UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

FORM 10-Q

 

(Mark One)

ý  QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2003

 

or

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to                   

 

Commission File Number 1-10521

 

 

CITY NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware		95-2568550
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
City National Center 400 North Roxbury Drive, Beverly Hills, California		90210
(Address of principal executive offices)		(Zip Code)

 

Registrant’s telephone number, including area code    (310) 888-6000

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

 

 

Number of shares of common stock outstanding at April 30, 2003: 48,475,940

 

 

PART 1 - FINANCIAL INFORMATON

ITEM 1. FINANCIAL STATEMENTS

 

CITY NATIONAL CORPORATION

CONSOLIDATED BALANCE SHEET

(Unaudited)

 

Dollars in thousands, except per share amounts		March 31, 2003			December 31, 2002			March 31, 2002
Assets
Cash and due from banks		$	448,152		$	497,273		$	426,846
Federal funds sold		615,000			460,000			484,000
Securities available-for-sale - cost $2,478,311; $2,169,444 and $1,905,948 at March 31, 2003, December 31, 2002 and March 31, 2002, respectively		2,531,809			2,226,656			1,901,824
Trading account securities		76,263			172,211			163,125
Loans		7,832,823			7,999,470			7,752,024
Less allowance for credit losses		169,480			164,502			155,657
Net loans		7,663,343			7,834,968			7,596,367
Premises and equipment, net		62,630			61,208			63,404
Deferred tax asset		43,602			36,578			54,413
Goodwill		230,084			229,834			230,881
Core deposit intangibles		25,032			27,007			33,015
Bank owned life insurance		60,682			60,119			59,738
Affordable housing investments		67,326			68,848			57,933
Other assets		181,663			186,766			137,474
Customers’ acceptance liability		6,886			8,924			8,329
Total assets		$	12,012,472		$	11,870,392		$	11,217,349
Liabilities
Demand deposits		$	4,625,439		$	4,764,234		$	3,690,225
Interest checking deposits		660,448			692,261			583,507
Money market deposits		3,101,656			2,929,501			2,551,833
Savings deposits		206,724			198,288			241,541
Time deposits-under $100,000		213,492			218,447			251,417
Time deposits-$100,000 and over		1,056,087			1,036,967			1,338,701
Total deposits		9,863,846			9,839,698			8,657,224
Federal funds purchased and securities sold under repurchase agreements		156,002			266,727			179,140
Other short-term borrowings		140,125			125,125			793,625
Subordinated debt		302,573			303,795			267,449
Long-term debt		274,001			68,682			194,389
Other liabilities		147,350			147,482			118,190
Acceptances outstanding		6,886			8,924			8,329
Total liabilities		10,890,783			10,760,433			10,218,346
Commitments and contingencies
Shareholders’ Equity
Preferred Stock authorized - 5,000,000 : none outstanding		—			—			—
Common Stock-par value-$1.00; authorized - 75,000,000; Issued - 50,282,743 shares at March 31, 2003 and December 31, 2002 and 49,681,899 shares at March 31, 2002		50,283			50,283			49,682
Additional paid-in capital		399,551			400,866			381,041
Accumulated other comprehensive income		37,631			40,400			2,719
Retained earnings		708,849			675,195			565,561
Treasury shares, at cost - 1,694,129; 1,299,312; and 0 shares at March 31, 2003, December, 31, 2002 and March 31, 2002, respectively		(74,625		)	(56,785		)	—
Total shareholders’ equity		1,121,689			1,109,959			999,003
Total liabilities and shareholders’ equity		$	12,012,472		$	11,870,392		$	11,217,349

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

2

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

 

		For the three months ended March 31,
In thousands, except per share amounts		2003			2002
Interest Income
Loans		$	115,736		$	120,618
Securities available-for-sale		29,431			27,028
Federal funds sold and securities purchased under resale agreements		411			507
Trading account		98			205
Total interest income		145,676			148,358
Interest Expense
Deposits		13,474			18,943
Subordinated debt		1,414			2,195
Other long-term debt		1,352			1,141
Federal funds purchased and securities sold under repurchase agreements		625			780
Other short-term borrowings		594			3,604
Total interest expense		17,459			26,663
Net interest income		128,217			121,695
Provision for credit losses		17,500			11,000
Net interest income after provision for credit losses		110,717			110,695
Noninterest Income
Trust fees and investment fee revenue		15,480			14,274
Cash management and deposit transaction charges		10,917			10,369
International services		4,328			3,791
Bank owned life insurance		714			673
Gain on sale of loans and assets		102			1,679
Gain on sale of securities		1,230			688
Other		6,205			4,469
Total noninterest income		38,976			35,943
Noninterest Expense
Salaries and employee benefits		51,805			47,470
Net occupancy of premises		6,969			6,180
Professional		6,436			5,229
Information services		4,253			4,360
Depreciation		3,119			3,392
Marketing and advertising		3,112			2,788
Office services		2,570			2,098
Amortization of core deposit intangibles		1,976			1,515
Equipment		666			482
Other operating		4,981			5,259
Total noninterest expense		85,887			78,773
Income before income taxes		63,806			67,865
Income taxes		20,151			23,629
Net income		43,655			44,236
Other comprehensive income
Unrealized loss on securities available-for-sale		(2,848		)	(10,252		)
Unrealized gain (loss) on cash flow hedges		528			(3,277		)
Less reclassification adjustment for gain included in net income		2,455			193
Income taxes (benefit)		(2,006		)	(5,767		)
Other comprehensive loss		(2,769		)	(7,955		)
Comprehensive income		$	40,886		$	36,281
Net income per share, basic		$	0.89		$	0.91
Net income per share, diluted		$	0.87		$	0.87
Shares used to compute income per share, basic		48,779			48,690
Shares used to compute income per share, diluted		50,124			50,803
Dividends per share		$	0.205		$	0.195

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

3

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

 

		For the three months ended March 31,
Dollars in thousands		2003			2002
Cash Flows From Operating Activities
Net income		$	43,655		$	44,236
Adjustments to net income:
Provision for credit losses		17,500			11,000
Amortization of core deposit intangibles		1,976			1,515
Depreciation		3,119			3,392
Deferred income tax (benefit)		(5,018		)	12,416
Gain on sales of loans and assets		(102		)	(1,679		)
Gain on sales of securities		(1,230		)	(688		)
Net increase in other (assets) liabilities		(43,047		)	(40,740		)
Net (increase) decrease in trading securities		95,948			(84,859		)
Other, net		52,845			32,165
Net cash provided (used) by operating activities		165,646			(23,242		)
Cash Flows From Investing Activities
Purchase of securities		(714,151		)	(213,688		)
Sales of securities available-for-sale		49,475			19,229
Maturities and paydowns of securities		354,823			131,271
Loan (originations) principal collections, net		151,765			(233,151		)
Purchase of premises and equipment		(5,449		)	(1,405		)
Net cash from acquisitions		—			35,633
Other, net		(1		)	2
Net cash used by investing activities		(163,538		)	(262,109		)
Cash Flows From Financing Activities
Net increase in deposits		24,148			87,559
Net increase (decrease) in federal funds purchased and securities sold under repurchase agreements		(110,725		)	7,609
Net increase in short-term borrowings, net of transfers from long-term debt		—			378,500
Repayment of long-term debt		(1,367		)	—
Net proceeds of issuance of senior debt		221,749			—
Proceeds from exercise of stock options		2,808			8,917
Stock repurchases		(22,841		)	—
Cash dividends paid		(10,001		)	(9,406		)
Net cash provided by financing activities		103,771			473,179
Net increase in cash and cash equivalents		105,879			187,828
Cash and cash equivalents at beginning of year		957,273			723,018
Cash and cash equivalents at end of period		$	1,063,152		$	910,846
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest		$	20,919		$	30,376
Income taxes		6,000			11,000
Non-cash investing activities:
Transfer from loans to foreclosed assets		$	—		$	530
Transfer from long-term debt to short-term borrowings		15,000			—

 

See accompanying Notes to the unaudited Consolidated Financial Statements.

