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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NUMBER 1-10521
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CITY NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
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DELAWARE 95-2568550
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
CITY NATIONAL CENTER 90210
400 NORTH ROXBURY DRIVE,
BEVERLY HILLS, CALIFORNIA
(Address of principal (Zip Code)
executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (310) 888-6000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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Common Stock, $1.00 par value New York Stock Exchange
NO SECURITIES ARE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT
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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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
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Number of shares of common stock outstanding at February 26,
1999: 46,260,862
Aggregate market value of the voting stock held by non-affiliates of the
Registrant as of February 26, 1999: $1,270,826,633
DOCUMENTS INCORPORATED BY REFERENCE
THE INFORMATION REQUIRED TO BE DISCLOSED PURSUANT TO PART III OF THIS REPORT
EITHER SHALL BE (I) DEEMED TO BE INCORPORATED BY REFERENCE FROM SELECTED
PORTIONS OF THE DEFINITIVE PROXY STATEMENT FOR CITY NATIONAL CORPORATION'S 1999
ANNUAL MEETING OF SHAREHOLDERS, IF SUCH PROXY STATEMENT IS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION PURSUANT TO REGULATION 14A NOT LATER THAN 120
DAYS AFTER THE END OF THE CORPORATION'S MOST RECENTLY COMPLETED FISCAL YEAR, OR
(II) INCLUDED IN AN AMENDMENT TO THIS REPORT FILED WITH THE COMMISSION ON FORM
10-K/A.
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PART I
ITEM 1. BUSINESS
City National Corporation (the Corporation) was organized in Delaware in
1968 to acquire the outstanding capital stock of City National Bank (the Bank).
Because the Bank comprises substantially all of the business of the Corporation,
references to the "Company" reflect the consolidated activities of the
Corporation and the Bank. The Corporation owns all the outstanding shares of the
Bank.
The Bank, which was founded in 1953 and opened for business in January 1954,
conducts business in Southern California. After giving effect to the opening of
the Bank's Burbank branch on March 1, 1999, the bank operates twenty five
banking offices in Los Angeles County, five in Orange County, three in San Diego
County, three in Riverside County and three in Ventura County.
On January 17, 1997, the Company completed its acquisition of Ventura County
National Bancorp (VCNB), a two bank holding company with six branches and total
assets at December 31, 1996 of $279.8 million. The total purchase price was
approximately $49.1 million. The Company issued approximately 1.3 million
treasury shares with a market value of approximately $28.1 million and paid the
remainder in cash.
On January 24, 1997, the Company completed its acquisition of Riverside
National Bank (RNB), a four branch bank with total assets at December 31, 1996
of $252.2 million. The total purchase price was approximately $41.4 million. The
Company issued approximately 1.0 million treasury shares with a market value of
approximately $20.7 million and paid the remainder in cash.
On January 9, 1998, the Company completed its acquisition of Harbor Bancorp
(HB), a one-bank holding company with six branches and total assets at December
31, 1997 of $241.8 million. The total purchase price was approximately $34.5
million. The Company issued approximately 540,000 shares, primarily from
treasury with an aggregate market value of $17.9 million and paid the remainder
in cash. The Company closed the Huntington Beach branch of Harbor Bank on
January 26, 1998.
On February 27, 1998, the Company sold its Wilmington branch, which was
acquired as part of the 1997 acquisition of VCNB, to Banco Popular, N.A.
(California).
On May 15, 1998, the Bank closed its former Magnolia branch, which had been
acquired as part of the Company's 1997 acquisition of RNB.
On December 31, 1998, the Company completed its acquisition of North
American Trust Company (NATC), an independent trust company, for $11.5 million
in an all cash transaction. NATC had approximately $4 billion in total assets
under management or administration.
The Company is engaged in one operating segment: providing private and
business banking services. The Bank operates primarily in the Southern
California market, and is the largest commercial bank headquartered in that
region. The Bank's principal customer base comprises small- to middle-market
companies with annual sales revenue of up to $250 million, entrepreneurs,
professionals, and high net worth individuals. The Bank typically serves
customers seeking relationship banking, which it seeks to provide through a high
level of personal service, tailored products, and private banking teams. The
Bank offers commercial and personal loans of all types, deposit, cash
management, international banking and other products and services. In addition,
the Bank lends, invests and provides services in accordance with its Community
Reinvestment Act commitment. Through City National Investments, the bank offers
personal and employee benefit trust and estate services and deals in money
market and other investments for its own account and for the customers. The Bank
also offers mutual funds in association with other companies.
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COMPETITION
The banking business is highly competitive. The Bank competes with domestic
and foreign banks for deposits, loans and other banking business. In addition,
other financial intermediaries, such as savings and loans, money market mutual
funds, credit unions and other financial services companies, compete with the
Bank. Furthermore, the geographic constraints on portions of the financial
services industry can be expected to erode.
Non-depository institutions can also be expected to increase the extent to
which they act as financial intermediaries.
MONETARY POLICY
The net income of the Bank is affected not only by general economic
conditions, but also by the policies of various governmental regulatory
authorities in the U.S. and abroad. In particular, the Board of Governors of the
Federal Reserve System (Federal Reserve Board) exerts a substantial influence on
interest rates and credit conditions, primarily through open market operations
in U.S. government securities, varying the discount rate on member bank
borrowings and setting reserve requirements against deposits. Federal Reserve
Board monetary policies have had a significant effect on the operating results
of financial institutions in the past and are expected to continue to do so in
the future.
SUPERVISION AND REGULATION
Bank holding companies, banks and their non-bank affiliates are extensively
regulated under both federal and state law. The following is not intended to be
an exhaustive description of the statutes and regulations applicable to the
Corporation's or the Bank's business. The description of statutory and
regulatory provisions is qualified in its entirety by reference to the
particular statutory or regulatory provisions.
Moreover, major new legislation and other regulatory changes affecting the
Corporation, the Bank, banking and the financial services industry in general
have occurred in the last several years and can be expected to occur in the
future. The nature, timing and impact of new and amended laws and regulations
cannot be accurately predicted.
BANK HOLDING COMPANIES
Bank holding companies are regulated under the Bank Holding Company Act (BHC
Act) and are supervised by the Federal Reserve Board. Under the BHC Act, the
Corporation files reports of its operations with the Federal Reserve Board and
is subject to examination by it.
The BHC Act requires, among other things, the Federal Reserve Board's prior
approval whenever a bank holding company proposes to (i) acquire all or
substantially all the assets of a bank, (ii) acquire direct or indirect
ownership or control of 5% or more of the voting shares of a bank, or (iii)
merge or consolidate with another bank holding company. In 1996, legislation was
approved to substantially streamline the application process for
well-capitalized and well-managed bank holding companies, and in 1997
regulations were adopted by the bank regulatory authorities to implement such
legislation.
In September 1994, the Riegle-Neal Interstate Banking and Branch Efficiency
Act (the Riegle-Neal Act) was enacted. Under the Riegle-Neal Act, interstate
banking is allowed in three different forms:
- A bank owned by a holding company may acquire a subsidiary bank anywhere
in the United States.
- A bank owned by a holding company may act as an agent in accepting
deposits or servicing loans for any other bank or savings and loan owned
by the holding company.
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- A bank itself may establish a branch in another state, but only if the
bank's home state permits interstate mergers and branches, and the other
state has not passed a law to prohibit interstate mergers or branches.
Interstate bank subsidiaries and branch banks are subject to concentration
limits, Community Reinvestment Act requirements, bank supervisory controls and
other restrictions of the Riegle-Neal Act and of state law.
California law permits bank holding companies in other states to acquire
California banks and bank holding companies, provided the acquiring company's
home state has enacted "reciprocal" legislation that expressly authorizes
California bank holding companies to acquire banks or bank holding companies in
that state on terms and conditions substantially no more restrictive than those
applicable to such an acquisition in California by a bank holding company from
the other state.
The BHC Act also prohibits a bank holding company, with certain exceptions,
from acquiring 5% or more of the voting shares of any company that is not a bank
and from engaging in any activities without the Federal Reserve Board's prior
approval other than (1) managing or controlling banks and other subsidiaries
authorized by the BHC Act, or (2) furnishing services to, or performing services
for, its subsidiaries. The BHC Act authorizes the Federal Reserve Board to
approve the ownership of shares in any company the activities of which have been
determined to be closely related to banking or to managing or controlling banks
as to be a proper incident thereto.
Consistent with its "source of strength" policy (see "Capital Adequacy
Requirements," below), the Federal Reserve Board has stated that, as a matter of
prudent banking, a bank holding company generally should not pay cash dividends
unless its net income available to common shareholders is sufficient to fund
fully the dividends, and the prospective rate of net income retention appears
consistent with the company's capital needs, asset quality and overall financial
condition.
A bank holding company and its subsidiaries are prohibited from engaging in
certain tying arrangements in connection with the extension of credit.
The Federal Reserve Board may, among other things, issue cease-and-desist
orders with respect to activities of bank holding companies and nonbanking
subsidiaries that represent unsafe or unsound practices or violate a law,
administrative order or written agreement with a federal banking regulator. The
Federal Reserve Board can also assess civil money penalties against companies or
individuals who violate the BHC Act or other federal laws or regulations, order
termination of nonbanking activities by nonbanking subsidiaries of bank holding
companies and order termination of ownership and control of a nonbanking
subsidiary by a bank holding company.
NATIONAL BANKS
The Bank is a national bank and, as such, is subject to supervision and
examination by the Office of the Comptroller of the Currency (OCC) and
requirements and restrictions under federal and state law, including
requirements to maintain reserves against deposits, restrictions on the types
and amounts of loans that may be granted and the interest that may be charged,
and limitations on the types of investments that may be made and services that
may be offered. Various consumer laws and regulations also affect the Bank's
operations. These laws primarily protect depositors and other customers of the
Bank, rather than the Corporation and its shareholders.
The Corporation's principal asset is its investment in the Bank. Bank
dividends are one of the Corporation's principal sources of liquidity. The
Bank's ability to pay dividends is limited by certain statutes and regulations.
OCC approval is required for a national bank to pay a dividend if the total of
all dividends declared in any calendar year exceeds the total of the bank's net
profits (as defined) for that year combined with its retained net profits for
the preceding two calendar years, less any required transfer to surplus. A
national bank may not pay any dividend that exceeds its net profits then on hand
after deducting
4
its loan losses and bad debts, as defined by the OCC. The OCC and the Federal
Reserve Board have also issued banking circulars emphasizing that the level of
cash dividends should bear a direct correlation to the level of a national
bank's current and expected earnings stream, the bank's need to maintain an
adequate capital base and other factors. National banks that are not in
compliance with regulatory capital requirements generally are not permitted to
pay dividends. The Bank is in compliance with such requirements. The OCC also
can prohibit a national bank from engaging in an unsafe or unsound practice in
its business. Depending on a bank's financial condition, payment of dividends
could be deemed to constitute an unsafe or unsound practice. Except under
certain circumstances and with prior regulatory approval, a bank may not pay a
dividend if, after so doing, it would be undercapitalized. The Bank's ability to
pay dividends in the future is, and could be further, influenced by regulatory
policies or agreements and by capital guidelines.
The Bank's ability to make funds available to the Corporation is also
subject to restrictions imposed by federal law on the Bank's ability to extend
credit to the Corporation to purchase assets from it, to issue a guarantee,
acceptance or letter of credit on its behalf (including an endorsement or
standby letter of credit), to invest in its stock or securities, or to take such
stock or securities as collateral for loans to any borrower. Such extensions of
credit and issuances generally must be secured and are generally limited, with
respect to the Corporation, to 10% of the Bank's capital stock and surplus.
The Bank is insured by the FDIC and therefore is subject to its regulations.
Among other things, the Federal Deposit Insurance Corporation Improvement Act of
1991 (FDICIA) provided authority for special assessments against insured
deposits and required the FDIC to develop a general risk-based assessment
system. During 1995, the Bank Insurance Fund reached its targeted level of 1.25%
of estimated insured deposits. The FDIC reduced the assessment rate for well
capitalized banks to $2,000 per year for 1996. Beginning January 1, 1998, the
FDIC collected an assessment against Bank Insurance Fund-assessable deposits to
be paid to the Financing Corporation of approximately 1.26 basis points on total
deposits, as defined.
Banks and bank holding companies are also subject to the Community
Reinvestment Act of 1977, as amended (CRA). CRA requires the Bank to ascertain
and meet the credit needs of the communities it serves, including low-income and
moderate-income neighborhoods. The Bank's compliance with CRA is reviewed and
evaluated by the OCC, which assigns the Bank a publicly available CRA rating at
the conclusion of the examination. Further, an assessment of CRA compliance is
also required in connection with applications for OCC approval of certain
activities, including establishing or relocating a branch office that accepts
deposits or merging or consolidating with, or acquiring the assets or assuming
the liabilities of, a federally regulated financial institution. An unfavorable
rating may be the basis for OCC denial of such an application, or approval may
be conditioned upon improvement of the applicant's CRA record. In the case of a
bank holding company applying for approval to acquire a bank or other bank
holding company, the Federal Reserve Board will assess the CRA record of each
subsidiary bank of the applicant, and such records may be the basis for denying
the application.
In the most recently completed CRA compliance examination, conducted in
1997, the OCC assigned the Bank a rating of "Satisfactory," the second highest
of four possible ratings. The CRA regulations governing the Corporation and the
Bank emphasize measurements of performance in the area of lending (specifically,
the bank's home mortgage, small business, small farm and community development
loans), investment (the bank's community development investments) and service
(the bank's community development services and the availability of its retail
banking services), although examiners are still given a degree of flexibility in
taking into account unique characteristics and needs of the bank's community and
its capacity and constraints in meeting such needs. The regulations also require
certain levels of collection and reporting of data regarding certain kinds of
loans.
Regulations adopted pursuant to FDICIA incorporate guidelines establishing
standards for safety and soundness, including operational and managerial
standards relating to internal controls and information
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systems, internal audit systems, loan documentation, credit underwriting,
interest rate exposure, assets growth and compensation, fees and benefits, and
prohibit compensation deemed excessive. If the OCC finds that a bank has failed
to meet any applicable standard, it may require the institution to submit an
acceptable plan to achieve compliance, and if the bank fails to comply, the OCC
must, by order, require it to correct the deficiency.
Banking regulations also mandate that the Bank maintain an adequate
allowance for loan losses. In compliance with these regulations, a quarterly
Analysis and Recommendation of the Allowance for Credit Losses is presented to
the Audit Committee of the Board of Directors by the Bank's Risk Management and
Credit Administration departments, to make certain that the allowance is
maintained within an acceptable range. While the allowance is allocated to
portfolio segments, the allowance is general in nature and is available for the
portfolio in its entirety. The allowance is allocated to loan portfolios based
on previous loan loss experience, management's evaluation of the current loan
portfolio including trends and concentrations, and current and expected economic
conditions. Classified loans are evaluated based on previous loan loss
experience while certain loans possessing similar credit risks are evaluated in
groups. Results of the Company's ongoing credit examination process and that of
its regulators also factor into the determination of the adequacy of the
allowance.
Banking agencies have also adopted regulations which mandate that regulators
take into consideration concentrations of credit risk and risks from
non-traditional activities, as well as an institution's ability to manage those
risks, when determining the adequacy of an institution's capital. This
evaluation will be made as a part of the institution's regular safety and
soundness examination. Banking agencies also have adopted regulations requiring
regulators to consider interest rate risk (when the interest rate sensitivity of
an institution's assets does not match the sensitivity of its liabilities or its
off-balance-sheet position) in the evaluation of a bank's capital adequacy.
The OCC has enforcement powers with respect to national banks for violations
of federal laws or regulations that are similar to the powers of the Federal
Reserve Board with respect to bank holding companies and nonbanking
subsidiaries. See "Bank Holding Companies," above.
CAPITAL ADEQUACY REQUIREMENTS
Both the Federal Reserve Board and the OCC have adopted similar, but not
identical, "risk-based" and "leverage" capital adequacy guidelines for bank
holding companies and national banks, respectively. Under the risk-based capital
guidelines, different categories of assets are assigned different risk weights,
ranging from zero percent for risk-free assets (E.G., cash) to 100% for
relatively high-risk assets (E.G., commercial loans). These risk weights are
multiplied by corresponding asset balances to determine a risk-adjusted asset
base. Certain off-balance sheet items (E.G., standby letters of credit) are
added to the risk-adjusted asset base. The minimum required ratio of total
capital to risk-weighted assets for both bank holding companies and national
banks is presently 8%. At least half of the total capital is required to be
"Tier 1 capital," consisting principally of common shareholders' equity, a
limited amount of perpetual preferred stock, trust preferred stock and minority
interests in the equity accounts of consolidated subsidiaries, less certain
intangible items. The remainder (Tier 2 capital) may consist of a limited amount
of subordinated debt, certain hybrid capital instruments and other debt
securities, preferred stock and a limited amount of the general loan-loss
allowance. As of December 31, 1998, the Corporation had a ratio of total capital
to risk-weighted assets (Total risk- based capital ratio) of 13.20% and a ratio
of Tier 1 capital to risk-weighted assets (Tier 1 risk-based capital ratio) of
9.43%, while the Bank had a total risk-based capital ratio of 12.65% and a Tier
1 risk-based capital ratio of 8.90%.
The minimum Tier 1 leverage ratio, consisting of Tier 1 capital to average
adjusted total assets, is 3% for bank holding companies and national banks that
have the highest regulatory examination rating and are not contemplating
significant growth or expansion. All other bank holding companies and national
banks are expected to maintain a ratio of at least 1% to 2% or more above the
stated minimum. As of
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December 31, 1998, the Corporation had a Tier 1 leverage ratio of 7.99%, and the
Bank's Tier 1 leverage ratio was 7.53%.
The OCC has adopted regulations under FDICIA establishing capital categories
for national banks and prompt corrective actions for undercapitalized
institutions. The regulations create five capital categories: well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized and
critically undercapitalized. The following table shows as of December 31, 1998
the minimum total risk-based capital, Tier 1 risk-based capital and Tier 1
leverage ratios, all of which must be satisfied for a bank to be classified as
well capitalized, adequately capitalized or undercapitalized, respectively,
together with the Bank's ratios which in all cases exceed the well capitalized
minimums.
MINUMUM TOTAL MINIMUM TIER 1 MINIMUM TIER
RISK-BASED RISK-BASED 1 LEVERAGE
CAPITAL RATIO CAPITAL RATIO RATIO
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City National Bank.................. 12.65% 8.90% 7.53%
Well capitalized (1)................ 10.00% 6.00% 5.00%
Adequately capitalized.............. 8.00% 4.00% 4.00%(2)
Undercapitalized.................... 6.00% 4.00% 3.00%
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(1) A bank may not be classified as well capitalized if it is subject to a
specific agreement with the OCC to meet and maintain a specified level of
capital.
(2) 3% for institutions having a composite rating of "1" in the most recent OCC
examination.
If any one or more of a bank's ratios are below the minimum required to be
classified as undercapitalized, it will be classified as significantly
undercapitalized. In addition, if its ratio of tangible equity to total assets
is 2% or less, it will be classified as critically undercapitalized. A bank may
be reclassified by the OCC to the next level below that determined by the
criteria described above if the OCC finds that it is in an unsafe or unsound
condition or if it has received a less-than-satisfactory rating for any of the
categories of asset quality, management, earnings or liquidity in its most
recent examination and the deficiency has not been corrected, except that a bank
cannot be reclassified as critically undercapitalized for such reasons.
Under FDICIA and its implementing regulations, the OCC may subject national
banks to a broad range of restrictions and regulatory requirements. A national
bank may not pay management fees to any person having control of the
institution, nor, except under certain circumstances and with prior regulatory
approval, make any capital distribution if, after doing so, it would be
undercapitalized. Undercapitalized banks are subject to increased monitoring by
the OCC, are restricted in their asset growth, must obtain regulatory approval
for certain corporate activities, such as acquisitions, new branches and new
lines of business, and, in most cases, must submit to the OCC a plan to bring
their capital levels to the minimum required in order to be classified as
adequately capitalized. The OCC may not approve a capital restoration plan
unless each company that controls the bank guarantees that the bank will comply
with it. Significantly and critically undercapitalized banks are subject to
additional mandatory and discretionary restrictions and, in the case of
critically undercapitalized institutions, must be placed into conservatorship or
receivership unless the OCC and the FDIC agree otherwise.
Under Federal Reserve Board policy, a bank holding company is expected to
act as a source of financial strength to its subsidiary banks and to commit
resources to support each such bank. In addition, a bank holding company is
required to guarantee that its subsidiary bank will comply with any capital
restoration plan required under FDICIA. The amount of such a guarantee is
limited to the lesser of (i) 5% of the bank's total assets at the time it became
undercapitalized, or (ii) the amount which is necessary (or would have been
necessary) to bring the bank into compliance with all applicable capital
standards as of the time the bank fails to comply with the capital restoration
plan. A holding company guarantee of a capital restoration plan for the Bank
would result in a priority claim to the holding company's assets ahead
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of its other unsecured creditors and shareholders that is enforceable even in
the event of the holding company's bankruptcy or the subsidiary bank's
insolvency.
YEAR 2000 ISSUES
During 1996, 1997, and 1998 the Federal Financial Institutions Examination
Council ("FFIEC"), an organization comprised of representatives of the major
bank regulatory agencies, including the Federal Reserve Board, the OCC and the
FDIC, issued a number of statements relating to Year 2000 Issues-the risks
attributed to the programming codes in many existing computer systems that may
result in inaccurate calculations based on any two-digit field containing the
value "00". For many systems, the two-digit "00" field will not permit accurate
calculations based on current formulas on or after January 1, 2000 because that
date may be read as January 1, 1900. The potential impact, particularly in the
financial services industry, is that date-sensitive calculations could be based
on erroneous data or could cause a systems failure.
The FFIEC Statement of May 5, 1997 (the "Statement"), as supplemented by the
FFIEC Guidelines of December 17, 1997 (the "Guidelines"), emphasize the need to
make all information processing systems Year 2000 compliant and to identify
specific concerns which should be considered in managing such a conversion
program. Among other things, the Statement and Guidelines: (a) outline the Year
2000 project management process; (b) identify certain external risk issues that
a Year 2000 conversion plan should consider, including reliance on vendors, data
exchange with other firms and Year 2000 compliance by borrowers; and (c)
describe other operational issues that may be relevant to a Year 2000 plan. The
Guidelines also outline the responsibilities of senior management and the board
of directors for addressing Year 2000 problems through active management and
oversight of efforts to ensure that adequate resources and personnel are devoted
to Year 2000 efforts. The Guidelines stress that Year 2000 Issues are an
enterprise-wide challenge, and not solely a technology issue, require management
to provide the board at least quarterly status reports on management's Year 2000
efforts and require development of a project planning process. The Guidelines
also clarify the Statement regarding Year 2000 compliance by an institution's
vendors. See the Noninterest Expense section of Management's Discussion and
Analysis for information regarding the Company's "Year 2000 Readiness
Disclosures."
ITEM 2. PROPERTIES
The Company has its principal offices in the City National Center, 400 North
Roxbury Drive, Beverly Hills, California 90210, which the Bank owns and
occupies. After giving effect to the opening of the Bank's Burbank branch on
March 1, 1999, the Company and its subsidiaries actively maintain operations in
39 banking offices and certain other properties.
Since 1967, the Bank's Pershing Square Banking Office and a number of Bank
departments have been the major tenant of the office building located at 606
South Olive Street in downtown Los Angeles. The building was originally
developed and built by a partnership between a wholly-owned subsidiary of the
Bank, Citinational Bancorporation, and Buckeye Construction Co. and Buckeye
Realty and Management Corporation (two corporations then affiliated with Mr.
Bram Goldsmith, Chairman of the Board of the Corporation). Since its completion,
the building has been owned by Citinational-Buckeye Building Co., a limited
partnership of which Citinational Bancorporation and Olive-Sixth Buckeye Co. are
the only general partners, each with a 29% partnership interest. Citinational
Bancorporation has an additional 3% interest as a limited partner of
Citinational-Buckeye Building Co.; the remainder is held by other, unaffiliated
limited partners. Olive-Sixth Buckeye Co. is a limited partnership of which Mr.
Goldsmith is a 49% general partner; therefore, Mr. Goldsmith has an indirect 14%
ownership interest in Citinational-Buckeye Building Co. The remaining general
partner and all limited partners of Olive-Sixth Buckeye Co. are not affiliated
with the Corporation. Since 1990, Citinational-Buckeye Building Co. has managed
the building, which is almost fully leased.
8
The major encumbrance on real properties owned directly by the Bank or its
subsidiaries is a deed of trust on the 606 South Olive Street building, securing
Citinational-Buckeye Building Company's note to City National Bank, which
matured on December 31, 1998 and on which the unpaid balance at December 31,
1998, was $15,491,182. Citinational-Buckeye Building Co. and the Bank are in the
process of renewing and/or extending the mortgage, although there can be no
assurance that such renewal and/or extension will be accomplished.
The Bank's subsidiary, Citinational Bancorporation, as of December 31, 1998
owned two buildings located on Olympic Boulevard in downtown Los Angeles, which
are occupied primarily by the Bank's support departments and one of which
contains a banking office. In addition, as of December 31, 1998, the Bank owned
three other branch properties; the former main office of Riverside National Bank
and one of its branches located in Riverside, and a branch located in Studio
City plus one former branch property in Riverside.
The remaining banking offices and other properties throughout Southern
California are leased by the Bank. Total annual rental payments (exclusive of
operating charges and real property taxes) approximate $15.2 million, with lease
expiration dates ranging from 1999 to 2009, exclusive of renewal options.
ITEM 3. LEGAL PROCEEDINGS
The Corporation and its subsidiaries are defendants in various pending
lawsuits. Based on present
knowledge, management and in-house counsel are of the opinion that the final
outcome of such lawsuits will not have a material adverse effect upon the
Corporation.
