GENERAL ECONOMIC CONDITIONS
RELATED TO THE TERRORIST ATTACKS ON SEPTEMBER 11, 2001, AND THEIR AFTERMATH, THE
WAR IN IRAQ, ADVERSE ECONOMIC CONDITIONS AFFECTING CERTAIN INDUSTRIES, INCLUDING
POWER COMPANIES AND THE AIRLINE INDUSTRY, FLUCTUATIONS IN INTEREST RATES, THE
CONTROLLING INTEREST IN US OF THE BANK OF TOKYO-MITSUBISHI, LTD. (BTM), WHICH IS
A WHOLLY-OWNED SUBSIDIARY OF MITSUBISHI TOKYO FINANCIAL GROUP, INC., COMPETITION
IN THE BANKING INDUSTRY, RESTRICTIONS ON DIVIDENDS, ADVERSE EFFECTS OF CURRENT
AND FUTURE BANKING RULES, REGULATIONS AND LEGISLATION, AND RISKS ASSOCIATED WITH
VARIOUS STRATEGIES WE MAY PURSUE, INCLUDING POTENTIAL ACQUISITIONS, DIVESTITURES
AND RESTRUCTURINGS. SEE ALSO THE SECTION ENTITLED "CERTAIN BUSINESS RISK
FACTORS" LOCATED NEAR THE END OF THIS "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION."
ALL REPORTS THAT WE FILE ELECTRONICALLY WITH THE SEC, INCLUDING THE ANNUAL
REPORT ON FORM 10-K OR 10-K/A, QUARTERLY REPORTS ON FORM 10-Q, AND CURRENT
REPORTS ON FORM 8-K, AS WELL AS ANY AMENDMENTS TO THOSE REPORTS, ARE ACCESSIBLE
AT NO COST ON OUR INTERNET WEBSITE AT WWW.UBOC.COM. THESE FILINGS ARE ALSO
ACCESSIBLE ON THE SEC'S WEBSITE AT WWW.SEC.GOV.
INTRODUCTION
We are a California-based, commercial bank holding company incorporated in
California, with consolidated assets of $42.7 billion at June 30, 2003. At June
30, 2003, Union Bank of California, N.A. (the Bank) was the fourth largest
commercial bank in California, based on total assets and total deposits in
California.
UnionBanCal Corporation and its banking subsidiary, Union Bank of
California, N.A., were created on April 1, 1996, by the combination of Union
Bank with BanCal Tri-State Corporation and its banking subsidiary, The Bank of
California, N.A. The combination was accounted for as a reorganization of
entities under common control, similar to a pooling of interests.
Since November 1999 through June 30, 2003, we have announced stock
repurchase plans totaling $500 million. We repurchased $86 million, $27 million,
and $18 million of common stock in 2002, the first quarter of 2003, and the
second quarter of 2003, respectively, as part of these repurchase plans. As of
June 30, 2003, $115 million of our common stock is authorized for repurchase. In
addition, on August 27, 2002, we announced that we purchased $300 million of our
common stock from our majority owner, BTM. At June 30, 2003, BTM owned
approximately 66 percent of our outstanding common stock.
20
SUMMARY
COMPARISON OF THREE MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2003
Net income was $144.8 million, or $0.96 per diluted common share, in the
second quarter of 2003, compared with $129.9 million, or $0.81 per diluted
common share, in the second quarter of 2002. This increase in diluted earnings
per share of $0.15, or 19 percent, above the second quarter of 2002 was due to a
$27.6 million, or 16 percent, increase in noninterest income, a $25.0 million,
or 50 percent, decrease in provision for credit losses, and a $0.1 million
increase in net interest income (on a taxable-equivalent basis), offset by a
$34.4 million, or 11 percent, increase in noninterest expense coupled with a
decrease in weighted average shares outstanding due to share repurchases. Other
highlights of the second quarter of 2003 include:
o Net interest income, on a taxable-equivalent basis, was $386.4 million
in the second quarter of 2003, an increase of $0.1 million over the
second quarter of 2002. Net interest margin in the second quarter of
2003 was 4.29 percent, a decrease of 45 basis points from the second
quarter of 2002.
o A provision for credit losses of $25.0 million was recorded in the
second quarter of 2003 compared with $50.0 million in the second
quarter of 2002. This resulted from management's regular assessment of
overall credit quality, loan portfolio composition, and business and
economic conditions in relation to the level of the allowance for
credit losses. The allowance for credit losses was $558.3 million, or
147 percent of total nonaccrual loans, at June 30, 2003, compared with
$624.9 million, or 151 percent of total nonaccrual loans, at June 30,
2002.
o Noninterest income was $203.2 million in the second quarter of 2003,
an increase of $27.6 million, or 16 percent, from the second quarter
of 2002. This increase included a $9.5 million increase in insurance
commissions mostly associated with our acquisitions of John Burnham &
Company and Tanner Insurance Brokers, Inc., an $8.1 million increase
in service charges on deposit accounts, a $7.0 million increase in
securities gains mainly attributable to a $9.0 million gain arising
from the early call of a Mexican Brady Bond, partly offset by a $4.4
million decrease in trust and investment management fees.
o Noninterest expense was $351.0 million in the second quarter of 2003,
an increase of $34.4 million, or 11 percent, over the second quarter
of 2002. This increase included a $12.8 million increase in salaries
and other compensation, which was primarily attributable to our 2002
acquisitions and new branch openings, higher employee benefits of $5.5
million and a $7.8 million increase in net occupancy, which included a
$4.2 million write-off of leasehold improvements.
o Income tax expense in the second quarter of 2003 was $68.2 million,
resulting in a 32 percent effective income tax rate. For the second
quarter of 2002, the effective income tax rate was 33 percent.
o Return on average assets was unchanged at 1.46 percent in both the
second quarter of 2003 and the second quarter of 2002. Our return on
average shareholders' equity increased to 14.81 percent in the second
quarter of 2003 compared to 13.90 percent in the second quarter of
2002.
o Total loans at June 30, 2003 were $25.7 billion, a slight increase of
$76.4 million from June 30, 2002.
o Nonperforming assets were $379.8 million at June 30, 2003, a decrease
of $35.2 million, or 8 percent, from June 30, 2002. Nonperforming
assets, as a percentage of total assets, decreased to 0.89 percent at
June 30, 2003, compared with 1.15 percent at June 30, 2002. Total
nonaccrual loans were $379.5 million at June 30, 2003, compared with
$414.5 million at June 30, 2002, contributing to a decrease in the
ratio of nonaccrual loans to total loans of 1.48 percent at June 30,
2003 from 1.62 percent at June 30, 2002.
21
o Our Tier 1 and total risk-based capital ratios were 11.44 percent and
13.06 percent, respectively, at June 30, 2003, compared with 11.90
percent and 13.65 percent, respectively, at June 30, 2002. Our
leverage ratio was 9.63 percent at June 30, 2003 compared with 10.77
percent at June 30, 2002.
COMPARISON OF SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2003
Net income was $280.3 million, or $1.85 per diluted common share, in the
first six months of 2003, compared with $244.7 million, or $1.54 per diluted
common share, in the first six months of 2002. This increase in diluted earnings
per share of $0.31, or 20 percent, above the first six months of 2002 was due to
a $53.6 million, or 16 percent, increase in noninterest income, a $50.0 million,
or 48 percent, decrease in provision for credit losses, and a $10.6 million, or
1 percent, increase in net interest income (on a taxable-equivalent basis),
offset by a $65.3 million, or 10 percent, increase in noninterest expense
coupled with a decrease in weighted average shares outstanding due to share
repurchases. Other highlights of the first six months of 2003 include:
o Net interest income, on a taxable-equivalent basis, was $777.8 million
in the first six months of 2003, an increase of $10.6 million, or 1
percent, over the first six months of 2002. Net interest margin in the
first six months of 2003 was 4.41 percent, a decrease of 36 basis
points from the first six months of 2002.
o A provision for credit losses of $55.0 million was recorded in the
first six months of 2003 compared with $105.0 million in the first six
months of 2002. This resulted from management's regular assessment of
overall credit quality, loan portfolio composition, and business and
economic conditions in relation to the level of the allowance for
credit losses.
o Noninterest income was $388.9 million in the first six months of 2003,
an increase of $53.6 million, or 16 percent, from the first six months
of 2002. This increase included a $15.3 million increase in insurance
commissions mostly associated with our acquisitions of John Burnham &
Company and Tanner Insurance Brokers, Inc., a $14.2 million increase
in service charges on deposit accounts, higher income related to
private capital investments, net, of $10.5 million mainly due to lower
writedowns in the current year, lower residual value writedowns on
auto leases of $9.0 million and a $7.0 million increase in securities
gains mainly attributable to a $9.0 million gain arising from the
early call of a Mexican Brady Bond, partly offset by a $8.5 million
decrease in trust and investment management fees.
o Noninterest expense was $693.6 million in the first six months of
2003, an increase of $65.3 million, or 10 percent, over the first six
months of 2002. This increase included a $32.1 million increase in
salaries and employee benefits primarily attributable to higher
salaries and other compensation of $18.0 million, mostly related to
our 2002 acquisitions and new branch openings, higher employee
benefits of $14.1 million and a $12.1 million increase in net
occupancy, which included a $4.2 million write-off of leasehold
improvements.
o Income tax expense in the first six months of 2003 was $136.6 million,
resulting in a 33 percent effective income tax rate. For the first six
months of 2002, the effective income tax rate was 34 percent.
o Return on average assets increased to 1.45 percent in the first six
months of 2003 compared to 1.39 percent in the first six months of
2002. Our return on average shareholders' equity increased to 14.50
percent in the first six months of 2003 compared to 13.38 percent in
the first six months of 2002.
BUSINESS SEGMENTS
We segregate our operations into four primary business units for the
purpose of management reporting, as shown in the table on the following page.
The results show the financial performance of our major business units.
22
The risk-adjusted return on capital (RAROC) methodology used seeks to
attribute economic capital to business units consistent with the level of risk
they assume. These risks are primarily credit risk, market risk and operational
risk. Credit risk is the potential loss in economic value due to the likelihood
that the obligor will not perform as agreed. Market risk is the potential loss
in fair value due to changes in interest rates, currency rates and equity
prices. Operational risk is the potential loss due to failures in internal
control, system failures, or external events.
The following tables reflect the condensed income statements, selected
average balance sheet items and selected financial ratios for each of our
primary business units. The information presented does not necessarily represent
the business units' financial condition and results of operations as if they
were independent entities. Also, the tables have been expanded to include
performance center earnings. A performance center is a special unit of the Bank
whose income generating activities, unlike typical profit centers, are based on
other business segment units' customer base. The revenues generated and expenses
incurred for those transactions entered into to accommodate our customers are
allocated to other business segments where the customer relationships reside. A
performance center's purpose is to foster cross-selling with a total
profitability view of the products and services it manages. For example, the
Global Markets Trading and Sales unit, within the Global Markets Group, is a
performance center that manages the foreign exchange, derivatives, and fixed
income securities activities within the Global Markets organization. Unlike
financial accounting, there is no authoritative body of guidance for management
accounting equivalent to US GAAP. Consequently, reported results are not
necessarily comparable with those presented by other companies.
The RAROC measurement methodology recognizes credit expense for expected
losses arising from credit risk and attributes economic capital related to
unexpected losses arising from credit, market and operational risks. As a result
of the methodology used by the RAROC model to calculate expected losses,
differences between the provision for credit losses and credit expense in any
one period could be significant. However, over an economic cycle, the cumulative
provision for credit losses and credit expense for expected losses should be
substantially the same. Business unit results are based on an internal
management reporting system used by management to measure the performance of the
units and UnionBanCal Corporation as a whole. Our management reporting system
identifies balance sheet and income statement items to each business unit based
on internal management accounting policies. Net interest income is determined
using our internal funds transfer pricing system, which assigns a cost of funds
to assets or a credit for funds to liabilities and capital, based on their type,
maturity or repricing characteristics. Noninterest income and expense directly
or indirectly attributable to a business unit are assigned to that business. The
business units are assigned the costs of products and services directly
attributable to their business activity through standard unit cost accounting
based on volume of usage. All other corporate expenses (overhead) are assigned
to the business units based on a predetermined percentage of usage.
23
We have restated the business units' results for the prior periods to
reflect transfer pricing changes and any reorganization changes that may have
occurred.
COMMUNITY BANKING
AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL
SERVICES GROUP SERVICES GROUP BANKING GROUP
--------------------- ---------------------- -------------------
AS OF AND FOR THE THREE MONTHS ENDED JUNE 30,
-------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
-------- -------- -------- -------- ------- -------
RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER
EARNINGS (DOLLARS IN THOUSANDS):
Net interest income.............................. $191,739 $212,859 $165,463 $204,011 $ 9,366 $ 9,829
Noninterest income............................... 94,305 111,872 54,474 61,552 16,632 26,090
-------- -------- -------- -------- ------- -------
Total revenue.................................... 286,044 324,731 219,937 265,563 25,998 35,919
Noninterest expense.............................. 172,781 197,037 95,017 105,134 15,266 15,258
Credit expense (income).......................... 8,911 8,064 47,487 42,145 460 547
-------- -------- -------- -------- ------- -------
Income (loss) before income tax expense (benefit) 104,352 119,630 77,433 118,284 10,272 20,114
Income tax expense (benefit)..................... 39,915 45,758 24,331 38,351 3,929 7,693
-------- -------- -------- -------- ------- -------
Net income (loss)................................ $ 64,437 $ 73,872 $ 53,102 $ 79,933 $ 6,343 $12,421
======== ======== ======== ======== ======= =======
PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income.............................. $ 222 $ 181 $ (326) $ (175) $ -- $ 10
Noninterest income............................... (12,387) (10,706) 14,715 17,039 1,157 253
Noninterest expense.............................. (9,628) (9,021) 8,437 9,504 861 83
Net income (loss)................................ (1,614) (948) 3,746 4,588 183 111
Total loans (dollars in millions)................ 26 25 (47) (45) -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................... $ 9,986 $ 11,229 $ 14,148 $ 13,071 $ 1,047 $ 1,606
Total assets..................................... 10,752 12,236 15,894 15,162 1,403 2,009
Total deposits(1)................................ 14,395 16,424 9,275 12,236 1,567 1,471
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............... 45% 45% 14% 19% 40% 73%
Return on average assets (2)..................... 2.40 2.42 1.34 2.11 1.81 2.48
Efficiency ratio(3).............................. 60.4 60.7 43.2 39.6 58.7 42.5
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
--------------------- ---------------------- --------------------
AS OF AND FOR THE THREE MONTHS ENDED JUNE 30,
--------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
-------- -------- -------- -------- -------- --------
RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER
EARNINGS (DOLLARS IN THOUSANDS):
Net interest income.......................... $ 12 $(60,157) $ 19,181 $ 19,235 $385,761 $385,777
Noninterest income........................... 4,708 1,882 5,487 1,775 175,606 203,171
-------- -------- -------- -------- -------- --------
Total revenue................................ 4,720 (58,275) 24,668 21,010 561,367 588,948
Noninterest expense.......................... 4,007 3,687 29,552 29,888 316,623 351,004
Credit expense (income)...................... 50 50 (6,908) (25,806) 50,000 25,000
-------- -------- -------- -------- -------- --------
Income (loss) before income tax expense
(benefit).................................... 663 (62,012) 2,024 16,928 194,744 212,944
Income tax expense (benefit)................. 254 (23,719) (3,627) 103 64,802 68,186
-------- -------- -------- -------- -------- --------
Net income (loss)............................ $ 409 $(38,293) $ 5,651 $ 16,825 $129,942 $144,758
======== ======== ======== ======== ======== ========
PERFORMANCE CENTER EARNINGS (DOLLARS IN
THOUSANDS):
Net interest income.......................... $ -- $ (128) $ 104 $ 112 $ -- $ --
Noninterest income........................... (6,934) (9,876) 3,449 3,290 -- --
Noninterest expense.......................... (1,217) (2,025) 1,547 1,459 -- --
Net income (loss)............................ (3,531) (4,927) 1,216 1,176 -- --
Total loans (dollars in millions)............ -- -- 21 20 -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)............................... $ 70 $ 287 $ 328 $ 324 $ 25,579 $ 26,517
Total assets................................. 6,902 9,454 779 915 35,730 39,776
Total deposits(1)............................ 2,070 1,071 915 1,385 28,222 32,587
FINANCIAL RATIOS:
Risk adjusted return on capital(2)........... --% (15)% na na na na
Return on average assets (2)................. 0.01 (1.63) na na 1.46% 1.46%
Efficiency ratio(3).......................... 84.9 na na na 56.4 59.5
- ----------------------------
<FN>
(1) Represents loans and deposits for each business segment after allocation
between the segments of loans and deposits originated in one segment but
managed by another segment.