 

4

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

		For the three months ended March 31,
Dollars in thousands		2003			2002
Common Stock
Balance, beginning of period		$	50,283		$	48,150
Stock issued for acquisitions		—			1,207
Stock options exercised		—			325
Balance, end of period		50,283			49,682
Additional paid-in capital
Balance, beginning of period		400,866			301,022
Tax benefit from stock options		878			2,687
Stock options exercised		(2,193		)	8,592
Excess of market value of shares issued for acquisitions over historical cost		—			68,740
Balance, end of period		399,551			381,041
Accumulated other comprehensive income
Balance, beginning of period		40,400			10,674
Other comprehensive loss net of income taxes		(2,769		)	(7,955		)
Balance, end of period		37,631			2,719
Retained earnings
Balance, beginning of period		675,195			530,731
Net income		43,655			44,236
Dividends paid		(10,001		)	(9,406		)
Balance, end of period		708,849			565,561
Treasury shares
Balance, beginning of period		(56,785		)	—
Purchase of shares		(22,841		)	—
Issuance of shares for stock options		5,001			—
Balance, end of period		(74,625		)	—
Total shareholders’ equity		$	1,121,689		$	999,003

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

5

 

CITY NATIONAL CORPORATION
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

1.               City National Corporation (the “Corporation”) 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 Corporation, references to the “Company” mean the Corporation and the Bank together.

 

2.               The results of operations reflect the interim adjustments, all of which are of a normal recurring nature and which, in the opinion of management, are necessary for a fair presentation of the results for the interim period presented.  These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002.  The results for the 2003 interim period are not necessarily indicative of the results expected for the full year.

 

3.               Trading account securities are stated at market value.  Investments not classified as trading securities are classified as securities available-for-sale and recorded at fair value.  Unrealized holding gains or losses for securities available-for-sale, net of taxes are excluded from net income and are reported as other comprehensive income included as a separate component of shareholders’ equity.

 

4.               Certain prior periods’ data have been reclassified to conform to current period presentation.

 

5.               Reserves established as a purchase price adjustment for the February 29, 2000 acquisition of The Pacific Bank N.A. of $0.9 million for exit costs relating to surplus space remain as of March 31, 2003.  Reserves established as a purchase price adjustment for the February 28, 2002 acquisition of Civic BanCorp of $0.9 million for exit costs relating to surplus space remain as of March 31, 2003.

 

6.               On February 13, 2003, the Corporation issued $225 million of 5.125 percent Senior Notes due 2013 in a private placement.  A like amount of exchange notes were subsequently registered pursuant to the Securities Act of 1933 in April 2003 and an exchange offering commenced with the senior notes, which offering will expire on May 23, 2003 unless extended.

 

7.               On January 22, 2003, the Board of Directors authorized a 1 million-share stock buyback program.  During the first quarter of 2003, 212,800 shares were repurchased under this program at an average price of $44.59 per share.  The Company repurchased an additional 292,500 shares at an average price of $45.65 per share under its prior stock buyback program bringing the total number of shares repurchased in the quarter to 505,300 shares.  The shares purchased under the buyback programs may be reissued for acquisitions, upon the exercise of stock options, or for other general corporate purposes. There were 1,694,129 treasury shares at March 31, 2003.

 

During April 2003, an additional 240,000 shares were repurchased under the current stock buyback program at an average price of $40.72 per share.

 

Basic earnings per share is based on the weighted average shares of common stock.  Diluted earnings per share gives effect to all dilutive potential common shares which consists only of stock options that were outstanding during the period.  At March 31, 2003, 689,051 stock options were antidilutive.

 

8.               The Company applies APB Opinion No. 25 in accounting for stock option plans and, accordingly, no compensation cost has been recognized for its plans in the financial statements.  As a practice, the Corporation’s stock option grants are such that the exercise price equals the current market price of the common stock.  Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123 using the Black Scholes option-pricing model, the Company’s proforma net income would have been reduced to the proforma amounts indicated below:

 

6

 

		For the three months ended March 31,
Dollars in thousands, except for per share amounts		2003			2002
Net income, as reported		$	43,655		$	44,236
Proforma net income		42,188			41,695
Net income per share, basic, as reported		0.89			0.91
Proforma net income per share, basic,		0.86			0.86
Net income per share, diluted, as reported		0.87			0.87
Proforma net income per share, diluted,		0.84			0.82
Percentage reduction in net income per share, diluted		3.45		%	5.75		%

 

The Company did not issue stock based performance awards in the first quarter of 2003 which contributed to the lower impact on proforma results in the first quarter of 2003.   Stock based performance awards are expected to be granted in the second quarter of 2003.

 

9.               In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities.”  Interpretation 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.  The recognition and measurement provisions of Interpretation 46 are effective for newly created variable interest entities formed after January 31, 2003, and for existing variable interest entities, on the first interim or annual reporting period beginning after June 15, 2003.  The Company will adopt the provisions of Interpretation 46 for existing variable interest entities on July 1, 2003, which is not expected to have a material effect on the Company’s financial statements.

 

In April 2003, the FASB issued Statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”.  Statement 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement 133.  In particular, this Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative and when a derivative contains a financing component that warrants special reporting in the statement of cash flows.  This Statement is generally effective for contracts entered into or modified after June 30, 2003 and is not expected to have a material impact on the Company’s financial statements.

 

10.         On April 1, 2003, the Corporation acquired Convergent Capital Management LLC, a privately held Chicago-based company, and substantially all of its asset management holdings, including its majority ownership interests in eight asset management firms and minority interests in two additional firms.  Combined, these 10 firms manage assets of approximately $6.5 billion.  The purchase price was $49.0 million, comprised of cash and the assumption of approximately $7.5 million of debt.