The Company is not aware of any material proceedings to which any director,
officer or affiliate of the Company, any owner of record or beneficially of more
than 5% of the voting securities of the Company, or any associate of any such
director, officer or security holder is a party adverse to the Company or any of
its subsidiaries or has a material interest adverse to the Company or any of its
subsidiaries.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There was no submission of matters to a vote of security holders during the
fourth quarter of the year ended December 31, 1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
Shown below are names and ages of all executive officers of the Corporation
and officers of the Bank who may be deemed to be executive officers of the
Corporation, with indication of all positions and offices with the Corporation
and the Bank. Mr. Russell Goldsmith is the son of Mr. Bram Goldsmith.
Capacities in which served:
PRESENT PRINCIPAL OCCUPATION AND PRINCIPAL
NAME AGE OCCUPATION DURING THE PAST FIVE YEARS
- - ------------------------------------------ --- ------------------------------------------
Bram Goldsmith............................ 76 Chief Executive Officer (until October
1995) and Chairman of the Board, City
National Corporation; Chairman of the
Board and Chief Executive Officer, City
National Bank, until October 1995
9
PRESENT PRINCIPAL OCCUPATION AND PRINCIPAL
NAME AGE OCCUPATION DURING THE PAST FIVE YEARS
- - ------------------------------------------ --- ------------------------------------------
Russell Goldsmith......................... 49 Chief Executive Officer and Vice Chairman,
City National Corporation, October 1995 to
present; Chairman of the Board and Chief
Executive Officer, City National Bank,
October 1995 to present; President,
Goldsmith Entertainment Company,
production and media company, 1994 to
1995; Consultant, Spelling Entertainment
Group, Inc, television and home video
company, 1994 to 1995; Chairman of the
Board and Chief Executive Officer,
Republic Pictures Corporation,
entertainment company, until 1994
George H. Benter, Jr...................... 57 President, City National Corporation, 1993
to present; President and Chief Operating
Officer, City National Bank, since 1992
Frank P. Pekny............................ 55 Executive Vice President and
Treasurer/Chief Financial Officer, City
National Corporation, since 1992. Vice
Chairman and Chief Financial Officer, City
National Bank since 1995; Executive Vice
President and Chief Financial Officer,
City National Bank, 1992 to October 1995
Robert A. Moore........................... 56 Executive Vice President and Manager,
Credit Services, City National Bank, since
1992
Jeffery L. Puchalski...................... 43 Executive Vice President and Senior Risk
Management Officer, City National Bank
from 1992
Richard H. Sheehan, Jr.................... 55 Senior Vice President, Secretary and
General Counsel, City National Bank and
City National Corporation 1994 to present;
Senior Vice President and Assistant
General Counsel, Bank of America, NT & SA,
commercial bank, 1987 to 1994
Heng W. Chen.............................. 46 Assistant Chief Financial Officer and
Assistant Treasurer, City National
Corporation and Senior Vice President,
Finance since 1998; Controller, City
National Corporation from 1995 to 1998;
Assistant Treasurer, City National
Corporation from 1992; Senior Vice
President-Finance and Controller, City
National Bank from 1995 to 1998
10
PRESENT PRINCIPAL OCCUPATION AND PRINCIPAL
NAME AGE OCCUPATION DURING THE PAST FIVE YEARS
- - ------------------------------------------ --- ------------------------------------------
Stephen D. McAvoy......................... 53 Controller, City National Corporation and
Senior Vice President and Controller, City
National Bank since March 1998; Vice
President-Controller Transamerica Home
Loan August 1997 to February 1998;
Consultant in the area of the Financial
Controller functions, Transamerica Home
Loan June 1997 to August 1997,
Transamerica Financial Services May 1996
to June 1997; Executive Vice President
First Interstate Bancorp April 1989 to
April 1996 and Controller to September
1994
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Corporation's common stock is listed and traded principally on the New
York Stock Exchange under the symbol "CYN," information concerning the range of
high and low sales prices for the Corporation's common stock, and the dividends
declared, for each quarterly period within the past two fiscal years in set
forth below.
DIVIDENDS
QUARTER ENDED HIGH LOW DECLARED
- - --------------------------------------------------- --------- --------- -----------
1998
March 31........................................... $ 39.31 $ 32.13 $ 0.14
June 30............................................ 40.44 34.69 0.14
September 30....................................... 39.19 27.88 0.14
December 31........................................ 41.63 26.56 0.14
1997
March 31........................................... $ 25.38 $ 20.38 $ 0.11
June 30............................................ 25.50 20.88 0.11
September 30....................................... 32.25 24.25 0.11
December 31........................................ 37.50 28.00 0.11
As of February 26, 1999 the closing price of the Corporation's stock on the
New York Stock Exchange was $32.25 per share. As of that date, there were
approximately 2,100 record holders of the Corporation's common stock. On January
27, 1999, the Board of Directors authorized a regular quarterly cash dividend on
its common stock at an increased rate of $0.165 per share payable on February
22, 1999.
For a discussion of dividend restrictions on the Corporation's common stock,
see Note 11 (Availability of Funds From Subsidiaries, Restrictions on Cash
Balances; Capital) to the consolidated financial statements on page A-53 of this
report.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item appears on page A-2 under the caption
"SELECTED FINANCIAL INFORMATION," and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item appears on pages A-3 through A-30,
under the caption "MANAGEMENT'S DISCUSSION AND ANALYSIS," and is incorporated
herein by reference.
ITEM 7A. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item appears on pages A-15 through A-18
under the caption "MANAGEMENT'S DISCUSSION AND ANALYSIS" and is incorporated
herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item appears on pages A-33 through A-61,
and on page A-31 under the captions "1998 QUARTERLY OPERATING RESULTS" and "1997
QUARTERLY OPERATING RESULTS" and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
12
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item, to the extent not included under the
caption "Executive Officers of the Registrant" in Part I of this report, or
below, will appear under the caption "Election of Directors" in the
Corporation's definitive proxy statement for the 1999 Annual Meeting of
Stockholders (the "1999 Proxy Statement"), and such information either shall be
(i) deemed to be incorporated herein by reference from that portion of the 1999
Proxy Statement, if filed with the Securities and Exchange Commission pursuant
to Regulation 14A not later than 120 days after the end of the Corporation's
most recently completed fiscal year, or (ii) included in an amendment to this
report filed with the Commission on Form 10-K/A.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will appear under the captions
"Compensation of Directors and Executive Officers," "Board Compensation and
Directors Nominating Committee Report on Executive Compensation" and
"Stockholder Return Graph" in the 1999 Proxy Statement, and such information
either shall be (i) deemed to be incorporated herein by reference from those
portions of the 1999 Proxy Statement, if filed with the Securities and Exchange
Commission pursuant to Regulation 14A not later than 120 days after the end of
the Corporation's most recently completed fiscal year, or (ii) included in an
amendment to this report filed with the Commission on Form 10-K/A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will appear under the captions "Record
Date, Number of Shares Outstanding and Voting Rights; Security Ownership of
Certain Beneficial Owners" and "Security Ownership of Management" in the 1999
Proxy Statement, and such information either shall be (i) deemed to be
incorporated herein by reference from that portion of the 1999 Proxy Statement,
if filed with the Securities and Exchange Commission pursuant to Regulation 14A
not later than 120 days after the end of the Corporation's most recently
completed fiscal year, or (ii) included in an amendment to this report filed
with the Commission on Form 10-K/A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will appear under the caption "Certain
Transactions with Management and Others" in the 1999 Proxy Statement, and such
information either shall be (i) deemed to be incorporated herein by reference
from that portion of the 1999 Proxy Statement, if filed with the Securities and
Exchange Commission pursuant to Regulation 14A not later than 120 days after the
end of the Corporation's most recently completed fiscal year, or (ii) included
in an amendment to this report filed with the Commission on Form 10-K/A. Also
see Note 5 (Loans and Allowance for Credit Losses) to the consolidated financial
statements on page A-44 through A-46 of this report.
13
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements:
Management's Responsibility for Financial Statements................. A-32
Independent Auditors' Report......................................... A-33
Consolidated Balance Sheet at December 31, 1998 and 1997............. A-34
Consolidated Statement of Income and Comprehensive Income for each of
the years in the three-year period ended December 31, 1998......... A-35
Consolidated Statement of Cash Flows for each of the years in the
three-year period ended December 31, 1998.......................... A-36
Consolidated Statement of Changes in Shareholders' Equity for each of
the years in the three-year period ended December 31, 1998......... A-37
Notes to the Consolidated Financial Statements....................... A-38
2. All other schedules and separate financial statements of 50% or less owned
companies accounted for by the equity method have been omitted because they
are not applicable.
3. Exhibits (listed by numbers corresponding to Exhibit Table of Item 601 in
Regulation S-K)
NO.
- - ---------
3.1 Certificate of Incorporation (This Exhibit is incorporated by reference from
the Registrant's Annual Report on Form 10-K for the year ended December 31,
1990.)
3.2 By-Laws, as amended to date (This Exhibit is incorporated by reference from the
Registrant's Annual Report on Form 10-K for the year ended December 31, 1996 as
amended by the Registrant's Form 8-A filed on March 12, 1997.)
4.1 6 3/8% Subordinated Notes Due 2008 in the principal amount of $125 million
(This Exhibit is incorporated by reference from the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1997.)
4.2 Stockholder Rights Plan (This Exhibit is incorporated by reference from the
Registrant's Form 8-A filed on March 12, 1997.)
10.2.2 Employment Agreement made as of March 18, 1998, by and between Bram Goldsmith
and City National Bank, including Sixth Amendment to Split Dollar Life
Insurance Agreement Collateral Assignment Plan between City National Bank and
the Goldsmith 1980 Insurance Trust, dated March 18, 1998 (This Exhibit is
incorporated by reference from the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1997.)
10.3 Split Dollar Life Insurance Agreement Collateral Assignment Plan between City
National Bank and the Goldsmith 1980 Insurance Trust, dated as of June 13,
1980, as amended to December 31, 1991 (This Exhibit is incorporated by
reference from the Company's Annual Report on Form 10-K for the year ended
December 31, 1991.)
10.3.1 Fifth Amendment to Split Dollar Life Insurance Agreement Collateral Assignment
Plan between City National Bank and the Goldsmith 1980 Insurance Trust, dated
May 15, 1995 (This Exhibit is incorporated by reference from the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1997.)
14
NO.
- - ---------
10.10 City National Corporation 1985 Stock Option Plan, as amended to date (This
Exhibit is incorporated by reference from the Company's Annual Report on Form
10-K for the year ended December 31, 1991.)
10.22.1 Stock Option Agreement Under the City National Corporation 1985 Stock Option
Plan dated as of October 16, 1995, between City National Corporation and
Russell Goldsmith (This Exhibit is incorporated by reference from the Company's
Annual Report on Form 10-K for the year ended December 31, 1995.)
10.22.2 Employment Agreement data as of July 15, 1998 by and between Russell Goldsmith
and City National Bank (This Exhibit is incorporated by reference from the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30,
1998.)
10.24 City National Corporation 1995 Omnibus Plan (This Exhibit is incorporated by
reference from the Company's Annual Report on Form 10-K for the year ended
December 31, 1995.)
10.24.1 Amended and Restated Section 2.8 of City National Corporation 1995 Omnibus Plan
(This Exhibit is incorporated by reference from the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1997.)
10.28 Lease dated September 30, 1996, between Citinational-Buckeye Building Co. and
City National Bank for space until December 31, 2006 (This Exhibit is
incorporated by reference from the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1997.)
21 Subsidiaries of the registrant
23.1 Consent of KPMG LLP
27 Financial Data Schedules
(b) During the calendar quarter ended December 31, 1998, the registrant did
not file any current reports on Form 8-K.
15
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CITY NATIONAL CORPORATION
(Registrant)
By /s/ RUSSELL D. GOLDSMITH
------------------------------------------
Russell D. Goldsmith,
CHIEF EXECUTIVE OFFICER
March 15, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- - --------------------------------------------------- ----------------------------------------- -----------------
/s/ RUSSELL D. GOLDSMITH
----------------------------------------
Russell D. Goldsmith Chief Executive Officer and Director March 15, 1999
(Principal Executive Officer)
/s/ FRANK P. PEKNY
---------------------------------------- Executive Vice President and
Frank P. Pekny Treasurer/Chief Financial Officer March 15, 1999
(Principal Financial Officer)
/s/ STEPHEN D. MCAVOY
----------------------------------------
Stephen D. McAvoy Controller March 15, 1999
(Principal Accounting Officer)
/s/ BRAM GOLDSMITH
---------------------------------------- Chairman of the Board and Director March 15, 1999
Bram Goldsmith
/s/ GEORGE H. BENTER, JR.
---------------------------------------- President and Director March 15, 1999
George H. Benter, Jr.
/s/ RICHARD L. BLOCH
---------------------------------------- Director March 15, 1999
Richard L. Bloch
/s/ STUART D. BUCHALTER
---------------------------------------- Director March 15, 1999
Stuart D. Buchalter
16
SIGNATURE TITLE DATE
- - --------------------------------------------------- ----------------------------------------- -----------------
/s/ EZUNIAL BURTS
---------------------------------------- Director March 15, 1999
Ezunial Burts
/s/ BARRY M. MEYER
---------------------------------------- Director March 15, 1999
Barry M. Meyer
/s/ CHARLES E. RICKERSHAUSER, JR.
---------------------------------------- Director March 15, 1999
Charles E. Rickershauser, Jr.
/s/ EDWARD SANDERS
---------------------------------------- Director March 15, 1999
Edward Sanders
/s/ ANDREA L. VAN DE KAMP
---------------------------------------- Director March 15, 1999
Andrea L. Van De Kamp
/s/ KENNETH ZIFFREN
---------------------------------------- Director March 15, 1999
Kenneth Ziffren
17
FINANCIAL HIGHLIGHTS
INCREASE
(DECREASE)
DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS 1998 1997 AMOUNT
- - ------------------------------------------------------------------------ ------------ ------------ ------------
FOR THE YEAR
Net income............................................................ $ 96,228 $ 80,133 $ 16,095
Net income per common share, basic.................................... 2.08 1.74 0.34
Net income per common share, diluted.................................. 2.00 1.68 0.32
Dividends, per common share........................................... 0.56 0.44 0.12
AT YEAR END
Assets................................................................ $ 6,427,781 $ 5,252,032 $ 1,175,749
Deposits.............................................................. 4,887,402 4,228,348 659,054
Loans................................................................. 4,530,427 3,825,224 705,203
Securities............................................................ 1,012,526 833,122 179,404
Shareholder's equity.................................................. 561,803 508,670 53,133
Book value, per common share.......................................... 12.21 11.03 1.18
AVERAGE BALANCES
Assets................................................................ $ 5,633,829 $ 4,703,886 $ 929,943
Deposits.............................................................. 4,267,602 3,614,068 653,534
Loans................................................................. 4,213,853 3,387,784 826,069
Securities............................................................ 842,346 829,557 12,789
Shareholder's equity.................................................. 538,426 472,843 65,583
SELECTED RATIOS
Return on average assets.............................................. 1.71% 1.70% 0.01%
Return on average shareholder's equity................................ 17.87 16.95 0.92
Tier 1 leverage....................................................... 7.99 9.19 (1.20)
Tier 1 risk-based capital............................................. 9.43 10.99 (1.56)
Total risk-based capital.............................................. 13.20 12.27 0.93
Dividend payout ratio, per share...................................... 27.06 26.19 0.87
Net interest margin................................................... 5.86 6.13 (0.27)
Efficiency ratio...................................................... 56.87 58.22 (1.35)
A-1
SELECTED FINANCIAL INFORMATION
AS OF OR FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------
DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA 1998 1997 1996 1995 1994
- - ------------------------------------------------------ --------- --------- --------- --------- ---------
STATEMENT OF OPERATIONS DATA:
Interest income..................................... $ 423,949 $ 357,996 $ 282,123 $ 217,594 $ 181,825
Interest expense.................................... 130,278 104,328 82,389 55,331 38,414
--------- --------- --------- --------- ---------
Net interest income................................. 293,671 253,668 199,734 162,263 143,411
Provision for credit losses......................... -- -- -- -- 7,535
Noninterest income.................................. 67,684 53,418 43,995 34,566 32,797
Noninterest expense................................. 211,331 181,757 144,595 118,076 115,999
--------- --------- --------- --------- ---------
Income before taxes................................. 150,024 125,329 99,134 78,753 52,674
Income taxes........................................ 53,796 45,196 32,571 29,961 15,511
--------- --------- --------- --------- ---------
Net income........................................ $ 96,228 $ 80,133 $ 66,563 $ 48,792 $ 37,163
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
PER SHARE DATA:
Net income per share, basic......................... $ 2.08 $ 1.74 $ 1.52 $ 1.08 $ 0.83
Net income per share, diluted....................... 2.00 1.68 1.47 1.06 0.81
Cash dividends declared............................. 0.56 0.44 0.36 0.26 0.05
Book value per share................................ 12.21 11.03 9.13 8.19 7.32
Shares used to compute net income per share,
basic............................................. 46,357 46,018 43,888 45,198 44,725
Shares used to compute net income per share,
diluted........................................... 48,141 47,809 45,146 45,886 45,626
BALANCE SHEET DATA--AT PERIOD END:
Assets.............................................. $6,427,781 $5,252,032 $4,216,496 $4,157,551 $3,012,775
Loans............................................... 4,530,427 3,825,224 2,839,435 2,346,611 1,643,918
Securities.......................................... 1,012,526 833,122 811,092 975,407 749,435
Interest-earning assets............................. 5,982,968 4,838,926 3,844,834 3,784,245 2,716,524
Deposits............................................ 4,887,402 4,228,348 3,386,523 3,248,035 2,417,762
Shareholders' equity................................ 561,803 508,670 400,747 366,957 330,721
BALANCE SHEET DATA--AVERAGE BALANCES:
Assets.............................................. $5,633,829 $4,703,886 $3,821,314 $2,849,807 $2,831,471
Loans............................................... 4,213,853 3,387,784 2,539,323 1,758,671 1,537,997
Securities.......................................... 842,346 829,557 839,564 705,122 854,823
Interest-earning assets............................. 5,187,897 4,290,453 3,505,422 2,624,436 2,594,241
Deposits............................................ 4,267,602 3,614,068 2,871,870 2,062,412 2,241,175
Shareholders' equity................................ 538,426 472,843 373,491 350,551 313,196
ASSET QUALITY:
Nonaccrual loans.................................... $ 23,138 $ 27,566 $ 41,543 $ 48,124 $ 58,801
ORE................................................. 3,480 2,126 15,116 7,439 4,726
--------- --------- --------- --------- ---------
Total nonaccrual loans and ORE.................... $ 26,618 $ 29,692 $ 56,659 $ 55,563 $ 63,527
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
PERFORMANCE RATIOS:
Return on average assets............................ 1.71% 1.70% 1.74% 1.71% 1.31%
Return on average shareholders' equity.............. 17.87 16.95 17.82 13.92 11.87
Net interest spread................................. 4.27 4.64 4.47 4.84 4.60
Net interest margin................................. 5.86 6.13 5.87 6.26 5.57
Average shareholders' equity to average assets...... 9.56 10.05 9.77 12.30 11.06
ASSET QUALITY RATIOS:
Nonaccrual loans to total loans..................... 0.51% 0.72% 1.46% 2.05% 3.58%
Nonaccrual loans and ORE to total loans and ORE..... 0.59 0.78 1.98 2.36 3.85
Allowance for credit losses to total loans.......... 2.99 3.60 4.58 5.60 6.41
Allowance for credit losses to nonaccrual loans..... 584.92 499.75 313.14 273.28 179.15
Net (charge offs) recoveries to average loans....... (0.12) 0.02 (0.06) 0.40 (0.83)
A-2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
City National Corporation (the "Company") is the holding company for City
National Bank (the "Bank"). In light of the fact that the Bank comprises
substantially all of the business of the Company, references to the "Company"
mean the Company and the Bank together.
See "Cautionary Statement for Purposes of the "Safe Harbor' Provision of the
Private Securities Litigation Reform Act of 1995", below in connection with
"forward looking" statements included in this section and in the Results of
Operations and Balance Sheet Analysis sections.
The Company regularly evaluates, and holds discussions with, various
potential acquisition candidates. As a general rule the Company does not
publicly announce such acquisitions until after a definitive agreement has been
reached. Also as a matter of policy, the Company generally does not make any
specific projections as to future earnings nor does it endorse any projections
regarding future performance, which may be made by others.
Consolidated net income was $96.2 million, or $2.00 per diluted common share
in 1998, compared to $80.1 million, or $1.68 per diluted common share in 1997.
Net income per basic share was $2.08 in 1998 compared with $1.74 in 1997. The
increase in net income reflects the growth in the Company's loans and deposits
during 1998 including the impact from the acquisition of HB in January 1998.
Fully taxable equivalent net interest income in 1998 increased $41.1 million
over 1997 and noninterest income increased $14.3 million compared with 1997.
Partially offsetting these increases were a $29.6 million increase in
noninterest expense, compared with 1997 and a $8.6 million increase in income
tax expense in 1998.
The return on average assets was 1.71% and the return on average common
equity was 17.87%, compared with 1.70% and 16.95%, respectively, in 1997.
Income before the amortization of goodwill and core deposit intangibles (net
of applicable taxes) ("cash" earnings) for the year ended December 31, 1998 were
$101.7 million, or $2.11 per diluted common share, compared with $84.1 million,
or $1.76 per diluted common share for the year ended December 31, 1997. On the
same basis, the return on average assets was 1.82% and the return on average
common equity was 20.98%, compared with 1.80% and 19.53%, respectively, in 1997.
"Cash" income is presented because it measures the Company's ability to support
growth, pay dividends and repurchase stock. The Company's "cash" income per
share and other ratios are not necessarily comparable to similarly titled
measures reported by other companies.
Average assets increased to $5,633.8 million in 1998 from $4,703.9 million
in 1997, an increase of $929.9 million or 19.8%, largely due to increased loans
and the acquisition of HB. Total average loans increased $826.1 million or 24.4%
between 1997 and 1998 due to internal loan originations of both commercial,
residential first trust deed and construction loans, approximately $152.8
million from the HB acquisition and participations in domestic bank
non-relationship syndicated loans. Average core deposits (checking, savings and
money market accounts and time certificates of deposit of less than $100,000)
increased to $3,506.6 million in 1998 from $3,079.6 million in 1997, an increase
of $427.0 million or 13.9% due to the Company's increased marketing efforts in
1998 and approximately $163.6 million from the acquisition of HB.
Nonaccrual loans decreased to $23.1 million at December 31, 1998, or 0.51%
of total loans, compared to $27.6 million, or 0.72% a year earlier. ORE totaled
$3.5 million at year end, up from $2.1 million a year earlier.
The allowance for credit losses at December 31, 1998 was $135.3 million or
3.0% of loans outstanding at year end. Net chargeoffs totaled $5.2 million in
1998, compared with net recoveries of $0.7 million in 1997. Based on its review
of the loan portfolio, management considers the allowance for credit losses to
be adequate. Based on expected loan growth, the level of nonperforming loans,
anticipated recoveries in the
A-3
first half of 1999 of loans previously charged-off and a relatively constant low
level of chargeoffs, it is anticipated that the level of the allowance will
remain stable through the first half of 1999 without a provision for credit
losses. However, credit quality will be influenced by underlying trends in the
economic cycle, particularly for Southern California, among a variety of other
factors, which are beyond management's control. Consequently, no assurances can
be given that the Company will not sustain loan losses, in any particular
period, that are sizable in relation to the allowance for credit losses.
Additionally, subsequent evaluations of the loan portfolio, in light of factors
then prevailing, by the Company and its regulators may indicate a requirement
for increases in the allowance for credit losses through charges to the
provision for credit losses.
On January 9, 1998, the Company completed its acquisition of HB for $34.5
million. The Company issued approximately 540,000 shares, primarily treasury
shares, with an aggregate market value of $17.9 million and paid the remainder
in cash. HB had total assets, loans and deposits of $241.8 million, $152.8
million and $221.3 million, respectively, at December 31, 1997. The acquisition
of HB resulted in the recording of goodwill and intangibles of approximately
$24.0 million.
On January 12, 1998, the Company's wholly owned subsidiary, City National
Bank, issued $125 million of 6 3/8% Subordinated Notes, due in 2008, in a
private offering. Proceeds, which qualify as Tier II capital, were used for
general corporate purposes.
On February 27, 1998, the Company sold its Wilmington branch, which was
acquired as part of the 1997 acquisition of VCNB, to Banco Popular, N.A.
(California). With the sale the purchaser received approximately $40 million of
deposits.
On May 15, 1998, the Bank closed its former Magnolia branch, which had been
acquired as part of the Company's 1997 acquisition of RNB, transferring accounts
to other nearby offices.
In September 1998, the Company announced a program for the repurchase of up
to 1.0 million shares of its common stock. At December 31, 1998, a total of
128,000 shares had been repurchased at a cost of $3.5 million, or an average
price of $27.38 per share. Also in September, the Company completed another 1.0
million common shares stock buyback program that had been announced in April at
a cost of $34.3 million, or an average price of $34.27 per share. On April 29,
1998, the Company completed a share repurchase program announced in March 1997
of 1.5 million shares of its common stock at a total cost of $42.7 million, or
an average price of $28.46 per share.
On December 31, 1998, the Company completed its acquisition of North
American Trust Company (NATC), an independent trust company, for $11.5 million
in an all cash transaction. NATC had approximately $4 billion in total assets
under management or administration.
The Company paid dividends of $0.56 per share of common stock in 1998 and
$0.44 per share of common stock in 1997. On January 27, 1999, the Board of
Directors authorized a regular quarterly cash dividend on common stock at an
increased rate of $0.165 per share to shareholders of record on February 10,
1999, payable on February 22, 1999.