(2) Annualized.
(3) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income and noninterest
income. Foreclosed asset expense (income) was ($13) thousand and nil in the
second quarters of 2002 and 2003, respectively.
na = not applicable
</FN>
24
COMMUNITY BANKING
AND INVESTMENT COMMERCIAL FINANCIAL INTERNATIONAL
SERVICES GROUP SERVICES GROUP BANKING GROUP
--------------------- ---------------------- --------------------
AS OF AND FOR THE SIX MONTHS ENDED JUNE 30,
--------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
-------- -------- -------- -------- -------- --------
RESULTS OF OPERATIONS AFTER PERFORMANCE CENTER
EARNINGS (DOLLARS IN THOUSANDS):
Net interest income.............................. $370,758 $418,550 $325,617 $396,362 $ 18,871 $ 20,048
Noninterest income............................... 183,409 213,469 102,978 119,462 32,720 41,573
-------- -------- -------- -------- -------- --------
Total revenue.................................... 554,167 632,019 428,595 515,824 51,591 61,621
Noninterest expense.............................. 348,148 396,255 186,551 204,532 30,409 30,182
Credit expense (income).......................... 17,891 15,782 94,520 84,607 954 1,052
-------- -------- -------- -------- -------- --------
Income (loss) before income tax expense (benefit) 188,128 219,982 147,524 226,685 20,228 30,387
Income tax expense (benefit)..................... 71,959 84,143 47,038 73,804 7,737 11,623
-------- -------- -------- -------- -------- --------
Net income (loss)................................ $116,169 $135,839 $100,486 $152,881 $ 12,491 $ 18,764
======== ======== ======== ======== ======== ========
PERFORMANCE CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income.............................. $ 443 $ 368 $ (672) $ (367) $ -- $ 14
Noninterest income............................... (24,672) (21,077) 29,537 31,888 2,041 585
Noninterest expense.............................. (18,744) (17,227) 16,225 17,811 1,627 334
Net income (loss)................................ (3,453) (2,190) 7,920 8,553 256 163
Total loans (dollars in millions)................ 26 26 (46) (46) -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)................................... $ 9,764 $ 11,171 $ 14,136 $13,301 $ 1,032 $ 1,566
Total assets..................................... 10,532 12,132 15,878 15,375 1,357 1,966
Total deposits(1)................................ 14,092 16,105 9,094 11,797 1,562 1,494
FINANCIAL RATIOS:
Risk adjusted return on capital(2)............... 41% 42% 13% 18% 39% 59%
Return on average assets (2)..................... 2.22 2.25 1.27 1.99 1.86 1.92
Efficiency ratio(3).............................. 62.8 62.7 43.5 39.7 58.9 49.0
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
--------------------- ---------------------- ----------------------
AS OF AND FOR THE SIX MONTHS ENDED JUNE 30,
----------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
-------- -------- -------- -------- --------- ---------
RESULTS OF OPERATIONS AFTER PERFORMANCE
CENTER EARNINGS (DOLLARS IN THOUSANDS):
Net interest income...................... $ 12,718 $(93,775) $ 38,237 $ 35,372 $ 766,201 $ 776,557
Noninterest income....................... 6,226 3,408 10,016 11,030 335,349 388,942
-------- -------- -------- -------- --------- ---------
Total revenue............................ 18,944 (90,367) 48,254 46,402 1,101,550 1,165,499
Noninterest expense...................... 7,921 7,800 55,249 54,835 628,278 693,604
Credit expense (income).................. 100 100 (8,465) (46,541) 105,000 55,000
-------- -------- -------- -------- --------- ---------
Income (loss) before income tax expense
(benefit)................................ 10,923 (98,267) 1,470 38,108 368,272 416,895
Income tax expense (benefit)............. 4,178 (37,587) (7,359) 4,637 123,553 136,620
-------- -------- -------- -------- --------- ---------
Net income (loss)........................ $ 6,745 $(60,680) $ 8,828 $ 33,471 $ 244,719 $ 280,275
======== ======== ======== ======== ========= =========
PERFORMANCE CENTER EARNINGS (DOLLARS IN
THOUSANDS):
Net interest income...................... $ -- $ (230) $ 229 $ 215 $ -- $ --
Noninterest income....................... (13,569) (17,949) 6,663 6,553 -- --
Noninterest expense...................... (2,232) (3,653) 3,124 2,735 -- --
Net income (loss)........................ (7,001) (8,970) 2,278 24,444 -- --
Total loans (dollars in millions)........ -- -- 20 20 -- --
AVERAGE BALANCES (DOLLARS IN MILLIONS):
Total loans(1)........................... $ 85 $ 251 $ 338 $ 331 $ 25,355 $ 26,620
Total assets............................. 6,814 8,714 828 879 35,409 39,066
Total deposits(1)........................ 2,242 1,139 907 1,302 27,897 31,837
FINANCIAL RATIOS:
Risk adjusted return on capital(2)....... 2% (12)% na na na na
Return on average assets (2)............. 0.19 (1.41) na na 1.39% 1.45%
Efficiency ratio(3)...................... 41.8 na na na 57.0 59.4
- ---------------------------
<FN>
(1) Represents loans and deposits for each business segment after allocation
between the segments of loans and deposits originated in one segment but
managed by another segment.
(2) Annualized.
(3) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income and noninterest
income. Foreclosed asset expense was $112 thousand and $51 thousand in the
first six months of 2002 and 2003, respectively.
na = not applicable
</FN>
25
COMMUNITY BANKING AND INVESTMENT SERVICES GROUP
The Community Banking and Investment Services Group provides financial
products including a set of credit, deposit, trust, risk management, and
insurance products delivered through branches, relationship managers, private
bankers, trust administrators, and insurance agents to individuals and small
businesses.
In the second quarter of 2003, net income increased $9.4 million, or 15
percent, compared to the second quarter of 2002. Total revenue increased $38.7
million, or 14 percent, compared to a year earlier. Increased asset and deposit
volumes offset the effect of a lower interest rate environment leading to an
increase of $21.1 million, or 11 percent, in net interest income over the prior
year. Excluding auto lease residual writedowns of $3.0 million and none in the
second quarter of 2002 and 2003, respectively, and the impact of performance
center earnings, noninterest income was $12.9 million, or 12 percent, higher
than the prior year primarily due to our acquisitions of John Burnham & Company,
in the fourth quarter of 2002, and Tanner Insurance Brokers, Inc., on April 1,
2003, and higher deposit-related service fees. Noninterest expense increased
$24.3 million, or 14 percent, in the second quarter of 2003 compared to the
second quarter of 2002 with the majority of that increase being attributable to
higher salaries and employee benefits mainly related to acquisitions, deposit
gathering, small business growth and residential loan growth over the second
quarter of 2002.
In 2003, the Community Banking and Investment Services Group continues to
emphasize growing the consumer asset portfolio, expanding wealth management
services, extending the small business franchise, expanding the branch network,
and expanding cross selling activities throughout the Bank. The strategy for
growing the consumer asset portfolio primarily focused on mortgage and home
equity products that may be originated through the branch network, as well as
through channels such as wholesalers, correspondents, and whole loan purchases.
As of June 30, 2003, residential mortgages have grown by $1.1 billion, or 20
percent, from the prior year. The Wealth Management division is focused on
becoming a growing provider of banking and investment products for affluent
individuals in geographic areas already served by us. We seek to provide quality
service superior to that of our competitors and offer our customers an
attractive product suite. Core elements of the initiative to extend our small
business franchise include improving our sales force, increasing marketing
activities, adding new locations, and developing online capabilities to
complement physical distribution. Expansion of the distribution network will be
achieved through acquisitions and new branch openings. During 2002, we completed
our acquisitions of Valencia Bank and Trust, a commercial bank with $266 million
in assets and five branches, and First Western Bank, a commercial bank with $224
million in assets and seven branches. On July 1, 2003, we completed the
acquisition of Monterey Bay Bank, a $632 million-asset savings and loan
association headquartered in Watsonville, California, with eight full-service
branches in the Greater Monterey Bay area.
The Community Banking and Investment Services Group is comprised of five
major divisions: Community Banking, Wealth Management, Institutional Services
and Asset Management, Consumer Asset Management, and Insurance Services.
COMMUNITY BANKING serves its customers through 267 full-service branches in
California, 4 full-service branches in Oregon and Washington, and a network of
528 proprietary ATMs. Customers may also access our services 24 hours a day by
telephone or through our BANK@HOME product at www.uboc.com. In addition, the
division offers automated teller and point-of-sale merchant services.
This division is organized by service delivery method, by markets and by
geography. We serve our customers in the following ways:
o through community banking branches, which serve consumers and
businesses with checking and deposit services, as well as various
types of consumer financing;
o through on-line access to our internet banking services, which augment
our physical delivery channels by providing an array of customer
transaction, bill payment and loan payment services;
26
o through branches and business banking centers, which serve businesses
with annual sales up to $5 million; and
o through in-store branches, which also serve consumers and businesses.
Wealth Management provides private banking services to our affluent
clientele as well as brokerage products and services.
o The Private Bank focuses primarily on delivering financial services to
high net worth individuals with sophisticated financial needs as well
as to professional service firms. Specific products and services
include trust and estate services, investment account management
services, and deposit and credit products. A key strategy of The
Private Bank is to expand its business by leveraging existing Bank
client relationships. Through 13 existing locations, The Private Bank
relationship managers offer all of our available products and
services.
o Our brokerage products and services are provided through UBOC
Investment Services, Inc., a registered broker/dealer offering
investment products to individuals and institutional clients. Its
primary strategy is to further penetrate our existing client base.
INSTITUTIONAL SERVICES AND ASSET MANAGEMENT provides investment management
and administration services for a broad range of individuals and institutions.
o HighMark Capital Management, Inc., a registered investment advisor,
provides investment advisory services to institutional clients and its
proprietary mutual funds, the affiliated HighMark Funds. It also
provides advisory services to Union Bank of California, N.A. trust and
agency clients, including corporations, pension funds and individuals.
HighMark Capital Management, Inc. also provides mutual fund support
services. HighMark Capital Management, Inc.'s strategy is to increase
assets under management by broadening its client base and helping to
expand the distribution of shares of its mutual fund clients.
o Institutional Services provides custody, corporate trust, and
retirement plan services. Custody Services provides both domestic and
international safekeeping/settlement services in addition to
securities lending. Corporate Trust acts as trustee for corporate and
municipal debt issues. Retirement Services provides a full range of
defined benefit and defined contribution administrative services,
including trustee services, administration, investment management, and
401(k) valuation services. The client base of Institutional Services
includes financial institutions, corporations, government agencies,
unions, insurance companies, mutual funds, investment managers, and
non-profit organizations. Institutional Services' strategy is to
continue to leverage and expand our position in our target markets. As
we announced on April 30, 2002, we acquired a substantial portion of
the trust and institutional custody business of a bank located in
Southern California.
CONSUMER ASSET MANAGEMENT is the centralized underwriting, processing,
servicing, collection and administration for consumer assets including
residential loans and merchant bank cards.
o Consumer Asset Management is centralized in two California sites, one
in San Diego and one in Brea, and
o provides customer and credit management services for consumer loan
products.
CERTAIN INDUSTRY DEVELOPMENTS
Union Bank of California, N.A. is a member of MasterCard International
Incorporated ("MCI"), VISA U.S.A., Inc. and VISA International, Inc. (together,
"Visa"), is an issuer of debit cards, primarily of the MCI "MasterMoney" card,
and is an MCI and Visa merchant bank card services bank.
27
In 1996, Wal-Mart Stores, Inc. and several other retailers sued MCI and
Visa in cases now pending in federal court in New York, asserting that MCI and
Visa's rules regarding uniform acceptance of all Visa and MasterCard credit and
debit cards were an illegal tying arrangement.
Prior to trial, MCI and Visa agreed to settle these cases. The settlements
reportedly remain subject to court approval. Neither we nor Union Bank of
California, N.A. are a party to these suits, and neither will be directly liable
for these settlements. However, MCI or Visa may seek to assess, or assert claims
against, their members to fund the settlements. In addition, even if no direct
claim is asserted against members, the implementation of the settlements could
adversely affect their operations.
In the year ended December 31, 2002, interchange income from our debit card
operations was less than one percent of our gross revenues. While our 2003 debit
card interchange income can be expected to be reduced if the settlements are
approved and implemented in the current year, we cannot predict what effect the
settlements will have on the competitive environment or our future earnings from
debit card operations.
INSURANCE SERVICES provides a range of risk management services and
insurance products to business and retail customers. The group, which includes
our fourth quarter 2001 acquisition of Armstrong/Robitaille, Inc., our fourth
quarter 2002 acquisition of John Burnham & Company, and our April 1, 2003
acquisition of Tanner Insurance Brokers, Inc., offers its risk management and
insurance products through offices in California and Oregon.
Through alliances with other financial institutions, the Community Banking
and Investment Services Group offers additional products and services, such as
credit cards, leasing, and asset-based and leveraged financing.
The group competes with larger banks by attempting to provide service
quality superior to that of its major competitors. The group's primary means of
competing with community banks include its branch network and its technology to
deliver banking services. The group also offers convenient banking hours to
consumers through our drive-through banking locations and selected branches that
are open seven days a week.