 

7

 

CITY NATIONAL CORPORATION

FINANCIAL HIGHLIGHTS

(Unaudited)

 

		At or for the three months ended									Percentage change March 31, 2003 from
Dollars in thousands, except per share amounts		March 31, 2003			December 31, 2002			March 31, 2002			December 31, 2002		March 31, 2002
For The Quarter
Net income		$	43,655		$	44,419		$	44,236		(2	)%	(1	)%
Net income per common share, basic		0.89			0.90			0.91			(1	)	(2	)
Net income per common share, diluted		0.87			0.87			0.87			0		0
Dividends, per common share		0.205			0.195			0.195			5		5
At Quarter End
Assets		$	12,012,472		$	11,870,392		$	11,217,349		1		7
Deposits		9,863,846			9,839,698			8,657,224			0		14
Loans		7,832,823			7,999,470			7,752,024			(2	)	1
Securities		2,531,809			2,226,656			1,901,824			14		33
Shareholders’ equity		1,121,689			1,109,959			999,003			1		12
Book value per share		23.09			22.66			20.11			2		15
Average Balances
Assets		$	11,480,626		$	11,312,332		$	10,344,129		1		11
Deposits		9,373,839			9,284,335			7,933,481			1		18
Loans		7,964,338			7,970,874			7,465,430			0		7
Securities		2,385,584			2,048,467			1,863,495			16		28
Shareholders’ equity		1,117,573			1,108,090			945,778			1		18
Selected Ratios
Return on average assets		1.54		%	1.56		%	1.73		%	(1	)	(11	)
Return on average shareholders’ equity		15.84			15.90			18.97			0		(16	)
Corporation’s tier 1 leverage		7.65			7.55			7.31			1		5
Corporation’s tier 1 risk-based capital		10.30			9.87			9.05			4		14
Corporation’s total risk-based capital		14.46			14.26			13.55			1		7
Dividend payout ratio, per share		22.91			21.87			21.27			5		8
Net interest margin		5.07			5.17			5.34			(2	)	(5	)
Efficiency ratio*		50.28			51.28			48.89			(2	)	3
Asset Quality Ratios
Nonaccrual loans to total loans		1.27		%	0.89		%	0.65		%	43		95
Nonaccrual loans and ORE to total loans and ORE		1.28			0.90			0.65			42		97
Allowance for credit losses to total loans		2.16			2.06			2.01			5		7
Allowance for credit losses to non accrual loans		169.93			230.53			310.47			(26	)	(45	)
Net charge-offs to average loans - annualized		(0.64		)	(0.61		)	(0.38		)	5		68

 

* The efficiency ratio is defined as noninterest expense excluding ORE expense divided by total revenue (net interest income on a tax-equivalent basis and noninterest income).

 

8

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

See “Cautionary Statement for Purposes of the ‘Safe Harbor’ Provisions of the Private Securities Litigation Reform Act of 1995”, below relating to “forward-looking” statements included in this report.

 

RESULTS OF OPERATIONS

 

Critical Accounting Policies

 

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition.  The Company has identified four policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions.  These policies relate to the accounting for securities, the allowance for credit losses, derivatives and hedging activities and stock based performance plans.  The Company, in consultation with the Audit Committee, has reviewed and approved these critical accounting policies, which are further described in Management’s Discussion and Analysis and Note 1 (Summary of Significant Accounting Policies) to Financial Statement in the Company’s 2002 Form 10-K.

 

Overview

 

The Corporation recorded net income of $43.7 million, or $0.87 per common share, for the first quarter of 2003, compared with net income of $44.2 million, or $0.87 per share, for the first quarter of 2002 on fewer common shares outstanding this year.

 

First-Quarter Highlights

 

•                  Average deposits were up 18 percent from a year ago and 1 percent from the prior quarter.

 

•                  Average loan growth, which was up 7 percent from a year ago, was essentially level compared with the prior quarter due to ongoing economic uncertainties heightened by current world-wide events.

 

•                  Net interest income was up 5 percent from the first quarter of 2002.

 

•                  Noninterest income continued to increase, up 8 percent from a year ago and 4 percent from last quarter.

 

•                  The Company strengthened its allowance for credit loss as nonaccrual loans increased.

 

•                  Exposure to purchased syndicated media and telecommunication outstanding loan balances declined 30 percent from December 31, 2002 to $49.9 million at March 31, 2003.

 

		For the three months ended March 31,						% Change		For the three months ended December 31, 2002
Dollars in millions, except per share		2003			2002
Earnings Per Share		$	0.87		$	0.87		—		$	0.87
Net Income		43.7			44.2			(1	)	44.4
Return on Assets		1.54		%	1.73		%	(11	)	1.56		%
Return on Equity		15.84			18.97			(16	)	15.90

 

9

 

Return on average assets declined due to an increase in assets.  The lower return on average shareholders’ equity was due primarily to a higher level of shareholders’ equity from retained net income and from the exercise of stock options, net of treasury share repurchases.

 

Outlook

 

Consistent with its April 15, 2003 first quarter earnings release, management continues to expect net income per diluted common share for 2003 to be approximately 5 to 8 percent higher than net income per diluted common share for 2002 based on the business indicators below:

 

•                    Average loan growth 2 to 5 percent

•                    Average deposit growth  6 to 9 percent

•                    Net interest margin 5.00 to 5.10 percent

•                    Provision for credit losses $65 million to $75 million

•                    Noninterest income growth 18 to 21 percent

•                    Noninterest expense growth 9 to 12 percent

•                    Effective tax rate 31 to 33 percent

 

Revenues

 

Revenues (net interest income plus noninterest income) increased 6 percent to $167.2 million in the first quarter of 2003 from $157.6 million in the first quarter of 2002, due in part to the acquisition of Civic BanCorp (“Civic”) in February 2002.   However, they decreased 1 percent from the fourth quarter of 2002, reflecting, in part, the fewer days in the first quarter.

 

Net Interest Income

 

Net interest income reached $131.9 million on a fully taxable-equivalent basis, up 5 percent from $125.4 million in the first quarter of 2002.  Average deposits continued to increase over the prior-year quarter as well as from the prior quarter.  Loans grew over the same period last year. However, they were essentially level compared with the prior quarter due to continuing economic uncertainties heightened by current world-wide events.  The net interest margin narrowed as a result of repricing and as excess funding, including prepayments of higher yielding fixed-rate assets, was invested in lower yielding available-for-sale short-term securities.

 

		For the three month ended March 31,						% Change		For the three months ended December 31, 2002
Dollars in millions		2003			2002
Average Loans		$	7,964.3		$	7,465.4		7		$	7,970.9
Average Securities Available-For-Sale		2,441.8			1,924.5			27		2,117.9
Average deposits		9,373.8			7,933.5			18		9,284.3
Fully Taxable-Equivalent Net Interest Income		131.9			125.4			5		135.2
Net interest Margin		5.07		%	5.34		%	(5	)	5.17		%

 

Compared with the prior-year first-quarter averages, commercial loans rose 4 percent, residential first mortgage loans rose 8 percent, real estate mortgage loans rose 11 percent, and real estate construction loans rose 9 percent, reflecting in part the impact of the purchase of Civic.  Compared to the prior quarter, average residential first mortgage loans and construction loans increased while commercial loans decreased, partly due to a reduction in purchased syndicated media and telecommunication loan balances.

 

10

 

Average securities available-for-sale continued to increase as the demand for loans slowed.  As of March 31, 2003 unrealized gains on securities available-for-sale were $53.5 million.

 

During the first quarter of 2003, average core deposits - which include all deposits except time deposits of $100,000 or more – rose to $8.3 billion, an increase of 26 percent over the $6.6 billion reported for the first quarter of 2002. They rose 2 percent over the fourth quarter of 2002.  Average core deposits represented 89 percent of the total average deposit base for the first quarter of 2003, compared with 83 percent for the first quarter of 2002 and 88 percent for the fourth quarter of 2002.  New clients and higher client balances maintained as deposits to pay for services contributed to the continued growth of deposits.

 

The Bank’s prime rate was 4.25 percent as of March 31, 2003, compared with 4.75 percent a year earlier.