A-4
RESULTS OF OPERATIONS
OPERATIONS SUMMARY
INCREASE INCREASE
(DECREASE) (DECREASE) YEAR ENDED DECEMBER
YEAR ---------------------- YEAR ---------------------- 31,
DOLLARS IN THOUSANDS ENDED % ENDED % --------------------
EXCEPT PER SHARE AMOUNTS 1998 AMOUNT -- 1997 AMOUNT -- 1996 1995
- - -------------------------------- --------- ----------- --------- ----------- --------- ---------
Interest income(1).............. $ 434,512 $ 67,007 18 $ 367,505 $ 79,456 28 $ 288,049 $ 219,626
Interest expense................ 130,278 25,950 25 104,328 21,939 27 82,389 55,331
-- --
--------- ----------- --------- ----------- --------- ---------
Net interest income............. 304,234 41,057 16 263,177 57,517 28 205,660 164,295
Provision for credit losses..... -- -- -- -- -- -- -- --
Noninterest income.............. 67,684 14,266 27 53,418 9,423 21 43,995 34,566
Noninterest expense:
Staff expense................. 114,965 17,331 18 97,634 20,623 27 77,011 65,375
Other expense................. 96,366 12,243 15 84,123 16,539 24 67,584 52,701
-- --
--------- ----------- --------- ----------- --------- ---------
Total....................... 211,331 29,574 16 181,757 37,162 26 144,595 118,076
-- --
--------- ----------- --------- ----------- --------- ---------
Income before income taxes...... 160,587 25,749 19 134,838 29,778 28 105,060 80,785
Income taxes.................... 53,796 8,600 19 45,196 12,625 39 32,571 29,961
Less: adjustments(1)............ 10,563 1,054 11 9,509 3,583 60 5,926 2,032
-- --
--------- ----------- --------- ----------- --------- ---------
Net income.................. $ 96,228 $ 16,095 20 $ 80,133 $ 13,570 20 $ 66,563 $ 48,792
-- --
-- --
--------- ----------- --------- ----------- --------- ---------
--------- ----------- --------- ----------- --------- ---------
Net income per share,
diluted................... $ 2.00 $ 0.32 19 $ 1.68 $ 0.21 14 $ 1.47 $ 1.06
-- --
-- --
--------- ----------- --------- ----------- --------- ---------
--------- ----------- --------- ----------- --------- ---------
DOLLARS IN THOUSANDS
EXCEPT PER SHARE AMOUNTS 1994
- - -------------------------------- ---------
Interest income(1).............. $ 182,960
Interest expense................ 38,414
---------
Net interest income............. 144,546
Provision for credit losses..... 7,535
Noninterest income.............. 32,797
Noninterest expense:
Staff expense................. 64,396
Other expense................. 51,603
---------
Total....................... 115,999
---------
Income before income taxes...... 53,809
Income taxes.................... 15,511
Less: adjustments(1)............ 1,135
---------
Net income.................. $ 37,163
---------
---------
Net income per share,
diluted................... $ 0.81
---------
---------
- - ------------------------------
(1) Includes amounts to convert nontaxable income to a fully taxable equivalent
basis.
OPERATIONS SUMMARY ANALYSIS
NET INTEREST INCOME
1998 COMPARED WITH 1997
Taxable equivalent net interest income totaled $304.2 million in 1998, up
$41.1 million, or 15.6% from 1997. The increase from 1997 to 1998 was due to a
$897.4 million, or 20.9% increase in average total earning assets less a
decrease in the net interest margin to 5.86% from 6.13% despite interest
recovered on nonaccrual and charged off loans increasing $0.7 million for the
year.
Average loans increased to $4,213.9 million in 1998 from $3,387.8 million in
1997, an increase of $826.1 million or 24.4%. The majority of this increase
reflects higher average commercial loans outstanding, up $562.5 million or
34.6%. This increase resulted from the Bank's increased marketing efforts,
including the formation of several specialized industry teams in 1998 and the
expanding of the media-communications group, the acquisition of HB and
participations in domestic bank non-relationship syndicated loans that add
geographic and industry diversification and liquidity to the portfolio. Average
residential first mortgage loans increased $86.6 million or 9.2% due to
continued strong internal loan originations, primarily of fixed rate mortgages.
Average construction loans increased $63.9 million or 50.0% due to the Bank's
emphasis in this area. Average real estate mortgage loans increased $108.1
million or 16.7% primarily due to the impact of the acquisition of HB. Average
loan balances are expected to increase in 1999, resulting from continued loan
growth.
Average total investment and available-for-sale securities increased $12.8
million or 1.5% between 1997 and 1998 from investing excess deposit and
borrowing growth which were not yet needed to fund loan growth.
Average noninterest-bearing deposits increased to $1,858.0 million in 1998
from $1,522.7 million in 1997, an increase of $335.2 million or 22.0%, while
average interest-bearing core deposits increased to $1,648.6 million in 1998
from $1,556.9 million in 1997, an increase of $91.7 million or 5.9%. Average
time deposits of $100,000 or more increased $226.6 million or 42.4% between 1997
and 1998. These increases resulted from the Bank's increased marketing efforts
as well as from the acquisition of HB.
A-5
RATIOS TO AVERAGE ASSETS
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
Net interest income(1)............................................ 5.40% 5.59% 5.38% 5.76% 5.10%
Noninterest income................................................ 1.20 1.14 1.15 1.21 1.16
Less provision for credit losses.................................. -- -- -- -- 0.27
Less noninterest expense:
Staff expense................................................... 2.04 2.08 2.02 2.29 2.27
Other expense................................................... 1.59 1.67 1.72 1.85 1.82
Amortization of goodwill and core deposit intangibles........... 0.12 0.12 0.04 -- --
--- --- --- --- ---
Total......................................................... 3.75 3.87 3.78 4.14 4.09
--- --- --- --- ---
Income before income taxes(1)..................................... 2.85 2.86 2.75 2.83 1.90
Income taxes and adjustments(1)................................... 1.14 1.16 1.01 1.12 0.59
--- --- --- --- ---
Net income........................................................ 1.71% 1.70% 1.74% 1.71% 1.31%
--- --- --- --- ---
--- --- --- --- ---
- - ------------------------
(1) Fully taxable equivalent basis.
1997 COMPARED WITH 1996
Taxable equivalent net interest income totaled $263.2 million in 1997, up
$57.5 million, or 28.0% from 1996. The increase from 1996 to 1997 was due to a
$785.0 million, or 22.4% increase in total earning assets and an increase in the
net interest margin to 6.13% from 5.87%.
Average loans increased to $3,387.8 million in 1997 from $2,539.3 million in
1996, an increase of $848.5 million or 33.4%. The majority of this increase
reflects higher average commercial loans outstanding, up $500.0 million or
44.5%. This increase resulted from the Bank's increased marketing efforts,
including the formation of several specialized industry teams in 1997, the
acquisitions of VCNB and RNB and participations in domestic bank
non-relationship syndicated loans that add geographic and industry
diversification and liquidity to the portfolio. Average residential first
mortgage loans increased $158.7 million or 20.3% due to continued strong
internal loan originations, primarily of fixed rate mortgages. The Company
purchased $74.7 million in single family mortgages during 1997, which was
substantially less than mortgage loan repayments and prepayments from purchased
mortgages. Average construction loans increased $39.4 million or 44.5% due to
the Bank's emphasis in this area. Average real estate mortgage loans increased
$138.1 million or 27.1% primarily due to the impact of the acquisitions of VCNB
and RNB.
Average total investment and available-for-sale securities decreased $10.0
million or 1.2% between 1996 and 1997 as a result of the redeployment of the
proceeds from securities maturities and sales to fund the growth in loans.
Average noninterest-bearing deposits increased to $1,522.7 million in 1997
from $1,193.0 million in 1996, an increase of $329.7 million or 27.6%, while
average interest-bearing core deposits increased to $1,556.9 million in 1997
from $1,315.3 million in 1996, an increase of $241.6 million or 18.4%. Average
time deposits of $100,000 or more increased $170.8 million or 47.0% between 1996
and 1997. These increases resulted from the Bank's increased marketing efforts
as well as from the acquisitions of VCNB and RNB.
The following table shows the change in net interest income broken down
between volume and rate. The change in interest due to both rate and volume has
been allocated to the change due to volume and rate in proportion to the
relationship of the absolute dollar amounts of the change in each.
A-6
CHANGES IN NET INTEREST INCOME
1998 VS 1997 1997 VS 1996
---------------------------------- ---------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO NET DUE TO NET
DOLLARS IN THOUSANDS--FULLY TAXABLE --------------------- INCREASE -------------------- INCREASE
EQUIVALENT BASIS VOLUME RATE (DECREASE) VOLUME RATE (DECREASE)
- - --------------------------------------------- --------- ---------- ----------- --------- --------- -----------
Interest earned on:
Interest-bearing deposits in other banks... $ 404 $ 32 $ 436 $ (1,112) $ (249) $ (1,361)
Loans...................................... 72,739 (10,111) 62,628 77,116 3,618 80,734
Investment securities...................... (1,278) (501) (1,779) 3,421 144 3,565
Securities available-for-sale.............. 2,191 1,044 3,235 (3,893) 1,874 (2,019)
Trading account securities................. 473 (143) 330 636 162 798
Federal funds sold and securities purchased
under resale agreements.................. 2,239 (82) 2,157 (2,255) (6) (2,261)
--------- ---------- ----------- --------- --------- -----------
Total interest-earning assets............ 76,768 (9,761) 67,007 73,913 5,543 79,456
--------- ---------- ----------- --------- --------- -----------
Interest paid on:
Interest checking.......................... 183 (109) 74 513 239 752
Money market deposits...................... 2,863 160 3,023 2,114 292 2,406
Savings deposits........................... 19 447 466 1,238 13 1,251
Other time deposits........................ 10,691 (306) 10,385 13,400 724 14,124
Other borrowings........................... 11,372 630 12,002 2,289 1,117 3,406
--------- ---------- ----------- --------- --------- -----------
Total interest-bearing liabilities....... 25,128 822 25,950 19,554 2,385 21,939
--------- ---------- ----------- --------- --------- -----------
$ 51,640 $ (10,583) $ 41,057 $ 54,359 $ 3,158 $ 57,517
--------- ---------- ----------- --------- --------- -----------
--------- ---------- ----------- --------- --------- -----------
A-7
The following table shows average balances and interest rates for the last
five years.
NET INTEREST INCOME SUMMARY
1998 1997
----------------------------------- -----------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
DOLLARS IN THOUSANDS BALANCE EXPENSE(1) RATE BALANCE EXPENSE(1) RATE
- - ---------------------------------------------- --------- ----------- ----------- --------- ----------- -----------
ASSETS
Earning assets(2)
Loans:
Commercial.............................. $2,186,395 $ 195,288 8.93% $1,623,851 $ 150,528 9.27%
Residential first mortgage.............. 1,028,966 76,874 7.47 942,381 73,199 7.77
Real estate construction................ 191,782 20,874 10.88 127,867 15,004 11.73
Real estate commercial mortgage......... 755,752 71,976 9.52 647,658 63,662 9.83
Installment............................. 50,958 5,044 9.90 46,027 5,035 10.94
--------- ----------- --------- -----------
Total loans(3).......................... 4,213,853 370,056 8.78 3,387,784 307,428 9.07
Due from banks--interest bearing.......... 9,504 536 5.64 2,238 100 4.47
State and municipal investment
securities.............................. 103,491 7,044 6.81 105,325 7,400 7.03
Taxable investment securities............. 100,350 6,260 6.24 117,874 7,683 6.52
Securities available-for-sale............. 638,505 44,057 6.90 606,358 40,822 6.73
Federal funds sold and securities
purchased under resale agreements....... 66,379 3,458 5.21 23,485 1,301 5.54
Trading account securities................ 55,815 3,101 5.56 47,389 2,771 5.85
--------- ----------- --------- -----------
Total earning assets.................... 5,187,897 434,512 8.38 4,290,453 367,505 8.57
----------- -----------
Allowance for credit losses............... (137,257) (136,587)
Cash and due from banks................... 310,201 327,013
Other nonearning assets................... 272,988 223,007
--------- ---------
Total assets............................ $5,633,829 $4,703,886
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
Interest checking accounts................ 385,075 3,751 0.97 $ 366,997 3,677 1.00
Money market accounts..................... 892,765 27,018 3.03 797,902 23,995 3.01
Savings deposits.......................... 169,606 6,167 3.64 169,030 5,701 3.37
Time deposits--under $100,000............. 201,152 10,428 5.18 222,972 11,414 5.12
Time deposits--$100,000 and over.......... 761,048 39,873 5.24 534,431 28,502 5.33
--------- ----------- --------- -----------
Total interest--bearing deposits........ 2,409,646 87,237 3.62 2,091,332 73,289 3.50
Federal funds purchased and securities
sold under repurchase agreements........ 407,315 21,824 5.36 222,617 11,731 5.27
Other borrowings.......................... 355,820 21,217 5.96 338,930 19,308 5.70
--------- ----------- --------- -----------
Total interest--bearing liabilities..... 3,172,781 130,278 4.11 2,652,879 104,328 3.93
----------- -----------
Noninterest--bearing deposits............... 1,857,956 1,522,736
Other liabilities........................... 64,666 55,428
Shareholders' equity........................ 538,426 472,843
--------- ---------
Total liabilities and shareholders'
equity................................ $5,633,829 $4,703,886
--------- ---------
--------- ---------
Net interest spread........................... 4.27% 4.64%
----- -----
----- -----
Fully taxable equivalent net interest
income...................................... $ 304,234 $ 263,177
----------- -----------
----------- -----------
Net interest margin........................... 5.86% 6.13%
----- -----
----- -----
- - ------------------------------
(1) Fully taxable equivalent basis.
(2) Includes average nonaccrual loans of $32,140, $37,879, $45,813, $46,931 and
$69,164 for 1998, 1997, 1996, 1995 and 1994, respectively.
(3) Loan income includes loan fees of $12,185, $8,857, $7,492, $6,850 and $6,835
for 1998, 1997, 1996, 1995 and 1994, respectively.
A-8
1996 1995 1994
- - ----------------------------------- ----------------------------------- -----------------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST AVERAGE INCOME/ INTEREST
BALANCE EXPENSE(1) RATE BALANCE EXPENSE(1) RATE BALANCE EXPENSE(1) RATE
- - --------- ----------- ----------- --------- ----------- ----------- --------- ----------- -----------
$1,123,819 $ 101,039 8.99% $ 874,875 $ 88,629 10.13% $ 865,672 $ 74,893 8.65%
783,648 62,293 7.95 375,932 29,454 7.83 68,768 4,541 6.60
88,498 10,295 11.63 49,160 6,168 12.55 17,947 1,853 10.32
509,565 49,452 9.70 423,462 42,297 9.99 545,724 45,474 8.33
33,793 3,615 10.70 35,242 3,570 10.13 39,886 3,959 9.93
- - --------- ----------- --------- ----------- --------- -----------
2,539,323 226,694 8.93 1,758,671 170,118 9.67 1,537,997 130,720 8.50
25,989 1,461 5.62 7,151 424 5.93 655 17 2.60
57,461 4,061 7.07 23,793 1,717 7.22 17,799 1,320 7.42
116,970 7,457 6.38 516,495 27,709 5.36 697,421 34,070 4.89
665,133 42,841 6.44 164,834 10,519 6.38 139,603 8,301 5.95
64,230 3,562 5.55 116,387 7,013 6.03 173,451 7,264 4.19
36,316 1,973 5.43 37,105 2,126 5.73 27,315 1,268 4.64
- - --------- ----------- --------- ----------- --------- -----------
3,505,422 288,049 8.22 2,624,436 219,626 8.37 2,594,241 182,960 7.05
----------- ----------- -----------
(129,788) (110,570) (113,100)
284,331 239,032 249,768
161,349 96,909 100,562
- - --------- --------- ---------
$3,821,314 $2,849,807 $2,831,471
- - --------- --------- ---------
- - --------- --------- ---------
$ 316,146 2,925 0.93 $ 268,593 2,638 0.98 $ 285,983 2,758 0.96
726,942 21,589 2.97 595,467 16,892 2.84 719,203 16,212 2.25
132,591 4,450 3.36 79,391 1,564 1.97 95,097 1,869 1.97
139,572 7,196 5.16 80,341 3,826 4.76 88,195 3,226 3.66
363,659 18,596 5.11 140,020 7,119 5.08 145,463 4,958 3.41
- - --------- ----------- --------- ----------- --------- -----------
1,678,910 54,756 3.26 1,163,812 32,039 2.75 1,333,941 29,023 2.18
253,853 12,835 5.06 287,015 16,404 5.72 215,130 8,552 3.98
265,638 14,798 5.57 114,865 6,888 6.00 20,348 839 4.12
- - --------- ----------- --------- ----------- --------- -----------
2,198,401 82,389 3.75 1,565,692 55,331 3.53 1,569,419 38,414 2.45
----------- ----------- -----------
1,192,960 898,600 907,234
56,462 34,964 41,622
373,491 350,551 313,196
- - --------- --------- ---------
$3,821,314 $2,849,807 $2,831,471
- - --------- --------- ---------
- - --------- --------- ---------
4.47% 4.84% 4.60%
----- ----- -----
----- ----- -----
$ 205,660 $ 164,295 $ 144,546
----------- ----------- -----------
----------- ----------- -----------
5.87% 6.26% 5.57%
----- ----- -----
----- ----- -----
A-9
PROVISION FOR CREDIT LOSSES
The provision for credit losses charged to operations reflects management's
judgment of the adequacy of the allowance for credit losses and is determined
through periodic analysis of the loan portfolio. This analysis includes a
detailed review of the classification and categorization of problem and
potential problem loans and loans to be charged off; an assessment of the
overall quality and collectibility of the portfolio; and consideration of the
loan loss experience, trends in problem loans and concentrations of credit risk,
as well as current and expected future economic conditions (particularly in
Southern California). The Bank has an internal risk analysis and review staff
that ultimately reports to the Audit Committee of the Board of Directors and
continuously reviews loan quality. Such reviews also assist management in
establishing the level of the allowance for credit losses.
Since 1994, the Company has not recorded a provision for credit losses. In
1998 and 1996, net chargeoffs totaled $5.2 million and $1.4 million,
respectively compared with net recoveries of $0.7 million and $7.1 million in
1997 and 1995, respectively. The Company did not record a provision for credit
losses for the last four years because of the combination of loan growth; low
net chargeoffs including net recoveries in two of the four years; a change in
the risk profile of the loan portfolio, 23% of which now consists of residential
first mortgages; the continued reduction in problem loans; and the improvement
of the Southern California economy. Based on continued loan growth, the level of
nonperforming loans, anticipated recoveries in the first half of 1999 of loans
previously charged-off and a relatively constant level of chargeoffs, it is
anticipated that the level of the allowance will remain stable through the first
half of 1999 without a provision for credit losses. However, credit quality will
be influenced by underlying trends in the economic cycle, particularly in
Southern California, and other factors which are beyond management's control.
Consequently, no assurances can be given that the Company will not sustain loan
losses, in any particular period, that are sizable in relation to the allowance
for credit losses. Additionally, subsequent evaluation of the loan portfolio, in
light of factors then prevailing, by the Company and its regulators may indicate
a requirement for increases in the allowance for credit losses through charges
to the provision for credit losses.
NONINTEREST INCOME
Noninterest income in 1998 totaled $67.7 million, up $14.3 million or 26.7%
from 1997 which was up $9.4 million or 21.4% from 1996. A breakdown of
noninterest income by category is reflected below.
ANALYSIS OF CHANGES IN NONINTEREST INCOME
INCREASE (DECREASE) INCREASE (DECREASE)
---------------------- ----------------------
DOLLARS IN MILLIONS 1998 AMOUNT % 1997 AMOUNT %
- - ----------------------------------------------------------- --------- ----------- --- --------- ----------- ---
Service charges on deposit accounts........................ $ 17.4 $ 3.1 21.4 $ 14.3 $ 3.5 32.4
Investment services........................................ 16.3 3.1 24.0 13.2 1.7 14.8
Trust fees................................................. 9.4 1.1 12.9 8.3 1.1 15.3
International services..................................... 8.1 0.8 11.5 7.3 2.1 40.4
Bank owned life insurance.................................. 2.1 2.1 -- -- -- --
Gain on sale of loans and assets........................... 1.8 0.2 12.5 1.6 0.5 45.5
Gain (loss) on sale of securities.......................... 3.1 4.1 NM (1.0) (1.2) NM
All other income........................................... 9.5 (0.2) (2.1) 9.7 1.7 21.3
--------- ----- --- --------- ----- ---
Total.................................................. $ 67.7 $ 14.3 26.7 $ 53.4 $ 9.4 21.4
--------- ----- --- --------- ----- ---
--------- ----- --- --------- ----- ---
DOLLARS IN MILLIONS 1996
- - ----------------------------------------------------------- ---------
Service charges on deposit accounts........................ $ 10.8
Investment services........................................ 11.5
Trust fees................................................. 7.2
International services..................................... 5.2
Bank owned life insurance.................................. --
Gain on sale of loans and assets........................... 1.1
Gain (loss) on sale of securities.......................... 0.2
All other income........................................... 8.0
---------
Total.................................................. $ 44.0
---------
---------
Service charges on deposit accounts increased $3.1 million, or 21.4%,
compared to a 32.4% increase in 1997. The increase in 1998 is the result of the
acquisition of HB and strong growth in deposits as well as higher service charge
rates. The increase in 1997 was the result of the acquisitions of VCNB and RNB
and strong growth in deposits. Service charges on deposit accounts are expected
to increase in 1999 primarily as a result of higher service charge rates.
A-10
Investment services income, which includes fees, commissions and markups on
securities transactions with customers, and fees on money market mutual funds,
increased in 1998, compared to 1997, by $3.1 million or 24.0% primarily due to
new investment products offered to customers and an increase in customers. Trust
fees increased by $1.1 million, or 12.9% from 1997 to 1998 due to upgrading
existing customers and to an increased number of customers. The increase in
investment services income and trust fees from 1996 to 1997 was also
attributable to the same factors discussed above. At December 31, 1998 the
Company had approximately $14.9 billion of assets, including $1.8 billion in
money market funds, under custody or management in City National Investments,
compared to $7.6 billion at December 31, 1997. Although it is expected that
there will be some attrition in assets under custody or management from the
amounts acquired as part of the NATC acquisition, investment services income and
trust fees are expected to increase in 1999 primarily as a result of the
acquisition of NATC and a continued emphasis on developing and marketing new
products in these areas.
International fee income increased $0.8 million or 11.5% from 1997 to 1998
and $2.1 million or 40.4% from 1996 to 1997 due to the hiring of several
experienced foreign exchange traders and the expansion of international
activities. International income is expected to increase in 1999, although at a
slower rate than in past years. In 1998, the Company purchased Bank Owned Life
Insurance which generated $2.1 million of income for the year.
Gains on the sale of available-for-sale securities in 1998 totaled $3.1
million compared to losses of $1.0 million in 1997 and gains of $0.2 million in
1996, respectively.
NONINTEREST EXPENSE
Noninterest expense totaled $211.3 million in 1998, up $29.5 million or
16.2% from 1997 which was up $37.2 million or 25.7% from 1996. A breakdown of
noninterest expense by category is reflected below.
ANALYSIS OF CHANGES IN NONINTEREST EXPENSE*
INCREASE (DECREASE) INCREASE (DECREASE)
---------------------- ----------------------
DOLLARS IN MILLIONS 1998 AMOUNT % 1997 AMOUNT %
- - ------------------------------------------------------- --------- ----------- --------- --------- ----------- ---------
Salaries and employee benefits......................... $ 115.0 $ 17.4 17.8 $ 97.6 $ 20.6 26.8
--------- ----- --------- --------- ----- ---------
All Other:
Professional......................................... 23.4 5.5 30.7 17.9 6.4 55.7
Net occupancy of premises............................ 14.2 2.1 17.4 12.1 3.1 34.4
Information services................................. 8.8 (3.9) (30.7) 12.7 1.8 16.5
Marketing and advertising............................ 10.3 2.3 28.8 8.0 2.4 42.9
Depreciation......................................... 8.8 2.7 44.3 6.1 1.0 19.6
Office supplies...................................... 7.3 -- -- 7.3 2.5 52.1
Amortization of goodwill and core deposit
intangibles........................................ 6.9 1.3 23.2 5.6 4.1 N/M
Equipment............................................ 2.3 (0.2) (8.0) 2.5 0.3 13.6
Other operating...................................... 14.3 2.3 19.2 12.0 (5.0) (29.4)
--------- ----- --------- --------- ----- ---------
Total all other.................................... 96.3 12.1 14.4 84.2 16.6 24.6
--------- ----- --------- --------- ----- ---------
Total............................................ $ 211.3 $ 29.5 16.2 $ 181.8 $ 37.2 25.7
--------- ----- --------- --------- ----- ---------
--------- ----- --------- --------- ----- ---------
DOLLARS IN MILLIONS 1996
- - ------------------------------------------------------- ---------
Salaries and employee benefits......................... $ 77.0
---------
All Other:
Professional......................................... 11.5
Net occupancy of premises............................ 9.0
Information services................................. 10.9
Marketing and advertising............................ 5.6
Depreciation......................................... 5.1
Office supplies...................................... 4.8
Amortization of goodwill and core deposit
intangibles........................................ 1.5
Equipment............................................ 2.2
Other operating...................................... 17.0
---------
Total all other.................................... 67.6
---------
Total............................................ $ 144.6
---------
---------
*Certain prior years' data have been reclassified to conform to current year
presentation.
Staff expense increased 17.8% in 1998 compared to a 26.8% increase in 1997.
The increase in 1998 and 1997 is the result of the additional personnel that
joined the Bank as a result of the acquisitions, the hiring of new personnel in
the Bank's expansion efforts and higher costs associated with performance
incentives and contributions to the City National Corporation Profit Sharing
Plan. On a full-time equivalent basis, staff levels have increased to 1,670 at
December 31, 1998 from 1,570 at December 31, 1997. Staff levels are expected to
increase slightly in 1999.
A-11
The remaining expense categories increased $12.1 million, or 14.4%, between
1997 and 1998. The increase in professional expense resulted primarily from
higher customer service expense on increased deposits. Marketing and advertising
expense has grown as the Company expanded its advertising program. The increase
in depreciation expense resulted from the Company's capital expenditures during
1998 of $18.0 million. The decrease in information services in 1998 relates to
the absence of costs incurred in 1997 for data processing conversions and the
buyout of the Company's former data processing contract. Amortization of
goodwill and core deposit intangibles increased $1.3 million due to the
acquisition of HB. Other expense in 1998 includes a $0.8 million charge for NATC
integration expenses of which $0.6 million was paid in 1998 and $0.2 million
will be paid during the first half of 1999. The remaining other increases
resulted from the acquisition of HB, higher operating losses and other factors.