The group competes with a number of commercial banks, internet banks,
savings associations and credit unions, as well as more specialized financial
service providers such as investment brokerage companies, consumer finance
companies, and residential real estate lenders. The group's primary competitors
are other major depository institutions such as Bank of America, Citibank,
Washington Mutual and Wells Fargo, as well as smaller community banks in the
markets in which we operate.
COMMERCIAL FINANCIAL SERVICES GROUP
The Commercial Financial Services Group offers financing and cash
management services to middle-market and large corporate businesses primarily
headquartered in the western United States. The Commercial Financial Services
Group has continued to focus specialized financing expertise to specific
geographic markets and industry segments such as energy, entertainment, and real
estate. Relationship managers in the Commercial Financial Services Group provide
credit services, including commercial loans, accounts receivable and inventory
financing, project financing, lease financing, trade financing and real estate
financing. In addition to credit services, the group offers its customers access
to cash management services delivered through deposit managers with experience
in cash management solutions for businesses and government entities.
In the second quarter of 2003, net income increased $26.8 million, or 51
percent, compared to the second quarter of 2002. Net interest income increased
$38.5 million, or 23 percent, partially attributable to the impact of increasing
deposit balances and a lower cost of funds resulting from the lower interest
rate environment. Beginning in 2003, the transfer pricing credit for funds
provides for a floor on analyzed DDA balances, which was triggered during the
first quarter of 2003. Had such a floor existed in the second
28
quarter of 2002, net interest income would have been higher by approximately $11
million. Excluding higher income in the private equity portfolio of $3.7 million
mainly related to lower writedowns on private capital investments in the second
quarter of 2003 compared to the second quarter of 2002, noninterest income
increased $3.4 million, or 6 percent. This 6 percent increase was mainly
attributable to higher deposit-related service fees. Noninterest expense
increased $10.1 million, or 11 percent, compared to a year earlier due to higher
expenses to support increased product sales and deposit volume. Credit expense
decreased $5.3 million mainly attributable to a refinement in the RAROC
allocation of capital and expected losses and lower loan balances
year-over-year.
The group's initiatives during 2003 include expanding wholesale deposit
activities and increasing domestic trade financing. Loan strategies include
originating, underwriting and syndicating loans in core competency markets, such
as the California middle-market, commercial real estate, energy, entertainment,
equipment leasing and commercial finance. The Commercial Financial Services
Group provides strong processing services, including services such as check
processing, front-end item processing, cash vault services and digital imaging.
The Commercial Financial Services Group is comprised of the following
business units:
o the Commercial Banking Division, which serves California middle-market
and large corporate companies with commercial lending, trade
financing, and asset-based loans;
o the Corporate Deposit and Treasury Management Division, which provides
deposit and cash management expertise to clients in the middle-market,
large corporate market, government agencies and specialized
industries;
o the Real Estate Industries Division, which provides real estate
lending products such as construction loans, commercial mortgages and
bridge financing;
o the Energy Capital Services Division, which provides custom financing
and project financing to oil and gas companies, as well as power and
utility companies, nationwide and internationally; and
o the Corporate Capital Markets Division, which provides custom
financing to middle-market and large corporate clients in their
defined industries and geographic markets, together with limited
merchant and investment banking related products and services.
The group competes with other banks primarily on the basis of the quality
of its relationship managers, the delivery of quality customer service, and its
reputation as a "business bank."
The group's main strategy is to target industries and companies for which
the group can reasonably expect to be one of a customer's primary banks.
Consistent with its strategy, the group attempts to serve a large part of its
targeted customers' credit and depository needs.
The group competes with a variety of other financial services companies.
Competitors include other major California banks, as well as regional, national
and international banks. In addition, the group competes with investment banks,
commercial finance companies, leasing companies, and insurance companies.
INTERNATIONAL BANKING GROUP
The International Banking Group focuses on providing correspondent banking
and trade finance related products and services to international financial
institutions worldwide, primarily in Asia. This focus includes products and
services such as letters of credit, international payments, collections and
financing of mostly short-term transactions. The group also serves certain
foreign firms and US corporate clients in selected countries where we have
branches, including Hong Kong, Japan, Korea, the Philippines and Taiwan. In the
US, the group serves mostly subsidiaries and affiliates of non-Japanese Asian
companies
29
and US branches/agencies of foreign banks. The majority of the revenue generated
by the International Banking Group is from customers domiciled outside of the
US.
In the second quarter of 2003, net income increased $6.1 million, or 96
percent, compared to the second quarter of 2002. Total revenue in the second
quarter of 2003 increased $9.9 million, or 38 percent, compared to the second
quarter of 2002. Net interest income increased $0.5 million, or 5 percent, from
the second quarter of 2002, mainly attributable to higher loan volume.
Noninterest income was $9.5 million, or 57 percent, higher than the second
quarter of 2002, mainly attributable to a $9.0 million gain on an early call of
a Mexican Brady Bond in the second quarter of 2003. Noninterest expense of $15.3
million was relatively unchanged from the second quarter of 2002. Credit expense
of $0.5 million was relatively unchanged from the second quarter of 2002. The
International Banking Group's business revolves around short-term trade
financing, mostly to banks, which we believe tends to result in service-related
income, as well as significantly lower credit risk when compared to other
lending activities.
The group has a long history of providing correspondent banking and
trade-related products and services to international financial institutions. We
believe the group continues to achieve strong customer loyalty in the
correspondent banking market. The International Banking Group, headquartered in
San Francisco, also maintains representative offices in Asia and Latin America
and an international banking subsidiary in New York.
GLOBAL MARKETS GROUP
The Global Markets Group conducts business activities primarily to support
the previously described business groups and their customers. This group offers
a broad range of risk management products, such as foreign exchange contracts
and interest rate swaps and options. It trades money market, government, agency,
and other securities to meet investment needs of our institutional and business
clients. Another primary area of the group is treasury management for our
Company, which encompasses wholesale funding, liquidity management, interest
rate risk management, including securities portfolio management, and hedging
activities. The Global Markets Group results include the transfer pricing
activity for the Bank, which allocates to the other business segments their cost
of funds on all asset categories or credit for funds in the case of all
liability categories.
In the second quarter of 2003, net loss was $38.3 million compared to net
income of $0.4 million in the second quarter of 2002. Total revenue in the
second quarter of 2003 decreased by $63.0 million, or 1,335 percent, compared to
the second quarter of 2002, resulting from a $60.2 million decrease in net
interest income. The decrease in net interest income was primarily attributable
to a higher transfer pricing residual in the second quarter of 2003 caused by
significantly higher quarter-over-prior year quarter growth in deposits, which
are priced on longer-term liability rates, compared to credits on earning
assets, which are priced on shorter-term lending rates. Beginning in 2003, the
transfer pricing credit for funds provides for a floor on analyzed DDA balances,
which was triggered during the first quarter 2003. Had such a floor existed in
the second quarter of 2002, net interest income would have declined by
approximately $11 million. Noninterest income was $2.9 million, or 60 percent,
lower than the second quarter of 2002, mainly attributable to gains of $2.0
million on the sale of securities in the prior year quarter. Compared to the
second quarter of 2002, noninterest expense decreased $0.3 million, or 8
percent.
OTHER
"Other" includes the following items:
o corporate activities that are not directly attributable to one of the
four major business units. Included in this category are certain other
nonrecurring items such as merger and integration expense, certain
parent company non-bank subsidiaries, and the elimination of the fully
taxable-equivalent basis amount;
30
o the adjustment between the credit expense under RAROC and the
provision for credit losses under US GAAP and earnings associated with
unallocated equity capital;
o the Pacific Rim Corporate Group, with assets at June 30, 2003 of
$342.4 million, which offers a range of credit, deposit, and
investment management products and services to companies in the US,
which are affiliated with companies headquartered in Japan; and
o the residual costs of support groups.
Net income for "Other" in the second quarter of 2003 was $16.8 million. The
results were impacted by the following factors:
o Credit expense (income) of ($25.8) million was due to the difference
between the $25.0 million in provision for credit losses calculated
under our US GAAP methodology and the $50.8 million in expected losses
for the reportable business segments, which utilizes the RAROC
methodology;
o Net interest income of $19.2 million, which resulted from the
differences between the credit for equity for the reportable segments
under RAROC and the net interest income earned by UnionBanCal
Corporation, and a credit for deposits in the Pacific Rim Corporate
Group;
o Noninterest income of $1.8 million; and
o Noninterest expense of $29.9 million.
Net income for "Other" in the second quarter of 2002 was $5.7 million. The
results were impacted by the following factors:
o Credit expense (income) of ($6.9) million was due to the difference
between the $50.0 million in provision for credit losses calculated
under our US GAAP methodology and the $56.9 million in expected losses
for the reportable business segments, which utilizes the RAROC
methodology; offset by
o Net interest income of $19.2 million, which resulted from the
differences between the credit for equity for the reportable segments
under RAROC and the net interest income earned by UnionBanCal
Corporation, and a credit for deposits in the Pacific Rim Corporate
Group;
o Noninterest income of $5.5 million; and
o Noninterest expense of $29.6 million.
31
NET INTEREST INCOME
The following tables show the major components of net interest income and
net interest margin.
FOR THE THREE MONTHS ENDED
---------------------------------------------------------------------------------------
JUNE 30, 2002 JUNE 30, 2003
---------------------------------------- ----------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(DOLLARS IN THOUSANDS) BALANCE EXPENSE(1) RATE(1) BALANCE EXPENSE(1) RATE(1)
- ------------------------------------- ----------- ---------- ------- ----------- ---------- -------
ASSETS
Loans:(2)
Domestic........................... $24,538,646 $ 371,173 6.06% $24,916,936 $ 346,204 5.63%
Foreign(3)......................... 1,040,200 7,587 2.93 1,600,380 8,995 2.28
Securities--taxable.................. 5,570,242 77,553 5.57 7,685,140 77,341 4.03
Securities--tax-exempt............... 36,946 998 10.81 40,984 1,016 9.91
Interest bearing deposits in banks. 120,411 629 2.09 221,004 1,130 2.05
Federal funds sold and securities
purchased under resale agreements 1,090,306 4,828 1.78 1,276,224 4,001 1.26
Trading account assets............... 277,877 972 1.40 333,820 981 1.18
----------- ---------- ----------- ----------
Total earning assets........... 32,674,628 463,740 5.69 36,074,488 439,668 4.88
---------- ----------
Allowance for credit losses.......... (630,120) (585,597)
Cash and due from banks.............. 1,833,950 2,099,440
Premises and equipment, net.......... 498,683 509,372
Other assets......................... 1,353,351 1,678,646
----------- -----------
Total assets................... $35,730,492 $39,776,349
=========== ===========
LIABILITIES
Domestic deposits:
Interest bearing................... $ 7,883,320 $ 22,551 1.15 $ 9,928,211 $ 18,799 0.76
Savings and consumer time.......... 3,599,305 15,267 1.70 3,871,674 11,277 1.17
Large time......................... 3,218,788 17,593 2.19 2,532,971 10,141 1.61
Foreign deposits(3).................. 1,614,335 6,105 1.52 1,224,201 2,811 0.92
----------- ---------- ----------- ----------
Total interest bearing deposits 16,315,748 61,516 1.51 17,557,057 43,028 0.98
----------- ---------- ----------- ----------
Federal funds purchased and
securities sold under repurchase
agreements......................... 361,412 1,396 1.55 333,415 747 0.90
Commercial paper..................... 1,033,358 4,536 1.76 995,048 2,946 1.19
Other borrowed funds................. 667,234 3,635 2.19 138,074 1,055 3.06
Medium and long-term debt............ 399,681 2,411 2.42 399,745 1,818 1.82
UnionBanCal Corporation--obligated
mandatorily redeemable preferred
securities of subsidiary grantor
trust.............................. 352,375 3,948 4.47 351,553 3,652 4.16
----------- ---------- ----------- ----------
Total borrowed funds........... 2,814,060 15,926 2.27 2,217,835 10,218 1.85
----------- ---------- ----------- ----------
Total interest bearing
liabilities................. 19,129,808 77,442 1.62 19,774,892 53,246 1.08
---------- ----------
Noninterest bearing deposits......... 11,906,497 15,030,116
Other liabilities.................... 945,152 1,052,065
----------- -----------
Total liabilities.............. 31,981,457 35,857,073
SHAREHOLDERS' EQUITY
Common equity........................ 3,749,035 3,919,276
----------- -----------
Total shareholders' equity..... 3,749,035 3,919,276
----------- -----------
Total liabilities and
shareholders' equity........ $35,730,492 $39,776,349
=========== ===========
Net interest income/margin
(taxable-equivalent basis)......... 386,298 4.74% 386,422 4.29%
Less: taxable-equivalent adjustment.. 537 645
---------- ----------
Net interest income............ $ 385,761 $ 385,777
========== ==========
- ------------------------------------
<FN>
(1) Yields and interest income are presented on a taxable-equivalent basis
using the federal statutory tax rate of 35 percent.
(2) Average balances on loans outstanding include all nonperforming loans. The
amortized portion of net loan origination fees (costs) is included in
interest income on loans, representing an adjustment to the yield.
(3) Foreign loans and deposits are those loans and deposits originated in
foreign branches.