 

As part of the Company’s long-standing asset liability management strategy, its “plain vanilla” interest rate swaps hedging loans, deposits and borrowings with a notional value of $1.0 billion added $7.5 million to net interest income in the first quarter of 2003, compared with $7.9 million in the first quarter of 2002 and $7.6 million for the fourth quarter of 2002.  These amounts included $4.5 million, $3.2 million and $3.8 million, respectively, for interest swaps qualifying as fair-value hedges.  Income from swaps qualifying as cash-flow hedges was $3.0 million for the first quarter of 2003, compared with $4.7 million for the first quarter of 2002 and $3.8 million for the fourth quarter of 2002.  Income from existing swaps qualifying as cash flow hedges of loans expected to be recorded in net interest income within the next 12 months is $7.6 million.

 

Interest income recovered on nonaccrual and charged-off loans included above was $0.6 million for the first quarter of 2003, compared with $0.4 million for the first quarter of 2002 and $0.9 million for the fourth quarter of 2002.

 

The following tables present the components of net interest income on a fully taxable-equivalent basis for the three months ended March 31, 2003 and 2002.  To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pre-tax equivalents based on the marginal corporate federal tax rate of 35 percent.

 

11

 

Net Interest Income Summary

 

		For the three months ended March 31, 2003								For the three months ended March 31, 2002
Dollars in thousands		Average Balance			Interest income/ expense(2)			Average interest rate		Average Balance			Interest income/ expense(2)			Average interest rate
Assets
Interest-earning assets
Loans
Commercial		$	3,560,411		$	47,190		5.38	%	$	3,432,475		$	53,009		6.26	%
Real estate mortgages		1,908,554			31,652			6.73		1,717,838			30,897			7.29
Residential first mortgages		1,756,838			28,164			6.50		1,633,024			28,279			7.02
Real estate construction		663,956			8,840			5.40		610,878			8,394			5.57
Installment		74,579			1,500			8.16		71,215			1,607			9.15
Total loans (1)		7,964,338			117,346			5.98		7,465,430			122,186			6.64
Securities available-for-sale		2,385,584			31,460			5.35		1,863,495			29,154			6.34
Federal funds sold and securities purchased under resale agreements		132,989			411			1.25		129,697			507			1.59
Trading account securities		56,212			101			0.73		61,048			208			1.38
Total interest-earning assets		10,539,123			149,318			5.75		9,519,670			152,055			6.48
Allowance for credit losses		(169,424		)						(150,151		)
Cash and due from banks		441,078								423,346
Other nonearning assets		669,849								551,264
Total assets		$	11,480,626							$	10,344,129
Liabilities and Shareholders’ Equity
Interest-bearing deposits
Interest checking accounts		$	674,809		337			0.20		$	564,711		353			0.25
Money market accounts		2,988,825			7,573			1.03		2,133,778			7,747			1.47
Savings deposits		198,295			262			0.54		242,930			727			1.21
Time deposits - under $100,000		215,691			1,010			1.90		234,302			1,598			2.77
Time deposits - $100,000 and over		1,047,354			4,292			1.66		1,332,771			8,518			2.59
Total interest - bearing deposits		5,124,974			13,474			1.07		4,508,492			18,943			1.70
Federal funds purchased and securities sold under repurchase agreements		219,518			625			1.15		201,215			780			1.57
Other borrowings		615,443			3,360			2.21		1,157,088			6,940			2.43
Total interest - bearing liabilities		5,959,935			17,459			1.19		5,866,795			26,663			1.84
Noninterest - bearing deposits		4,248,865								3,424,989
Other liabilities		154,253								106,567
Shareholders’ equity		1,117,573								945,778
Total liabilities and shareholders’ equity		$	11,480,626							$	10,344,129
Net interest spread								4.56	%							4.64	%
Fully taxable-equivalent net interest income					$	131,859							$	125,392
Net interest margin								5.07	%							5.34	%

 

(1) Includes average nonaccrual loans of $83,037 and $43,592 for 2003 and 2002, respectively.

(2) Loan income includes loan fees of $5,428 and $6,317 for 2003 and 2002, respectively.

 

12

 

Net interest income is impacted by the volume, mix and rate of interest-earning assets and interest-bearing liabilities.  The following table shows changes in net interest income on a fully taxable-equivalent basis between the first quarter of 2003 and the first quarter of 2002, as well as between the first quarter of 2002 and the first quarter of 2001.

 

Changes In Net Interest Income

 

Dollars in thousands		For the three months ended March 31, 2003 vs 2002									For the three months ended March 31, 2002 vs 2001
		Increase (decrease) due to						Net increase (decrease)			Increase (decrease) due to						Net increase (decrease)
		Volume			Rate						Volume			Rate
Interest earned on:
Loans		$	7,823		$	(12,663	)	$	(4,840	)	$	18,463		$	(36,672	)	$	(18,209	)
Securities available-for-sale		7,323			(5,017		)	2,306			5,977			(2,504		)	3,473
Federal funds sold and securities purchased under resale agreements		13			(109		)	(96		)	(33		)	(496		)	(529		)
Trading account securities		(15		)	(92		)	(107		)	621			(717		)	(96		)
Total interest-earning assets		15,144			(17,881		)	(2,737		)	25,028			(40,389		)	(15,361		)
Interest paid on:
Interest checking deposits		61			(77		)	(16		)	(4		)	(340		)	(344		)
Money market deposits		2,551			(2,725		)	(174		)	5,006			(8,544		)	(3,538		)
Savings deposits		(116		)	(349		)	(465		)	(38		)	(1,380		)	(1,418		)
Other time deposits		(1,713		)	(3,101		)	(4,814		)	(4,252		)	(13,407		)	(17,659		)
Other borrowings		(2,638		)	(1,097		)	(3,735		)	1,814			(11,467		)	(9,653		)
Total interest-bearing liabilities		(1,855		)	(7,349		)	(9,204		)	2,526			(35,138		)	(32,612		)
		$	16,999		$	(10,532	)	$	6,467		$	22,502		$	(5,251	)	$	17,251

 

The impact of interest rate swaps, which increases loan interest income and reduces deposit and borrowing interest expense, is included in rate changes.

 

Provision for Credit Losses

 

The Company recorded a provision for credit losses of $17.5 million for the first quarter of 2003, compared with $11.0 million for the same period in 2002.  The provision for credit losses in the fourth quarter of 2002 was $17.5 million. The higher provision for credit losses over the first quarter of 2002 primarily reflects increasing nonaccrual loan levels, charge-offs, management’s ongoing assessment of the credit quality of the portfolio and the current economic environment, most notably including the continuing weakness in Northern California and some of the loans in the Company’s aircraft lessor portfolio.  See “¾ Allowance for Credit Losses.”

 

Noninterest Income

 

The Company continues to emphasize growth in noninterest income - which increased 8 percent to $39.0 million for the first quarter of 2003, compared with $35.9 million for the first quarter of 2002.  Noninterest income increased 4 percent over the fourth quarter of 2002.

 

Noninterest income for the first quarter of 2003 was 23 percent of total revenues, compared with 23 percent for the first quarter of 2002 and 22 percent for the fourth quarter of 2002.

 

13

 

Trust and Investment Fee Revenue

 

		At or for the three months ended March 31,						% Change		At or for the three months ended December 31, 2002
Dollars in millions		2003			2002
Assets Under Administration		$	19,840.8		$	18,786.8		6		$	19,513.3
Assets Under Management*		6,978.0			7,265.2			(4	)	7,407.0
Trust and Investment Fee Revenue		15.5			14.3			8		16.0

 

* Included above in Assets Under Administration

 

The reduction in assets under management is primarily attributable to the fact that clients are maintaining lower balances in money-market accounts due to their low interest rates. New business in all other categories, aided by strong relative investment performance, offset the decline in assets caused by lower market values.  The year-over-prior-year revenue increase was driven by higher balances under administration while the decrease from the prior quarter is the result of fewer days - and therefore lower transaction volume — in the first quarter.