Due to the acquisition of NATC on December 31, 1998, most categories of
noninterest expense are expected to increase in 1999.
The remaining expense categories increased $16.6 million, or 24.6%, between
1996 and 1997. The increase in professional expense resulted primarily from $3.1
million in consulting and other professional fees attributed to the conversion
to the new data processing system which was completed in the latter part of
1997. The increase in marketing and advertising expense resulted from the
Company's expanded advertising program. The increase in depreciation expense
resulted from the Company's expenditures during 1997 totaling $17.7 million for
new PC's, item processing and telecommunications equipment as well as the major
remodeling of several floors in City National Center, the Company's headquarters
building. The increase in office expense resulted from higher office supplies
and telecommunications expenses due to the increased number of personnel and
branches, primarily resulting from the acquisitions of VCNB and RNB. In March
1997, the Company reached agreements with its insurance carriers regarding a
lender liability lawsuit which it settled with a former bank customer in the
fourth quarter of 1996. The insurance reimbursements of $2.5 million have been
credited to other noninterest expense and offset most of the $3.4 million lender
liability charge recorded in the fourth quarter of 1996. Amortization of
goodwill and core deposit intangibles increased $4.1 million due to the
acquisitions of VCNB and RNB. The remaining other increases resulted from the
acquisitions of VCNB and RNB, including $1.7 million in acquisition related
charges in 1997 compared to $0.7 million in 1996, higher operating losses and
other factors. ORE operations included in other operating expense resulted in
net income of $0.2 million, $2.6 million and $0.2 million in 1998, 1997 and
1996, respectively. The $2.6 million income from ORE activities in 1997 was
primarily due to the sale of properties.
The Year 2000 issue is the result of computer programs written using two
digits (rather than four) to define years. Computers or other equipment with
date-sensitive software may recognize "00" as 1900 rather than 2000. This could
result in system failure or miscalculations. If the Company or significant
customers, suppliers or other third parties fail to correct Year 2000 issues,
the Company's ability to operate could be affected. Following is the Company's
"Year 2000 Readiness Disclosure":
"During 1998, efforts continued to address Year 2000 matters in accordance
with the Company's five-phase project plan which covers information technology
as well as embedded systems. The five phases are awareness, assessment,
renovation, validation and implementation with contingency planning as a part of
the validation phase. As previously reported, the first two phases of awareness
and assessment have been completed. The Company has now completed approximately
85% of its renovation phase. The renovation phase pertains only to internal
programs and applications that are not mission critical. There are no mission
critical systems requiring renovation. As part of the validation phase, the
Company has certified as Year 2000 ready 100% of its internal mission critical
hardware and software applications and has certified approximately 50% of non
mission critical hardware and software applications as Year 2000 ready. The
Company expects to complete the validation of external service bureau and third
party vendors by March 31, 1999. On October 4, 1998, M&I, the Bank's core
processing provider, successfully completed the Year 2000 upgrade of its
software. The upgrade had no production impact on either Bank customers or the
Bank. Final Year 2000 certification will be completed with M&I by the end of the
first quarter of 1999. In accordance with the Federal Financial Institution
Examination Council's guidances, the Company
A-12
expects to complete its implementation of mission critical internal and external
systems and applications by June 30, 1999. The Company has developed a
contingency plan for each of its mission critical business functions which
establish trigger dates for implementation of the plan for each software
application that is not Year 2000 compliant. However, these plans do not
guarantee that circumstances beyond the Company's control will not adversely
impact operations. At this time, based on assessments and testing to date, the
Company does not foresee any Year 2000 issues that would materially impair the
Bank's ability to conduct business.
The Company is engaged in the ongoing process of considering and examining
whether or not there would be a material effect on its business, net income or
balance sheet if its vendors, suppliers and customers do not become Year 2000
compliant in a timely manner. With regard to customer readiness, the Company has
queried and continues to query all commercial borrowers with loans of $1.0
million and over. For those customers having responded, it has been determined
that the customer base would either be only slightly impacted by Year 2000
matters or the customer's compliance efforts at this time are satisfactory. In
addition, there is a group of customers who have indicated their compliance will
be in the future and the Company continues to monitor their progress. The
Company is also considering customized action plans and disengagement strategies
for any high risk borrowers. Where the Company is a third party vendor to
customers, as in the area of cash management, it is believed at this time, that
the Company will reach readiness by March 31, 1999. However, if the Company is
not compliant, customers will be allowed to terminate their contracts. The loss
of revenue from this type of relationship would not be material. The Company's
analysis of the corporate counterparties for its investments and current hedging
position is underway and the effect if any should be finalized by March 31,
1999."
In 1998, approximately $1.7 million was directly and indirectly expensed on
Year 2000 matters. This amount excludes hardware and software that was replaced
in the normal course of business. Total direct and indirect expenses are
expected to be at the same level in 1999.
INCOME TAXES
The 1998 effective tax rate was 35.9% compared to 36.1% in 1997 and 32.9% in
1996. The effective rates differed from the applicable statutory federal tax
rate due to various factors including state taxes, tax exempt income including
interest on bank owned life insurance, amortization of nondeductible goodwill
and recognition of previously unrecorded deferred tax benefits.
The Company recognized $5.0 million in previously unrecorded California
deferred tax benefits in 1996 resulting from the Company's continued and
increasing profitability and the Company's evaluation of deferred tax assets
which it believes are more likely than not to be realized on future tax returns.
The effective tax rate for 1999 is expected to increase but will still be
below the combined statutory federal and California tax rates due to the impact
of municipal securities and leases, bank owned life insurance, the dividends
received deduction for preferred stock, and tax credits from investments in low
income housing.
A-13
BALANCE SHEET ANALYSIS
CAPITAL
At December 31, 1998, the Company's and the Bank's Tier 1 capital, which is
comprised of common shareholders' equity as modified by certain regulatory
adjustments, amounted to $474.9 million and $446.5 million, respectively. At
December 31, 1997, the Company's and the Bank's Tier 1 capital amounted to
$448.0 million and $381.6 million, respectively. The increase from December 31,
1997 resulted from retention of 1998 earnings, the issuance of shares for the
acquisition of HB and the exercise of stock options, less dividends paid and
amounts related to shares repurchased.
The following table presents the regulatory standards for well capitalized
institutions and the capital ratios for the Company and the Bank at December 31,
1998, 1997 and 1996.
REGULATORY DECEMBER 31
WELL CAPITALIZED -------------------------------
STANDARDS 1998 1997 1996
----------------- --------- --------- ---------
CITY NATIONAL CORPORATION
Tier 1 leverage................................ 4.00% 7.99% 9.19% 9.75%
Tier 1 risk-based capital...................... 6.00 9.43 10.99 13.26
Total risk-based capital....................... 10.00 13.20 12.27 14.55
CITY NATIONAL BANK
Tier 1 leverage................................ 5.00 7.53 7.93 8.22
Tier 1 risk-based capital...................... 6.00 8.90 9.50 11.24
Total risk-based capital....................... 10.00 12.65 10.78 12.53
The Company paid dividends totaling $0.56 per share of common stock in 1998
and $0.44 per share of common stock in 1997. On January 27, 1999, the Board of
Directors authorized a regular quarterly cash dividend on common stock at an
increased rate of $0.165 per share to shareholders of record on February 10,
1999, payable on February 22, 1999.
In September 1998, the Company announced a program for the repurchase of up
to 1.0 million shares of its common stock. At December 31, 1998, a total of
128,000 shares had been repurchased at a cost of $3.5 million, or an average
price of $27.38 per share. Also in September, the Company completed another 1.0
million common shares stock buyback program that had been announced in April at
a cost of $34.3 million, or an average price of $34.27 per share. On April 29,
1998, the Company completed a share repurchase program announced in March 1997
of 1.5 million shares of its common stock at a total cost of $42.7 million, or
an average price of $28.46 per share.
On January 12, 1998, the Company's wholly owned subsidiary, City National
Bank, issued $125 million of 6 3/8% Subordinated Notes, due in 2008.
On March 3, 1997, the Company announced that its Board of Directors had
adopted a Stockholder Rights Plan designed to assure that all City National
shareholders would receive fair treatment in the event of any future "change of
control" (as that term is defined in the Rights Plan) of the Company. The Rights
Plan provides each City National Stockholder with one right for each common
share held. Under certain conditions, each right would be exercisable to
purchase that number of City National common shares having at that time a market
value equal to two times the then current exercise price. The rights are subject
to redemption by the board of directors at $.001 per right at any time prior to
the first date upon which they become exercisable.
LIQUIDITY MANAGEMENT
The objective of liquidity management is the ability to maintain cash flow
adequate to fund the Company's operations and meet obligations and other
commitments on a timely and cost effective basis.
A-14
The Company achieves this objective through the selection of asset and liability
maturity mixes that it believes best meet the needs of the Company. The
Company's liquidity position is enhanced by its ability to raise additional
funds as needed in the money markets.
The Company's core deposit base in recent years provided the majority of the
Company's funding requirements. This relatively stable and low-cost source of
funds has, along with shareholders' equity provided 72% and 76% of funding for
average total assets in 1998 and 1997, respectively.
A significant portion of remaining funding of average total assets is
provided by short-term federal fund purchases and sales of securities under
repurchase agreements. This funding source, on average, totaled $407.3 million
and $222.6 million in 1998 and 1997, respectively. Additionally, the Bank
increased its funding from other borrowings, primarily Federal Home Loan Bank
advances, to $355.8 million on average in 1998 from $338.9 million in 1997.
Liquidity is also provided by assets such as federal funds sold, securities
purchased under resale agreements and trading account securities which may be
immediately converted to cash at minimal cost. The aggregate of these assets
averaged $122.2 million during 1998, up $51.3 million, or 72.4% from the prior
year. This increase resulted from the Company's decision to actively manage this
book of assets to generate income for the Company.
Liquidity is also provided by the portfolio of available-for-sale securities
which totals $1,012.5 million at December 31, 1998. The unpledged portion of
available-for-sale securities at December 31, 1998 totaled $450.6 million and
would be available as collateral for borrowing. Maturing loans also provide
liquidity, and $2,032.5 million of the Bank's loans are scheduled to mature in
1999.
ASSET LIABILITY MANAGEMENT
The principal objective of asset/liability management is to maximize net
interest margin subject to margin volatility and liquidity constraints. Margin
volatility results when the rate reset (or repricing) characteristics of assets
are materially different from those of the Company's liabilities. Liquidity risk
results from the mismatching of asset and liability cash flows. Management
chooses asset/liability strategies that promote stable earnings and reliable
funding. Interest rate risk and funding positions are kept within limits
established by the Company's board of directors to ensure that risk-taking is
not excessive and that liquidity is properly managed.
The Company has established three measurement processes to quantify and
manage exposure to interest rate risk: net interest income simulation modeling,
gap analysis, and present value of equity analysis. Net interest income
simulations are used to identify the direction and severity of interest rate
risk exposure across a twelve month forecast horizon. Gap analysis provides
insight into structural mismatches of assets and liability repricing
characteristics. Present value of equity calculations are used to estimate the
theoretical price sensitivity of shareholder equity to changes in interest
rates.
Generally, an asset sensitive gap indicates that net interest income will
improve during a period of rising interest rates. The gap report is based on the
contractual cash flows of all asset and liability balances on the Company's
books. The contractual life of these balances may differ substantially from
their expected lives however. For example, checking accounts are all subject to
immediate withdrawal. Experience suggests that these accounts will have an
average life of several years. Also, certain loans (such as first mortgages) are
subject to prepayment. The cash flows shown in the gap report are adjusted to
reflect these behaviors. The gap report also shows the effects that interest
rate swaps have had on the repricing profile of the Company.
The table on page A-18 shows the Company's interest rate gap position as of
December 31, 1998 and 1997. Rate sensitive assets are expected to exceed rate
sensitive liabilities by $138.0 million over the first year of the cash flow
horizon. The gap is the result of the Company's natural composition of assets
and liabilities, which include loans tied to the prime and checking account
deposits. This gap is further reduced
A-15
by interest rate swaps. The Company at December 31, 1998 had $710 million of
notional principal in "receive" fixed-pay LIBOR interest rate swaps, of which
$545 million have maturities greater than one year. The one year cumulative
hedged gap is $(407.0) million, or about six percent of total assets. From
December 31, 1997 to December 31, 1998, the Company's one year cumulative hedged
gap decreased from $131.8 million to $(407.0) million as a result of increases
in assets and interest rate swaps that do not reprice until after one year.
Since interest rate changes do not affect all categories of assets and
liabilities equally or simultaneously, a cumulative gap analysis alone cannot be
used to evaluate the Company's interest rate sensitivity position. To supplement
traditional gap analysis, the Company uses simulation modeling to estimate the
potential effects of changing interest rates. This process allows the Company to
fully explore the complex relationships within the gap over time and various
interest rate scenarios.
The following table presents in tabular form information about the Company's
financial instruments that are sensitive to changes in interest rates. The table
presents principal cash flows and related average interest rates by expected
re-pricing or maturity dates and fair values as of December 31, 1998. Expected
re-pricing or maturities of assets are contractual. Interest-bearing demand and
savings deposits are included in the earliest maturity category, even though
withdrawal of these balances is not contractually required and may not actually
occur during that period. Average interest rates on variable rate instruments
are based upon the Company's interest rate forecast. Actual re-pricing or
maturities of interest-sensitive assets and liabilities could vary substantially
from expectations if different assumptions are used or if actual experience
differs from the assumptions used.
INTEREST-SENSITIVE FINANCIAL INSTRUMENT MATURITIES
FAIR
DOLLARS IN MILLIONS 1999 2000 2001 2002 2003 THEREAFTER TOTAL VALUE
- - --------------------------------- --------- --------- --------- --------- --------- ----------- --------- ---------
INTEREST-SENSITIVE ASSETS:
LOANS
Commercial..................... $ 2,078.0 $ 102.4 $ 91.1 $ 39.4 $ 50.4 $ 96.6 $ 2,457.9 $ 2,462.6
Average interest rate........ 7.65% 6.78% 7.03% 6.58% 6.75% 6.04% 7.49%
Real estate construction....... 219.6 1.2 14.6 0.2 0.4 1.0 237.0 237.4
Average interest rate........ 8.68% 17.84% 7.99% 7.86% 8.45% 7.77% 8.68%
Real estate commercial
mortgage..................... 402.9 31.4 37.1 39.9 39.4 197.0 747.7 761.2
Average interest rate........ 8.56% 8.66% 8.51% 8.69% 8.48% 8.03% 8.42%
Residential first mortgage..... 261.8 140.4 103.8 80.2 65.1 386.9 1,038.2 1,112.5
Average interest rate........ 7.60% 7.34% 7.37% 7.38% 7.39% 7.47% 7.46%
Installment loans.............. 15.1 8.2 5.7 3.2 1.5 15.9 49.6 49.3
Average interest rate........ 11.58% 10.00% 9.75% 9.37% 8.91% 9.39% 10.18%
--------- --------- --------- --------- --------- ----------- --------- ---------
Total interest-sensitive
assets................... $ 2,977.4 $ 283.6 $ 252.3 $ 162.9 $ 156.8 $ 697.4 $ 4,530.4 $ 4,623.0
--------- --------- --------- --------- --------- ----------- --------- ---------
--------- --------- --------- --------- --------- ----------- --------- ---------
INTEREST-SENSITIVE LIABILITIES:
DEPOSITS
Interest checking.............. $ 452.2 $ $ $ $ $ $ 452.2 $ 452.2
Average interest rate........ 0.97% 0.97%
Savings........................ 183.4 183.4 183.4
Average interest rate........ 3.64% 3.64%
Money market................... 927.7 927.7 927.7
Average interest rate........ 3.03% 3.03%
Time........................... 862.6 46.3 25.8 4.6 2.0 0.1 941.4 940.4
Average interest rate........ 4.76% 5.54% 5.48% 5.94% 4.97% 6.24% 4.82%
--------- --------- --------- --------- --------- ----------- --------- ---------
Total interest-sensitive
liabilities.............. $ 2,425.9 $ 46.3 $ 25.8 $ 4.6 $ 2.0 $ 0.1 $ 2,504.7 $ 2,503.7
--------- --------- --------- --------- --------- ----------- --------- ---------
--------- --------- --------- --------- --------- ----------- --------- ---------
The use of interest rate swaps to manage interest rate exposure involves the
risk of dealing with counterparties and their ability to meet contractual terms.
These counterparties must receive appropriate
A-16
credit approval before the Company enters into an interest rate contract.
Notional principal amounts express the volume of these transactions, although
the amounts potentially subject to credit and market risk are much smaller. At
December 31, 1998, all of the Company's interest rate swaps were entered into as
hedges against a decrease in interest income generated from prime based loans if
the prime decreased or to convert fixed rate deposits and borrowings into
floating rate liabilities. The Company has not entered into transactions
involving any other interest rate derivative financial instruments, such as
interest rate floors, caps and interest rate futures contracts.
The table below shows the notional amounts of the Company's interest rate
swap maturities and average rates at December 31, 1998:
INTEREST RATE SWAP MATURITIES AND AVERAGE RATES
NOTIONAL AMOUNTS IN MILLIONS 1999 2000 2001 2002 TOTAL FAIR VALUE
- - -------------------------------------------------------- --------- --------- --------- --------- --------- -----
Receive-fixed rate (hedge loans and deposits)
Notional amount....................................... $ 165.0 $ 435.0 $ 60.0 $ 50.0 $ 710.0 $ 6.4(1)
Weighted average rate received........................ 5.89% 5.54% 5.70% 5.92% 5.66%
Weighted average rate paid............................ 5.42% 5.51% 5.29% 5.31% 5.45%
- - ------------------------------
(1) Estimated net gain to settle derivative contracts.
At December 31, 1998, the Company's outstanding foreign exchange contracts
for both those purchased as well as sold totaled $10.5 million. The Company
enters into foreign exchange contracts with its customers and counterparty banks
solely for the purpose of offsetting or hedging transaction and economic
exposures arising out of commercial transactions. The Company's policies
prohibit outright speculation by the Company and its employees. The Company
actively manages its foreign exchange exposures within prescribed risk limits
and controls. All foreign exchange contracts outstanding at December 31, 1998
had remaining maturities of six months or less.
A-17
INTEREST RATE GAP POSITION
SUBJECT TO OVER 10
IMMEDIATE 1ST REMAINDER OF YEARS > 1 YEARS > 6 YEARS &
DOLLARS IN MILLIONS REPRICING QUARTER FIRST YEAR THROUGH 5 THROUGH 10 NON-STATED TOTAL
- - -------------------------------------- ----------- --------- ------------- ----------- ------------- ----------- ---------
DECEMBER 31, 1998
ASSETS
Investment.......................... $ 415.2 $ 138.2 $ 124.1 $ 528.5 $ 199.2 $ 46.8 $ 1,452.0
Net Loans........................... 1,467.3 908.0 515.3 852.9 389.4 262.2 4,395.1
Non Earning Assets.................. 184.9 13.1 44.6 338.1 -- -- 580.7
----------- --------- ------------- ----------- ------ ----------- ---------
Total Assets...................... 2,067.4 1,059.3 684.0 1,719.5 588.6 309.0 6,427.8
----------- --------- ------------- ----------- ------ ----------- ---------
LIABILITIES
Checking Accounts................... 1,381.7 -- -- 1,001.0 -- -- 2,382.7
Other Core Deposits................. 768.4 71.9 97.3 813.3 0.1 -- 1,751.0
CDs over $100M & Other Time
Deposits.......................... -- 485.2 125.6 87.6 55.3 -- 753.7
----------- --------- ------------- ----------- ------ ----------- ---------
Total Deposits...................... 2,150.1 557.1 222.9 1,901.9 55.4 -- 4,887.4
Total Borrowed Funds................ 368.3 374.3 -- 50.0 124.0 -- 916.6
Other Liabilities................... -- -- -- 62.0 -- -- 62.0
----------- --------- ------------- ----------- ------ ----------- ---------
Total Liabilities................. 2,518.4 931.4 222.9 2,013.9 179.4 -- 5,866.0
Total Capital..................... -- -- -- -- -- 561.8 561.8
----------- --------- ------------- ----------- ------ ----------- ---------
Total Liabilities and Capital... 2,518.4 931.4 222.9 2,013.9 179.4 561.8 6,427.8
----------- --------- ------------- ----------- ------ ----------- ---------
Gap................................... $ (451.0) $ 127.9 $ 461.1 $ (294.4) $ 409.2 $ (252.8) $ --
----------- --------- ------------- ----------- ------ ----------- ---------
----------- --------- ------------- ----------- ------ ----------- ---------
Cumulative Gap........................ $ (451.0) $ (323.1) $ 138.0 $ (156.4) $ 252.8 $ --
Interest Rate Swaps................... (710.0) 35.0 130.0 545.0 -- --
----------- --------- ------------- ----------- ------ -----------
Hedged Gap............................ $(1,161.0) $ 162.9 $ 591.1 $ 250.6 $ 409.2 $ (252.8)
----------- --------- ------------- ----------- ------ -----------
----------- --------- ------------- ----------- ------ -----------
Cumulative Hedged Gap................. $(1,161.0) $ (998.1) $ (407.0) $ (156.4) $ 252.8 $ --
----------- --------- ------------- ----------- ------ -----------
----------- --------- ------------- ----------- ------ -----------
Cumulative Hedged Gap as a % of Total
Assets.............................. (18)% (16)% (6)% (2)% 4% -- %
----------- --------- ------------- ----------- ------ -----------
----------- --------- ------------- ----------- ------ -----------
DECEMBER 31, 1997
ASSETS
Investment.......................... $ 181.6 $ 85.5 $ 112.6 $ 515.8 $ 57.5 $ 60.7 $ 1,013.7
Net Loans........................... 1,518.7 612.6 384.7 718.9 314.9 137.7 3,687.5
Non Earning Assets.................. 227.3 7.7 34.1 281.7 -- 550.8
----------- --------- ------------- ----------- ------ ----------- ---------
Total Assets...................... 1,927.6 705.8 531.4 1,516.4 372.4 198.4 5,252.0
----------- --------- ------------- ----------- ------ ----------- ---------
LIABILITIES
Checking Accounts................... 1,027.0 -- -- 1,000.0 -- -- 2,027.0
Other Core Deposits................. 566.2 62.0 118.5 841.4 0.1 -- 1,588.2
CDs over $100M & Other Time
Deposits.......................... -- 406.7 183.6 22.7 0.1 -- 613.1
----------- --------- ------------- ----------- ------ ----------- ---------
Total Deposits...................... 1,593.2 468.7 302.1 1,864.1 0.2 -- 4,228.3
Total Borrowed Funds................ 259.2 150.0 9.8 50.0 -- -- 469.0
Other Liabilities................... -- -- -- 46.0 -- -- 46.0
----------- --------- ------------- ----------- ------ ----------- ---------
Total Liabilities................. 1,852.4 618.7 311.9 1,960.1 0.2 -- 4,743.3
Total Capital..................... -- -- -- -- -- 508.7 508.7
----------- --------- ------------- ----------- ------ ----------- ---------
Total Liabilities and Capital... 1,852.4 618.7 311.9 1,960.1 0.2 508.7 5,252.0
----------- --------- ------------- ----------- ------ ----------- ---------
Gap................................... $ 75.2 $ 87.1 $ 219.5 $ (443.7) $ 372.2 $ (310.3) $ --
----------- --------- ------------- ----------- ------ ----------- ---------
----------- --------- ------------- ----------- ------ ----------- ---------
Cumulative Gap........................ $ 75.2 $ 162.3 $ 381.8 $ (61.9) $ 310.3 $ --
Interest Rate Swaps................... (425.0) 50.0 125.0 250.0 -- --
----------- --------- ------------- ----------- ------ -----------
Hedged Gap............................ $ (349.8) $ 137.1 $ 344.5 $ (193.7) $ 372.2 $ (310.3)
----------- --------- ------------- ----------- ------ -----------
----------- --------- ------------- ----------- ------ -----------
Cumulative Hedged Gap................. $ (349.8) $ (212.7) $ 131.8 $ (61.9) $ 310.3 $ --
----------- --------- ------------- ----------- ------ -----------
----------- --------- ------------- ----------- ------ -----------
Cumulative Hedged Gap as a % of Total
Assets.............................. (7)% (4)% 3% (1)% 6% -- %
----------- --------- ------------- ----------- ------ -----------
----------- --------- ------------- ----------- ------ -----------
A-18
SECURITIES
Prior to December 31, 1998, the Company classified its securities as
investment, available-for-sale or trading. Those securities which the Company
had the ability and intent to hold to maturity were classified as investment
securities. Effective on December 31, 1998, these investment securities were
transferred to available-for-sale. Securities held to facilitate customer
trading orders are classified as trading securities. All other securities are
classified as available-for-sale.
Comparative period-end security portfolio balances are presented below:
INVESTMENT SECURITIES
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------ ----------------------
DOLLARS IN THOUSANDS COST FAIR VALUE COST FAIR VALUE
- - --------------------------------------------------------------- ---------- ------------ ---------- ----------
Mortgage-backed................................................ $ -- $ -- $ 107,386 $ 107,728
State and Municipal............................................ -- -- 107,567 108,756
Other debt..................................................... -- -- 3,216 3,216
---------- ------------ ---------- ----------
Total debt securities........................................ -- -- 218,169 219,700
Equity......................................................... -- -- 7,765 7,765
---------- ------------ ---------- ----------
Total securities............................................. $ -- $ -- $ 225,934 $ 227,465
---------- ------------ ---------- ----------
---------- ------------ ---------- ----------
AVAILABLE-FOR-SALE SECURITIES
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------ ----------------------
DOLLARS IN THOUSANDS COST FAIR VALUE COST FAIR VALUE
- - --------------------------------------------------------------- ---------- ------------ ---------- ----------
U.S. Government and federal agency............................. $ 268,838 $ 275,145 $ 255,552 $ 257,057
Mortgage-backed................................................ 348,826 351,469 171,439 172,075
State and Municipal............................................ 121,743 123,845 5,911 5,997
Other debt..................................................... 145,852 152,692 23,928 25,920
---------- ------------ ---------- ----------
Total debt securities........................................ 885,259 903,151 456,830 461,049
Marketable equity securities................................... 104,893 109,375 141,080 146,139
---------- ------------ ---------- ----------
Total securities............................................. $ 990,152 $ 1,012,526 $ 597,910 $ 607,188
---------- ------------ ---------- ----------
---------- ------------ ---------- ----------
At December 31, 1998, securities available-for-sale totaled $1,012.5
million, an increase of $405.3 million or 66.8% from December 31, 1997. The
transfer of investment securities to available-for-sale securities on December
31, 1998 accounted for $182.6 million of the increase. The remaining increase
was from investing a portion of deposit and borrowing growth which was not
needed to fund loan growth. The average duration of total available-for-sale
securities at December 31, 1998 was 4.3 years compared with 2.8 years for the
combined investment and available-for-sale security portfolio at December 31,
1997.