</FN>
32
FOR THE SIX MONTHS ENDED
---------------------------------------------------------------------------------------
JUNE 30, 2002 JUNE 30, 2003
---------------------------------------- ----------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(DOLLARS IN THOUSANDS) BALANCE EXPENSE(1) RATE(1) BALANCE EXPENSE(1) RATE(1)
------------------------------------ ----------- ---------- ------- ----------- ---------- -------
ASSETS
Loans:(2)
Domestic........................... $24,314,639 $ 739,235 6.12% $25,051,062 $ 701,277 5.63%
Foreign(3)......................... 1,039,909 15,509 3.01 1,568,556 17,161 2.21
Securities--taxable................. 5,561,342 158,216 5.69 7,351,834 156,520 4.26
Securities--tax-exempt.............. 37,586 1,989 10.59 41,461 2,030 9.79
Interest bearing deposits in banks.. 102,509 1,125 2.21 212,266 2,092 1.99
Federal funds sold and securities
purchased under resale agreements.. 1,013,769 8,887 1.77 908,213 5,678 1.26
Trading account assets.............. 257,735 1,692 1.32 320,683 1,938 1.22
----------- ---------- ----------- ----------
Total earning assets........... 32,327,489 926,653 5.76 35,454,075 886,696 5.03
---------- ----------
Allowance for credit losses......... (637,210) (594,370)
Cash and due from banks............. 1,887,985 2,097,220
Premises and equipment, net......... 497,483 508,175
Other assets........................ 1,333,050 1,601,121
----------- -----------
Total assets................... $35,408,797 $39,066,221
=========== ===========
LIABILITIES
Domestic deposits:
Interest bearing................... $ 7,672,584 45,709 1.20 $ 9,648,251 37,608 0.79
Savings and consumer time.......... 3,574,422 32,237 1.82 3,845,754 23,593 1.24
Large time......................... 3,351,398 37,400 2.25 2,473,968 20,587 1.68
Foreign deposits(3)................. 1,681,420 12,369 1.48 1,303,747 6,017 0.93
----------- ---------- ----------- ----------
Total interest bearing deposits 16,279,824 127,715 1.58 17,271,720 87,805 1.03
----------- ---------- ----------- ----------
Federal funds purchased and
securities sold under repurchase
agreements......................... 450,800 3,345 1.50 424,955 2,074 0.98
Commercial paper.................... 976,624 8,510 1.76 959,386 5,674 1.19
Other borrowed funds................ 682,558 7,078 2.09 155,375 2,310 3.00
Medium and long-term debt........... 399,834 4,823 2.43 399,737 3,684 1.86
UnionBanCal Corporation--obligated
mandatorily redeemable preferred
securities of subsidiary grantor
trust.............................. 352,337 7,911 4.47 351,603 7,323 4.17
----------- ---------- ----------- ----------
Total borrowed funds........... 2,862,153 31,667 2.23 2,291,056 21,065 1.85
----------- ---------- ----------- ----------
Total interest bearing
liabilities................. 19,141,977 159,382 1.68 19,562,776 108,870 1.12
---------- ----------
Noninterest bearing deposits........ 11,617,577 14,565,228
Other liabilities................... 961,999 1,041,308
----------- -----------
Total liabilities.............. 31,721,553 35,169,312
SHAREHOLDERS' EQUITY
Common equity....................... 3,687,244 3,896,909
----------- -----------
Total shareholders' equity..... 3,687,244 3,896,909
----------- -----------
Total liabilities and
shareholders' equity........ $35,408,797 $39,066,221
=========== ===========
Net interest income/margin
(taxable-equivalent basis)........... 767,271 4.77% 777,826 4.41%
Less: taxable-equivalent adjustment. 1,070 1,269
---------- ----------
Net interest income............ $ 766,201 $ 776,557
========== ==========
- -------------------------------
<FN>
(1) Yields and interest income are presented on a taxable-equivalent basis
using the federal statutory tax rate of 35 percent.
(2) Average balances on loans outstanding include all nonperforming loans. The
amortized portion of net loan origination fees (costs) is included in
interest income on loans, representing an adjustment to the yield.
(3) Foreign loans and deposits are those loans and deposits originated in
foreign branches.
</FN>
33
THREE MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2003
Our net interest income is impacted by changes in interest rates, the
steepening and flattening of the yield curve and changes in volumes and mix of
earning assets, deposits, and interest bearing liabilities. Net interest income,
on a taxable-equivalent basis, was $386.4 million in the second quarter of 2003,
compared with $386.3 million in the second quarter of 2002. This slight increase
of $0.1 million was attributable primarily to the impact of the decreasing
interest rate environment throughout the prior year on interest bearing
liabilities, increasing average noninterest bearing deposits, and higher earning
assets, mostly offset by significantly lower yields on our earning assets.
Decreasing market rates resulted in lower rates on our interest bearing
liabilities of 54 basis points on average balances of $19.8 billion, which was
mostly offset by lower average yield of 81 basis points on average earning
assets of $36.1 billion, which was favorably impacted by higher interest rate
derivatives income of $10.4 million. Mitigating the impact of the lower interest
rate environment on our net interest margin was an increase in average earning
assets of $3.4 billion, primarily in securities and residential mortgage loans,
funded by a $3.1 billion, or 26 percent, increase in average noninterest bearing
deposits. As a result of these changes and a flattening yield curve environment,
as short-term interest rates rise while long-term interest rates decline, our
net interest margin decreased by 45 basis points, to 4.29 percent.
Average earning assets were $36.1 billion in the second quarter of 2003,
compared with $32.7 billion in the second quarter of 2002. This growth was
attributable to a $2.1 billion, or 38 percent, increase in average securities
and a $938.5 million, or 4 percent, increase in average loans. The increase in
average securities, which were comprised primarily of fixed rate securities,
reflected liquidity and interest rate risk management actions. The increase in
average loans was mostly due to a $1.2 billion increase in average residential
mortgages, which was a result of a strategic portfolio shift from more volatile
commercial loans. Other loan activities included an increase in average
commercial mortgages of $449.9 million and a decrease in average commercial,
financial, and industrial loans of $609.8 million.
Deposit growth, especially in our title and escrow industries, has
contributed significantly to our lower cost of funds year-over-year. Average
noninterest bearing deposits were $3.1 billion, or 26 percent, higher in the
second quarter of 2003 over the prior year, which included a $1.1 billion
increase in average title and escrow deposits. We anticipate that growth rates
in average noninterest bearing deposits will decline from the 2002 growth rates
as refinancings slow down due to interest rate increases.
SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2003
Our net interest income is impacted by changes in interest rates, the
steepening and flattening of the yield curve and changes in volumes and mix of
earning assets, deposits, and interest bearing liabilities. Net interest income,
on a taxable-equivalent basis, was $777.8 million in the first six months of
2003, compared with $767.3 million in the first six months of 2002. This
increase of $10.5 million, or 1 percent, was attributable primarily to the
impact of the decreasing interest rate environment throughout the prior year on
interest bearing liabilities, increasing average noninterest bearing deposits,
and higher earning assets, partly offset by significantly lower yields on our
earning assets. Decreasing market rates resulted in lower rates on our interest
bearing liabilities of 56 basis points on average balances of $19.6 billion,
which was partly offset by a lower average yield of 73 basis points on average
earning assets of $35.5 billion, which was favorably impacted by higher interest
rate derivatives income of $16.3 million. Mitigating the impact of the lower
interest rate environment on our net interest margin was an increase in average
earning assets of $3.1 billion, primarily in securities and residential mortgage
loans, funded by a $2.9 billion, or 25 percent, increase in average noninterest
bearing deposits. As a result of these changes and a flattening yield curve
environment, as short-term interest rates rise while long-term interest rates
decline, our net interest margin decreased by 36 basis points, to 4.41 percent.
Average earning assets were $35.5 billion in the first six months of 2003,
compared with $32.3 billion in 2002. This growth was attributable to a $1.8
billion, or 32 percent, increase in average securities and a
34
$1.3 billion, or 5 percent, increase in average loans. The increase in average
securities, which were comprised primarily of fixed rate securities, reflected
liquidity and interest rate risk management actions. The increase in average
loans was mostly due to a $1.3 billion increase in average residential
mortgages, which was a result of a strategic portfolio shift from more volatile
commercial loans. Other loan activities included an increase in average
commercial mortgages of $485.6 million and a decrease in average commercial,
financial, and industrial loans of $507.9 million.
Deposit growth, especially in our title and escrow industries, has
contributed significantly to our lower cost of funds year-over-year. Average
noninterest bearing deposits were $2.9 billion, or 25 percent, higher in the
first six months of 2003 over the first six months of 2002, which included a
$973.1 million increase in average title and escrow deposits.
NONINTEREST INCOME
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
---------------------------------------------- ----------------------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
JUNE 30, JUNE 30, ------------------- JUNE 30, JUNE 30, -------------------
(DOLLARS IN THOUSANDS) 2002 2003 AMOUNT PERCENT 2002 2003 AMOUNT PERCENT
- --------------------------- -------- -------- ------- ------- -------- -------- ------- -------
Service charges on deposit
accounts................. $ 69,869 $ 77,942 $ 8,073 11.55% $136,012 $150,229 $14,217 10.45%
Trust and investment
management fees.......... 37,587 33,141 (4,446) (11.83) 74,312 65,816 (8,496) (11.43)
International commissions
and fees................. 19,239 21,276 2,037 10.59 37,462 40,889 3,427 9.15
Insurance commissions...... 6,252 15,706 9,454 151.22 13,405 28,711 15,306 114.18
Card processing fees, net.. 8,736 9,340 604 6.91 17,275 19,022 1,747 10.11
Brokerage commissions and
fees..................... 9,275 8,729 (546) (5.89) 18,907 17,595 (1,312) (6.94)
Foreign exchange trading
gains, net............... 7,011 6,958 (53) (0.76) 13,459 13,892 433 3.22
Merchant banking fees...... 9,081 6,191 (2,890) (31.82) 16,026 12,209 (3,817) (23.82)
Securities gains, net...... 1,969 9,013 7,044 357.75 1,969 9,013 7,044 357.75
Other...................... 6,587 14,875 8,288 125.82 6,522 31,566 25,044 383.99
-------- -------- ------- -------- -------- -------
Total noninterest income. $175,606 $203,171 $27,565 15.70% $335,349 $388,942 $53,593 15.98%
======== ======== ======= ======== ======== =======
THREE MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2003
In the second quarter of 2003, noninterest income was $203.2 million, an
increase of $27.6 million, or 16 percent, over the second quarter of 2002. This
increase was mainly attributable to a $9.5 million increase in insurance
commissions mostly associated with our acquisitions of John Burnham & Company
and Tanner Insurance Brokers, Inc., a $8.1 million increase in service charges
on deposit accounts, higher income related to private capital investments, net,
of $3.7 million mainly due to lower writedowns in the current year, lower
residual value writedowns on auto leases of $3.0 million and a $7.0 million
increase in securities gains mainly attributable to a $9.0 million gain arising
from the early call of a Mexican Brady Bond, partly offset by a $4.4 million
decrease in trust and investment management fees.
Revenue from service charges on deposit accounts was $77.9 million, an
increase of $8.1 million or 12 percent over the second quarter of 2002. This
increase was primarily attributable to a 20 percent increase in quarterly
average demand deposits (excluding title and escrow deposits) and overdraft fees
of $3.5 million associated with a new overdraft program introduced in April
2003.
Trust and investment management fees were $33.1 million, a decrease of $4.4
million, or 12 percent, from the second quarter of 2002. This decrease is
primarily attributable to the decline in equity market values and lower revenues
as our clients shift toward fixed income investments. In addition, the current
low interest rate environment has led to a significant reduction in balances in
the HighMark money market funds. Total assets under administration of $145.2
billion at June 30, 2003 increased by $8.3 billion, or 6 percent, from June 30,
2002.
35
Insurance commissions were $15.7 million, an increase of $9.5 million, or
151 percent, over the second quarter of 2002, reflecting the incremental
revenues associated with our insurance agency acquisitions.
Securities gains, net, were $9.0 million compared to securities gains, net,
of $2.0 million in the second quarter of 2002. In the second quarter of 2003, we
realized a gain of $9.0 million on an early call of a Mexican Brady Bond.
Other noninterest income was $14.9 million, an increase of $8.3 million, or
126 percent from the second quarter of 2002. This increase was mainly
attributable to:
o an increase in income related to private capital investments, net, of
$3.7 million primarily due to lower writedowns on private capital
investments of $4.4 million in the second quarter of 2003 compared to
the second quarter of 2002. Our private capital investments include
direct investments in private and public companies and indirect
investments in private equity funds. The fair values of publicly
traded investments are determined by using quoted market prices.
Investments that are not publicly traded are initially valued at cost
and subsequent adjustments to fair value are estimated based on a
company's businesses model, current projected financial performance,
liquidity and overall economic and market conditions, and
o no residual value writedowns on auto leases in the second quarter of
2003 compared to residual value writedowns of $3.0 million in the
second quarter of 2002. The decline in our impairment for residual
values for the auto lease portfolio over the previous year was
impacted by (a) our decision to cease originating auto leases in April
2001, which resulted in a reduction in the number of automobiles under
lease at June 30, 2003; and (b) the current period determination of
used car valuations, obtained from a nationally recognized automobile
valuation expert and our own experience. Residual values are affected
by the rate at which automobiles are returned to the lessor and the
auction values of the automobiles themselves. In 2003, the rate of
decline in used car prices and the rate of increase in number of cars
we expect to be returned over the remaining life of the portfolio,
slowed from the previous year. As of June 30, 2003, auto lease
financing was $156.2 million compared to $310.7 million for the same
period last year.
SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2003
In the first six months of 2003, noninterest income was $388.9 million, an
increase of $53.6 million, or 16 percent, over the first six months of 2002.
This increase was mainly attributable to a $15.3 million increase in insurance
commissions mostly associated with our insurance agency acquisitions, a $14.2
million increase in service charges on deposit accounts, higher income related
to private capital investments, net, of $10.5 million primarily due to lower
writedowns in the current year, lower residual value writedowns on auto leases
of $9.0 million and a $7.0 million increase in securities gains mainly
attributable to a $9.0 million gain arising from the early call of a Mexican
Brady Bond, partly offset by an $8.5 million decrease in trust and investment
management fees.
Revenue from service charges on deposit accounts was $150.2 million, an
increase of $14.2 million, or 10 percent, over the first six months of 2002.
This increase was primarily attributable to a 20 percent increase in quarterly
average demand deposits (excluding title escrow deposits) and overdraft fees of
$3.5 million associated with a new overdraft program introduced in April 2003.
Trust and investment management fees were $65.8 million, a decrease of $8.5
million, or 11 percent, from the first six months of 2002. This decrease is
primarily attributable to the decline in equity market values and lower revenues
as our clients shift toward fixed income investments. In addition, the current
low interest rate environment has led to a significant reduction in balances in
the HighMark money market funds.
36
Insurance commissions were $28.7 million, an increase of $15.3 million, or
114 percent, reflecting the incremental revenues associated with our insurance
agency acquisitions, and growth in insurance commissions at
Armstrong/Robitaille, Inc.
Securities gains, net, were $9.0 million compared to securities gains, net,
of $2.0 million in the first six months of 2002. In the first six months of
2003, we realized a gain of $9.0 million on an early call of a Mexican Brady
Bond.
Other noninterest income was $31.6 million, an increase of $25.0 million,
or 384 percent, from the first six months of 2002. This increase was mainly
attributable to an increase in income related to private capital investments,
net, of $10.5 million primarily due to lower writedowns in the current year, a
decrease of $9.0 million in residual value writedowns on auto leases and a $3.3
million insurance recovery from the September 11, 2001 World Trade Center attack
recorded in the first quarter of 2003.