 

Other Noninterest Income

 

Cash management and deposit transaction fees for the first quarter of 2003 increased 5 percent over both the first quarter and the fourth quarter of 2002. Strong growth in deposits, higher sales of cash management products and the impact on fees of a reduction in the earnings credit on analyzed deposit accounts contributed to this growth.

 

International services fees were up 14 percent over the prior-year quarter but down 14 percent from the fourth quarter of 2002.  Higher foreign exchange and standby letter of credit revenue fueled the year-over-year revenue growth.  Revenue fell from the fourth quarter of 2002, however, as imports and exports declined amid security concerns, higher fuel costs and business uncertainty world-wide.

 

Other income includes $1.2 million of fees received from the sale of certain merchant credit card business.

 

Gains on the sale of loans and other assets and gains on the sale of securities for the first quarter of 2003 amounted to $1.3 million compared with $2.4 million for the first quarter of 2002 and $0.1 million for the fourth quarter 2002.

 

Noninterest Expense

 

Noninterest expense was $85.9 million in the first quarter of 2003, up 9 percent from $78.8 million for the first quarter of 2002 but down 3 percent from $88.5 million for the fourth quarter of 2002. Expenses grew over the same period last year primarily because of the Company’s continued growth, including the addition of Civic and costs associated with additional colleagues primarily in Northern California and New York.  Fourth-quarter expenses included certain collection activity costs, start-up costs of the New York office, and costs to upgrade facilities and technology systems, which did not recur in the current quarter.

 

The Company’s efficiency ratio for the first quarter of 2003 was 50.28 percent, compared with 48.89 percent for the first quarter of 2002 and 51.28 percent for the fourth quarter of 2002.

 

Income Taxes

 

The first-quarter 2003 effective tax rate was 31.6 percent, compared with 30.1 percent for all of 2002.  The higher effective tax rate over the prior year reflects the absence of certain tax benefits recorded in 2002.

 

The effective tax rates differ from the applicable statutory federal tax rate due to various factors, including state taxes and the impact of the Company’s real estate investment trust subsidiaries on state taxes, tax-exempt income including interest on bank-owned life insurance, and affordable housing investments.

 

14

 

The Company’s tax returns are open for audits by the Internal Revenue Service back to 1998 and by the Franchise Tax Board of the State of California back to 1996.  From time to time, there may be differences in opinions with the respect to tax treatment accorded transactions.  When, and if, such differences occur and become probable and estimable, such amounts will be recognized.

 

BALANCE SHEET ANALYSIS

 

Average assets reached $11.5 billion for the first quarter of 2003, an increase of 11 percent over the $10.3 billion in average assets for the first quarter of 2002 and 1 percent over the $11.3 billion in average assets for the fourth quarter of 2002.  Total assets at March 31, 2003 increased 7 percent to $12.0 billion from $11.2 billion at March 31, 2002. Total assets at December 31, 2002 were $11.9 billion.

 

Total average interest-earning assets were $10.5 billion for the first quarter of 2003, an increase of 11 percent over the $9.5 billion in average interest-earning assets for the first quarter of 2002 and 2 percent higher than the $10.4 billion in average interest-earning assets for the fourth quarter of 2002.

 

Securities

 

Comparative period-end security portfolio balances are presented below:

 

Securities Available-for-Sale

 

		March 31, 2003						December 31, 2002						March 31, 2002
Dollars in thousands		Cost			Fair Value			Cost			Fair Value			Cost			Fair Value
U.S. Government and federal agency		$	287,444		$	292,055		$	317,183		$	324,223		$	328,725		$	330,046
Mortgage-backed		1,763,370			1,801,838			1,448,673			1,491,489			1,114,243			1,115,884
State and Municipal		228,619			241,479			224,013			236,591			212,298			214,773
Other		5,449			4,620			5,451			4,600			31,911			30,499
Total debt securities		2,284,882			2,339,992			1,995,320			2,056,903			1,687,177			1,691,202
Marketable equities securities		193,429			191,817			174,124			169,753			218,771			210,622
Total securities		$	2,478,311		$	2,531,809		$	2,169,444		$	2,226,656		$	1,905,948		$	1,901,824

 

Average securities available-for-sale continued to increase as the demand for loans slowed.  At March 31, 2003, securities available-for-sale totaled $2.5 billion, an increase of $630.0 million compared with holdings at March 31, 2002 and an increase of $305.2 million from December 31, 2002.  At March 31, 2003 the portfolio had an unrealized net gain of $53.5 million compared with a net gain of $57.2 million and a net loss of $4.1 million at December 31, 2002 and March 31, 2002, respectively.  The average duration of total available-for-sale securities at March 31, 2003 was 2.3 years compared with 2.1 years at December 31, 2002 and 3.5 years at March 31, 2002.

 

The following table provides the expected remaining maturities and yields (taxable-equivalent basis) of debt securities within the securities portfolio as of March 31, 2003.  To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pre-tax equivalents based on the marginal corporate federal tax rate of 35 percent.

 

15

 

Debt Securities Available-for-Sale

 

		One year or less					Over 1 year thru 5 years					Over 5 years thru 10 years					Over 10 years					Total
Dollars in thousands		Amount			Yield (%)		Amount			Yield (%)		Amount			Yield (%)		Amount			Yield (%)		Amount			Yield (%)
U.S. Government and federal agency		$	—		—		$	278,599		3.44		$	13,456		6.21		$	—		—		$	292,055		3.57
Mortgage-backed		—			—		—			—		4,647			6.93		1,797,191			5.29		1,801,838			5.29
State and Municipal		13,360			6.94		85,965			6.56		105,133			6.81		37,021			6.62		241,479			6.70
Other		—			—		4,620			7.45		—			—		—			—		4,620			7.45
Total debt securities		$	13,360		6.94		$	369,184		4.22		$	123,236		6.75		$	1,834,212		5.32		$	2,339,992		5.23
Amortized cost		$	13,214				$	360,264				$	116,081				$	1,795,323				$	2,284,882

 

Dividend income included in interest income on securities in the Unaudited Consolidated Statement of Income and Comprehensive Income for the first quarter of 2003 and 2002 was $1.9 million and $2.7 million, respectively.

 

Loan Portfolio

 

A comparative period-end loan table is presented below:

 

Loans

 

Dollars in thousands		March 31, 2003			December 31, 2002			March 31, 2002
Commercial		$	3,401,610		$	3,609,053		$	3,548,545
Residential first mortgages		1,762,629			1,738,909			1,679,969
Real estate mortgages		1,920,209			1,934,409			1,840,060
Real estate construction		676,618			640,861			606,768
Installment		71,757			76,238			76,682
Total loans, gross		7,832,823			7,999,470			7,752,024
Less allowance for credit losses		169,480			164,502			155,657
Total loans, net		$	7,663,343		$	7,834,968		$	7,596,367

 

Total loans at March 31, 2003 were 1 percent higher than March 31, 2002 but decreased 2 percent from December 31, 2002.  At March 31, 2003, the Company’s loan portfolio included $620.9 million of loans to borrowers located in Northern California and $87.1 million of syndicated non-relationship commercial loans and purchased media and telecommunication loans.  The Company’s purchased media and telecommunication loan portfolio contains 16 loans with commitment and outstanding balances of $78.8 million and $49.9 million, respectively, or just slightly more than one-half of 1 percent of the loan portfolio.