A-19
The following tables provide the expected remaining maturities and yields
(taxable-equivalent basis) of debt securities within the securities portfolio at
December 31, 1998.
AVAILABLE-FOR-SALE DEBT SECURITIES
ONE YEAR OVER 1 YEAR OVER 5 YEARS TOTAL
OR LESS THRU 5 YEARS THRU 10 YEARS OVER 10 YEARS 1998
------------------------ ---------------------- ------------------------ ---------------------- ---------
DOLLARS IN THOUSANDS AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT
- - --------------------- ----------- ----- --------- ----- ----------- ----- --------- ----- ---------
U.S. Government and
federal agency..... $ 30,411 6.15% $ 192,478 6.11% $ 52,256 6.11% $ -- -- % $ 275,145
Mortgage-backed...... 1,036 7.02 2,430 6.11 14,864 6.10 333,139 6.64 351,469
State and Municipal.. 18,715 6.36 73,083 6.73 28,397 6.42 3,650 6.46 123,845
Other debt........... -- -- 2,154 7.00 1,000 7.50 149,538 7.79 152,692
----------- --- --------- --- ----------- --- --------- --- ---------
Total debt
securities....... $ 50,162 6.25% $ 270,145 6.28% $ 96,517 6.21% $ 486,327 6.99% $ 903,151
----------- --- --------- --- ----------- --- --------- --- ---------
----------- --- --------- --- ----------- --- --------- --- ---------
Amortized cost..... $ 49,712 $ 263,726 $ 95,008 $ 476,813 $ 885,259
----------- --------- ----------- --------- ---------
----------- --------- ----------- --------- ---------
TOTAL TOTAL
1997 1996
---------------------- ----------------------
DOLLARS IN THOUSANDS YIELD AMOUNT YIELD AMOUNT YIELD
- - --------------------- ----- --------- ----- --------- -----
U.S. Government and
federal agency..... 6.11% $ 257,057 6.31% $ 372,316 5.69%
Mortgage-backed...... 6.61 172,075 6.66 127,936 6.28
State and Municipal.. 6.60 5,997 6.71 14,067 6.76
Other debt........... 7.78 25,920 7.79 34,011 5.11
--- --------- --- --------- ---
Total debt
securities....... 6.65% $ 461,049 6.67% $ 548,330 5.82%
--- --------- --- --------- ---
--- --------- --- --------- ---
Amortized cost..... $ 456,830 $ 553,537
--------- ---------
--------- ---------
INVESTMENT DEBT SECURITIES
ONE YEAR OVER 1 YEAR OVER 5 YEARS TOTAL
OR LESS THRU 5 YEARS THRU 10 YEARS OVER 10 YEARS 1998
------------------------ ---------------------- ------------------------ ---------------------- ---------
DOLLARS IN THOUSANDS AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT
- - --------------------- ----------- ----- --------- ----- ----------- ----- --------- ----- ---------
Mortgage-backed...... % % % % $ --
State and Municipal.. --
Other debt........... --
----------- --- --------- --- ----------- --- --------- --- ---------
Total debt
securities....... $ -- % $ -- % $ -- % $ -- % $ --
----------- --------- ----------- --------- ---------
----------- --------- ----------- --------- ---------
Fair value......... $ -- $ -- $ -- $ -- $ --
----------- --------- ----------- --------- ---------
----------- --------- ----------- --------- ---------
TOTAL TOTAL
1997 1996
---------------------- ----------------------
DOLLARS IN THOUSANDS YIELD AMOUNT YIELD AMOUNT YIELD
- - --------------------- ----- --------- ----- --------- -----
Mortgage-backed...... % $ 107,386 6.57% $ 97,638 6.45%
State and Municipal.. 107,567 6.75 88,445 6.72
Other debt........... 3,216 6.40 9,146 6.49
--- --------- --- --------- ---
Total debt
securities....... % $ 218,169 6.65% $ 195,229 6.57%
--------- --------- ---
--------- --------- ---
Fair value......... $ 219,700 $ 194,655
--------- ---------
--------- ---------
Dividend income included in interest income on securities in the Consolidated
Statement of Income and Comprehensive Income was $8.7 million in both 1998 and
1997.
A-20
LOAN PORTFOLIO
The following table shows the Company's consolidated loans by type of loan
or borrower and their percentage distribution:
LOAN PORTFOLIO
DECEMBER 31,
-----------------------------------------------------
DOLLARS IN THOUSANDS 1998 1997 1996 1995 1994
- - ------------------------------------------------------ --------- --------- --------- --------- ---------
Commercial............................................ $2,457,946 $1,972,232 $1,334,577 $1,080,125 $ 906,417
Residential first mortgage............................ 1,038,229 980,040 882,573 593,546 212,595
Real estate construction.............................. 237,015 144,558 92,322 81,318 31,201
Real estate commercial mortgage....................... 747,711 686,188 499,377 553,095 457,030
Installment........................................... 49,526 42,206 30,586 38,527 36,675
--------- --------- --------- --------- ---------
Total loans........................................... $4,530,427 $3,825,224 $2,839,435 $2,346,611 $1,643,918
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Commercial............................................ 54.3% 51.6% 46.9% 46.0% 55.2%
Residential first mortgage............................ 22.9 25.6 31.1 25.3 12.9
Real estate construction.............................. 5.2 3.8 3.3 3.5 1.9
Real estate commercial mortgage....................... 16.5 17.9 17.6 23.6 27.8
Installment........................................... 1.1 1.1 1.1 1.6 2.2
--------- --------- --------- --------- ---------
Total loans........................................... 100.0% 100.0% 100.0% 100.0% 100.0%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
GENERAL
The Company's loan portfolio consists primarily of short-term loans for
businesses and real estate purposes. At December 31, 1998, approximately 54% of
the loan portfolio was commercial loans (including participations in domestic
bank non-relationship syndicated loans that add geographic and industry
diversification and liquidity to the portfolio), 23% was residential first
mortgages and 22% was in real estate other. The legal lending limit for any one
borrower was approximately $106 million at December 31, 1998.
The commercial loan portfolio primarily consists of loans to middle-market
companies, professional and business borrowers and associated individuals. The
Bank provides revolving lines of credit, term loans, asset based loans,
residential first trust deed mortgages, commercial real estate secured loans,
and trade facilities.
Included in commercial loans as of December 31, 1998 were participations in
domestic bank non-relationship syndicated loans of approximately $507.3 million
or 11.2% of total loans. As of December 31, 1997, participations in domestic
bank non-relationship syndicated loans were $240.4 million or 6.3% of total
loans.
In addition, commercial loans includes unsecured loans to real estate
developers and customers involved in real estate investments and commercial
loans where real estate partially secures the borrowing.
Residential first mortgage loans which comprise 23% of total loans at
December 31, 1998, continued a five-year growth trend, increasing $58.2 million,
or 5.9% to $1,038.2 million at December 31, 1998. At December 31, 1998, 75.2% of
the portfolio was originated internally and the balance was purchased from third
parties. The Company expects continued runoff of the purchased residential first
mortgage loan portfolio in 1999.
A-21
The real estate construction portfolio (5% of the loan portfolio) consists
of 81% commercial and 19% residential. Such loans are made on the basis of the
economic viability for the specific project, the cash flow resources of the
developer, the developer's equity in the project and the underlying financial
strength of the borrower. The Company's policy is to monitor each loan with
respect to incurred costs, sales price and sales cycle. Following is a breakdown
of real estate construction loans by collateral type:
REAL ESTATE CONSTRUCTION LOANS BY TYPE
DECEMBER 31,
----------------------
DOLLARS IN THOUSANDS 1998 1997
- - ---------------------------------------------------------------------- ---------- ----------
Industrial............................................................ $ 98,853 $ 54,628
Office building....................................................... 10,226 8,712
Shopping centers...................................................... 47,906 15,314
1-4 family (includes land)............................................ 28,079 34,304
Condominiums/apartments............................................... 16,413 10,189
Other improved property............................................... 35,538 21,411
---------- ----------
Total......................................................... $ 237,015 $ 144,558
---------- ----------
---------- ----------
Real estate commercial mortgages (17% of the loan portfolio) consists of 79%
commercial and 21% residential. The increase during 1998 was primarily due to
the acquisition of HB. Following is a breakdown of real estate commercial
mortgage loans by collateral type:
REAL ESTATE COMMERCIAL MORTGAGE LOANS BY TYPE
DECEMBER 31,
----------------------
DOLLARS IN THOUSANDS 1998 1997
- - ---------------------------------------------------------------------- ---------- ----------
Industrial............................................................ $ 209,411 $ 225,921
Office building....................................................... 75,616 88,973
Shopping centers...................................................... 61,903 70,816
1-4 family (includes land)............................................ 5,660 9,186
Condominiums/apartments............................................... 117,661 95,485
Land, nonresidential.................................................. 6,923 7,270
Churches/religious.................................................... 13,527 10,560
Equity lines of credit................................................ 36,030 42,249
Other improved property............................................... 220,980 135,728
---------- ----------
Total......................................................... $ 747,711 $ 686,188
---------- ----------
---------- ----------
Installment loans consist primarily of loans to individuals for personal
uses, such as installment purchases and a variety of other consumer purchases.
Concentrations of credit risk arise when a number of customers are engaged
in similar business activities, or activities in the same geographic region, or
have similar economic features that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic
conditions. Although the Company has a diversified loan portfolio, a substantial
portion of the customers' ability to honor loan terms is reliant upon the
economic stability of Southern California, which in some degree relies on the
stability of entertainment and media companies. Loans are generally made on the
basis of a secure repayment source as the first priority and collateral is
generally a secondary source for loan qualification.
The Company's lending activities are predominately in Southern California
although participations in domestic bank non-relationship syndicated loans,
which comprise approximately 11.2% of the total loan
A-22
portfolio at December 31, 1998, are primarily to borrowers located out of state.
The Bank has no direct foreign loans. However, the Company does have some loans
to domestic customers who are engaged in international trade, operations, or
film productions. The Company's diverse portfolio of carefully analyzed and
selected loans to entities engaged in the entertainment or media businesses
amounted to $720.1 million at December 31, 1998, a 53.0% increase from the
$470.6 million at December 31, 1997.
Inherent in any loan portfolio are risks associated with certain types of
loans. The Company assesses and manages credit risk on an ongoing basis through
diversification guidelines, lending limits, credit review and approval policies
and internal monitoring. As part of the control process, an independent credit
review function regularly examines the Company's loan portfolio and other credit
related products, including unused commitments and letters of credit. In
addition to this internal credit process, the Company's loan portfolio is
subject to examination by external regulators in the normal course of business.
Credit quality will be influenced by underlying trends in the economic and
business cycle. The Company seeks to manage and control its risk through
diversification of the portfolio by type of loan, industry concentration and
type of borrower as well as specific maximum loan-to-value (LTV) limitations as
to various categories of real estate related loans. These ratios are as follows:
MAXIMUM LTV RATIOS
MAXIMUM
CATEGORY OF REAL ESTATE COLLATERAL LTV RATIOS
- - ---------------------------------------------------------------------------------- ---------------
Industrial........................................................................ 80%
Office building................................................................... 75
Shopping centers.................................................................. 80
1-4 family (includes land)........................................................ 80
Condominiums/apartments........................................................... 80
Land, nonresidential.............................................................. 50
Churches/religious................................................................ 75
Equity lines of credit............................................................ 80
Other improved property........................................................... 70
The Company's loan policy provides that any term loan on income-producing
properties must have a minumum debt service coverage of at least 1.20 to 1 for
non-owner occupied property and at least 1.05 to 1 for owner occupied.
One of the significant risks associated with real estate lending is the risk
associated with the possible existence of environmental risks or hazards on or
in property affiliated with the loan. The Bank mitigates such risks through the
use of an Environmental Risk Questionnaire for all loans secured by real estate.
A Phase I environmental report is required if indicated by the questionnaire or
if for any other reason it is determined appropriate. Other reasons would
include the industrial use of environmentally sensitive substances or the
proximity to other known environmental problems. A Phase II report is required
in certain cases, depending on the outcome of the Phase I report.
ACTIVITY
Total loans were $4,530.4 million, $3,825.2 million and $2,839.4 million at
December 31, 1998, 1997 and 1996, respectively. Gross loans averaged $4,213.9
million, $3,387.8 million and $2,539.3 million for the years 1998, 1997 and
1996, respectively. The increase in total loans of $705.2 million during 1998
relates to the overall growth in the Bank's loan portfolio and the acquisition
of HB. The most significant areas of growth were the increase in commercial
loans of $485.7 million. In addition, residential first mortgages increased
$58.2 million, while real estate construction and real estate commercial
mortgages increased by $92.5 million and $61.5 million, respectively. Similar
growth occurred in 1997. These increases were mainly
A-23
due to the Bank's business development efforts and the strength of the local
economy as well as the expansion of participations in domestic bank
non-relationship syndicated loans.
The economic climate in Southern California has been generally strong in
1998 and 1997. However, the competitive environment within the Company's
marketplace for additional loan growth has become more aggressive between
lenders resulting in increasing competitive pricing. To the extent that such
competitive activity continues during 1999 and the Company finds it necessary to
meet such competition, the Company's net interest margin could decline.
At December 31, 1998, 44.0% of commercial loans, 40.2% of real estate loans
and 5.6% of installment loans outstanding were floating interest rate loans.
Floating rate loans comprised 41.9% of the total loan portfolio at December 31,
1998 and 44.8% at December 31, 1997. Total loans at December 31, 1998 consisted
of 44.9% due in one year or less, 21.1% due in 1-5 years and 34.0% due after 5
years.
The loan maturities shown in the table below are based on contractual
maturities. As is customary in the banking industry, loans that meet sound
underwriting criteria can be renewed by mutual agreement between the Bank and
the borrower. Because the Bank is unable to estimate the extent to which its
borrowers will renew their loans the table is based on contractual maturities.
LOAN MATURITIES
DECEMBER 31, 1998
--------------------------------------------------------------------------------
RESIDENTIAL REAL ESTATE
FIRST REAL ESTATE COMMERCIAL
DOLLARS IN THOUSANDS COMMERCIAL MORTGAGE CONSTRUCTION MORTGAGE INSTALLMENT TOTAL
- - ------------------------------- ------------ ------------ ------------ ----------- ----------- ------------
Aggregate maturities of loan
balances due:
In one year or less
Interest rate--floating...... $ 707,106 $ 13,669 $ 147,509 $ 111,574 $ 291 $ 980,149
Interest rate--fixed......... 975,371 1,110 11,686 61,295 2,938 1,052,400
After one year but within five
years
Interest rate--floating...... 264,936 33,029 72,822 216,768 588 588,143
Interest rate--fixed......... 212,295 1,554 2,773 127,968 24,742 369,332
After five years
Interest rate--floating...... 109,143 188,397 470 29,284 1,893 329,187
Interest rate--fixed......... 189,095 800,470 1,755 200,822 19,074 1,211,216
------------ ------------ ------------ ----------- ----------- ------------
Total loans................ $ 2,457,946 $ 1,038,229 $ 237,015 $ 747,711 $ 49,526 $ 4,530,427
------------ ------------ ------------ ----------- ----------- ------------
------------ ------------ ------------ ----------- ----------- ------------
A-24
ASSET QUALITY
ALLOWANCE FOR CREDIT LOSSES
A consequence of lending activities is that losses may be experienced. The
amount of such losses will vary from time to time depending upon the risk
characteristics of the loan portfolio as affected by economic conditions, rising
interest rates and the financial experience of borrowers. The allowance for
credit losses, which provides for the risk of losses inherent in the credit
extension process, is increased by the provision for credit losses charged to
expense and decreased by the amount of chargeoffs, net of recoveries. There is
no precise method of predicting specific losses or amounts that ultimately may
be charged off on particular segments of the loan portfolio. Similarly, the
adequacy of the allowance for credit losses and the level of the related
provision for credit losses is determined on a judgmental basis by management
based on consideration of previous loan loss experience, management's evaluation
of the current loan portfolio including industry trends and concentrations and
on current and expected economic conditions. Examinations of the loan portfolio
are also conducted periodically by its regulators. Management and the Audit
Committee of the Board of Directors evaluate the allowance and determine its
desired level. Based on known information available to it at the date of this
Report, management believes that the Company's allowance for credit losses was
adequate for foreseeable losses at December 31, 1998.
Based on expected loan growth, the level of nonperforming loans, anticipated
recoveries in the first half of 1999 of loans previously charged-off and a
relatively constant low level of chargeoffs, it is anticipated that the level of
the allowance will remain stable through the first half of 1999 without a
provision for credit losses.
The following table summarizes the activity in the allowance for credit
losses for the five years ended December 31, 1998:
ALLOWANCE FOR CREDIT LOSSES
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
DOLLARS IN THOUSANDS 1998 1997 1996 1995 1994
- - ------------------------------------------------------ --------- --------- --------- --------- ---------
Average amount of loans outstanding................... $4,213,853 $3,387,784 $2,539,323 $1,758,671 $1,537,997
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Balance of allowance for credit losses, beginning of
year................................................ $ 137,761 $ 130,089 $ 131,514 $ 105,343 $ 110,499
--------- --------- --------- --------- ---------
Loans charged off:
Commercial.......................................... (15,019) (14,651) (14,647) (11,124) (22,038)
Real estate commercial mortgage..................... (1,382) (4,275) (5,338) (5,869) (26,354)
Residential first mortgage.......................... (1,128) (474) (253) -- --
Installment......................................... (107) (112) (104) (48) (128)
--------- --------- --------- --------- ---------
Total loans charged off........................... (17,636) (19,512) (20,342) (17,041) (48,520)
--------- --------- --------- --------- ---------
Recoveries of loans previously charged off:
Commercial.......................................... 11,556 11,098 13,325 22,045 34,163
Real estate construction............................ -- -- -- -- 161
Real estate commercial mortgage..................... 397 8,894 5,313 1,862 758
Residential first mortgage.......................... 503 58 -- -- --
Installment......................................... 11 118 279 228 747
--------- --------- --------- --------- ---------
Total recoveries.................................. 12,467 20,168 18,917 24,135 35,829
--------- --------- --------- --------- ---------
Net loans (charged off) recovered..................... (5,169) 656 (1,425) 7,094 (12,691)
Additions to allowance charged to operating expense... -- -- -- -- 7,535
Acquisitions.......................................... 2,747 7,016 19,077
--------- --------- --------- --------- ---------
Balance, end of year.................................. $ 135,339 $ 137,761 $ 130,089 $ 131,514 $ 105,343
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Ratio of net (charge offs) recoveries to average
loans............................................... (0.12)% 0.02% (0.06)% 0.40% (0.83)%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net chargeoffs were $5.2 million or 0.12% of average loans during 1998. Net
recoveries were $0.7 million or 0.02% of average loans during 1997. During 1996,
the Company experienced net chargeoffs
A-25
of $1.4 million or 0.06% of average loans during 1996. The increase in net
chargeoffs in 1998 resulted primarily from a decrease in recoveries on real
estate-commercial mortgages. Management believes that it will continue to have a
significant amount of recoveries in 1999 but that recoveries will continue to
decrease.
The allowance for credit losses as a percentage of total loans was 2.99%,
3.60% and 4.58% at December 31, 1998, 1997 and 1996, respectively. The allowance
for loan losses as a percentage of nonperforming loans was 584.9%, 499.8% and
313.1% at December 31, 1998, 1997 and 1996, respectively. See "Nonaccrual, Past
Due and Restructured Loans".
Based on an evaluation of individual credits, previous loan loss experience,
management's evaluation of the current loan portfolio and current and expected
economic conditions, management has allocated the allowance for credit losses as
shown for the past five years in the table below.
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
ALLOWANCE AMOUNT PERCENT OF LOANS TO TOTAL LOANS
----------------------------------------------------- -------------------------------------
DOLLARS IN THOUSANDS 1998 1997 1996 1995 1994 1998 1997 1996
- - --------------------------- --------- --------- --------- --------- --------- ----- ----- -----
Commercial................. $ 100,811 $ 91,914 $ 75,754 $ 37,778 $ 55,179 54% 51% 47%
Real estate construction... 1,950 3,357 2,405 4,550 2,341 5 4 3
Real estate commercial
mortgage................. 16,508 27,378 37,748 77,730 43,745 17 18 18
Residential first
mortgage................. 15,625 14,750 13,283 10,705 3,200 23 26 31
Installment................ 445 362 899 751 878 1 1 1
--------- --------- --------- --------- --------- --- --- ---
Total.................. $ 135,339 $ 137,761 $ 130,089 $ 131,514 $ 105,343 100% 100% 100%
--------- --------- --------- --------- --------- --- --- ---
--------- --------- --------- --------- --------- --- --- ---
DOLLARS IN THOUSANDS 1995 1994
- - --------------------------- ----- -----
Commercial................. 46% 55%
Real estate construction... 3 2
Real estate commercial
mortgage................. 24 28
Residential first
mortgage................. 25 13
Installment................ 2 2
--- ---
Total.................. 100% 100%
--- ---
--- ---
While the allowance is allocated to portfolios, the allowance is general in
nature and is available for the portfolio in its entirety. Due to commercial
loan growth including participations purchased from other lenders, possible loan
losses as a result of Year 2000 computer problems that may adversely impact
borrowers, and a continuing decrease in problem loans in the real estate
mortgage category during 1998, an increased portion of the allowance for credit
losses was allocated to the commercial loan category from that allocated in
1997. An increase in problem loans in the commercial category and a decrease in
problem loans in the real estate commercial mortgage category during 1997
resulted in an increased portion of the allowance for credit losses being
allocated to the commercial category from that allocated in 1996. The level of
the allowance has remained stable since 1995 primarily as a result of a low
level of net (chargeoffs) recoveries as indicated in the previous table.
At December 31, 1998, there was no allowance for impaired loans while there
was a $0.5 million allowance on impaired loans with outstanding balances of $3.0
million at December 31, 1997. The allowance represents the difference between
the value of the collateral supporting those loans and the outstanding balances
of those loans and is included in the allowance for credit losses. A loan is
considered impaired when it is probable that a creditor will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Once a loan is determined to be impaired, SFAS No. 114 requires that
the impairment be measured based on the present value of the expected future
cash flows discounted at the loan's effective interest rate, except that as a
practical expedient, the impairment may be measured by using the loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent. The Company's policy is to record cash receipts on
impaired loans first as reductions in principal and then to interest income. At
December 31, 1998 and 1997, the Company had identified impaired loans with
recorded investments of $13.7 million and $16.6 million, respectively.
A-26
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
The following table presents information concerning nonaccrual loans, ORE,
accruing loans which are contractually past due 90 days or more as to interest
or principal payments and still accruing, and restructured loans:
NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS
DECEMBER 31,
-----------------------------------------------------
1998
---------
DOLLARS IN THOUSANDS 1997 1996 1995 1994
- - ----------------------------------------------------- --------- --------- --------- ---------
Nonaccrual loans:
Real estate mortgage............................... $ 17,204 $ 19,243 $ 25,661 $ 39,536 $ 35,534
Commercial......................................... 4,763 6,589 15,882 8,316 23,267
Installment........................................ 1,171 1,734 -- 272 --
--------- --------- --------- --------- ---------
Total............................................ 23,138 27,566 41,543 48,124 58,801
ORE.................................................. 3,480 2,126 15,116 7,439 4,726
--------- --------- --------- --------- ---------
Total nonaccrual loans and ORE....................... $ 26,618 $ 29,692 $ 56,659 $ 55,563 $ 63,527
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Total nonaccrual loans as a percentage of total
loans.............................................. 0.51% 0.72% 1.46% 2.05% 3.58%
Total nonaccrual loans and ORE as a percentage of
total loans and ORE................................ 0.59 0.78 1.98 2.36 3.85
Allowance for credit losses to total loans........... 2.99 3.60 4.58 5.60 6.41
Allowance for credit losses to nonaccrual loans...... 584.92 499.75 313.14 273.28 179.15
Loans past due 90 days or more on accrual status:
Real estate........................................ $ 949 $ 13,370 $ 4,076 $ 3,816 $ 2,830
Commercial......................................... 7,661 9,226 8,076 2,623 1,068
Installment........................................ 13 3,596 292 58 404
--------- --------- --------- --------- ---------
Total............................................ $ 8,623 $ 26,192 $ 12,444 $ 6,497 $ 4,302
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Restructured loans:
On accrual status.................................. $ 1,982 $ 2,813 $ 2,569 $ 5,483 $ 2,061
On nonaccrual status............................... 1,682 1,286 -- 1,707 7,043
--------- --------- --------- --------- ---------
Total............................................ $ 3,664 $ 4,099 $ 2,569 $ 7,190 $ 9,104
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Bank policy requires that a loan be placed on nonaccrual status if either
principal or interest payments are past due in excess of ninety days unless the
loan is both well secured and in process of collection, or if full collection of
interest or principal becomes uncertain, regardless of the time period involved.