NONINTEREST EXPENSE
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------------------------- ----------------------------------------------
INCREASE INCREASE
(DECREASE) (DECREASE)
JUNE 30, JUNE 30, -------------------- JUNE 30, JUNE 30, -------------------
(DOLLARS IN THOUSANDS) 2002 2003 AMOUNT PERCENT 2002 2003 AMOUNT PERCENT
- --------------------------- -------- -------- ------- ------- -------- -------- ------- -------
Salaries and other
compensation............ $154,209 $161,567 $ 7,358 4.77% $296,633 $314,627 $17,994 6.07%
Employee benefits......... 31,891 37,362 5,471 17.16 68,343 82,409 14,066 20.58
-------- -------- ------- -------- -------- -------
Salaries and employee
benefits................ 186,100 198,929 12,829 6.89 364,976 397,036 32,060 8.78
Net occupancy............. 25,029 32,866 7,837 31.31 48,410 60,502 12,092 24.98
Equipment................. 15,967 16,354 387 2.42 32,307 33,025 718 2.22
Communications............ 12,568 13,354 786 6.25 26,509 27,198 689 2.60
Professional services..... 10,936 13,566 2,630 24.05 20,439 25,580 5,141 25.15
Software.................. 10,039 10,849 810 8.07 21,549 22,925 1,376 6.39
Advertising and public
relations............... 8,621 9,693 1,072 12.43 18,629 19,360 731 3.92
Data processing........... 7,540 7,744 204 2.71 16,531 16,228 (303) (1.83)
Intangible asset
amortization............ 1,280 3,227 1,947 152.11 2,164 5,704 3,540 163.59
Foreclosed asset expense
(income)................ (13) -- 13 (100.00) 112 51 (61) (54.46)
Other..................... 38,556 44,422 5,866 15.21 76,652 85,995 9,343 12.19
-------- -------- ------- -------- -------- -------
Total noninterest expense $316,623 $351,004 $34,381 10.86% $628,278 $693,604 $65,326 10.40%
======== ======== ======= ======== ======== =======
THREE MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2003
In the second quarter of 2003, noninterest expense was $351.0 million, an
increase of $34.4 million, or 11 percent, over the second quarter of 2002. This
increase was primarily due to a $12.8 million increase in salaries and employee
benefits and a $7.8 million increase in net occupancy, which included a $4.2
million write-off of leasehold improvements.
Salaries and employee benefits were $198.9 million, an increase of $12.8
million, or 7 percent, over the second quarter of 2002. This increase was
primarily attributable to annual merit increases, higher staff levels associated
with our recent acquisitions, and increased insurance and worker's compensation
benefits expenses.
Net occupancy expense was $32.9 million, an increase of $7.8 million, or 31
percent over the second quarter of 2002. This increase was primarily
attributable to recent acquisitions, new branch openings, other facilities
restructuring initiatives, higher property insurance and a $4.2 million
write-off of leasehold improvements.
37
Professional services expense was $13.6 million, an increase of $2.6
million, or 24 percent, over the second quarter of 2002. This increase was
primarily attributable to higher consulting and other professional service
expenses.
Intangible asset amortization was $3.2 million, an increase of $1.9
million, or 152 percent, from the second quarter of 2002. This increase was
primarily associated with our acquisitions in the fourth quarter of 2002 and in
the second quarter of 2003.
Other noninterest expense was $44.4 million, an increase of $5.9 million,
or 15 percent over the second quarter of 2002. This increase included a $2.6
million increase in unguaranteed low-income housing credit amortization expense
and $2.1 million in write-offs related to two software development projects.
SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2003
In the first six months of 2003, noninterest expense was $693.6 million, an
increase of $65.3 million, or 10 percent, over the first six months of 2002.
This increase was primarily due to a $32.1 million increase in salaries and
employee benefits and a $12.1 million increase in net occupancy, including $4.2
million related to the write-off of leasehold improvements.
Salaries and employee benefits were $397.0 million, an increase of $32.1
million, or 9 percent, over the first six months of 2002. This increase was
primarily attributable to annual merit increases, higher staff levels mostly
associated with our recent acquisitions, increased insurance and health benefits
expense, and 401(k) plan expenses.
Net occupancy expense was $60.5 million, an increase of $12.1 million, or
25 percent, over the first six months of 2002. This increase was primarily
attributable to recent acquisitions, new branch openings, other facilities
restructuring initiatives, higher property insurance and a $4.2 million
write-off of leasehold improvements.
Professional services expense was $25.6 million, an increase of $5.1
million, or 25 percent over the first six months of 2002. This increase was
primarily attributable to increased legal services, consulting and other
professional service expenses.
Intangible asset amortization was $5.7 million, an increase of $3.5
million, or 164 percent, from the first six months of 2002. This increase was
primarily associated with our acquisitions in the fourth quarter of 2002 and in
the second quarter of 2003.
Other noninterest expense was $86.0 million, an increase of $9.3 million,
or 12 percent, over the first six months of 2002. This increase included a $4.8
million increase in unguaranteed low-income housing credit amortization expense
and $2.1 million in write-offs related to two software development projects.
INCOME TAX EXPENSE
Income tax expense in the second quarter of 2003 was $68.2 million,
resulting in a 32 percent effective income tax rate. Income tax expense in the
second quarter of 2003 included a $2.7 million refund of income taxes paid in
1998, 1999, and 2000, resulting from the settlement of several tax issues with
the Internal Revenue Service. For the second quarter of 2002, the effective
income tax rate was 33 percent.
Income tax expense in the first six months of 2003 was $136.6 million,
resulting in a 33 percent effective income tax rate. For the first six months of
2002, the effective income tax rate was 34 percent.
38
LOANS
The following table shows loans outstanding by loan type.
PERCENT CHANGE TO
JUNE 30, 2003 FROM:
--------------------------
JUNE 30, DECEMBER 31, JUNE 30, JUNE 30, DECEMBER 31,
(DOLLARS IN THOUSANDS) 2002 2002 2003 2002 2002
- ------------------------------------------- ----------- ----------- ----------- -------- ------------
Domestic:
Commercial, financial and industrial..... $11,006,283 $10,338,508 $ 9,404,285 (14.56)% (9.04)%
Construction............................. 1,163,530 1,285,204 1,110,794 (4.53) (13.57)
Mortgage:
Residential............................ 5,673,529 6,382,227 6,799,874 19.85 6.54
Commercial............................. 3,769,068 4,150,178 4,172,864 10.71 0.55
----------- ----------- -----------
Total mortgage....................... 9,442,597 10,532,405 10,972,738 16.20 4.18
Consumer:
Installment............................ 997,973 909,787 851,857 (14.64) (6.37)
Revolving lines of credit.............. 988,996 1,102,771 1,179,961 19.31 7.00
----------- ----------- -----------
Total consumer....................... 1,986,969 2,012,558 2,031,818 2.26 0.96
Lease financing.......................... 880,892 812,918 704,353 (20.04) (13.35)
----------- ----------- -----------
Total loans in domestic offices...... 24,480,271 24,981,593 24,223,988 (1.05) (3.03)
Loans originated in foreign branches....... 1,112,035 1,456,490 1,444,672 29.91 (0.81)
----------- ----------- -----------
Total loans.......................... $25,592,306 $26,438,083 $25,668,660 0.30% (2.91)%
=========== =========== ===========
Our lending activities are predominantly domestic, with such loans
comprising 94 percent of the total loan portfolio at June 30, 2003. Total loans
at June 30, 2003, were $25.7 billion, an increase of $76 million, or 0.3
percent, from June 30, 2002. The increase was mainly attributable to an increase
in the residential mortgage portfolio of $1.1 billion, an increase in the
commercial mortgage portfolio of $404 million, and an increase in the loans
originated in foreign branches of $333 million, partly offset by a decline in
the commercial, financial and industrial loan portfolio of $1.6 billion and a
decline in lease financing of $177 million.
Commercial, financial and industrial loans represent one of the largest
categories in the loan portfolio. These loans are extended principally to
corporations, middle-market businesses, and small businesses, with no industry
concentration exceeding 10 percent of total loans. This portfolio has a high
degree of geographic diversification based upon our customers' revenue bases,
which we believe lowers our vulnerability to changes in the economic outlook of
any particular region of the US. The commercial, financial and industrial loan
portfolio was $9.4 billion, or 37 percent of total loans, at June 30, 2003,
compared with $11.0 billion, or 43 percent of total loans, at June 30, 2002. The
decrease of $1.6 billion, or 15 percent, from the prior year was primarily
attributable to current economic conditions that have reduced loan demand in
some segments. Loan sales and managed exits are consistent with our strategy to
reduce our exposure to more volatile commercial loans and increase the
percentage of more stable consumer loans (including residential mortgages).
The construction loan portfolio totaled $1.1 billion, or 4 percent of total
loans, at June 30, 2003, compared with $1.2 billion, or 5 percent of total
loans, at June 30, 2002. This decrease of $53 million, or 5 percent, from the
prior year was primarily attributable to the slowing economy and its impact on
development and construction projects.
Commercial mortgages were $4.2 billion, or 16 percent of total loans, at
June 30, 2003, compared with $3.8 billion, or 15 percent, at June 30, 2002. The
mortgage loan portfolio consists of loans on commercial
39
and industrial projects primarily in California. The increase in commercial
mortgages of $404 million, or 11 percent, from June 30, 2002, was primarily due
to demand in the Southern California real estate market.
Residential mortgages were $6.8 billion, or 26 percent of total loans, at
June 30, 2003, compared with $5.7 billion, or 22 percent of total loans, at June
30, 2002. The increase in residential mortgages of $1.1 billion, or 20 percent,
from June 30, 2002, continues to be influenced by our strategic decision to
increase our residential mortgage portfolio through increased in-house
production and additional wholesale and correspondent channels. While we hold
most of the loans we originate, we sell most of our 30-year, fixed rate
non-Community Reinvestment Act (CRA) residential mortgage loans.
Consumer loans totaled $2.0 billion, or 8 percent of total loans, at June
30, 2003, compared with $2.0 billion, or 8 percent of total loans, at June 30,
2002. The slight increase of $44.8 million, or 2 percent, was primarily
attributable to an increase in home equity loans, partially offset by pay-offs
related to the run-off of the automobile dealer lending business exited in the
third quarter of 2000. The indirect automobile dealer lending portfolio at June
30, 2003 was $93.9 million.
Lease financing totaled $704.4 million, or 3 percent of total loans, at
June 30, 2003, compared with $880.9 million, or 3 percent of total loans, at
June 30, 2002. As we announced in 2001, we have ceased originating auto leases.
At June 30, 2003, our portfolio had declined to $156.2 million and will decline
40 percent by December 2003, 90 percent by December 2004, and will fully mature
by mid-year 2006.
Loans originated in foreign branches totaled $1.4 billion, or 6 percent of
total loans, at June 30, 2003, compared with $1.1 billion, or 4 percent, at June
30, 2002. The increase in loans originated in foreign branches of $332.6
million, or 30 percent, from June 30, 2002, was primarily attributable to higher
borrowings from financial institutions attracted to lower US interest rates and
increased lending in Canada.
CROSS-BORDER OUTSTANDINGS
Our cross-border outstandings reflect certain additional economic and
political risks that are not reflected in domestic outstandings. These risks
include those arising from exchange rate fluctuations and restrictions on the
transfer of funds. The following table sets forth our cross-border outstandings
as of June 30, 2002, December 31, 2002 and June 30, 2003, for any country where
such outstandings exceeded 1 percent of total assets. The cross-border
outstandings were compiled based upon category and domicile of ultimate risk and
are comprised of balances with banks, trading account assets, securities
available for sale, securities purchased under resale agreements, loans, accrued
interest receivable, acceptances outstanding and investments with foreign
entities. The amounts outstanding exclude local currency outstandings. For any
country shown in the table below, we do not have significant local currency
outstandings that are not hedged or are not funded by local currency borrowings.
PUBLIC CORPORATIONS
FINANCIAL SECTOR AND OTHER TOTAL
(DOLLARS IN MILLIONS) INSTITUTIONS ENTITIES BORROWERS OUTSTANDINGS
- ---------------------------------- ------------ -------- ------------ ------------
June 30, 2002
Korea............................. $491 $-- $42 $533
December 31, 2002
Korea............................. $599 $-- $75 $674
June 30, 2003
Korea............................. $559 $-- $73 $632
PROVISION FOR CREDIT LOSSES
We recorded a $25 million provision for credit losses in the second quarter
of 2003, compared with a $50 million provision for credit losses for the same
period in the prior year. The provision for credit losses in the first six
months of 2003 was $55 million, compared with a $105 million provision for
credit losses for the same period in the prior year. Provisions for credit
losses are charged to income to bring our allowance for credit losses to a level
deemed appropriate by management based on the factors discussed under "Allowance
for Credit Losses" below.
40
ALLOWANCE FOR CREDIT LOSSES
We maintain an allowance for credit losses to absorb losses inherent in the
loan portfolio. The allowance is based on our regular, quarterly assessments of
the probable estimated losses inherent in the loan portfolio, and to a lesser
extent, unused commitments to provide financing. Our methodology for measuring
the appropriate level of the allowance relies on several key elements, which
include the formula allowance, specific allowances for identified problem loans
and portfolio segments, and the unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding
loans, leases and unused commitments, in each case based on the internal risk
grade of such credit exposures. Changes in risk grades affect the amount of the
formula allowance. Loss factors are based on our historical loss experience and
may be adjusted for significant factors that, in management's judgment, affect
the collectibility of the portfolio as of the evaluation date. Loss factors are
developed in the following ways:
o pass graded loss factors for commercial, financial, and industrial
loans, as well as all problem graded loan loss factors, are derived
from a migration model that tracks historical losses over a period,
which we believe captures the inherent losses in our loan portfolio;
o pass graded loss factors for commercial real estate loans and
construction loans are based on the average annual net charge-off rate
over a period reflective of a full economic cycle; and
o pooled loan loss factors (not individually graded loans) are based on
expected net charge-offs for one year. Pooled loans are loans that are
homogeneous in nature, such as consumer installment, home equity,
residential mortgage loans and automobile leases.
We believe that an economic cycle is a period in which both upturns and
downturns in the economy have been reflected. We calculate loss factors over a
time interval that spans what we believe constitutes a complete and
representative economic cycle.
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to a credit or a
portfolio segment that management believes indicate the probability that a loss
has been incurred. This amount may be determined either by a method prescribed
by SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended
by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income
Recognition and Disclosures" or methods that include a range of probable
outcomes based upon certain qualitative factors.
The unallocated allowance is based on management's evaluation of conditions
that are not directly reflected in the determination of the formula and specific
allowances. The evaluation of the inherent loss with respect to these conditions
is subject to a higher degree of uncertainty because they may not be identified
with specific problem credits or portfolio segments. The conditions evaluated in
connection with the unallocated allowance include the following, which existed
at the balance sheet date:
o general economic and business conditions affecting our key lending
areas;
o credit quality trends (including trends in nonperforming loans
expected to result from existing conditions);
o collateral values;
o loan volumes and concentrations;
o seasoning of the loan portfolio;
o specific industry conditions within portfolio segments;
o recent loss experience in particular segments of the portfolio;
o duration of the current economic cycle;
41
o bank regulatory examination results; and
o findings of our internal credit examiners.
Executive management reviews these conditions quarterly in discussion with
our senior credit officers. To the extent that any of these conditions is
evidenced by a specifically identifiable problem credit or portfolio segment as
of the evaluation date, management's estimate of the effect of such conditions
may be reflected as a specific allowance, applicable to such credit or portfolio
segment. Where any of these conditions is not evidenced by a specifically
identifiable problem credit or portfolio segment as of the evaluation date,
management's evaluation of the probable loss related to such condition is
reflected in the unallocated allowance.