 

16

 

Following is a breakdown of the media and telecommunication loans by industry type as of March 31, 2003:

 

Dollars in thousands		Number		Commitments			Outstandings			Percentage
Telecommunications		6		$	23,122		$	13,581		27	%
Wireless		3		21,849			13,003			26
Television Broadcasting		3		12,889			11,899			24
Publishing		2		12,590			5,497			11
Radio Broadcasting		1		5,000			2,850			6
Cable Television		1		3,356			3,115			6
		16		$	78,806		$	49,945		100	%

 

The media and telecommunication loan portfolio balances exclude the available-for-sale loans which are carried in other assets.

 

The following table presents information concerning nonaccrual loans, ORE, and restructured loans.  Bank policy requires that a loan be placed on nonaccrual status if (1) either principal or interest payments are 90 days past due, unless the loan is both well secured and in process of collection, (2) full collection of interest or principal becomes uncertain, regardless of the time period involved or (3) regulators’ ratings of credits suggest that the loan be placed on nonaccrual.

 

Nonaccrual Loans, ORE and Restructured Loans

 

Dollars in thousands		March 31, 2003			December 31, 2002			March 31, 2002
Nonaccrual loans:
Commercial		$	85,075		$	52,890		$	42,368
Real estate
Residential first mortgages		307			711			568
Real estate mortgages		12,582			12,014			6,553
Real estate construction		1,774			5,267			202
		14,663			17,992			7,323
Installment		—			475			445
Total		99,738			71,357			50,136
ORE		210			670			505
Total nonaccrual loans and ORE		$	99,948		$	72,027		$	50,641
Total non accrual loans as a percentage of total loans		1.27		%	0.89		%	0.65		%
Total non accrual loans and ORE as a percentage of total loans and ORE		1.28			0.90			0.65
Allowance for credit losses to total loans		2.16			2.06			2.01
Allowance for credit losses to nonaccrual loans		169.93			230.53			310.47
Loans past due 90 days or more on accrual status:
Commercial		$	907		$	5,854		$	1,968
Real estate
Residential first mortgages		—			104			—
Real estate mortgages		964			—			—
Real estate construction		—			—			—
		964			104			—
Installment		—			198			663
Total		$	1,871		$	6,156		$	2,631

 

17

 

Nonperforming assets reached $99.9 million at March 31, 2003, up from $50.6 million at the end of the first quarter of 2002 and up $27.9 million from the fourth quarter of 2002.  Most of the $27.9 million increase in nonperforming asset balances for the quarter came from 5 nonaccrual commercial loans.  Approximately one-third of the March 31, 2003 nonperforming assets related to syndicated non-relationship commercial loans and purchased syndicated media and telecommunication loans.  One-third related to loans to Northern California borrowers, and the remaining one-third related to all other borrowers.   There were 4 purchased syndicated media and telecommunication loans totaling $11.3 million of outstandings on nonaccrual status at March 31, 2003, compared with 5 loans totaling $15.9 million at December 31, 2002.  All aircraft lessor loans are current and none are on nonaccrual as of March 31, 2003.

 

At March 31, 2003, nonaccrual loans included $99.7 million of impaired loans which had an allowance for credit losses of $22.3 million allocated to them.  At December 31, 2002, nonaccrual loans included $70.3 million of impaired loans which had an allowance of $13.5 million allocated to them.  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. Impairment on loans less than $500,000 is measured using historical loss factors, which approximates the discounted cash flows method.

 

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 on impaired loans first as reductions in principal and then as interest income.

 

The following table summarizes the changes in nonaccrual loans for the three months ended March 31, 2003 and 2002.

 

Changes in Nonaccrual Loans

 

 

In addition to loans disclosed above as nonaccrual or restructured, management has also identified $22.6 million of credits, including one aircraft lessor loan for $1.3 million, and commercial credits to 21 other borrowers, where the ability to comply with the present loan payment terms in the future is questionable. However, the inability of the borrower to comply with repayment terms was not sufficiently probable to place the loan on nonaccrual status at March 31, 2003. Estimated potential losses from these potential problem loans have been provided for in determining the adequacy of the allowance for credit losses at March 31, 2003.

 

18

 

Management’s classification of credits as nonaccrual, restructured or problems does not necessarily indicate that the principal is uncollectable in whole or in part.

 

Allowance for Credit Losses

 

The allowance for credit losses at March 31, 2003 totaled $169.5 million, or 2.16 percent of outstanding loans.  This compares with an allowance of $155.7 million, or 2.01 percent at March 31, 2002 and an allowance of $164.5 million, or 2.06 percent at December 31, 2002.  The allowance for credit losses as a percentage of nonaccrual loans was 170 percent at March 31, 2003, compared with 310 percent at March 31, 2002 and 231 percent at December 31, 2002.  Management believes the allowance for credit losses is adequate to cover risks in the portfolio at March 31, 2003.

 

Net loan charge-offs were $12.5 million and $7.0 million for the first quarters of 2003 and 2002, respectively, and $12.2 million for the fourth quarter of 2002.  First-quarter 2003 charge-offs included $5.3 million relating to the Company’s purchased syndicated media and telecommunication portfolio. As an annualized percentage of average loans, net charge-offs were 0.64 percent, 0.38 percent and 0.61 percent for the first quarters of 2003 and 2002 and the fourth quarter of 2002, respectively.

 

The allowance for credit losses is maintained at a level that management deems appropriate based on a thorough analysis of numerous factors, including levels of net charge-offs and nonaccrual loans and continuing growth in the loan portfolio.  Credit quality will be influenced by underlying trends in the economy, particularly in California, and other factors that may be beyond management’s control.  No assurances can be given that the Company will not sustain credit losses, in any particular period, that are sizable in relation to the allowance for credit losses.  Based on known information available to it at the date of this report, management believes the allowance for credit losses is adequate to cover risks inherent in the portfolio at March 31, 2003.  Subsequent evaluation of the loan portfolio, in light of factors then prevailing, will dictate the level of provisions required to maintain the adequacy of the allowance for credit losses.

 

The table below summarizes the changes in the allowance for credit losses for the three months ended March 31, 2003 and 2002.

 

19

 

Changes in Allowance for Credit Losses

 

		For the three months ended March 31,
Dollars in thousands		2003			2002
Loans outstanding		$	7,832,823		$		7,752,024
Average amount of loans outstanding		$	7,964,338		$	7,465,430
Balance of allowance for credit losses, beginning of period		$	164,502		$	142,862
Loans charged off:
Commercial		(13,287		)	(8,384				)
Real estate and other		1,595			912
Total loans charged off		(14,882		)	(9,296				)
Less recoveries of loans previously charged off:
Commercial		2,268			1,027
Real estate and other		92			1,277
Total recoveries		2,360			2,304
Net loans charged off		(12,522		)	(6,992				)
Additions to allowance charged to operating expense		17,500			11,000
Additions to allowance from acquisition		—			8,787
Balance, end of period		$	169,480		$	155,657
Total net charge-offs to average loans (annualized)		(0.64		)%	(0.38				)%
Ratio of allowance for credit losses to total period end loans		2.16			2.01

 

Other Assets

 

Other assets included the following:

 

Other Assets

 

Dollars in thousands		March 31, 2003			December 31, 2002			March 31, 2002
Interest rate swap mark-to-market		$	57,538		$	56,690		$	13,393
Accrued interest receivable		43,724			45,124			48,407
Claim in receivership and other assets		23,214			23,142			22,320
Loans held-for-sale		10,412			18,155			12,980
Income tax refund		3,305			3,464			—
Other		43,470			40,191			40,374
Total other assets		$	181,663		$	186,766		$	137,474

 

The claim in receivership and other assets were acquired in the acquisition of Pacific Bank.  The claim in receivership, which is approximately half of the balance, is expected to be realized in 2003.