At December 31, 1998, in addition to loans disclosed above as past due,
nonaccrual or restructured, management also identified $2.9 million of loans
about which the ability of the borrowers to comply with the present loan payment
terms in the future is questionable. However, the inability of the borrowers to
comply with repayment terms was not sufficiently probable to place the loan on
nonaccrual status. This amount was determined based on analysis of information
known to management about the borrower's financial condition and current and
expected economic conditions. If economic conditions change, adversely or
otherwise, or if additional facts on borrowers' financial condition come to
light, then the amount of potential problem loans may change, possibly
significantly. Estimated potential losses from these potential problem loans
have been provided for in determining the allowance for credit losses.
A-27
The table below summarizes the approximate changes in nonaccrual loans for
the years ended December 31, 1998 and 1997.
CHANGES IN NONACCRUAL LOANS
YEAR ENDED DECEMBER
31,
----------------------
1998
----------
DOLLARS IN THOUSANDS 1997
- - ---------------------------------------------------------------------- ----------
Balance, beginning of the year........................................ $ 27,566 $ 41,543
Loans placed on nonaccrual............................................ 31,430 32,930
Loans acquired........................................................ 3,055 2,438
Charge offs........................................................... (10,711) (12,788)
Loans returned to accrual status...................................... (409) (9,798)
Repayments (including interest applied to principal).................. (27,762) (23,598)
Transfers to ORE...................................................... (31) (3,161)
---------- ----------
Balance, end of year.................................................. $ 23,138 $ 27,566
---------- ----------
---------- ----------
The additional interest income that would/(would not) have been recorded
from nonaccrual loans, if the loans had not been on nonaccrual status was $2.0
million, $(0.1) million and $2.1 million for the years ended December 31, 1998,
1997 and 1996, respectively. Interest payments received on nonaccrual loans are
applied to principal unless there is no doubt as to ultimate full repayment of
principal, in which case, the interest payment is recognized as interest income.
Interest income includes $2.0 million, $5.5 million and $4.1 million for the
years ended December 31, 1998, 1997, and 1996, respectively, from collection of
interest related to nonaccrual loans. Interest income not recognized on
nonaccrual loans reduced the net interest margin by 4, 0 and 6 basis points for
the years ended December 31, 1998, 1997 and 1996, respectively.
OTHER REAL ESTATE
The Company's OREO totaled $3.5 million at year end 1998 compared to $2.1
million a year ago. The Company's policy is to record these properties at
estimated fair value, net of selling expenses, at the time they are transferred
into ORE, thereby tying future gains or losses from sale or potential additional
write-downs to underlying changes in the market.
COMMITMENTS AND LINES OF CREDIT
In the normal course of business, the Company is a party to financial
instruments with off-balance sheet risk. These financial instruments include
commitments to extend credit, letters of credit and financial guarantees. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount reflected in the consolidated statement of
financial conditions. Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since a portion of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customer's credit worthiness on a case-by-case basis.
The Company had outstanding loan commitments aggregating $2,273.8 million at
December 31, 1998. In addition, the Company had $150.3 million outstanding in
bankers acceptances and letters of credit of which $129.0 relate to standby
letters of credit at December 31, 1998. Substantially all of the Company's loan
commitments are on a variable rate basis and are comprise of real estate and
commercial loan commitments.
A-28
DEPOSITS AND BORROWED FUNDS
Providing a stable source of low-cost funding, core deposits include
noninterest bearing demand deposits, NOW and money market accounts, savings
accounts and time deposits less than $100,000. Average core deposits were
$3,506.6 million in 1998 compared to $3,079.6 million in 1997. The increase was
due primarily to internally generated growth and in the acquisition of HB.
Short and long-term borrowed funds provided additional funding to support
loan growth. Average borrowed funds were $763.1 million in 1998 compared to
$561.5 million in 1997.
A maturity distribution of certificates of deposits of $100,000 or more at
year-end follows:
DOLLARS IN THOUSANDS 1998 1997
- - ---------------------------------------------------------------------- ---------- ----------
Under 3 months........................................................ $ 485,244 $ 275,590
4 to 12 months........................................................ 125,623 188,764
1 to 5 years.......................................................... 87,573 119,760
Over 5 years.......................................................... 55,275 29,014
---------- ----------
Total............................................................. $ 753,715 $ 613,128
---------- ----------
---------- ----------
At December 31, 1998 and 1997, the aggregate amount of deposits by foreign
depositors in domestic offices totaled $36.4 million and $31.8 million,
respectively, the majority of which was interest bearing. The Bank had brokered
deposits of $90.0 million and $21.7 million, at December 31, 1998 and 1997,
respectively.
Details regarding federal funds purchased and securities sold under
repurchase agreements as well as other short-term borrowings follows.
1998 1997 1996
--------------------------------- --------------------------------- ---------------------------------
BALANCE BALANCE BALANCE
DOLLARS IN AT AVERAGE AVERAGE AT AVERAGE AVERAGE AT AVERAGE AVERAGE
THOUSANDS YEAR-END BALANCE RATE YEAR-END BALANCE RATE YEAR-END BALANCE RATE
- - ------------------ --------- --------- ----------- --------- --------- ----------- --------- --------- -----------
Federal funds
purchased and
securities sold
under repurchase
agreements...... $ 276,311 $ 407,315 5.36% $ 206,427 $ 222,617 5.27% $ 194,549 $ 253,853 5.06%
Other short-term
borrowings...... 317,001 82,855 5.54 212,575 315,886 5.21 148,642 232,379 5.52
A-29
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS
OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company wishes to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 as to "forward looking"
statements in this Form 10-K which are not historical facts. The Company
cautions readers that the following important factors could affect the Company's
business and cause actual results to differ materially from those expressed in
any forward looking statement made by, or on behalf of, the Company.
- ECONOMIC CONDITIONS. The Company's results are strongly influenced by
general economic conditions in its market area, Southern California, and a
deterioration in these conditions could have a material adverse impact on
the quality of the Bank's loan portfolio and the demand for its products
and services. In particular, changes in economic conditions in the real
estate and entertainment industries may affect the Company's performance.
- INTEREST RATES. Management anticipates that interest rates will remain
flat or slightly higher. If interest rates vary substantially from present
levels, this may cause the Company's results to differ materially.
- GOVERNMENT REGULATION AND MONETARY POLICY. All forward-looking statements
presume a continuation of the existing regulatory environment and U.S.
Government monetary policies. The banking industry is subject to extensive
federal and state regulations, and significant new laws or changes in, or
repeals of, existing laws may cause results to differ materially. Further,
federal monetary policy, particularly as implemented through the Federal
Reserve System, significantly affects credit conditions for the Bank,
primarily through open market operations in U.S. government securities,
the discount rate for member bank borrowing and bank reserve requirements,
and a material change in these conditions would be likely to have an
impact on results.
- COMPETITION. The Bank competes with numerous other domestic and foreign
financial institutions and non-depository financial intermediaries.
Results may differ if circumstances affecting the nature or level of
competitive change, such as the merger of competing financial
institutions.
- CREDIT QUALITY. A significant source of risk arises from the possibility
that losses will be sustained because borrowers, guarantors and related
parties may fail to perform in accordance with the terms of their loans.
The Bank has adopted underwriting and credit policies, including the
establishment and review of the allowance for credit losses, that
management believes are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying
the Bank's credit portfolio, but such policies and procedures may not
prevent unexpected losses that could adversely affect the Company's
results.
- OTHER RISKS. From time to time, the Company details other risks to its
business and/or its financial results in its filings with the Securities
and Exchange Commission.
While management believes that its assumptions regarding these and other
factors on which forward-looking statements are based are reasonable, such
assumptions are necessarily speculative in nature, and actual outcomes can be
expected to differ to some degree. Consequently, there can be no assurance that
the results described in such forward-looking statements will, in fact, be
achieved.
A-30
QUARTERLY RESULTS
The following table summarizes quarterly operating results for 1998 and
1997.
1998 QUARTERLY OPERATING RESULTS
QUARTER ENDED
---------------------------------------------------
DOLLARS IN THOUSANDS MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, TOTAL
- - ------------------------------------------------- ----------- --------- ------------- ------------ ---------
Interest income.................................. $ 103,448 $ 103,359 $ 107,510 $ 109,632 $ 423,949
Interest expense................................. 30,624 31,087 33,829 34,738 130,278
----------- --------- ------------- ------------ ---------
Net interest income.............................. 72,824 72,272 73,681 74,894 293,671
Provision for credit losses...................... -- -- -- -- --
----------- --------- ------------- ------------ ---------
Net interest income after provision for credit
losses......................................... 72,824 72,272 73,681 74,894 293,671
Noninterest income............................... 15,391 17,111 15,678 16,432 64,612
Gain on sale of securities....................... 974 235 1,120 743 3,072
Noninterest expense.............................. 54,366 52,973 50,859 53,133 211,331
----------- --------- ------------- ------------ ---------
Income before taxes.............................. 34,823 36,645 39,620 38,936 150,024
Income taxes..................................... 12,354 13,009 14,231 14,202 53,796
----------- --------- ------------- ------------ ---------
Net income....................................... $ 22,469 $ 23,636 $ 25,389 $ 24,734 $ 96,228
----------- --------- ------------- ------------ ---------
----------- --------- ------------- ------------ ---------
Net income per share, basic...................... $ 0.48 $ 0.51 $ 0.55 $ 0.54 $ 2.08
----------- --------- ------------- ------------ ---------
----------- --------- ------------- ------------ ---------
Net income per share, diluted.................... $ 0.46 $ 0.49 $ 0.53 $ 0.52 $ 2.00
----------- --------- ------------- ------------ ---------
----------- --------- ------------- ------------ ---------
1997 QUARTERLY OPERATING RESULTS
QUARTER ENDED
---------------------------------------------------
DOLLARS IN THOUSANDS MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, TOTAL
- - ------------------------------------------------- ----------- --------- ------------- ------------ ---------
Interest income.................................. $ 83,307 $ 88,696 $ 92,195 $ 93,798 $ 357,996
Interest expense................................. 23,535 25,904 27,612 27,277 104,328
----------- --------- ------------- ------------ ---------
Net interest income.............................. 59,772 62,792 64,583 66,521 253,668
Provision for credit losses...................... -- -- -- -- --
----------- --------- ------------- ------------ ---------
Net interest income after provision for credit
losses......................................... 59,772 62,792 64,583 66,521 253,668
Noninterest income............................... 12,902 13,676 13,272 14,616 54,466
Gain (loss) on sale of securities................ (277) (262) (224) (285) (1,048)
Noninterest expense.............................. 43,925 45,314 44,947 47,571 181,757
----------- --------- ------------- ------------ ---------
Income before taxes.............................. 28,472 30,892 32,684 33,281 125,329
Income taxes..................................... 10,469 11,334 11,790 11,603 45,196
----------- --------- ------------- ------------ ---------
Net income....................................... $ 18,003 $ 19,558 $ 20,894 $ 21,678 $ 80,133
----------- --------- ------------- ------------ ---------
----------- --------- ------------- ------------ ---------
Net income per share, basic(1)................... $ 0.39 $ 0.42 $ 0.45 $ 0.47 $ 1.74
----------- --------- ------------- ------------ ---------
----------- --------- ------------- ------------ ---------
Net income per share, diluted.................... $ 0.38 $ 0.41 $ 0.44 $ 0.45 $ 1.68
----------- --------- ------------- ------------ ---------
----------- --------- ------------- ------------ ---------
- - --------------------------
(1) Due to rounding quarterly per share amounts do not add up to total.
A-31
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation of the Company's consolidated
financial statements and related information appearing in this annual report.
Management believes that the consolidated financial statements fairly reflect
the form and substance of transactions, and that the consolidated financial
statements reasonably present the Company's financial position and results of
operations in conformity with generally accepted accounting principles.
Management also has included in the Company's consolidated financial statements
amounts that are based on estimates and judgements that it believes are
reasonable under the circumstances.
The independent auditors audit the Company's consolidated financial
statements in accordance with generally accepted auditing standards and provide
an objective, independent review of the fairness of reported operating results
and financial position.
The Board of Directors of the Corporation has an Audit Committee composed
solely of three non-management Directors. The Committee meets periodically with
financial management, the internal auditors and the independent auditors to
review accounting control, auditing and financial matters.
/s/ RUSSELL GOLDSMITH
Russell Goldsmith
Chief Executive Officer
/s/ BRAM GOLDSMITH
Bram Goldsmith
Chairman of the Board
/s/ FRANK P. PEKNY
Frank P. Pekny
Executive Vice President and
Chief Financial Officer
A-32
INDEPENDENT AUDITORS' REPORT
To Board of Directors and Shareholders of
City National Corporation:
We have audited the accompanying consolidated balance sheet of City National
Corporation and subsidiaries as of December 31, 1998 and 1997 and the related
consolidated statements of income and comprehensive income, changes in
shareholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of City
National Corporation and subsidiaries as of December 31, 1998 and 1997 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998 in conformity with generally accepted
accounting principles.
KPMG LLP
Los Angeles, California
January 14, 1999
A-33
CITY NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEET
DECEMBER 31,
--------------------
DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS 1998 1997
- - ------------------------------------------------------------------------------------------ --------- ---------
ASSETS
Cash and due from banks................................................................... $ 285,843 $ 327,398
Federal funds sold........................................................................ 405,000 150,000
Interest-bearing deposits in other banks.................................................. 524 301
Investment securities (fair value $227,465 in 1997)....................................... -- 225,934
Securities available-for-sale (cost $990,152 in 1998 and $597,910 in 1997)................ 1,012,526 607,188
Trading account securities................................................................ 34,491 30,279
Loans..................................................................................... 4,530,427 3,825,224
Less allowance for credit losses.......................................................... 135,339 137,761
--------- ---------
Net loans............................................................................... 4,395,088 3,687,463
Premises and equipment, net............................................................... 55,766 43,402
Customers' acceptance liability........................................................... 1,759 1,553
Deferred tax asset........................................................................ 45,738 58,815
Goodwill and core deposit intangibles..................................................... 73,706 54,921
Bank owned life insurance................................................................. 42,545 --
Other assets.............................................................................. 74,795 64,778
--------- ---------
Total assets............................................................................ $6,427,781 $5,252,032
--------- ---------
--------- ---------
LIABILITIES
Demand deposits........................................................................... $2,382,724 $2,027,014
Interest checking deposits................................................................ 452,249 439,071
Money market deposits..................................................................... 927,651 773,291
Savings deposits.......................................................................... 183,353 171,100
Time deposits--under $100,000............................................................. 187,710 204,744
Time deposits--$100,000 and over.......................................................... 753,715 613,128
--------- ---------
Total deposits.......................................................................... 4,887,402 4,228,348
Federal funds purchased and securities sold under repurchase agreements................... 276,311 206,427
Other short-term borrowings............................................................... 317,001 212,575
Subordinated debt......................................................................... 123,265 --
Long-term debt............................................................................ 200,000 50,000
Other liabilities......................................................................... 60,240 44,459
Acceptances outstanding................................................................... 1,759 1,553
--------- ---------
Total liabilities....................................................................... 5,865,978 4,743,362
--------- ---------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preferred Stock authorized--5,000,000; none outstanding................................... -- --
Common Stock--par value--$1.00; authorized--75,000,000
Issued--46,885,182 shares in 1998 and 46,700,891 shares in 1997......................... 46,885 46,701
Additional paid-in capital................................................................ 287,363 297,654
Accumulated other comprehensive income.................................................... 12,901 5,349
Retained earnings......................................................................... 243,275 173,089
Treasury shares, at cost--877,945 shares in 1998 and 563,928 shares in 1997............... (28,621) (14,123)
--------- ---------
Total shareholders' equity.............................................................. 561,803 508,670
--------- ---------
Total liabilities and shareholders' equity.............................................. $6,427,781 $5,252,032
--------- ---------
--------- ---------
See accompanying Notes to Consolidated Financial Statements.
A-34
CITY NATIONAL CORPORATION
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
IN THOUSANDS, EXCEPT PER SHARE AMOUNTS 1998 1997 1996
- - ----------------------------------------------------------------------------------- --------- --------- ---------
INTEREST INCOME
Loans............................................................................ $ 365,352 $ 304,057 $ 224,702
Securities available-for-sale.................................................... 40,956 37,539 40,485
Investments securities........................................................... 11,318 12,534 11,525
Trading account.................................................................. 2,865 2,565 1,849
Federal funds sold and securities purchased under resale agreements.............. 3,458 1,301 3,562
--------- --------- ---------
Total interest income.......................................................... 423,949 357,996 282,123
--------- --------- ---------
INTEREST EXPENSE
Deposits......................................................................... 87,237 73,289 54,756
Federal funds purchased and securities sold under repurchase agreements.......... 21,824 11,731 12,835
Other short-term borrowings...................................................... 4,591 16,470 12,835
Subordinated debt................................................................ 7,912 -- --
Other long-term debt............................................................. 8,714 2,838 1,963
--------- --------- ---------
Total interest expense......................................................... 130,278 104,328 82,389
--------- --------- ---------
Net interest income.............................................................. 293,671 253,668 199,734
Provision for credit losses...................................................... -- -- --
--------- --------- ---------
Net interest income after provision for credit losses............................ 293,671 253,668 199,734
--------- --------- ---------
NONINTEREST INCOME
Service charges on deposit accounts.............................................. 17,386 14,321 10,798
Investment services.............................................................. 16,330 13,221 11,453
Trust fees....................................................................... 9,376 8,304 7,176
International services........................................................... 8,106 7,271 5,181
Bank owned life insurance........................................................ 2,146 -- --
Gain on sale of assets........................................................... 1,823 1,604 1,124
Gain (loss) on sale of available-for-sale securities............................. 3,072 (1,048) 187
Other............................................................................ 9,445 9,745 8,076
--------- --------- ---------
Total noninterest income....................................................... 67,684 53,418 43,995
--------- --------- ---------
NONINTEREST EXPENSE
Salaries and other employee benefits............................................. 114,965 97,634 77,011
Professional..................................................................... 23,445 17,899 11,462
Net occupancy of premises........................................................ 14,189 12,138 8,976
Information services............................................................. 8,805 12,662 10,895
Marketing and advertising........................................................ 10,313 7,972 5,563
Depreciation..................................................................... 8,816 6,144 5,143
Office services.................................................................. 7,308 7,286 4,828
Equipment........................................................................ 2,250 2,460 2,249
Amortization of goodwill and core deposit intangibles............................ 6,854 5,619 1,522
Other operating.................................................................. 14,571 14,510 17,146
Other real estate................................................................ (185) (2,567) (200)
--------- --------- ---------
Total noninterest expense...................................................... 211,331 181,757 144,595
--------- --------- ---------
Income before income taxes....................................................... 150,024 125,329 99,134
Income taxes..................................................................... 53,796 45,196 32,571
--------- --------- ---------
Net income....................................................................... 96,228 80,133 66,563
--------- --------- ---------
Other comprehensive income
Unrealized gains (losses) on securities available-for-sale..................... 16,270 11,991 (5,519)
Reclassification adjustment for (gains) losses included in noninterest
income........................................................................ (3,173) 1,004 (1,323)
Income taxes (benefits)........................................................ 5,545 5,497 (2,738)
--------- --------- ---------
Other comprehensive income (loss)................................................ 7,552 7,498 (4,104)
--------- --------- ---------
Comprehensive income............................................................. $ 103,780 $ 87,631 $ 62,459
--------- --------- ---------
--------- --------- ---------
Net income per share, basic...................................................... $ 2.08 $ 1.74 $ 1.52
--------- --------- ---------
--------- --------- ---------
Net income per share, diluted.................................................... $ 2.00 $ 1.68 $ 1.47
--------- --------- ---------
--------- --------- ---------
Shares used to compute net income per share, basic............................... 46,357 46,018 43,888
--------- --------- ---------
--------- --------- ---------
Shares used to compute net income per share, diluted............................. 48,141 47,809 45,146
--------- --------- ---------
--------- --------- ---------
Dividends per share.............................................................. $ 0.56 $ 0.44 $ 0.36
--------- --------- ---------
--------- --------- ---------
See accompanying Notes to Consolidated Financial Statements.
A-35
CITY NATIONAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
DOLLARS IN THOUSANDS 1998 1997 1996
- - --------------------------------------------------------------------------------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income....................................................................... $ 96,228 $ 80,133 $ 66,563
Adjustments to net income:
Writedowns on ORE.............................................................. 122 -- 229
Gain on sales of ORE........................................................... (475) (3,730) (325)
Depreciation................................................................... 8,816 6,144 5,143
Amortization of goodwill and core deposit intangibles.......................... 6,854 5,619 1,522
Net (increase) decrease in trading securities.................................. (4,212) 1,850 (2,401)
Deferred income tax expense (benefit).......................................... 11,856 4,288 (8,996)
Prepaid income taxes........................................................... -- -- (4,932)
Net increase in other liabilities (assets)..................................... 14,954 16,446 (24,699)
Gain (loss) on sale of securities.............................................. 3,072 (1,048) 187
Other, net..................................................................... (2,692) (16,475) 33,064
--------- --------- ---------
Net cash provided by operating activities.................................... 134,523 93,227 65,355
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Net (increase) decrease in short-term investments................................ (223) 10,667 69,718
Purchase of securities available-for-sale........................................ (537,855) (322,392) (418,339)
Sales of securities available-for-sale........................................... 246,052 340,762 327,456
Maturities of securities available-for-sale...................................... 109,357 58,089 328,644
Maturities of investment securities.............................................. 29,817 15,993 34,819
Purchase of investment securities................................................ (3,971) (46,147) (123,706)
Purchase of residential mortgage loans........................................... (40,646) (74,681) (250,726)
Sale of residential mortgage loans............................................... -- 47,513 62,717
(Loan originations) and principal collections, net............................... (534,023) (634,616) (340,802)
Proceeds from sales of ORE....................................................... 2,204 26,473 5,730
Proceeds from sale of leveraged leases........................................... -- -- 1,824
Purchase of premises and equipment............................................... (18,034) (17,695) (1,444)
Net cash from acquisitions....................................................... 32,419 42,876 --
Bank owned life insurance premium paid........................................... (40,399) -- --
Other, net....................................................................... 881 1,966 24,207
--------- --------- ---------
Net cash used by investing activities.......................................... (754,421) (551,192) (279,902)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in federal funds purchased and securities sold under
repurchase agreements.......................................................... 69,884 11,878 (63,804)
Net increase in deposits......................................................... 453,454 390,646 138,488
Net increase (decrease) in short-term borrowings................................. 104,426 54,133 (46,458)
Proceeds from issuance of other long-term debt................................... 150,000 50,000 9,800
Repayment of long-term debt...................................................... -- (25,000) --
Net proceeds of subordinated debt................................................ 124,081 -- --
Proceeds from exercise of stock options.......................................... 12,321 11,367 7,847
Stock repurchases................................................................ (59,768) (22,503) (22,384)
Cash dividends paid.............................................................. (26,042) (20,310) (15,815)
Other, net....................................................................... 4,987 2,906 (2,421)
--------- --------- ---------
Net cash provided by financing activities...................................... 833,343 453,117 5,253
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents............................. 213,445 (4,848) (209,294)
Cash and cash equivalents at beginning of year................................... 477,398 482,246 691,540
--------- --------- ---------
Cash and cash equivalents at end of year......................................... $ 690,843 $ 477,398 $ 482,246
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest..................................................................... $ 122,739 $ 103,392 $ 82,535
Income taxes................................................................. 37,950 38,502 31,750
Non-cash investing activities:
Transfer from loans to foreclosed assets..................................... 4,010 11,885 15,608
Transfers from investment securities to securities available-for-sale........ 182,557 -- --
See accompanying Notes to Consolidated Financial Statements.
A-36
CITY NATIONAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
ACCUMULATED
ADDITIONAL OTHER TOTAL
SHARES COMMON PAID-IN COMPREHENSIVE RETAINED TREASURY SHAREHOLDERS'
DOLLARS IN THOUSANDS ISSUED STOCK CAPITAL INCOME (LOSS) EARNINGS STOCK EQUITY
- - ---------------------------- --------- ----------- ----------- --------------- --------- ----------- -------------
Balances, December 31,
1995...................... 45,553,724 $ 45,554 $ 266,829 $ 1,955 $ 62,518 $ (9,899) $ 366,957
Net income.................. -- -- -- -- 66,563 -- 66,563
Issuance of shares for stock
options................... 749,058 749 7,098 -- -- -- 7,847
Tax benefit from stock
options................... -- -- 1,683 -- -- -- 1,683
Cash dividends.............. -- -- -- -- (15,815) -- (15,815)
Other comprehensive loss net
of tax.................... -- -- -- (4,104) -- -- (4,104)
Repurchased shares.......... -- -- -- -- -- (22,384) (22,384)
--------- ----------- ----------- ------- --------- ----------- -------------
Balances, December 31,
1996...................... 46,302,782 46,303 275,610 (2,149) 113,266 (32,283) 400,747
Net income.................. -- -- -- -- 80,133 -- 80,133
Issuance of shares for stock
options................... 398,109 398 949 -- -- 10,020 11,367
Tax benefit from stock
options................... -- -- 2,908 -- -- -- 2,908
Cash dividends.............. -- -- -- -- (20,310) -- (20,310)
Other comprehensive income
net of tax................ -- -- -- 7,498 -- -- 7,498
Repurchased shares, net..... -- -- -- -- -- (22,503) (22,503)
Issuance of treasury shares
for acquisitions.......... -- -- 18,187 -- -- 30,643 48,830
--------- ----------- ----------- ------- --------- ----------- -------------
Balances, December 31,
1997...................... 46,700,891 46,701 297,654 5,349 173,089 (14,123) 508,670
Net income.................. -- -- -- -- 96,228 -- 96,228
Issuance of shares for stock
options................... 53,342 53 (22,185) -- -- 34,453 12,321
Tax benefit from stock
options................... -- -- 4,987 -- -- -- 4,987
Cash dividends.............. -- -- -- -- (26,042) -- (26,042)
Other comprehensive income
net of tax................ -- -- -- 7,552 -- -- 7,552
Repurchased shares, net..... -- -- -- -- -- (59,768) (59,768)
Issuance of shares for
acquisition............... 130,949 131 6,907 -- -- 10,817 17,855
--------- ----------- ----------- ------- --------- ----------- -------------
Balances, December 31,
1998...................... 46,885,182 $ 46,885 $ 287,363 $ 12,901 $ 243,275 $ (28,621) $ 561,803
--------- ----------- ----------- ------- --------- ----------- -------------
--------- ----------- ----------- ------- --------- ----------- -------------
See accompanying Notes to Consolidated Financial Statements.