The allowance for credit losses is based upon estimates of probable losses
inherent in the loan portfolio. The actual losses can vary from the estimated
amounts. Our methodology includes several features that are intended to reduce
the differences between estimated and actual losses. The loss migration model
that is used to establish the loan loss factors for problem graded loans and
pass graded commercial, financial, and industrial loans is designed to be
self-correcting by taking into account our loss experience over prescribed
periods. Similarly, by basing the pass graded loan loss factors over a period
reflective of an economic cycle, the methodology is designed to take into
account our recent loss experience for commercial real estate mortgages and
construction loans. Pooled loan loss factors are adjusted quarterly primarily
based upon the level of net charge-offs expected by management in the next
twelve months. Furthermore, based on management's judgement, our methodology
permits adjustments to any loss factor used in the computation of the formula
allowance for significant factors, which affect the collectibility of the
portfolio as of the evaluation date, but are not reflected in the loss factors.
By assessing the probable estimated losses inherent in the loan portfolio on a
quarterly basis, we are able to adjust specific and inherent loss estimates
based upon the most recent information that has become available.
COMPARISON OF THE TOTAL ALLOWANCE AND RELATED PROVISION FOR CREDIT LOSSES
FROM DECEMBER 31, 2002
At December 31, 2002, our total allowance for credit losses was $609
million, or 2.30 percent of the total loan portfolio and 180.9 percent of total
nonaccrual loans. At June 30, 2003, our total allowance for credit losses was
$558 million, or 2.17 percent of the total loan portfolio and 147.1 percent of
total nonaccrual loans. In addition, the allowance incorporates the results of
measuring impaired loans as provided in SFAS No. 114 as amended by SFAS No. 118.
These accounting standards prescribe the measurement methods, income recognition
and disclosures related to impaired loans. At December 31, 2002, total impaired
loans were $300 million, and the associated impairment allowance was $106
million, compared with $327 million and $113 million, respectively, at June 30,
2003. On June 30, 2003 and December 31, 2002, the total allowance for credit
losses for off-balance sheet commitments was $72.3 million and $75.4 million,
respectively.
During the second quarter of 2003, there were no changes in estimation
methods or assumptions that affected our methodology for assessing the
appropriateness of the formula and specific allowances for credit losses.
Changes in estimates and assumptions regarding the effects of economic and
business conditions on borrowers and other factors, which are described below,
affected the assessment of the unallocated allowance.
We recorded a $25 million provision in the second quarter of 2003, which
took into consideration the following factors: the continued slow US economy;
the adverse impact on the airline industry from the war in Iraq, severe acute
respiratory syndrome (SARS), and the generally weak economy; uncertain, although
improving, conditions in the communications/media, power, and other sectors in
domestic markets in which we operate; and growth and changes in the composition
of the loan portfolio.
42
CHANGES IN THE FORMULA AND SPECIFIC ALLOWANCES
At June 30, 2003, the formula allowance was $276 million, compared to $294
million at December 31, 2002, a decrease of $18 million. The specific allowance
was $124 million at June 30, 2003, compared to $121 million at December 31,
2002, an increase of $3 million. The changes in both the formula and specific
allowances reflect the movement of credits to nonaccrual status and the
reduction in the amount of commercial loans.
CHANGES IN THE UNALLOCATED ALLOWANCE
At June 30, 2003, the unallocated allowance was $158 million, compared to
$194 million at December 31, 2002, a decrease of $36 million. In evaluating the
appropriateness of the unallocated allowance, we considered the following
factors, as well as more general factors such as the interest rate environment
and the impact of the economic downturn on those borrowers who have a more
leveraged financial profile:
o With respect to the communications/media industry, management
considered the impact of weakened consumer confidence on consumer
spending and advertising revenues, as well as the increasingly
competitive environment facing telecommunication carriers, which could
be in the range of $12 million to $33 million.
o With respect to the commercial real estate sector, management
considered weak demand growth and continuing excess supply in many
markets, as well as the specific weakness in Northern California
resulting from regional over-dependence on the hi-tech sector and some
portfolio concentration in the office and apartment markets, which
could be in the range of $16 million to $32 million.
o With respect to power companies and utilities, management considered
excess generating capacity, cyclical weakness in demand, high debt
burdens and capital market disaffection in the unregulated
merchant-energy sector, which could be in the range of $15 million to
$30 million.
o With respect to cross-border loans and acceptances to certain
Asia/Pacific Rim countries, management considered the effects of slow
US growth coupled with the continuing struggle against recession and
deflation in Japan, which could be in the range of $8 million to $17
million.
o With respect to the retail sector, management considered the adverse
effects of the weak economy and less robust consumer spending
resulting in unwanted accumulation of inventories, which could be in
the range of $6 million to $12 million.
o With respect to leasing, management considered the on-going problems
of the airline industry as it continues to struggle with the weak
economy and excess capacity, exacerbated by the war in Iraq and public
health concerns about SARS, which could be in the range of $6 million
to $12 million.
o With respect to the technology industry, management considered weak
capital spending in the US, as well as the effects of excess capacity
and steepening price declines in many technology segments, which could
be in the range of $4 million to $9 million.
There can be no assurance that the adverse impact of any of these
conditions on us will not be in excess of the ranges set forth above.
Although in certain instances the downgrading of a loan resulting from
these effects was reflected in the formula allowance, management believes that
in most instances the impact of these events on the collectibility of the
applicable loans may not have been reflected in the level of nonperforming loans
or in the internal risk grading process with respect of such loans. Accordingly,
our evaluation of the probable losses related to these factors was reflected in
the unallocated allowance. The evaluations of the inherent
43
losses with respect to these factors were subject to higher degrees of
uncertainty because they were not identified with specific problem credits.
CHANGE IN THE TOTAL ALLOWANCE FOR CREDIT LOSSES
The following table sets forth a reconciliation of changes in our allowance
for credit losses.
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------- ---------------------
(DOLLARS IN THOUSANDS) 2002 2003 2002 2003
- -------------------------------------------------------------- -------- -------- -------- --------
Balance, beginning of period.................................. $629,367 $586,197 $634,509 $609,190
Loans charged off:
Commercial, financial and industrial........................ 67,952 51,130 130,178 88,956
Commercial mortgage......................................... -- -- 20 --
Consumer.................................................... 2,476 2,429 5,235 5,085
Lease financing............................................. 674 13,190 1,507 32,208
-------- -------- -------- --------
Total loans charged off................................... 71,102 66,749 136,940 126,249
Recoveries of loans previously charged off:
Commercial, financial and industrial........................ 12,822 13,008 17,339 18,587
Construction................................................ 40 -- 40 --
Commercial mortgage......................................... 44 44 139 150
Consumer.................................................... 873 697 1,781 1,420
Lease financing............................................. 182 50 383 168
-------- -------- -------- --------
Total recoveries of loans previously charged off.......... 13,961 13,799 19,682 20,325
-------- -------- -------- --------
Net loans charged off................................... 57,141 52,950 117,258 105,924
Provision for credit losses................................... 50,000 25,000 105,000 55,000
Foreign translation adjustment and other net additions(2)..... 2,722 35 2,697 16
-------- -------- -------- --------
Balance, end of period........................................ $624,948 $558,282 $624,948 $558,282
======== ======== ======== ========
Allowance for credit losses to total loans.................... 2.44% 2.17% 2.44% 2.17%
Provision for credit losses to net loans charged off.......... 87.50 47.21 89.55 51.92
Net loans charged off to average loans outstanding
for the period(1)............................................ 0.90 0.80 0.93 0.80
- ---------------------------
<FN>
(1) Annualized.
(2) Includes $2.4 million related to the First Western Bank acquisition in the
second quarter of 2002.
</FN>
Total loans charged off in the second quarter of 2003 decreased by $4.4
million from the second quarter of 2002, primarily due to a $16.8 million
decrease in commercial, financial and industrial loans charged off, partly
offset by a $12.5 million increase in lease financing charge-offs. Charge-offs
reflect the realization of losses in the portfolio that were recognized
previously through provisions for credit losses.
Second quarter 2003 recoveries of loans previously charged off decreased by
$0.2 million from the second quarter of 2002. The percentage of net loans
charged off to average loans outstanding for the second quarter of 2003
decreased by 10 basis points from the same period in 2002. At June 30, 2003, the
allowance for credit losses exceeded the annualized net loans charged off during
the second quarter of 2003, reflecting management's belief, based on the
foregoing analysis, that there are additional losses inherent in the portfolio.
Historical net charge-offs are not necessarily indicative of the amount of
net charge-offs that we will realize in the future.
44
NONPERFORMING ASSETS
JUNE 30, DECEMBER 31, JUNE 30,
(DOLLARS IN THOUSANDS) 2002 2002 2003
- -------------------------------------------------------------- -------- ----------- --------
Commercial, financial and industrial.......................... $386,912 $ 276,415 $273,896
Construction.................................................. -- -- 1,559
Commercial mortgage........................................... 24,201 23,980 48,479
Lease financing............................................... 3,369 36,294 52,568
Loan originated in foreign branches........................... -- -- 2,985
-------- ----------- --------
Total nonaccrual loans...................................... 414,482 336,689 379,487
Foreclosed assets............................................. 490 715 271
-------- ----------- --------
Total nonperforming assets.................................. $414,972 $ 337,404 $379,758
======== =========== ========
Allowance for credit losses................................... $624,948 $ 609,190 $558,282
======== =========== ========
Nonaccrual loans to total loans............................... 1.62% 1.27% 1.48%
Allowance for credit losses to nonaccrual loans............... 150.78 180.94 147.11
Nonperforming assets to total loans and foreclosed assets..... 1.62 1.28 1.48
Nonperforming assets to total assets.......................... 1.15 0.84 0.89
At June 30, 2003, nonperforming assets totaled $379.8 million, an increase
of $42.4 million, or 13 percent, from December 31, 2002. The increase was
primarily due to our decision to place additional airplane leases on nonaccrual,
partially offset by our decision during the second quarter of 2003, to return
two airplane leases, totaling $18.3 million, to accrual status. In addition, we
placed two San Francisco Bay Area office loans, totaling approximately $22.8
million, on nonaccrual status.
Nonaccrual loans as a percentage of total loans were 1.48 percent at June
30, 2003, compared with 1.62 percent at June 30, 2002. Nonperforming assets as a
percentage of total loans and foreclosed assets were 1.48 percent at June 30,
2003, compared to 1.62 percent at June 30, 2002.
LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING
JUNE 30, DECEMBER 31, JUNE 30,
(DOLLARS IN THOUSANDS) 2002 2002 2003
- ------------------------------------------------------------------ -------- ----------- --------
Commercial, financial and industrial.............................. $ 11,096 $ 1,705 $ 1,728
Construction...................................................... -- 679 2,311
Mortgage:
Residential..................................................... 5,104 3,211 3,915
Commercial...................................................... 523 506 540
-------- ----------- --------
Total mortgage................................................ 5,627 3,717 4,455
Consumer and other................................................ 1,513 2,072 1,879
-------- ----------- --------
Total loans 90 days or more past due and still accruing......... $ 18,236 $ 8,173 $ 10,373
45
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT INTEREST RATE RISK MANAGEMENT
(OTHER THAN TRADING)
THE FOLLOWING INFORMATION ON MARKET RISK ASSOCIATED WITH INTEREST RATE RISK
IS BEING PROVIDED IN ORDER TO EXPAND THE INFORMATION ON THE ASSUMPTIONS USED IN
OUR SIMULATION MODELS, WHICH QUANTIFY OUR SENSITIVITY TO CHANGES IN INTEREST
RATES. SEE ALSO PART I, ITEM 3 OF THIS DOCUMENT, TITLED "QUANTITATIVE AND
QUALITATIVE DISCLOSURE ABOUT MARKET RISK."
Market risk is the risk of loss to future earnings, to fair values, or to
future cash flows that may result from changes in the price of a financial
instrument. The value of a financial instrument may change as a result of
changes in interest rates, foreign currency exchange rates, commodity prices,
equity prices, and other market changes that affect market risk sensitive
instruments. Market risk is attributable to all market risk sensitive financial
instruments, including securities, loans, deposits, and borrowings, as well as
derivative instruments. Our exposure to market risk is a function of our asset
and liability management activities, our trading activities for our own account,
and our role as a financial intermediary in customer-related transactions. The
objective of market risk management is to avoid excessive exposure of our
earnings and equity to loss and to reduce the volatility inherent in certain
financial instruments.
The management of market risk is governed by policies reviewed and approved
annually by our Board of Directors (Board). The Board assigns responsibility for
market risk management to the Chief Executive Officer as the administrator of
the Asset & Liability Management Committee (ALCO), which is composed of
UnionBanCal Corporation executives. ALCO meets monthly and reports quarterly to
the Finance and Capital Committee of the Board on activities related to the
management of market risk. As part of the management of our market risk, ALCO
may direct changes in the mix of assets and liabilities and the extent to which
we utilize investment securities and derivative instruments such as interest
rate swaps, caps and floors to hedge our interest rate exposures. ALCO reviews
and approves specific market risk management programs involving investment and
hedging activities and certain market risk limits. The ALCO Chairman is
responsible for the company-wide management of market risk. The Treasurer is
responsible for implementing funding, investing, and hedging strategies designed
to manage this risk. On a day-to-day basis, the monitoring of market risk takes
place at a centralized level within the Market Risk Monitoring unit (MRM). MRM
is responsible for measuring risks to ensure compliance with all market risk
limits and guidelines incorporated within the policies and procedures
established by the Board and ALCO. MRM reports monthly to ALCO on trading risk
exposures and on compliance with interest rate risk, securities portfolio and
derivatives policy limits. MRM also reports quarterly to ALCO on the
effectiveness of our hedging activities. In addition, periodic reviews by
internal audit and regulators provide further evaluation of controls over the
risk management process.
We have separate and distinct methods for managing the market risk
associated with our trading activities and our asset and liability management
activities, as described below.
INTEREST RATE RISK MANAGEMENT (OTHER THAN TRADING)
We engage in asset and liability management activities with the primary
purposes of managing the sensitivity of net interest income (NII) to changes in
interest rates within limits established by the Board and maintaining a risk
profile that is consistent with management's strategic objectives.
The Asset & Liability Management (ALM) Policy approved by the Board
requires monthly monitoring of interest rate risk by ALCO through a variety of
modeling techniques that are used to quantify the sensitivity of NII to changes
in interest rates. As directed by ALCO, and in consideration of the importance
of our demand deposit accounts as a funding source, NII is adjusted in the
official policy risk measure to incorporate the effect of certain noninterest
expense items related to these deposits that are nevertheless sensitive to
changes in interest rates. In managing interest rate risk, ALCO monitors NII
sensitivity on both an adjusted and unadjusted basis.