 

20

 

See ¾ “Net Interest Income” for a discussion of interest rate swaps that result in the swap mark-to-market asset of $57.5 million.

 

Off Balance Sheet

 

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 balance sheet.  Commitments to extend credit are agreements to lend to a client 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 client’s creditworthiness on a case-by-case basis.

 

The Company had outstanding loan commitments aggregating  $3,140.2 million at March 31, 2003.  In addition, the Company had $323.3 million outstanding in bankers’ acceptances and letters of credit of which $280.9 million relate to standby letters of credit at March 31, 2003.  Substantially all of the Company’s loan commitments are on a variable rate basis and are comprised of real estate and commercial loan commitments.

 

Deposits

 

Deposits totaled $9.9 billion at March 31, 2003, compared with $8.7 billion at March 31, 2002, an increase of 14 percent and increased slightly over the $9.8 billion at December 31, 2002.  New clients and a lower earnings credit on analyzed deposit accounts resulting from lower interest rates, contributed to the growth of deposits.

 

Demand deposits accounted for 47 percent of total deposits at March 31, 2003.  Core deposits, which continued to provide substantial benefits to the Bank’s cost of funds, were 89 percent of total deposits at March 31, 2003.  See “¾ Net Interest Income.”

 

CAPITAL ADEQUACY REQUIREMENT

 

The following table presents the regulatory standards for well capitalized institutions and the capital ratios for the Corporation and the Bank at March 31, 2003, December 31, 2002 and March 31, 2002.

 

 

Tier 1 capital ratios include the impact of $25.5 million of preferred stock issued by real estate investment trust subsidiaries of the Bank which is included in other liabilities.

 

On January 22, 2003, the Board of Directors authorized a 1 million-share stock buyback program.  During the first quarter of 2003, 212,800 shares were repurchased under this program at an average price of $44.59 per share.  The Company repurchased an additional 292,500 at an average price of $45.65 per share under its prior stock buyback program bringing the total number of shares repurchased in the quarter to 505,300 shares.  The shares

 

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purchased under the buyback programs may be reissued for acquisitions, upon the exercise of stock options, or for other general corporate purposes. There were 1,694,129 treasury shares at March 31, 2003.

 

LIQUIDITY MANAGEMENT

 

The Company continues to manage its liquidity through the combination of core deposits, federal funds purchased, repurchase agreements, collateralized borrowing lines at the Federal Reserve Bank and the Federal Home Loan Bank of San Francisco and a portfolio of securities available-for-sale.  Liquidity is also provided by maturing securities and loans.

 

Average core deposits and shareholders’ equity comprised 82 percent of total funding of average assets in the first quarter of 2003, compared with 73 percent in the first quarter of 2002.  This increase allowed the Company to decrease its use of more costly alternative funding sources.   See “¾ Net Interest Income.”

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

ASSET/LIABILITY MANAGEMENT

 

The principal objective of asset/liability management is to maximize net interest income 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 Board of Directors to ensure that risk taking is managed within prudent interest rate and liquidity guidelines.

 

A quantitative and qualitative discussion about market risk is included on pages A-16 to A-20 of the Corporation’s Form 10-K for the year ended December 31, 2002. During the first quarter of 2003, the Company maintained a moderate asset sensitive interest rate position.  Based on the balance sheet at March 31, 2003, the Company’s net interest income simulation model indicates that net interest income would not be substantially adversely impacted by changes in interest rates. A rapid and sustained decline in interest rates would result in a decrease in projected net interest income of approximately 1.9% over the twenty-four month horizon. The magnitude of the decline is constrained by the low level of interest rates on March 31, 2003 and is subject to minimum interest rate levels.  The 1.9% at-risk amount is down slightly from the 2.2% at-risk amount based on the balance sheet at December 31, 2002. A rapid and sustained increase in rates would cause net interest income to improve by over 10.0% as measured at March 31, 2003.  This is essentially unchanged from the December 31, 2002 results.  Exposure is within the ALCO management guideline. The Company continues to use a variety of tools to manage its asset sensitivity.

 

As of March 31, 2003, the Company had $1,001.4 million of notional principal in receive fixed-pay LIBOR interest rate swaps, of which $916.4 million have maturities greater than one year. The Company’s interest-rate risk-management instruments had a fair value and credit exposure risk of $57.5 million and $56.7 million at March 31, 2003 and December 31, 2002, respectively taking into consideration legal right of offset. The credit exposure represents the cost to replace, on a present value basis and at current market rates, the net positive value of all contracts for each counterparty that were outstanding at the end of the period. The Company’s swap agreements require collateral to mitigate the amount of credit risk if certain market value exposure thresholds are exceeded. As of March 31, 2003, collateral securing swap agreements consisted of securities with a total market value of $32.8 million to reduce counterparty exposure.

 

At March 31, 2003, the Company’s outstanding foreign exchange contracts for both those purchased as well as sold totaled $72.7 million including $2.4 million of foreign exchange contracts with maturities over 1 year.  Outstanding foreign exchange contracts for both those purchased as well as sold were $70.6 million at December 31, 2002.  The Company enters into foreign exchange contracts with its clients and counterparty banks primarily for the purpose of offsetting or hedging for clients’ transaction and economic exposures arising out of commercial transactions.  The Company’s policies also permit limited proprietary currency positioning.  The Company actively manages its foreign exchange exposures within prescribed risk limits and controls.

 

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ITEM 4.  CONTROL AND PROCEDURES

 

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

 

Under SEC rules, the Company is required to maintain disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.  The Company’s disclosure controls and procedures were designed to ensure that material information related to the Company, including its consolidated subsidiaries, is made known to management, including the chief executive officer and chief financial officer, in a timely manner.  In connection with the Company’s system of disclosure controls and procedures, the Company has created a disclosure committee which consists of certain members of the Company’s senior management.  The system is further supported by formal policies and procedures, including a Code of Conduct designed to ensure employees adhere to the highest standards of personal and professional integrity.  In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to use its judgment in evaluating the cost to benefit relationship of possible controls and procedures.

 

Within the 90-day period prior to the filing date of this report, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures.  The Company’s management, including the Company’s disclosure committee and its chief executive officer and chief financial officer, supervised and participated in the evaluation.  Based on the evaluation, the chief executive officer and the chief financial officer concluded that the Company’s disclosure controls and procedures were effective as of the evaluation date.

 

CHANGES IN INTERNAL CONTROLS

 

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

 

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CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS
OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

 

We have made forward-looking statements in this document that are subject to risks and uncertainties. These statements are based on the beliefs and assumptions of our management, and on information currently available to our management. Forward-looking statements include the information concerning our possible or assumed future results of operations, business and earnings outlook and statements preceded by, followed by, or that include the words “will,” believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” or similar expressions.

 

Our management believes these forward-looking statements are reasonable. However, you should not place undue reliance on the forward-looking statements, since they are based on current expectations. Actual results may differ materially from those currently expected or anticipated.