A-37
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of City National Corporation (the
Corporation) and of City National Bank (the Bank) and its subsidiaries conform
to generally accepted accounting principles and to prevailing practices within
the banking industry. The preparation of these consolidated financial statements
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities, and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reported periods. Actual
results could differ from those estimates.
City National Corporation and subsidiaries (the Company), through its
primary subsidiary, the Bank, provides private and business banking services
primarily in the Southern California market. The Bank's principal customer base
comprises small- to middle-market companies with annual sales revenue of up to
$250 million, entrepreneurs, professionals, and high net worth individuals. The
Bank typically serves customers seeking relationship banking, which it seeks to
provide through a high level of personal service, tailored products, and private
banking teams. The Bank offers commercial and personal loans of all types,
deposit, cash management, international banking and other products and services.
In addition, the Bank lends, invests and provides services in accordance with
its Community Reinvestment Act commitment. Through City National Investments,
the bank offers personal and employee benefit trust and estate services and
deals in money market and other investments for its own account and for the
customers. The Bank also offers mutual funds in association with other
companies.
BASIS OF PRESENTATION
The consolidated financial statements of the Company include the accounts of
the Corporation; its non-bank subsidiary; the Bank, and the Bank's wholly owned
subsidiaries after elimination of all material inter-company transactions.
Certain prior years' data have been reclassified to conform to current year
presentation.
The Company and its subsidiaries are on the accrual basis of accounting for
income and expenses. In accordance with the usual practice of banks, assets and
liabilities of individual trust, agency and fiduciary funds have not been
included in the financial statements.
SECURITIES
On December 31, 1998, the Company changed its intent to hold all investment
securities to maturity and therefore has classified all securities other than
trading securities as available-for-sale valued at fair value. Trading
securities are valued at market value with any unrealized gains or losses
included in income. Unrealized gains or losses on available-for-sale securities
are excluded from net income but are included in comprehensive income net of
taxes. Premiums or discounts on available-for-sale securities are amortized or
accreted into income using the interest method. Realized gains or losses on
sales of available-for-sale securities are recorded using the specific
identification method. Investment services income consists of fees, commissions
and markups on securities transactions with customers and money market mutual
fund fees.
LOANS
Loans are generally carried at principal amounts less net deferred loan
fees. Net deferred loan fees include deferred unamortized fees less direct
incremental loan origination costs. Interest income is accrued as earned. Net
deferred fees are accreted into interest income using the interest method.
A-38
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loans are placed on nonaccrual status when a loan becomes 90 days past due
as to interest or principal unless the loan is both well secured and in process
of collection. Loans are also placed on nonaccrual status when the full
collection of interest or principal becomes uncertain. When a loan is placed on
nonaccrual status, the accrued and unpaid interest receivable is reversed and
the accretion of deferred loan fees is ceased. Thereafter, interest collected on
the loan is accounted for on the cash collection or cost recovery method until
qualifying for return to accrual status. Generally, a loan may be returned to
accrual status when all delinquent principal and interest are brought current in
accordance with the terms of the loan agreement and certain performance criteria
have been met.
The Company considers a loan to be impaired when it is probable that it will
be unable to collect all amounts due according to the contractual terms of the
loan agreement. Once a loan is determined to be impaired, the impairment is
measured based on the present value of the expected future cash flows discounted
at the loan's effective interest rate, except that as a practical expedient, the
impairment is measured by using the loan's observable market price or the fair
value of the collateral if the loan is collateral dependent.
When the measurement of the impaired loan is less than the recorded amount
of the loan, an impairment is recognized by creating a valuation allowance with
a corresponding charge to the allowance for credit losses or by adjusting an
existing valuation allowance for the impaired loan with a corresponding charge
or credit to the allowance for credit losses.
The Company's policy is to record cash receipts received on impaired loans
first as reductions to principal and then to interest income.
ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses charged to operations reflects management's
judgement of the adequacy of the allowance for credit losses and is determined
through quarterly analytical reviews of the loan portfolio, problem loans and
consideration of such other factors as the Company's loan loss experience,
trends in problem loans, concentrations of credit risk, and current and expected
future economic conditions, as well as the results of the Company's ongoing
credit examination process and that of its regulators.
PREMISES AND EQUIPMENT
Bank premises and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation is computed generally on a straight-line basis
over the estimated useful life of each type of asset. Gains and losses on
dispositions are reflected in current operations. Maintenance and repairs are
charged to operating expenses.
OTHER REAL ESTATE (ORE)
Other real estate is comprised of real estate acquired in satisfaction of
loans. Properties acquired by foreclosure or deed in lieu of foreclosure are
transferred to ORE and are recorded at fair value less estimated costs to sell,
at the date of transfer of the property. The fair value of the ORE property is
based upon a current appraisal. Losses that result from the ongoing periodic
valuation of these properties are charged against ORE expense in the period in
which they are identified. Expenses for holding costs are charged to operations
as incurred.
A-39
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company files a consolidated federal income tax return and a combined
state income tax return. Deferred tax assets and liabilities are recognized for
the expected future tax consequences of existing differences between financial
reporting and tax reporting basis of assets and liabilities, as well as for
operating losses and tax credit carry forwards, using enacted tax laws and
rates. Deferred tax assets will be reduced through a valuation allowance
whenever it becomes more likely than not that all, or some portion, will be
realized. Deferred income taxes (benefit) represents the net change in the
deferred tax asset or liability balance during the year. This amount, together
with income taxes currently payable or refundable in the current year,
represents the total income taxes (benefit) for the year.
NET INCOME PER SHARE
Basic earnings per share is based on the weighted average shares of common
stock, which were calculated as 46,357,000, 46,018,000 and 43,888,000 for 1998,
1997 and 1996, respectively. Diluted earnings per share gives effect to all
dilutive potential common shares that were outstanding during part or all of the
year and were calculated as 48,141,000, 47,809,000 and 45,146,000, respectively.
GOODWILL AND CORE DEPOSIT INTANGIBLES
Goodwill represents the excess of the purchase price over the estimated fair
value of net assets associated with acquisition transactions of the Company
accounted for as purchases and is amortized over fifteen years. Core deposit
intangibles represent the intangible value of depositor relationships resulting
from deposit liabilities assumed in acquisitions and are amortized over seven
years. Goodwill and core deposit intangibles are evaluated periodically for
other than temporary impairment. Should such an assessment indicate that the
undiscounted value of an intangible may be impaired, the net book value of the
intangible would be written down to net estimated recoverable value. The
carrying value of goodwill and core deposit intangibles is net of accumulated
amortization of $11.2 million and $7.1 million at December 31, 1998 and December
31, 1997, respectively.
INTEREST-RATE-RISK MANAGEMENT ACTIVITIES
For those interest-rate instruments that alter the repricing characteristics
of assets or liabilities, the net differential to be paid or received on the
instrument is treated as an adjustment to the yield on the underlying assets or
liabilities (the accrual method). To qualify for the accrual method, the
interest-rate instrument must be designated to specific assets or liabilities or
pools of assets or liabilities, and must be effective at altering the
interest-rate characteristics of the related assets or liabilities.
STOCK OPTION PLAN
Compensation expense is recorded on the date of grant only if the current
market price of the underlying stock exceeded the exercise price. As a practice,
the exercise price equals the current market price and there is no compensation
expense. Pro forma net income and pro forma net income per share disclosures for
employee stock option grants are based on recognition as expense, over the
vesting period, of the fair value on the date of grant of all stock-based awards
made in 1995 and subsequent years.
A-40
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME
Beginning in 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (SFAS No, 130), which
requires the disclosure of comprehensive income and its components in a full set
of general purpose financial statements. Changes in unrealized gain (loss) on
available-for-sale securities net of income taxes is the only component of other
comprehensive income for the Company.
SEGMENT REPORTING
Beginning in 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" (SFAS No. 131). Management of the Company has determined that it is
engaged in only one operating segment, providing private and business banking
services.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133).
This Statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. This Statement is effective for fiscal
years beginning after June 15, 1999. The Company uses interest rate swaps to
manage interest rate exposure, which are accounted for as hedging activities and
does not believe that the implementation will have a significant impact on the
Company's financial position, net income or net comprehensive income.
NOTE 2. ACQUISITIONS
On December 31, 1998, the Company completed its acquisition of North
American Trust Company, an independent trust company for $11.5 million in an all
cash transaction. The acquisition of North American Trust Company resulted in
the recording of intangibles of approximately $11.3 million under the purchase
method of accounting including $1.0 million of severance, excess space and other
purchase price costs of which $0.2 million were paid in 1998. Payments are
expected to be made in the first half of 1999 of $0.3 million and the remaining
payments of $0.5 million relating to excess space are to be made over the
remaining 6.5 years of a lease.
On January 9, 1998, the Company completed its acquisition of Harbor Bancorp
(HB) for $34.5 million. The Company issued approximately 540,000 shares,
primarily from treasury with an aggregate market value of $17.9 million and paid
the remainder in cash. The acquisition of HB resulted in the recording of
goodwill and intangibles of approximately $24.0 million under the purchase
method of accounting. At December 31, 1998, the remaining unamortized balance
was approximately $21.7 million.
On January 24, 1997, the Company completed its acquisition of Riverside
National Bank (RNB). The Company paid approximately $41.4 million for RNB by
issuing approximately 1.0 million treasury shares with an aggregate market value
of approximately $20.7 million and paid the remainder in cash. The acquisition
of RNB was accounted for under the purchase method of accounting and resulted in
the recording of goodwill and intangibles of approximately $27.4 million. At
December 31, 1998, the remaining unamortized balance was approximately $21.6
million. The results of RNB's operations are included in those reported by the
Company beginning on January 25, 1997.
A-41
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. ACQUISITIONS (CONTINUED)
On January 17, 1997, the Company completed its acquisition of Ventura County
National Bancorp (VCNB). The Company paid approximately $49.1 million for VCNB
by issuing approximately 1.3 million treasury shares with an aggregate market
value of approximately $28.1 million and paid the remainder in cash. The
acquisition of VCNB was accounted for under the purchase method of accounting
and resulted in the recording of goodwill and intangibles of approximately $27.4
million. At December 31, 1998, the remaining unamortized balance was
approximately $19.1 million. The results of VCNB's operations are included in
those reported by the Company beginning on January 18, 1997.
NOTE 3. INVESTMENT SECURITIES
On December 31, 1998, all investment securities were transferred to
available-for-sale. The following is a summary of the amortized cost and
estimated fair value for the major categories of investment securities as of
December 31, 1997:
GROSS GROSS
CARRYING UNREALIZED UNREALIZED FAIR
DOLLARS IN THOUSANDS VALUE GAINS LOSSES VALUE
- - ----------------------------------------------------------------- ---------- ----------- ------ ----------
Mortgage-backed.................................................. $ 107,386 $ 693 $ 351 $ 107,728
State and Municipal.............................................. 107,567 1,370 181 108,756
Other debt....................................................... 3,216 -- -- 3,216
---------- ----------- ----- ----------
Total debt securities.......................................... 218,169 2,063 532 219,700
Marketable equity securities..................................... 7,765 -- -- 7,765
---------- ----------- ----- ----------
Total securities............................................... $ 225,934 $ 2,063 $ 532 $ 227,465
---------- ----------- ----- ----------
---------- ----------- ----- ----------
A-42
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. SECURITIES AVAILABLE-FOR-SALE
The following is a summary of amortized cost and estimated fair value for
the major categories of securities available-for-sale:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DOLLARS IN THOUSANDS COST GAINS LOSSES VALUE
- - --------------------------------------------------------------- ---------- ----------- ----------- ------------
December 31, 1998
U.S. Government and federal agency........................... $ 268,838 $ 6,323 $ 16 $ 275,145
Mortgage-backed.............................................. 348,826 3,043 400 351,469
State and Municipal.......................................... 121,743 2,180 78 123,845
Other debt................................................... 145,852 6,943 103 152,692
---------- ----------- ----------- ------------
Total debt securities...................................... 885,259 18,489 597 903,151
Marketable equity securities................................. 104,893 5,457 975 109,375
---------- ----------- ----------- ------------
Total securities........................................... $ 990,152 $ 23,946 $ 1,572 $ 1,012,526
---------- ----------- ----------- ------------
---------- ----------- ----------- ------------
December 31, 1997
U.S. Government and federal agency........................... $ 255,552 $ 2,105 $ 600 $ 257,057
Mortgage-backed.............................................. 171,439 1,247 611 172,075
State and Municipal.......................................... 5,911 86 -- 5,997
Other debt................................................... 23,928 1,992 -- 25,920
---------- ----------- ----------- ------------
Total debt securities...................................... 456,830 5,430 1,211 461,049
Marketable equity securities................................. 141,080 5,317 258 146,139
---------- ----------- ----------- ------------
Total securities........................................... $ 597,910 $ 10,747 $ 1,469 $ 607,188
---------- ----------- ----------- ------------
---------- ----------- ----------- ------------
A-43
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. SECURITIES AVAILABLE-FOR-SALE (CONTINUED)
Gross realized gains and losses related to the available-for-sale portfolios
were $5,299,000 and $2,227,000, respectively, for the year ended December 31,
1998, $638,000 and $1,686,000, respectively, for the year ended December 31,
1997 and $2,784,000 and $2,597,000, respectively, for the year ended December
31, 1996.
The following table provides the expected remaining maturities and yields
(taxable-equivalent basis) of debt securities at December 31, 1998, by
contractual maturity:
ONE YEAR OVER 1 YEAR OVER 5 YEARS TOTAL
OR LESS THRU 5 YEARS THRU 10 YEARS OVER 10 YEARS 1998
------------------------ ---------------------- ------------------------ ---------------------- ---------
DOLLARS IN THOUSANDS AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT
- - --------------------- ----------- ----- --------- ----- ----------- ----- --------- ----- ---------
U.S. Government and
federal agency..... $ 30,411 6.15% $ 192,478 6.11% $ 52,256 6.11% $ -- -- % $ 275,145
Mortgage-backed...... 1,036 7.02 2,430 6.11 14,864 6.10 333,139 6.64 351,469
State and Municipal.. 18,715 6.36 73,083 6.73 28,397 6.42 3,650 6.46 123,845
Other debt........... -- -- 2,154 7.00 1,000 7.50 149,538 7.79 152,692
----------- --- --------- --- ----------- --- --------- --- ---------
Total debt
securities....... $ 50,162 6.25% $ 270,145 6.28% $ 96,517 6.21% $ 486,327 6.99% $ 903,151
----------- --- --------- --- ----------- --- --------- --- ---------
----------- --- --------- --- ----------- --- --------- --- ---------
Amortized cost..... $ 49,712 $ 263,726 $ 95,008 $ 476,813 $ 885,259
----------- --------- ----------- --------- ---------
----------- --------- ----------- --------- ---------
TOTAL TOTAL
1997 1996
---------------------- ----------------------
DOLLARS IN THOUSANDS YIELD AMOUNT YIELD AMOUNT YIELD
- - --------------------- ----- --------- ----- --------- -----
U.S. Government and
federal agency..... 6.11% $ 257,057 6.31% $ 372,316 5.69%
Mortgage-backed...... 6.61 172,075 6.66 127,936 6.28
State and Municipal.. 6.60 5,997 6.71 14,067 6.76
Other debt........... 7.78 25,920 7.79 34,011 5.11
--- --------- --- --------- ---
Total debt
securities....... 6.65% $ 461,049 6.67% $ 548,330 5.82%
--- --------- --- --------- ---
--- --------- --- --------- ---
Amortized cost..... $ 456,830 $ 553,537
--------- ---------
--------- ---------
Available-for-sale securities totaling $561.9 million were pledged to secure
trust funds, public deposits, or for other purposes required or permitted by law
at December 31, 1998.
NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES
The following is a summary of the major categories of loans:
DECEMBER 31,
--------------------------
DOLLARS IN THOUSANDS 1998 1997
- - ------------------------------------------------------------------ ------------ ------------
Commercial........................................................ $ 2,457,946 $ 1,972,232
Residential first mortgage........................................ 1,038,229 980,040
Real estate construction.......................................... 237,015 144,558
Real estate commercial mortgage................................... 747,711 686,188
Installment....................................................... 49,526 42,206
------------ ------------
Total loans (net of unearned income and fees of $7,203 and
$4,310)......................................................... $ 4,530,427 $ 3,825,224
------------ ------------
------------ ------------
At December 31, 1998 and 1997, the Company had identified impaired loans
with recorded investments of $13.7 million and $16.6 million, respectively.
There were no impaired loans with allocated allowances for credit losses as of
December 31, 1998. Allowances of $0.5 million on loans with outstanding balances
of $3.0 million existed as of December 31, 1997. The allowances represent the
differences between the value of the collateral supporting the loans and their
outstanding balances. For 1998 and 1997, the average balance of impaired loans
was $0.3 million and $21.2 million, respectively. During 1998, 1997 and 1996, no
interest income was recognized on impaired loans until the book balances of
these loans were paid off.
A-44
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES (CONTINUED)
In the normal course of business, the Bank has loans to officers and
directors as well as loans to companies and individuals affiliated with or
guaranteed by officers and directors of the Company and the Bank. These loans
were made in the ordinary course of business at rates and terms no more
favorable than those offered to other customers with a similar credit standing.
The aggregate dollar amounts of these loans were $17.2 million and $17.0 million
at December 31, 1998 and 1997, respectively. During 1998, new loans made totaled
$0.4 million and repayments totaled $0.2 million. Interest income recognized on
these loans amounted to $1.5 million, $1.4 million and $1.4 million during 1998,
1997 and 1996, respectively. At December 31, 1998, none of these loans were on
nonaccrual status. Based on analysis of information presently known to
management about the loans to officers and Directors and their affiliates,
management believes all have the ability to comply with the present loan
repayment terms.
Loans past due 90 days or more and still accruing interest totaled $8.6
million, $26.2 million and $12.4 million at December 31, 1998, 1997 and 1996,
respectively. Restructured loans totaled $3.7 million, $4.1 million, and $2.6
million at December 31, 1998, 1997 and 1996, respectively.
The following is a summary of activity in the allowance for credit losses:
DOLLARS IN THOUSANDS 1998 1997 1996
- - --------------------------------------------------------- ---------- ---------- ----------
Balance, January 1....................................... $ 137,761 $ 130,089 $ 131,514
Allowance of acquired institutions....................... 2,747 7,016 --
Charge offs.............................................. (17,636) (19,512) (20,342)
Recoveries............................................... 12,467 20,168 18,917
---------- ---------- ----------
Net (charge offs) recoveries............................. (5,169) 656 (1,425)
---------- ---------- ----------
Balance, December 31..................................... $ 135,339 $ 137,761 $ 130,089
---------- ---------- ----------
---------- ---------- ----------
The following is a summary of non-performing loans and related interest
foregone (received):
DECEMBER 31,
-------------------------------
DOLLARS IN THOUSANDS 1998 1997 1996
- - ------------------------------------------------------------- --------- --------- ---------
Nonaccrual loans............................................. $ 23,138 $ 27,566 $ 41,543
--------- --------- ---------
--------- --------- ---------
Contractual interest due..................................... $ 3,967 $ 5,364 $ 6,262
Interest recognized.......................................... 1,973 5,490 4,135
--------- --------- ---------
Net interest foregone (received)........................... $ 1,994 $ (126) $ 2,127
--------- --------- ---------
--------- --------- ---------
A-45
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES (CONTINUED)
The Company has pledged all of its eligible residential first mortgages to
the Federal Home Loan Bank of San Francisco under that institution's blanket
lien program although not all of the pledged mortgages are being utilized to
collateralize current borrowings.
NOTE 6. PREMISES AND EQUIPMENT
The following is a summary of data for the major categories of premises and
equipment:
ACCUMULATED
DEPRECIATION
AND CARRYING
DOLLARS IN THOUSANDS COST AMORTIZATION VALUE
- - --------------------------------------------------------- ---------- ------------ ---------
DECEMBER 31, 1998
Premises, including land of $5,245..................... $ 51,549 $ 24,417 $ 27,132
Software............................................... 9,678 1,799 7,879
Furniture, fixtures and equipment...................... 54,219 33,464 20,755
---------- ------------ ---------
Total................................................ $ 115,446 $ 59,680 $ 55,766
---------- ------------ ---------
---------- ------------ ---------
DECEMBER 31, 1997
Premises, including land of $5,182..................... $ 50,270 $ 26,532 $ 23,738
Furniture, fixtures and equipment...................... 47,311 27,647 19,664
---------- ------------ ---------
Total................................................ $ 97,581 $ 54,179 $ 43,402
---------- ------------ ---------
---------- ------------ ---------
Depreciation and amortization expense was $8.8 million in 1998, $6.1 million
in 1997 and $5.1 million in 1996. Net rental payments on operating leases
included in net occupancy of premises in the Consolidated Statement of Income
and Comprehensive Income were $8.4 million in 1998, $7.1 million in 1997, and
$6.4 million in 1996.
The future net minimum rental commitments were as follows at December 31,
1998:
NET MINIMUM
RENTAL
DOLLARS IN THOUSANDS COMMITMENTS
- - ------------------------------------------------------------------------------- -------------
1999........................................................................... $ 15,231
2000........................................................................... 13,962
2001........................................................................... 12,520
2002........................................................................... 11,659
2003........................................................................... 8,936
Thereafter..................................................................... 20,841
-------------
Total.......................................................................... $ 83,149
-------------
-------------
A majority of the leases provide for the payment of taxes, maintenance,
insurance and certain other expenses applicable to the leased premises. Many of
the leases contain extension provisions and escalation clauses. The Bank paid
$1.1 million per year in 1998, 1997 and 1996 for rent and operating expense pass
throughs to a real estate partnership in which the Bank owns a 32% interest, and
Mr. Bram Goldsmith, Chairman, indirectly owns a 14% interest.
A-46
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. PREMISES AND EQUIPMENT (CONTINUED)
The rental commitment amounts in the table above reflect the contractual
obligations of the Company under all leases including those assumed from the
Acquired Banks and North American Trust Company. Lease obligations assumed from
the Acquired Banks and North American Trust Company have been adjusted to
current market values through purchase accounting adjustments. The allowance
thus created will be accreted over the terms of the leases and reduce the total
expense recognized by the Company in its operating expenses. At December 31,
1998, the Company is contractually entitled to receive minimum future rentals of
$8.8 million under noncancellable sub-leases.
NOTE 7. INCOME TAXES
Income tax (benefit) in the Consolidated Statement of Income and
Comprehensive Income includes the following amounts:
DOLLARS IN THOUSANDS CURRENT DEFERRED TOTAL
- - ------------------------------------------------------------- --------- --------- ---------
1998
Federal.................................................... $ 36,594 $ 2,544 $ 39,138
State...................................................... 5,346 9,312 14,658
--------- --------- ---------
Total.................................................... $ 41,940 $ 11,856 $ 53,796
--------- --------- ---------
--------- --------- ---------
1997
Federal.................................................... $ 30,684 $ 2,988 $ 33,672
State...................................................... 10,224 1,300 11,524
--------- --------- ---------
Total.................................................... $ 40,908 $ 4,288 $ 45,196
--------- --------- ---------
--------- --------- ---------
1996
Federal.................................................... $ 31,399 $ (3,639) $ 27,760
State...................................................... 10,168 (5,357) 4,811
--------- --------- ---------
Total.................................................... $ 41,567 $ (8,996) $ 32,571
--------- --------- ---------
--------- --------- ---------
A-47
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities at December 31,
1998 and 1997 are presented below.
NET DEFERRED TAX ASSETS
DOLLARS IN THOUSANDS 1998 1997
- - ------------------------------------------------------------------------ --------- ---------
Deferred tax assets:
Allowance for credit losses........................................... $ 44,557 $ 47,282
Net operating loss carryforwards...................................... 15,353 17,064
Accrued expenses...................................................... 4,126 3,189
State income taxes.................................................... 8,816 13,851
Purchase accounting fair value adjustment............................. 4,203 5,397
Other................................................................. 1,284 1,934
--------- ---------
Total gross deferred tax assets..................................... 78,339 88,717
Valuation allowance................................................... (5,297) (8,248)
--------- ---------
73,042 80,469
--------- ---------
Deferred tax liabilities:
Leveraged leases...................................................... 3,999 4,461
Core deposit and other intangibles.................................... 7,265 8,232
Installment sales..................................................... 1,177 1,264
Unrealized gains on available-for-sale securities..................... 9,473 3,929
Deferred loan origination costs....................................... 1,671 1,348
Loan fees............................................................. 1,338 1,117
Other................................................................. 2,381 1,303
--------- ---------
Total gross deferred tax liabilities................................ 27,304 21,654
--------- ---------
Net deferred tax assets................................................. $ 45,738 $ 58,815
--------- ---------
--------- ---------
A-48
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. INCOME TAXES (CONTINUED)
Income taxes resulted in effective tax rates that differ from the statutory
federal income tax rate for the following reasons:
% OF PRETAX INCOME (LOSS)
-------------------------------
1998 1997 1996
--------- --------- ---------
Statutory rate................................................. 35.0% 35.0% 35.0%
Net state income tax........................................... 6.3 6.0 6.4
Tax exempt income.............................................. (3.9) (4.4) (3.6)
Tax credits.................................................... (1.1) (0.8) (1.1)
Cash surrender value of life insurance......................... (0.5) -- --
Reduction in valuation allowances.............................. -- -- (4.3)
Amortization of goodwill....................................... 0.8 0.5 --
All other--net................................................. (0.7) (0.2) 0.5
--- --- ---
Effective tax provision........................................ 35.9% 36.1% 32.9%
--- --- ---
--- --- ---
The tax benefit of deductible temporary differences and net operating loss
carry forwards are recorded as an asset to the extent that management assesses
the utilization of such temporary differences and carry forwards to be "more
likely than not." The realization of tax benefits of deductible temporary
differences and carry forwards depends on whether the Company has sufficient
taxable income within the carry back and carry forward period permitted by the
tax law to allow for utilization of the deductible amounts. As of any period
end, the amount of deferred tax asset that is considered realizable could be
reduced if estimates of future taxable income are reduced.