46
Our unhedged NII remains inherently asset sensitive, meaning that our
assets generally reprice more quickly than our liabilities, particularly our
core deposits. Since the NII associated with an asset sensitive balance sheet
tends to decrease when interest rates decline and increase when interest rates
rise, derivative hedges and the securities portfolio are used to manage this
risk. In the second quarter of 2003, we did not enter into any derivative
hedges. We continued to increase the size of our securities portfolio in
response to strong growth in core deposits, which respond more slowly to changes
in market rates than wholesale liabilities. Together, our hedging and investment
activities resulted in an essentially neutral risk profile for the hedged
balance sheet with respect to parallel yield curve shifts. For a further
discussion of derivative instruments and our hedging strategies, see Note
16--"Derivative Instruments" of the Notes to Consolidated Financial Statements
included in our Form 10-K/A for the year ended December 31, 2002.
However, our NII is also sensitive to non-parallel shifts in the yield
curve. In general, our NII increases when the yield curve steepens (specifically
when short rates, under one year, drop and long rates, beyond one year, rise),
while a flattening curve tends to depress our NII and net interest margin. In
this respect, our NII is asset sensitive when measured against changes in long
rates and slightly liability sensitive when measured against changes in short
rates. This asset sensitivity in relation to a flattening of the yield curve is
manifested in the NII simulations primarily by an acceleration of mortgage
prepayments (in both the residential portfolio and investment securities
portfolio) when long rates decline. Prepayments depress NII even if interest
rates do not change because the cash flows from the prepaid assets that were
booked at higher rates must be reinvested at lower prevailing rates. As a
result, a continuation of the recent high volume of prepayments will further
compress our net interest margin and negatively affect NII in the coming months,
even if market rates remain at current levels.
Our official NII policy measure involves a simulation of "Earnings-at-Risk"
(EaR) in which we estimate the impact that gradual, ramped-on parallel shifts in
the yield curve would have on NII over a 12-month horizon. Under the Board's
policy limits, the negative change in simulated NII in either the up or down 200
basis point shock scenarios may not exceed 4 percent of NII as measured in the
base case, or no change, scenario. The following table sets forth the simulation
results in both the up and down 200 basis point ramp scenarios as of June 30,
2003(1):
MARCH 31, JUNE 30,
(DOLLARS IN MILLIONS) 2003 2003
- ------------------------------------------- -------- -------
+200 basis points.......................... $15.4 $6.7
as a percentage of base case NII........... 1.04% 0.46%
- -200 basis points.......................... $(15.3) $(2.4)
as a percentage of base case NII........... 1.04% 0.17%
- ------------------
(1) For these policy simulations, NII is adjusted to incorporate the effect of
certain non-interest expense items related to demand deposits that are
nevertheless sensitive to changes in interest rates.
EaR in the down 200 basis point scenario was ($2.4) million, or .17 percent
of adjusted NII in the base case scenario, well within the Board's guidelines.
However, with federal funds and LIBOR rates already below two percent, a
downward ramp scenario of 200 basis points would result in short-term rate
levels below zero. As a result, we believe that a downward ramp scenario of 100
basis points provides a more reasonable measure of asset sensitivity in a
falling interest rate environment. As of June 30, 2003, the difference between
adjusted NII in the base case and adjusted NII after a gradual 100 basis point
downward ramp was a positive $2.4 million, or .17 percent of the base case.
Management's goal in the NII simulations is to capture the risk embedded in
the balance sheet. As a result, asset and liability balances are kept constant
throughout the analysis horizon. Two exceptions are non-maturity deposits, which
vary with levels of interest rates according to statistically derived balance
equations, and discretionary derivative hedges and fixed income portfolios,
which are allowed to run off.
47
Additional assumptions are made to model the future behavior of deposit rates
and loan spreads based on statistical analysis, management's outlook, and
historical experience. The prepayment risks related to residential loans and
mortgage-backed securities are measured using industry estimates of prepayment
speeds. The sensitivity of the simulation results to the underlying assumptions
is tested as a regular part of the risk measurement process by running
simulations with different assumptions. In addition, management supplements the
official risk measures based on the constant balance sheet assumption with
volume-based simulations of NII based on forecasted balances and with
value-based simulations that measure the sensitivity of economic-value-of-equity
(EVE) to changes in interest rates. We believe that, together, these simulations
provide management with a reasonably comprehensive view of the sensitivity of
our operating results to changes in interest rates, at least over the
measurement horizon. However, as with any financial model, the underlying
assumptions are inherently uncertain and subject to refinement as modeling
techniques and theory improve and historical data becomes more readily
accessible. Consequently, our simulation models cannot predict with certainty
how rising or falling interest rates might impact net interest income. Actual
and simulated NII results will differ to the extent there are differences
between actual and assumed interest rate changes, balance sheet volumes, and
management strategies, among other factors.
TRADING ACTIVITIES
We enter into trading account activities primarily as a financial
intermediary for customers, and, to a minor extent, for our own account. By
acting as a financial intermediary, we are able to provide our customers with
access to a wide range of products from the securities, foreign exchange, and
derivatives markets. In acting for our own account, we may take positions in
some of these instruments with the objective of generating trading profits.
These activities expose us to two primary types of market risk: interest rate
and foreign currency exchange risk.
In order to manage interest rate and foreign currency exchange risk
associated with our trading activities, we utilize a variety of non-statistical
methods including: position limits for each trading activity, daily marking of
all positions to market, daily profit and loss statements, position reports, and
independent verification of all inventory pricing. Additionally, Market Risk
Monitoring (MRM) reports positions and profits and losses daily to the Treasurer
and trading managers and weekly to the ALCO Chairman. ALCO is provided reports
on a monthly basis. We believe that these procedures, which stress timely
communication between MRM and senior management, are the most important elements
of the risk management process.
We use a form of Value at Risk (VaR) methodology to measure the overall
market risk inherent in our trading account activities. Under this methodology,
management statistically calculates, with 97.5 percent confidence, the potential
loss in fair value that we might experience if an adverse shift in market prices
were to occur within a period of 5 business days. The amount of VaR is managed
within limits well below the maximum limit established by Board policy at 0.5
percent of shareholders' equity. The VaR model incorporates a number of key
assumptions, including assumed holding period and historical volatility based on
3 years of historical market data updated quarterly. The following table sets
forth the average, high and low VaR during the year for our trading activities.
MARCH 31, 2003 JUNE 30, 2003
---------------------- ----------------------
AVERAGE HIGH LOW AVERAGE HIGH LOW
(DOLLARS IN THOUSANDS) VAR VAR VAR VAR VAR VAR
- -------------------------------- ------- ---- --- ------- ---- ---
Foreign exchange................ $155 $293 $67 $152 $340 $67
Securities...................... 207 463 97 231 463 97
Consistent with our business strategy of focusing on the sale of capital
markets products to customers, we manage our trading risk exposures at
conservative levels, well below the trading risk policy limits established by
the Board. As a result, our foreign exchange business continues to derive the
bulk of its
48
revenue from customer-related transactions. We take inter-bank trading positions
only on a limited basis and we do not take any large or long-term strategic
positions in the market for the Bank's own portfolio. In 2002, we continued to
grow our customer-related foreign exchange business while maintaining an
essentially unchanged inter-bank trading risk profile as measured under our VaR
methodology.
The Securities Trading & Institutional Sales department serves the fixed
income needs of our institutional clients and acts as the fixed income
wholesaler for our broker/dealer subsidiary, UBOC Investment Services, Inc. As
with our foreign exchange business, we continue to generate the vast majority of
our securities income from customer-related transactions.
Our interest rate derivative contracts included as of June 30, 2003, $3.6
billion of derivative contracts entered into as an accommodation for customers.
We act as an intermediary and match these contracts, at a credit spread, to
contracts with major dealers, thus neutralizing the related market risk.
LIQUIDITY RISK
Liquidity risk represents the potential for loss as a result of limitations
on our ability to adjust our future cash flows to meet the needs of depositors
and borrowers and to fund operations on a timely and cost-effective basis. The
ALM Policy approved by the Board requires quarterly reviews of our liquidity by
ALCO. Additionally, ALCO conducts monthly ongoing reviews of our liquidity
situation. Liquidity is managed through this ALCO coordination process on a
Bank-wide basis, encompassing all major business units. The operating management
of liquidity is implemented through the funding and investment functions of the
Global Markets Group. Our liquidity management draws upon the strengths of our
extensive retail and commercial core deposit franchise, coupled with the ability
to obtain funds for various terms in a variety of domestic and international
money markets. Our securities portfolio represents a significant source of
additional liquidity.
Core deposits provide us with a sizable source of relatively stable and
low-cost funds. Our average core deposits, which include demand deposits, money
market demand accounts, savings, and consumer time deposits, combined with
average common shareholders' equity, funded 82 percent of average total assets
of $39.8 billion for the second quarter of 2003. Most of the remaining funding
was provided by short-term borrowings in the form of negotiable certificates of
deposit, large time deposits, foreign deposits, federal funds purchased,
securities sold under repurchase agreements, commercial paper, and other
borrowings. The securities portfolio provides additional enhancement to our
liquidity position, which may be created through either securities sales, or
repurchase agreements. Liquidity may also be provided by the sale or maturity of
assets. Such assets include interest-bearing deposits in banks, federal funds
sold, securities purchased under resale agreements, and trading account
securities. The aggregate of these assets averaged $1.8 billion for the quarter
ended June 30, 2003. Additional liquidity may be provided through loan
maturities and sales.
49
REGULATORY CAPITAL
The following tables summarizes our risk-based capital, risk-weighted
assets, and risk-based capital ratios.
UNIONBANCAL CORPORATION
MINIMUM
JUNE 30, DECEMBER 31, JUNE 30, REGULATORY
(DOLLARS IN THOUSANDS) 2002 2002 2003 REQUIREMENT
- ---------------------------------- ----------------- ----------------- ----------------- ----------------
CAPITAL COMPONENTS
Tier 1 capital.................... $ 3,834,103 $ 3,667,237 $ 3,791,651
Tier 2 capital.................... 562,165 573,858 538,163
----------------- ----------------- -----------------
Total risk-based capital.......... $ 4,396,268 $ 4,241,095 $ 4,329,814
================= ================= =================
Risk-weighted assets.............. $32,213,352 $32,811,441 $33,142,588
================= ================= =================
Quarterly average assets.......... $35,613,957 $37,595,002 $39,366,344
================= ================= =================
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------------- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to risk-weighted
assets)......................... $4,396,268 13.65% $4,241,095 12.93% $4,329,814 13.06% >$2,651,407 8.0%
-
Tier 1 capital (to risk-weighted
assets)......................... 3,834,103 11.90 3,667,237 11.18 3,791,651 11.44 > 1,325,704 4.0
-
Leverage(1)....................... 3,834,103 10.77 3,667,237 9.75 3,791,651 9.63 > 1,574,654 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) 2002 2002 2003 REQUIREMENT REQUIREMENT
- ---------------------------------- ----------------- ----------------- ----------------- ---------------- -------------------
CAPITAL COMPONENTS
Tier 1 capital.................... $ 3,473,828 $ 3,334,720 $ 3,490,596
Tier 2 capital.................... 471,258 484,062 467,613
----------------- ----------------- -----------------
Total risk-based capital.......... $ 3,945,086 $ 3,818,782 $ 3,958,209
================= ================= =================
Risk-weighted assets.............. $31,581,189 $32,161,047 $32,492,833
================= ================= =================
Quarterly average assets.......... $35,113,945 $37,019,328 $38,811,257
================= ================= =================
CAPITAL RATIOS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------------- ---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total capital (to risk-weighted
assets)......................... $3,945,086 12.49% $3,818,782 11.87% $3,958,209 12.18% >$2,599,427 8.0% >$3,249,283 10.0%
- -
Tier 1 capital (to risk-weighted
assets)......................... 3,473,828 11.00 3,334,720 10.37 3,490,596 10.74 > 1,299,713 4.0 > 1,949,570 6.0
- -
Leverage(1)....................... 3,473,828 9.89 3,334,720 9.01 3,490,596 8.99 > 1,552,450 4.0 > 1,940,563 5.0
- -
- ----------------------------
<FN>
(1) Tier 1 capital divided by quarterly average assets (excluding certain
intangible assets).
</FN>
We and Union Bank of California, N.A. are subject to various regulations of
the federal banking agencies, including minimum capital requirements. We both
are required to maintain minimum ratios of Total and Tier 1 capital to
risk-weighted assets and of Tier 1 capital to quarterly average assets (the
leverage ratio).
Compared with December 31, 2002, our Tier 1 risk-based capital ratio at
June 30, 2003, increased 26 basis points to 11.44 percent, our total risk-based
capital ratio increased 13 basis points to 13.06 percent, and our leverage ratio
decreased 12 basis points to 9.63 percent. The increase in our capital ratios
was primarily attributable to an increase in shareholders' equity, partly offset
by an increase in risk-weighted assets.
As of June 30, 2003, management believes the capital ratios of Union Bank
of California, N.A. met all regulatory requirements of "well-capitalized"
institutions, which are 10 percent for the total risk-based capital ratio, 6
percent for the Tier 1 risk-based capital ratio and 5 percent for the leverage
ratio.
50
CERTAIN BUSINESS RISK FACTORS
ADVERSE CALIFORNIA ECONOMIC CONDITIONS COULD ADVERSELY AFFECT OUR BUSINESS
A substantial majority of our assets, deposits and fee income are generated
in California. As a result, poor economic conditions in California may cause us
to incur losses associated with higher default rates and decreased collateral
values in our loan portfolio. Economic conditions in California are subject to
various uncertainties at this time, including the long-term impact of the
California energy crisis, the decline in the technology sector and the
California state government's recent budgetary crisis and continuing fiscal
difficulties. If economic conditions in California continue to decline, we
expect that our level of problem assets could increase.
THE CONTINUING WAR ON TERRORISM CONTRIBUTES TO THE CONTINUING DOWNTURN IN
US ECONOMIC CONDITIONS
On-going acts or threats of terrorism and actions taken by the US or other
governments as a result of such acts or threats have contributed to the
continuing downturn in US economic conditions and could further adversely affect
business and economic conditions in the US generally and in our principal
markets. For example, the events of September 11, 2001, caused a decrease in air
travel in the US, which adversely affected the airline industry and many other
travel-related industries, including those operating in California.
ADVERSE ECONOMIC FACTORS AFFECTING CERTAIN INDUSTRIES COULD ADVERSELY
AFFECT OUR BUSINESS
We are subject to certain industry-specific economic factors. For example,
a significant and increasing portion of our total loan portfolio is related to
residential real estate. Accordingly, a downturn in the real estate and housing
industries in California could have an adverse effect on our operations. In
addition, auto leases comprise a declining portion of our total loan portfolio.
We ceased originating auto leases in April 2001; however, continued
deterioration in the used car market may result in additional losses on the
valuation of auto lease residuals on our remaining auto leases. We provide
financing to businesses in a number of other industries that may be particularly
vulnerable to industry-specific economic factors, including the
communications/media industry, the retail industry, the airline industry, the
power industry and the technology industry. Industry-specific risks are beyond
our control and could adversely affect our portfolio of loans, potentially
resulting in an increase in nonperforming loans or charge-offs.