 

Forward-looking statements are not guarantees of performance. They involve risks, uncertainties, and assumptions. Our future results and shareholder values may differ materially from those expressed in these forward-looking statements. Many of the factors described below that will determine these results and values are beyond our ability to control or predict. For those statements, we claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995.

 

Forward-looking statements speak only as of the date they are made and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur as of the date the statements are made or to update earnings guidance including the factors that influence earnings.

 

A number of factors, some of which are beyond the Corporation’s ability to control or predict, could cause future results to differ materially from those contemplated by such forward-looking statements. These factors include (1) the unknown economic impact caused by the State of California’s budget shortfall, (2) earthquake or other natural disasters impacting the condition of real estate collateral, (3) the effect of acquisitions and integration of acquired businesses, and (4) economic uncertainty created by worldwide geopolitical unrest, hostilities and military action, terrorist attacks and related events, any of which could hurt our business.

 

•                                          Loan delinquencies may increase;

 

•                                          Problem assets and foreclosures may increase;

 

•                                          Demand for our products and services may decline; and

 

•                                          Collateral for loans made by us, especially real estate, may decline in value, in turn reducing clients’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.

 

Changes in interest rates affect our profitability.  We derive our income mainly from the difference or “spread” between the interest earned on loans, securities, and other interest-earning assets, and interest paid on deposits, borrowings, and other interest-bearing liabilities. In general, the wider the spread, the more we earn. When market rates of interest change, the interest we receive on our assets and the interest we pay on our liabilities fluctuates. This causes decreases in our spread and affects our net interest income. In addition, interest rates affect how much money we lend.

 

Significant changes in the provision or applications of laws or regulations affecting our business could materially affect our business. 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. Also, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects our credit conditions, primarily through open market operations in U.S. government securities, the discount rate for member bank borrowing, and bank reserve requirements. A material change in these conditions would affect our results. Parts of our business are also subject to federal and state securities laws and regulations. Significant changes in these laws and regulations would also affect our business.

 

We face strong competition from financial service companies and other companies that offer banking services which can hurt our business.  Increased competition in our market may result in reduced loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. Many competitors offer the banking services that we offer in our service area. These competitors include national, regional, and community banks. We also face competition from

 

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many other types of financial institutions, including, without limitation, savings and loans, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks, and other financial intermediaries. Recently passed legislation will make it easier for other types of financial institutions to compete with us.

 

Our results would be adversely affected if we suffered higher than expected losses on our loans.  We assume risk from the possibility that we will suffer losses because borrowers, guarantors, and related parties fail to perform under the terms of their loans. We try to minimize this risk by adopting and implementing what we believe are effective underwriting and credit policies and procedures, including how we establish and review the allowance for credit losses. We assess the likelihood of nonperformance, track loan performance, and diversify our credit portfolio. Those policies and procedures may still not prevent unexpected losses that could adversely affect our results.

 

Our financial results could be adversely affected by unanticipated changes in regulatory, judicial, or legislative tax treatment of business transactions.

 

PART II.                                                OTHER INFORMATION

 

ITEM 4.                                                     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

The Corporation’s Annual Shareholders’ Meeting was held on Wednesday, April 23, 2003, in Beverly Hills, California, at which the shareholders were asked to vote on the election of nominees to serve on the Corporation’s Board of Directors.

 

Votes regarding the election of four Class I directors to serve for a term of three years and until their successors are duly elected and qualified are as follows:

 

		For		Withheld
George H. Benter Jr.		40,986,368		1,221,174
Kenneth L. Coleman		40,994,560		1,212,982
Peter M. Thomas		41,000,757		1,206,785
Andrea l. VanDeKamp		41,003,266		1,204,276

 

Additional directors, whose terms of office as directors continued after the meeting, are as follows:

 

Class II Directors

 

Russell Goldsmith
Michael L. Meyer
Ronald L. Olson

 

Class III Directors

 

Richard L. Bloch
Bram Goldsmith
Bob Tuttle
Kenneth Ziffren

 

ITEM 6.                                                     EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                                  Exhibits

No.

 

10.(u)                  Employment Agreement made as of May 15, 2003, by and between Bram Goldsmith, and the Registrant and City National Bank

 

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99                                    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002

 

(b)                                 Reports on Form 8-K

 

On January 15, 2003, the Corporation filed a report on Form 8-K under item 5 regarding the financial results for the quarter and year ended December 31, 2002.  Included in the report was a press release dated January 14, 2002.

 

On January 17, 2003, the Corporation filed a report on Form 8-K under item 5 regarding the conference call for analysts and investors to discuss results for the fourth quarter and year-2002.  Included in the report was the transcript of the January 14, 2003 conference call.

 

On January 23, 2003, the Corporation filed a report regarding a new 1 million share stock repurchase program and the announcement of an increased fourth quarter 2002 common stock cash dividend.  Included in the report was a press release dated January 22, 2003.

 

On January 31, 2003, the Corporation filed a report regarding the announcement of a definitive agreement to acquire Convergent Capital Management LLC.  Included in the report was a press release dated January 31, 2003.

 

On February 3, 2003, the Corporation filed a report regarding the availability of a pre-recorded telephone message from City National’s Chief Executive Officer Russell Goldsmith on the transaction highlights of the Convergent Capital Management LLC acquisition.  Included in the report was a transcript of the January 31, 2003 pre-recorded message.

 

On February 13, 2003, the Corporation filed a report regarding the sale of $225 million of 10-year senior notes in a private offering to qualified institutional buyers under Rule 144A of the Securities Act of 1933.  Included in the report was a press release dated February 13, 2003.

 

On April 16, 2003, the Corporation filed a report on Form 8-K under item 9 (Regulation FD Disclosure) and item 12 (results of Operations and Financial Condition) of Form 8-K and is included under item 9 in accordance with SEC Release No. 33-8126 regarding the financial results for the quarter ended March 31, 2003.  Included in the report was a press release dated April 15, 2003.

 

On April 18, 2003, the Corporation filed a report on Form 8-K under item 9 (Regulation FD Disclosure) and item 12 (results of Operations and Financial Condition) of Form 8-K and is included under item 9 in accordance with SEC Release No. 33-8126 regarding the conference call for analysts and investors to discuss results for the quarter ended March 31, 2003.  Included in the report was the transcript of the April 15, 2003 conference call.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

			CITY NATIONAL CORPORATION
			(Registrant)
DATE:	May 12, 2003		/s/ Frank P. Pekny
			FRANK P. PEKNY
			Executive Vice President and Chief Financial Officer/Treasurer (Authorized Officer and Principal Financial Officer)

 

 

CHIEF EXECUTIVE OFFICER CERTIFICATION

 

 

I, Russell Goldsmith certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q of City National Corporation;

 

2.               Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report.

 

3.               Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.               The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a.               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b.              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c.               presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a.               all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

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b.              any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.               The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

DATE:	May 12, 2003		/s/ Russell Goldsmith
			RUSSELL GOLDSMITH
			Chief Executive Officer

 

 

CHIEF FINANCIAL OFFICER CERTIFICATION

 

 

I, Frank P. Pekny certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q of City National Corporation;

 

2.               Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report.

 

3.               Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.               The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a.               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b.              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c.               presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a.               all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b.              any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

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6.               The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

DATE:	May 12, 2003		/s/ Frank P. Pekny
			FRANK P. PEKNY
			Chief Executive Officer

 

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