As of January 1, 1996, the Company had a $19.8 million valuation allowance
principally related to net California deductible temporary differences of $76.0
million and net operating loss carryforwards of First LA. California law does
not permit carry backs and requires a 50% reduction of tax losses that are
carried forward. In 1996, the Company reduced the valuation allowance by $6.0
million as part of the Company's periodic reevaluation of deferred tax assets
which it believes are more likely than not to be realized in future tax returns.
The Company considered, among other factors, the record net income reported in
1997 in its evaluation of those deferred tax assets that it believes to be more
likely than not to be realized.
At December 31, 1998, First LA's federal net operating loss carry forwards
total $43.8 million, of which $18.6 million will expire in 2009 and $25.2
million will expire in 2010. First LA's California net operating loss carry
forwards total $21.3 million, of which $10.1 million will expire in 1999 and
$11.2 million will expire in 2000. During 1998, the Company reversed
approximately $3.0 million of the valuation allowance resulting from the
acquisition of First LA and reduced core deposit intangibles by a corresponding
amount.
NOTE 8. RETIREMENT PLAN
The Company has a profit sharing retirement plan with an IRS Section 401 (k)
feature covering eligible employees. Contributions are made on an annual basis
into a trust fund and are allocated to the participants based on their salaries.
The profit sharing contribution requirement is based on a percentage of annual
operating income. For 1998, 1997 and 1996, the Company recorded total
contributions expense of $8.1 million, $6.7 million and $5.6 million,
respectively.
A-49
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. RETIREMENT PLAN (CONTINUED)
Eligible employees may contribute up to 15% of their salary, but not more
than the maximum allowed under IRS regulations. In 1998 and 1997, the Bank
matched 50% of the first six percent of covered compensation. In 1996, the Bank
matched 10% of the first four percent of covered compensation contributed using
forfeitures and cash. For 1998, 1997, and 1996 the Bank's matching contribution
included in the total contribution above was $1,374,000, $1,318,000 and $40,000,
respectively.
The Company does not provide for any post retirement employee benefits
beyond the profit sharing retirement plan.
NOTE 9. STOCK OPTION PLANS
Under the 1995 Omnibus Plan (the Plan), 3,000,000 shares of the Company's
common stock were reserved for grant of stock options. The Corporation's 1983
Stock Option Plan and 1985 Stock Option Plan have expired but options granted
thereunder remain outstanding. Grants to employees will be at prices at least
equal to the market price of the Company's stock on the effective date of the
grant. In each succeeding year following the date of grant, 25% of the options
become exercisable. After ten years from grant, all unexercised options will
expire.
The per share weighted-average fair value of stock options granted during
1998, 1997 and 1996 was $15.55, $9.09 and $4.51 on the date of grant using the
Black Scholes option-pricing model with the following weighted-average
assumptions: 1998-expected dividend yield of 2.00%, volatility of 33.6%,
risk-free interest rate of 5.58% and expected life of 7.5 years; 1997-expected
dividend yield of 2.00%, volatility of 33.8%, risk-free interest rate of 6.49%
and an expected life of 7.5 years; 1996-expected dividend yield of 1.64%,
volatility of 35.0%, risk-free interest rate of 6.01%, and an expected life of
7.5 years.
The Company applies APB Opinion No. 25 in accounting for the Plan and,
accordingly, no compensation cost has been recognized for its stock options in
the financial statements. Had the Company determined compensation cost based on
the fair value at the grant date for its stock options under SFAS No. 123, the
Company's net income would have been reduced to the pro forma amounts indicated
below:
DOLLARS IN THOUSANDS 1998 1997 1996
- - ------------------------------------------------- --------- --------- ---------
Net income, as reported.......................... $ 96,228 $ 80,133 $ 66,563
Pro forma net income............................. 90,689 77,840 65,140
Net income per share, basic, as reported......... $ 2.08 $ 1.74 $ 1.52
Proforma net income per share, basic............. 1.96 1.69 1.48
Net income per share, diluted, as reported....... 2.00 1.68 1.47
Proforma net income per share, diluted........... 1.88 1.63 1.44
Pro forma net income reflects only options granted in 1998, 1997, 1996 and
1995. Therefore, the full impact of calculating compensation cost for stock
options under SFAS No. 123 is not reflected in the pro forma net income amounts
presented above because compensation cost is reflected over the options' vesting
period of generally four years and compensation cost for options granted prior
to January 1, 1995 is not considered.
A-50
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. STOCK OPTION PLANS (CONTINUED)
The following is a summary of the transactions under the stock option plans
described above:
STOCK OPTION PLANS:
1998 1997 1996
-------------------------- -------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER OF AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE
SHARES IN THOUSANDS SHARES OPTION PRICE SHARES OPTION PRICE SHARES OPTION PRICE
- - ------------------------------------------ ----------- ------------- ----------- ------------- ----------- -------------
Options outstanding, January 1............ 3,689 $ 14.57 3,687 $ 12.06 4,120 $ 11.76
Granted................................... 1,300 35.68 751 24.48 603 13.65
Converted for acquisitions................ 12 9.83 176 8.99 -- --
Exercised................................. (1,061) 11.61 (858) 13.05 (749) 10.48
Canceled or expired....................... (91) 23.40 (67) 14.79 (287) 16.14
----------- ------ ----- ------ ----- ------
Options outstanding, December 31.......... 3,849 $ 22.07 3,689 $ 14.57 3,687 $ 12.06
----------- ------ ----- ------ ----- ------
----------- ------ ----- ------ ----- ------
Exercisable............................... 1,851 2,283 2,424
----------- ----- -----
----------- ----- -----
During 1998 the Company issued 1,008,079 treasury shares and 53,342 newly
issued shares in connection with the exercise of stock options. In 1997 the
Company issued 459,891 treasury shares and 398,109 newly issued shares in
connection with the exercise of stock options. In 1996 the Company issued
749,058 of newly issued shares for the exercise of stock options.
The information concerning currently outstanding and exercisable options at
December 31, 1998 are as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER REMAINING OUTSTANDING NUMBER EXERCISE
SHARES IN THOUSANDS OUTSTANDING LIFE (YRS) PRICE EXERCISABLE PRICE
- - ----------------------------------------------------- ------------- ------------- ----------- ------------- -----------
Options issued at prices less than $12.00 per
share.............................................. 889 5.23 $ 9.02 799 $ 8.76
Options issued at prices between $12.00 and $13.99
per share.......................................... 881 6.48 13.28 661 13.22
Options issued at prices between $14.00 and $29.99
per share.......................................... 770 7.46 23.70 266 22.77
Options issued at prices between $30.00 and $40.00
per share.......................................... 1,309 9.31 35.86 125 32.85
----- -----
3,849 1,851
----- -----
----- -----
At December 31, 1998, nonstatutory and incentive stock options covering
835,357 and 1,015,435 shares, respectively, of the Company's common stock were
exercisable under the plans. At December 31, 1998, 179,744 shares were available
for future grants.
In addition to the above, the Corporation's 1995 Omnibus Plan provides for
the automatic annual grant, on the date of the Annual Meeting of Stockholders,
of a discounted stock option (which is not Incentive Stock Option) to each
non-employee director, including members of the Compensation and
A-51
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. STOCK OPTION PLANS (CONTINUED)
Directors Nominating Committee to purchase 500 shares of the Corporation's
Common Stock ("Director Stock Options"). The exercise price of Director Stock
Options is $1.00 per share, payable in cash or cash equivalents, by surrender of
the Corporation's Common Stock held by the director for at least a year before
exercise, or any combination of the two. Director Stock Options vest 6 months
after the date of issuance or upon the termination of the holder's directorship
(other than for cause), whichever is earlier, and expire 10 years after the date
of grant. Such options fully vest six months after grant. During 1998 and 1997,
options to purchase 3,500 and 4,000 shares respectively, were granted to
directors of the Company.
NOTE 10. BORROWED FUNDS
The following is a summary of borrowed funds of the Company excluding
overnight federal funds purchased and securities sold under agreements to
repurchase.
BORROWED FUNDS
DECEMBER 31,
----------------------
DOLLARS IN THOUSANDS 1998 1997
- - ---------------------------------------------------------------------- ---------- ----------
Other short-term borrowings:
Term federal funds purchased........................................ $ 175,000 $ 50,000
Guaranteed investment contract...................................... -- 9,800
Treasury, tax and loan note......................................... 92,001 52,775
Federal Home Loan Bank advances..................................... 50,000 100,000
---------- ----------
Total............................................................. $ 317,001 $ 212,575
---------- ----------
---------- ----------
Subordinated debt..................................................... $ 123,265 $ --
---------- ----------
---------- ----------
Long-term debt:
Federal Home Loan Bank advances..................................... 200,000 50,000
---------- ----------
Total............................................................. $ 200,000 $ 50,000
---------- ----------
---------- ----------
Short-term borrowings consist of funds with remaining maturities of one year
or less, and long-term debt consists of borrowings with remaining maturities of
greater than one year. The maximum amount of other short-term borrowings at any
month end was $483.1 million, $267.9 million and $206.6 million in 1998, 1997
and 1996, respectively.
A-52
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. BORROWED FUNDS (CONTINUED)
The maximum amount of securities sold under agreements to repurchase
outstanding at any month end was $47.2 million, $127.5 million and $141.3
million, in 1998, 1997 and 1996, respectively. The average amount of securities
sold under agreements to repurchase was $17.5 million, $53.4 million and $95.2
million during 1998, 1997 and 1996, respectively. The securities underlying the
agreements to repurchase remain under the Company's control.
On January 12, 1998, the Bank issued $125.0 million of 6 3/8% Subordinated
Notes, due in 2008, in a private offering. These Subordinated Notes qualify as
Tier II capital. The carrying value of the Subordinated Notes is net of discount
and issuance costs which are being amortized to interest expense to yield an
effective interest rate of 6.62%.
Federal Home Loan Bank advances outstanding as of December 31, 1998 (in
thousands of dollars) mature as follows:
INTEREST
BORROWINGS MATURITY RATE
----------- --------- ------------
$ 50,000 5/8/00 5.2750%
25,000 7/3/00 5.2325%
25,000 8/14/00 5.3217%
-----------
100,000
25,000 1/22/01 5.1481%
25,000 8/14/01 5.3317%
-----------
50,000
25,000 11/18/02 5.5800%
25,000 12/16/02 5.9900%
-----------
50,000
-----------
$ 200,000
-----------
-----------
Federal Home Loan Bank advances outstanding were $50.0 million as of
December 31, 1997; $25.0 million maturing on November 18, 2002, but putable
beginning on November 19, 1999 and any time thereafter, with a fixed interest
rate of 5.58% and $25.0 million maturing on December 16, 2002 with a fixed
interest rate of 5.99%.
The Bank had $403.8 million and $464.5 million of unused borrowing capacity
from the FHLB at December 31, 1998 and 1997, respectively.
NOTE 11. AVAILABILITY OF FUNDS FROM SUBSIDIARIES; RESTRICTIONS ON CASH BALANCES;
CAPITAL
The Company is authorized to issue 5,000,000 shares of Preferred Stock. The
Board of Directors has the authority to issue the preferred stock in one or more
series, and to fix the designations, rights, preferences, privileges,
qualifications and restrictions, including dividend rights, conversion rights,
voting rights, rights and terms of redemption, liquidation preferences and
sinking fund terms.
Historically, the majority of the funds for the payment of dividends by the
Company have been obtained from the Bank. Under federal banking law, dividends
declared by national banks in any calendar year may not, without the approval of
the Office of the Comptroller of the Currency (OCC), exceed net profits (as
defined), for that year combined with its retained net income for the preceding
two calendar
A-53
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. AVAILABILITY OF FUNDS FROM SUBSIDIARIES; RESTRICTIONS ON CASH BALANCES;
CAPITAL (CONTINUED)
years. At December 31, 1998, the Bank could have declared dividends of $79
million without the approval of regulators.
Federal banking law also prohibits the Corporation from borrowing from the
Bank on less than a fully secured basis. At December 31, 1998 and 1997, the
Corporation had borrowed from the Bank $13.1 million and $45.0 million,
respectively, all of which was appropriately secured in compliance with
regulatory requirements.
Federal Reserve Board regulations require that the Bank maintain certain
minimum reserve balances. Cash balances maintained to meet reserve requirements
are not available for use by the Bank or the Company. During 1998 and 1997,
reserve balances averaged approximately $16.0 million and $45.4 million,
respectively.
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory--and possibly
additional discretionary--actions by regulators that, if undertaken, could have
a direct material effect on the Company's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company and the Bank must meet specific capital guidelines that involve
quantitative measures of the Company and Bank's assets, liabilities and certain
off-balance-sheet items as calculated under the regulatory accounting practices.
The Company's and the Bank's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and
the Bank to maintain minimum amounts and ratios (set forth in the table below)
of total and Tier 1 capital (as defined in the regulations) to risk-weighted
assets (as defined). Management believes, as of December 31, 1998, the Company
and the Bank meet all capital adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the OCC
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk based and Tier 1 leverage ratios
as set forth in the following table. There are no conditions or events since
that notification that management believes have changed the institution's
category.
A-54
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. AVAILABILITY OF FUNDS FROM SUBSIDIARIES; RESTRICTIONS ON CASH BALANCES;
CAPITAL (CONTINUED)
The Company's actual amounts and ratios are presented in the table:
FOR CAPITAL
ACTUAL ADEQUACY PURPOSES
-------------------- --------------------
DOLLARS IN MILLIONS AMOUNT RATIO AMOUNT RATIO
- - ----------------------------------------------------- --------- --------- --------- ---------
As of December 1998:
Total capital
GREATER
THAN OR
EQUAL
(to risk weighted assets)........................ $ 664.9 13.20% $ 403.1 TO8.0%
Tier 1 capital
GREATER
THAN OR
EQUAL
(to risk weighted assets)........................ 474.9 9.43% 201.5 TO4.0%
Tier 1 capital
GREATER
THAN OR
EQUAL
(to average assets).............................. 474.9 7.99% 237.9 TO4.0%
As of December 1997:
Total capital
GREATER
THAN OR
EQUAL
(to risk weighted assets)........................ $ 500.0 12.27% $ 326.0 TO8.0%
Tier 1 capital
GREATER
THAN OR
EQUAL
(to risk weighted assets)........................ 448.0 10.99% 163.0 TO4.0%
Tier 1 capital
GREATER
THAN OR
EQUAL
(to average assets).............................. 448.0 9.19% 195.0 TO4.0%
A-55
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. AVAILABILITY OF FUNDS FROM SUBSIDIARIES; RESTRICTIONS ON CASH BALANCES;
CAPITAL (CONTINUED)
The Bank's actual amounts and ratios are presented in the table:
FOR CAPITAL
ACTUAL ADEQUACY PURPOSES
-------------------- --------------------
DOLLARS IN MILLIONS AMOUNT RATIO AMOUNT RATIO
- - ----------------------------------------------------- --------- --------- --------- ---------
As of December 1998:
Total capital
GREATER
THAN OR
EQUAL
(to risk weighted assets)........................ $ 634.8 12.65% $ 401.6 TO8.0%
Tier 1 capital
GREATER
THAN OR
EQUAL
(to risk weighted assets)........................ 446.5 8.90% 200.8 TO4.0%
Tier 1 capital
GREATER
THAN OR
EQUAL
(to average assets).............................. 446.5 7.53% 237.1 TO4.0%
As of December 1997:
Total capital
GREATER
THAN OR
EQUAL
(to risk weighted assets)........................ $ 432.9 10.78% $ 321.4 TO8.0%
Tier 1 capital
GREATER
THAN OR
EQUAL
(to risk weighted assets)........................ 381.6 9.50% 160.5 TO4.0%
Tier 1 capital
GREATER
THAN OR
EQUAL
(to average assets).............................. 381.6 7.93% 192.4 TO4.0%
A-56
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is a party to financial
instruments with off-balance-sheet risk. These financial instruments include
commitments to extend credit, letters of credit and financial guarantees. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount reflected in the consolidated statement of
financial condition.
Exposure to credit loss in the event of non-performance by the other party
to the financial instrument for commitments to extend credit, letters of credit
and financial guarantees written, is represented by the contractual notional
amount of those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since a portion of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's credit
worthiness on a case-by-case basis.
The Company had outstanding loan commitments aggregating $2,273.8 million
and $1,947.8 million at December 31, 1998 and 1997, respectively. In addition,
the Company had $150.3 million and $140.3 million outstanding in bankers
acceptances and letters of credit of which $129.0 million and $115.5 million
relate to standby letters of credit at December 31, 1998 and 1997, respectively.
Substantially all of the Company's loan commitments are on a variable rate basis
and are comprised of real estate and commercial loan commitments.
The Corporation or its subsidiaries are defendants in various pending
lawsuits claiming substantial amounts. Based upon present knowledge, management
and in-house counsel are of the opinion that the final outcome of such lawsuits
will not have a material adverse effect on the Corporation.
NOTE 13. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
CASH AND DUE FROM BANKS AND FEDERAL FUNDS SOLD
For these short-term instruments, the carrying amount is a reasonable
estimate of fair value.
SECURITIES AND TRADING ACCOUNT ASSETS
For securities held as investments or available-for-sale, fair value equals
quoted market price, if available. If a quoted market price is not available,
fair value is estimated using quoted market prices for similar securities. For
trading account securities, fair values are based on quoted market prices or
dealer quotes.
LOAN RECEIVABLES
For certain homogeneous categories of loans, such as some residential
mortgages, and other consumer loans, fair value is estimated using dealer
quotes, adjusted for differences in loan characteristics. The fair value of
other types of loans is estimated by discounting the future cash flows using the
current rates at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining
A-57
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
maturities. In establishing the credit risk component of the fair value
calculations for loans, the Company concluded that the allowance for credit
losses represented a reasonable estimate of the credit risk component of the
fair value of loans at December 31, 1998 and 1997.
DEPOSIT LIABILITIES
The fair value of demand and interest checking deposits, savings deposits,
and certain money market accounts is the amount payable on demand at the
reporting date. The fair value of fixed-maturity certificates of deposit is
estimated using the rates currently offered for deposits of similar remaining
maturities.
SHORT-TERM BORROWINGS
For short-term borrowings, the carrying amount is a reasonable estimate of
fair value.
LONG-TERM DEBT
The fair value of long term debt was estimated by discounting the future
payments at current interest rates.
COMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT, AND FINANCIAL
GUARANTEES WRITTEN
The fair value of commitments is estimated using the fees currently charged
to enter into similar agreements, taking into account the remaining terms of the
agreements and the present credit worthiness of the counter parties. The Company
does not make fixed-rate loan commitments. The fair value of letters of
guarantee and letters of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counter parties at the reporting date.
DERIVATIVES
The fair value of exchange traded derivatives is based on quoted market
prices or dealer quotes. The fair value of non-exchange traded derivatives
consists of net unrealized gains or losses, accrued interest receivable or
payable and any premiums paid or received.
A-58
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values of financial instruments of the company are as
follows:
DECEMBER 31,1998 DECEMBER 31,1997
-------------------- --------------------
CARRYING FAIR CARRYING FAIR
DOLLARS IN MILLIONS AMOUNT VALUE AMOUNT VALUE
- - ------------------------------------------------------------------- --------- --------- --------- ---------
Financial Assets:
Cash and due from banks............................................ $ 286.4 $ 286.4 $ 327.7 $ 327.7
Federal funds sold and securities purchased under resale
agreements....................................................... 405.0 405.0 150.0 150.0
Investment securities.............................................. -- -- 225.9 227.5
Securities available-for-sale...................................... 1,012.5 1,012.5 607.2 607.2
Trading account assets............................................. 34.5 34.5 30.3 30.3
Loans, net of allowance for credit losses.......................... 4,395.1 4,487.7 3,687.5 3,747.3
Financial Liabilities:
Deposits........................................................... 4,887.4 4,886.4 4,228.3 4,228.8
Federal funds purchased and securities sold under resale
agreements....................................................... 451.3 451.3 206.4 206.4
Other short-term borrowings........................................ 142.0 142.0 212.6 212.6
Long-term debt..................................................... 323.3 325.6 50.0 50.0
Commitments to extend credit....................................... (12.6) (12.6) (9.1) (9.1)
Derivative contracts............................................... 710.0(1) 6.4(2) 425.0(1) 1.7(2)
- - ------------------------
(1) Notional Amount
(2) Estimated net gains (losses) to settle derivative contracts as of respective
period ends
A-59
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14. PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS
Condensed parent company financial statements, which include transactions
with subsidiaries, follow:
CONDENSED BALANCE SHEET
DECEMBER 31,
----------------------
DOLLARS IN THOUSANDS 1998 1997
- - ------------------------------------------------------------------------------------------ ---------- ----------
ASSETS
Cash...................................................................................... $ 6,145 $ 6,075
Securities available-for-sale............................................................. 32,684 104,108
Other assets.............................................................................. 256 515
Investment in City National Bank.......................................................... 531,918 440,380
Investment in nonbank subsidiary.......................................................... 4,958 4,440
---------- ----------
Total assets............................................................................ $ 575,961 $ 555,518
---------- ----------
---------- ----------
LIABILITIES
Notes payable to City National Bank....................................................... $ 13,120 $ 45,000
Other liabilities......................................................................... 1,038 1,848
---------- ----------
Total liabilities....................................................................... 14,158 46,848
Shareholders' Equity...................................................................... 561,803 508,670
---------- ----------
Total liabilities and shareholders' equity.............................................. $ 575,961 $ 555,518
---------- ----------
---------- ----------
CONDENSED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
YEAR ENDED DECEMBER 31,
--------------------------------
DOLLARS IN THOUSANDS 1998 1997 1996
- - -------------------------------------------------------------------------------- ---------- --------- ---------
Income
Dividends from Bank........................................................... $ 42,238 $ 46,792 $ 63,891
Interest and dividend income.................................................. 5,378 6,318 4,313
Gain (loss) on sale of securities............................................. 2,142 (339) 407
---------- --------- ---------
Total income................................................................ 49,758 52,771 68,611
---------- --------- ---------
Interest on notes payable to Bank............................................... 2,217 2,555 1,720
Other expenses.................................................................. 661 411 463
---------- --------- ---------
Total expenses................................................................ 2,878 2,966 2,183
---------- --------- ---------
Income before taxes and equity in undistributed income of Bank.................. 46,880 49,805 66,428
Income taxes (benefit).......................................................... 490 (462) 22
---------- --------- ---------
Income before equity in undistributed income of Bank............................ 46,390 50,267 66,406
Equity in undistributed income of Bank.......................................... 49,838 29,866 157
---------- --------- ---------
Net income...................................................................... 96,228 80,133 66,563
Other comprehensive income (loss)............................................... 7,552 7,498 (4,104)
---------- --------- ---------
Comprehensive income............................................................ $ 103,780 $ 87,631 $ 62,459
---------- --------- ---------
---------- --------- ---------
A-59
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14. PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS (CONTINUED)
CONDENSED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------
DOLLARS IN THOUSANDS 1998 1997 1996
- - ----------------------------------------------------------------------------- ----------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................................... $ 96,228 $ 80,133 $ 66,563
Adjustments to net income:
Equity in undistributed income of Bank..................................... (49,838) (29,866) (157)
Other, net................................................................. 4,040 1,009 (363)
----------- ---------- ----------
Net cash provided by operating activites................................. 50,430 51,276 66,043
----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Net (increase) decrease in short-term investments............................ -- -- 9,400
Maturities of securities available-for-sale.................................. 30,766 22,423 2,000
Purchase of securities available-for-sale.................................... (22,938) (61,560) (39,096)
Sales of securities available-for-sale....................................... 61,549 5,813 4,731
Investment in subsidiaries................................................... (16,415) (24,582) --
Other, net................................................................... 2,047 -- (172)
----------- ---------- ----------
Net cash from (used by) investing activities............................... 55,009 (57,906) (23,137)
----------- ---------- ----------
CASH FLOWS FOR FINANCING ACTIVITIES
Cash dividends paid.......................................................... (26,042) (20,310) (15,815)
(Repayments to) borrowings from City National Bank........................... (31,880) 17,500 7,800
Repurchase of treasury shares................................................ (59,768) (22,503) (22,384)
Stock options exercised...................................................... 12,321 11,367 7,847
Other, net................................................................... -- 2,875 1,773
----------- ---------- ----------
Net cash used for financing activities..................................... (105,369) (11,071) (20,779)
----------- ---------- ----------
Net increase (decrease) in cash and cash equivalents......................... 70 (17,701) 22,127
Cash and cash equivalents at beginning of year............................... 6,075 23,776 1,649
----------- ---------- ----------
Cash and cash equivalents at end of year..................................... $ 6,145 $ 6,075 $ 23,776
----------- ---------- ----------
----------- ---------- ----------
NOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS
The following table presents the notional amount and fair value of
interest-rate risk-management instruments at December 31, 1998 and 1997:
1998 1997
------------------------ ------------------------
NOTIONAL FAIR NOTIONAL FAIR
DOLLARS IN MILLIONS AMOUNT VALUE AMOUNT VALUE
- - --------------------------------------------------------------- ----------- ----- ----------- -----
Receive-fixed/pay variable..................................... $ 710.0 $ 6.4 $ 425.0 $ 1.7
Interest-rate swap agreements involve the exchange of fixed- and
variable-rate interest payments based upon a notional principal amount and
maturity date. The Company's interest-rate risk-management instruments had an
exposure to credit risk of $6.4 million and $1.8 million at December 31, 1998
and 1997,
A-60
CITY NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
respectively. The credit exposure represents the cost to replace, on a present
value basis and at current market rates, all profitable contracts outstanding at
year end. The Company's swap agreements require the deposit of collateral to
mitigate the amount of credit risk if certain thresholds are exceeded. No
amounts were required to be deposited by the Company or its counterparties as of
December 31, 1998.
The periodic net settlement of interest-rate risk-management instruments is
recorded as an adjustment to net interest income. These interest-rate
risk-management instruments generated $1.7 million, $0.8 million and $0.3
million in net interest income in 1998, 1997 and 1996, respectively.
A-61