RISKS ASSOCIATED WITH CURTAILED MARKET ACCESS OF POWER COMPANIES COULD
AFFECT OUR PORTFOLIO CREDIT QUALITY
The failure of Enron Corporation, coupled with continued turbulence in the
energy markets, has significantly impacted debt ratings and equity valuations of
a broad spectrum of power companies, particularly those involved in energy
trading and in deregulated or non-regulated markets. These developments have
sharply reduced these companies' ability to access public debt and equity
markets, contributing to heightened liquidity pressures. Should these negative
trends continue and/or intensify, the credit quality of certain of our borrowers
could be adversely affected.
FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR BUSINESS
Significant increases in market interest rates, or the perception that an
increase may occur, could adversely affect both our ability to originate new
loans and our ability to grow. Conversely, further decreases in interest rates
could result in an acceleration in the prepayment of loans. An increase in
market interest rates could also adversely affect the ability of our
floating-rate borrowers to meet their higher payment obligations. If this
occurred, it could cause an increase in nonperforming assets and charge-offs,
which could adversely affect our business.
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FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR MARGIN SPREAD
Changes in market interest rates, including changes in the relationship
between short-term and long-term market interest rates or between different
interest rate indices, can impact our margin spread, that is, the difference
between the interest rates we charge on interest earning assets, such as loans,
and the interest rates we pay on interest bearing liabilities, such as deposits
or other borrowings. The impact, particularly in a falling interest rate
environment, could result in a decrease in our interest income relative to
interest expense.
SHAREHOLDER VOTES ARE CONTROLLED BY BTM; OUR INTERESTS MAY NOT BE THE SAME
AS BTM'S INTERESTS
BTM, a wholly owned subsidiary of Mitsubishi Tokyo Financial Group, Inc.,
owns a majority (approximately 66 percent as of June 30, 2003) of the
outstanding shares of our common stock. As a result, BTM can elect all of our
directors and, as a result, can control the vote on all matters, including
determinations such as: approval of mergers or other business combinations;
sales of all or substantially all of our assets; any matters submitted to a vote
of our shareholders; issuance of any additional common stock or other equity
securities; incurrence of debt other than in the ordinary course of business;
the selection and tenure of our Chief Executive Officer; payment of dividends
with respect to common stock or other equity securities; and other matters that
might be favorable to BTM.
A majority of our directors are not officers or employees of UnionBanCal
Corporation or any of our affiliates, including BTM. However, because of BTM's
control over the election of our directors, BTM could change the composition of
our Board of Directors so that the Board would not have a majority of outside
directors. BTM's ability to prevent an unsolicited bid for us or any other
change in control could have an adverse effect on the market price for our
common stock.
POSSIBLE FUTURE SALES OF SHARES BY BTM COULD ADVERSELY AFFECT THE MARKET
FOR OUR STOCK
BTM may sell shares of our common stock in compliance with the federal
securities laws. By virtue of BTM's current control of us, BTM could sell large
amounts of shares of our common stock by causing us to file a registration
statement that would allow them to sell shares more easily. In addition, BTM
could sell shares of our common stock without registration. Although we can make
no prediction as to the effect, if any, that such sales would have on the market
price of our common stock, sales of substantial amounts of our common stock, or
the perception that such sales could occur, could adversely affect the market
price of our common stock. If BTM sells or transfers shares of our common stock
as a block, another person or entity could become our controlling shareholder.
BTM'S FINANCIAL CONDITION COULD ADVERSELY AFFECT OUR OPERATIONS
Although we fund our operations independently of BTM and believe our
business is not necessarily closely related to BTM's business or outlook, BTM's
credit ratings may affect our credit ratings. BTM is also subject to regulatory
oversight and review by Japanese and US regulatory authorities. Our business
operations and expansion plans could be negatively affected by regulatory
concerns related to the Japanese financial system and BTM.
POTENTIAL CONFLICTS OF INTEREST WITH BTM COULD ADVERSELY AFFECT US
BTM's view of possible new businesses, strategies, acquisitions,
divestitures or other initiatives may differ from ours. This may delay or hinder
us from pursuing such initiatives.
Also, as part of BTM's normal risk management processes, BTM manages global
credit exposures and concentrations on an aggregate basis, including UnionBanCal
Corporation. Therefore, at certain levels or in certain circumstances, our
ability to approve certain credits or other banking transactions and categories
of customers is subject to the concurrence of BTM. We may wish to extend credit
or furnish other banking
52
services to the same customers as BTM. Our ability to do so may be limited for
various reasons, including BTM's aggregate credit exposure and marketing
policies.
Certain directors' and officers' ownership interests in BTM's common stock
or service as a director or officer or other employee of both us and BTM could
create or appear to create potential conflicts of interest, especially since
both of us compete in the US banking industry.
SUBSTANTIAL COMPETITION IN THE CALIFORNIA BANKING MARKET COULD ADVERSELY
AFFECT US
Banking is a highly competitive business. We compete actively for loan,
deposit, and other financial services business in California, as well as
nationally and internationally. Our competitors include a large number of state
and national banks, thrift institutions and major foreign-affiliated or foreign
banks, as well as many financial and non-financial firms that offer services
similar to those offered by us. Some of our competitors are community banks that
have strong local market positions. Other competitors include large financial
institutions (such as Bank of America, Citibank, Washington Mutual, and Wells
Fargo) that have substantial capital, technology and marketing resources. Such
large financial institutions may have greater access to capital at a lower cost
than us, which may adversely affect our ability to compete effectively.
Banks, securities firms, and insurance companies can now combine as a
"financial holding company." Financial holding companies can offer virtually any
type of financial service, including banking, securities underwriting, insurance
(both agency and underwriting), and merchant banking. Recently, a number of
foreign banks have acquired financial services companies in the US, further
increasing competition in the US market.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS COULD LIMIT AMOUNTS
PAYABLE TO US
As a holding company, a substantial portion of our cash flow typically
comes from dividends our bank and nonbank subsidiaries pay to us. Various
statutory provisions restrict the amount of dividends our subsidiaries can pay
to us without regulatory approval. In addition, if any of our subsidiaries
liquidate, that subsidiary's creditors will be entitled to receive distributions
from the assets of that subsidiary to satisfy their claims against it before we,
as a holder of an equity interest in the subsidiary, will be entitled to receive
any of the assets of the subsidiary.
ADVERSE EFFECTS OF, OR CHANGES IN, BANKING OR OTHER LAWS AND REGULATIONS OR
GOVERNMENTAL FISCAL OR MONETARY POLICIES COULD ADVERSELY AFFECT US
We are subject to significant federal and state regulation and supervision,
which is primarily for the benefit and protection of our customers and not for
the benefit of investors. In the past, our business has been materially affected
by these regulations. This trend is likely to continue in the future. Laws,
regulations or policies, including accounting standards and interpretations
currently affecting us and our subsidiaries may change at any time. Regulatory
authorities may also change their interpretation of these statutes and
regulations. Therefore, our business may be adversely affected by any future
changes in laws, regulations, policies or interpretations, including legislative
and regulatory reactions to the terrorist attack on September 11, 2001, and
future acts of terrorism, and the Enron Corporation, WorldCom, Inc. and other
major US corporate bankruptcies and reports of accounting irregularities at US
public companies, including various large and publicly traded companies.
Additionally, our international activities may be subject to the laws and
regulations of the jurisdiction where business is being conducted. International
laws, regulations and policies affecting us and our subsidiaries may change at
any time and affect our business opportunities and competitiveness in these
jurisdictions. Due to BTM's controlling ownership of us, laws, regulations and
policies adopted or enforced by the Government of Japan may adversely affect our
activities and investments and those of our subsidiaries in the future.
Additionally, our business is affected significantly by the fiscal and
monetary policies of the federal government and its agencies. We are
particularly affected by the policies of the Federal Reserve Board
53
(FRB), which regulates the supply of money and credit in the US. Under
long-standing policy of the FRB, a bank holding company is expected to act as a
source of financial strength for its subsidiary banks. As a result of that
policy, we may be required to commit financial and other resources to our
subsidiary bank in circumstances where we might not otherwise do so. Among the
instruments of monetary policy available to the FRB are (a) conducting open
market operations in US government securities, (b) changing the discount rates
of borrowings by depository institutions, and (c) imposing or changing reserve
requirements against certain borrowings by banks and their affiliates. These
methods are used in varying degrees and combinations to directly affect the
availability of bank loans and deposits, as well as the interest rates charged
on loans and paid on deposits. The policies of the FRB may have a material
effect on our business, results of operations and financial condition.
WE MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT OUR OPERATING STRATEGIES
From time to time, we develop long-term financial performance goals to
guide and measure the success of our operating strategies. We can make no
assurances that we will be successful in achieving these long-term goals or that
our operating strategies will be successful. Achieving success in these areas is
dependent on a number of factors, many of which are beyond our direct control.
Factors that may adversely affect our ability to attain our long-term financial
performance goals include:
o deterioration of our asset quality;
o our inability to control noninterest expense, including, but not
limited to, rising employee and healthcare costs;
o our inability to increase noninterest income;
o our inability to decrease reliance on revenues generated from assets;
o our ability to manage loan growth;
o our ability to find acquisition targets at valuation levels we find
attractive;
o regulatory and other impediments associated with making acquisitions;
o deterioration in general economic conditions, especially in our core
markets;
o decreases in our net interest margin;
o increases in competition;
o adverse regulatory or legislative developments; and
o unexpected increases in costs related to acquisitions.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR DIVESTITURES OR
RESTRUCTURING MAY ADVERSELY AFFECT US
We may seek to acquire or invest in companies, technologies, services or
products that complement our business. There can be no assurance that we will be
successful in completing any such acquisition or investment as this will depend
on the availability of prospective target companies at valuation levels we find
attractive and the competition for such opportunities from other bidders. In
addition, we continue to evaluate the performance of all of our businesses and
business lines and may sell a business or business line. Any acquisitions,
divestitures or restructuring may result in the issuance of potentially dilutive
equity securities, significant write-offs, including those related to goodwill
and other intangible assets, and/or the incurrence of debt, any of which could
have a material adverse effect on our business, financial condition and results
of operations. Acquisitions, divestitures or restructuring could involve
numerous additional risks including difficulties in obtaining any required
regulatory approvals and in the assimilation or separation of operations,
services, products and personnel, the diversion of management's attention from
other business concerns, higher than expected deposit attrition (run-off),
divestitures required by
54
regulatory authorities, the disruption of our business, and the potential loss
of key employees. There can be no assurance that we will be successful in
overcoming these or any other significant risks encountered.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
A complete explanation concerning our market risk exposure is incorporated
by reference from the text under the caption "Quantitative and Qualitative
Disclosures About Market Risk" in the Form 10-K/A for the year ended December
31, 2002 and by reference to Part I, Item 2 of this document under the captions
"Quantitative and Qualitative Disclosure about Interest Rate Risk Management
(Other Than Trading)," "Liquidity Risk," and "Certain Business Risk Factors."
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on their
evaluation as of June 30, 2003, our principal executive officer and principal
financial officer have concluded that our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934 (Exchange Act)) are effective to ensure that information required to be
disclosed by us in reports we file or submit under the Exchange Act is recorded,
processed, summarized, and reported within the time periods specified in
Securities and Exchange Commission (SEC) rules and forms.
(b) CHANGES IN INTERNAL CONTROLS. These officers have also concluded that
during the second quarter of 2003 there was no significant change in our
internal control over financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
55
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to various pending and threatened legal actions that arise
in the normal course of business. We maintain reserves for losses from legal
actions that are both probable and estimable.
Union Bank of California, N.A., our major subsidiary (the Bank), has been
named in two suits pending in the United States District Court for the Central
District of California, Christensen v. Union Bank of California (formerly
captioned as Rockoff v Union Bank of California et al)(filed December 21, 2001)
and Neilson v Union Bank of California et al (filed September 4, 2002), and one
suit in Los Angeles County Superior Court, Kilpatrick v Orrick Herrington &
Sutcliffe, et al (filed April 22, 2003 as to the Bank). The plaintiffs in these
suits collectively seek in excess of $250 million alleged to have been lost by
those who invested money in various investment arrangements conducted by an
individual named Reed Slatkin. Mr. Slatkin is alleged to have been operating a
fraudulent investment scheme commonly referred to as a "Ponzi" scheme. The
plaintiffs in the Christensen case are various investors in the arrangements
conducted by Mr. Slatkin and the plaintiffs in the Neilson case include both
investors and the trustee of Mr. Slatkin's bankruptcy estate. A substantial
majority of those who invested with Mr. Slatkin had no relationship with the
Bank. A small minority, comprising less than five percent of the investors, had
custodial accounts with the Bank. The Neilson case seeks to impose liability
upon the Bank and two other financial institutions for both the losses suffered
by those custodial customers as well as investors who had no relationship with
the Bank. The plaintiff in the Kilpatrick case is an individual investor who
seeks recovery of funds placed in an account for a limited liability company
which he formed with Slatkin.
Another suit has been filed with regard to an unrelated "Ponzi" scheme
perpetrated by PinnFund, USA, located in San Diego, California. The victims of
this scheme have filed suit against the Bank seeking $235 million. They assert
that the Bank improperly opened and administered a deposit account, which was
used by PinnFund in furtherance of the fraud.
Although these claims are in the preliminary stages, the Bank has numerous
legal defenses, which it will invoke. Based on our evaluation to date of these
claims, management believes that they will not result in a material adverse
effect on our financial position or results of operations. In addition, we
believe that the disposition of all other claims currently pending will also not
have a material adverse effect on our financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
For information regarding matters submitted to a vote at the Annual Meeting
of Shareholders on April 23, 2003 ("Annual Meeting"), see Part II, Item 4 of
Form 10-Q for the quarter ended March 31, 2003, incorporated herein.
At that annual meeting, our shareholders approved our reincorporation from
California to Delaware. This is expected to occur by the end of the year.
56
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS:
NO. DESCRIPTION
- ---- ----------------------------------------------------------------------
10.1 Form of Change-of-Control Agreement, dated as of May 1, 2003, between
UnionBanCal Corporation and each of the policy-making officers of
UnionBanCal Corporation(1)
31.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002(1)
31.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002(1)
32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002(1)
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002(1)
- ------------------------
(1) Provided herewith
(B) REPORTS ON FORM 8-K
We furnished a report on Form 8-K on April 16, 2003 reporting under Item 9
thereof that UnionBanCal Corporation issued a press release concerning earnings
for the first quarter of 2003.
57
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
UnionBanCal Corporation has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
UNIONBANCAL CORPORATION
(Registrant)
By: /S/ NORIMICHI KANARI
----------------------------------------------
Norimichi Kanari
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
By: /S/ DAVID I. MATSON
----------------------------------------------
David I. Matson
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(Principal Financial Officer)
By: /S/ DAVID A. ANDERSON
----------------------------------------------
David A. Anderson
SENIOR VICE PRESIDENT AND CONTROLLER
(Principal Accounting Officer)
Date: August 14, 2003
58