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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 September 30, 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.

 

YES   ý

 

NO   o

 

 

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

 

YES   ý

 

NO   o

 

Number of shares of common stock outstanding at October 31, 2003:  48,953,252

 

 



 

PART 1 - FINANCIAL INFORMATON

ITEM 1. FINANCIAL STATEMENTS

 

CITY NATIONAL CORPORATION

CONSOLIDATED BALANCE SHEET

(Unaudited)

 

Dollars in thousands, except per share amounts

 

September 30,
2003

 

December 31,
2002

 

September 30,
2002

 

Assets

 

 

 

 

 

 

 

Cash and due from banks

 

$

497,392

 

$

497,273

 

$

480,884

 

Federal funds sold

 

717,200

 

460,000

 

268,000

 

Securities available-for-sale - cost $3,381,676; $2,169,444 and $1,925,814 at September 30, 2003, December 31, 2002 and September 30, 2002, respectively

 

3,409,374

 

2,226,656

 

1,979,439

 

Trading account securities

 

92,024

 

172,211

 

66,581

 

Loans

 

7,542,147

 

7,999,470

 

7,966,801

 

Less allowance for credit losses

 

166,209

 

164,502

 

159,173

 

Net loans

 

7,375,938

 

7,834,968

 

7,807,628

 

 

 

 

 

 

 

 

 

Premises and equipment, net

 

64,403

 

61,208

 

59,990

 

Deferred tax asset

 

68,404

 

36,578

 

25,177

 

Goodwill

 

251,038

 

229,834

 

229,658

 

Intangibles

 

46,233

 

27,007

 

28,983

 

Bank owned life insurance

 

62,324

 

60,119

 

59,583

 

Affordable housing investments

 

65,609

 

68,848

 

53,688

 

Other assets

 

172,672

 

186,766

 

204,896

 

Customers’ acceptance liability

 

7,917

 

8,924

 

9,260

 

Total assets

 

$

12,830,528

 

$

11,870,392

 

$

11,273,767

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

Demand deposits

 

$

5,365,335

 

$

4,764,234

 

$

4,200,997

 

Interest checking deposits

 

729,892

 

692,261

 

627,765

 

Money market deposits

 

3,303,615

 

2,929,501

 

2,757,585

 

Savings deposits

 

212,688

 

198,288

 

219,968

 

Time deposits-under $100,000

 

205,625

 

218,447

 

221,601

 

Time deposits-$100,000 and over

 

968,546

 

1,036,967

 

1,098,806

 

Total deposits

 

10,785,701

 

9,839,698

 

9,126,722

 

Federal funds purchased and securities sold under repurchase agreements

 

103,346

 

266,727

 

231,389

 

Other short-term borrowings

 

15,125

 

125,125

 

294,125

 

Subordinated debt

 

299,898

 

303,795

 

301,917

 

Long-term debt

 

282,159

 

68,682

 

68,897

 

Other liabilities

 

126,539

 

126,303

 

102,137

 

Acceptances outstanding

 

7,917

 

8,924

 

9,260

 

 

 

 

 

 

 

 

 

Total liabilities

 

11,620,685

 

10,739,254

 

10,134,447

 

Minority interest in consolidated subsidiaries

 

26,044

 

21,179

 

13,465

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

 

 

Preferred Stock authorized - 5,000,000 : none outstanding

 

 

 

 

Common Stock-par value-$1.00; authorized - 75,000,000; Issued - 50,454,249; 50,282,743 and 50,275,643 shares at September 30, 2003, December 31, 2002 and September 30, 2002, respectively

 

50,454

 

50,283

 

50,276

 

Additional paid-in capital

 

401,612

 

400,866

 

400,994

 

Accumulated other comprehensive income

 

21,446

 

40,400

 

39,122

 

Retained earnings

 

783,902

 

675,195

 

640,563

 

Deferred equity compensation

 

(7,158

)

 

 

Treasury shares, at cost - 1,545,450; 1,299,312; and 112,338 shares at September 30, 2003, December, 31, 2002 and September 30, 2002, respectively

 

(66,457

)

(56,785

)

(5,100

)

 

 

 

 

 

 

 

 

Total shareholders’ equity

 

1,183,799

 

1,109,959

 

1,125,855

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

12,830,528

 

$

11,870,392

 

$

11,273,767

 

 

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
September 30,

 

For the nine months ended
September 30,

 

In thousands, except per share amounts

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Interest Income

 

 

 

 

 

 

 

 

 

Loans

 

$

107,515

 

$

127,682

 

$

334,427

 

$

375,004

 

Securities available-for-sale

 

33,162

 

26,235

 

94,885

 

81,186

 

Federal funds sold and securities purchased under resale agreements

 

1,511

 

540

 

2,693

 

1,751

 

Trading account

 

173

 

159

 

365

 

544

 

Total interest income

 

142,361

 

154,616

 

432,370

 

458,485

 

Interest Expense

 

 

 

 

 

 

 

 

 

Deposits

 

10,045

 

17,766

 

36,067

 

54,877

 

Subordinated debt

 

1,232

 

1,711

 

3,995

 

5,629

 

Other long-term debt

 

1,788

 

807

 

5,482

 

3,037

 

Federal funds purchased and securities sold under repurchase agreements

 

292

 

845

 

1,331

 

2,430

 

Other short-term borrowings

 

343

 

1,963

 

1,493

 

8,719

 

Total interest expense

 

13,700

 

23,092

 

48,368

 

74,692

 

Net interest income

 

128,661

 

131,524

 

384,002

 

383,793

 

Provision for credit losses

 

 

20,500

 

29,000

 

49,500

 

Net interest income after provision for credit losses

 

128,661

 

111,024

 

355,002

 

334,293

 

Noninterest Income

 

 

 

 

 

 

 

 

 

Trust fees and investment fee revenue

 

23,412

 

15,287

 

60,397

 

45,297

 

Cash management and deposit transaction charges

 

10,661

 

9,929

 

32,238

 

30,323

 

International services

 

4,845

 

4,747

 

14,192

 

13,257

 

Bank owned life insurance

 

747

 

737

 

2,192

 

2,129

 

Gain (loss) on sale of loans and assets

 

16

 

(3,756

)

118

 

(757

)

Gain on sale of securities

 

36

 

1,206

 

2,538

 

2,078

 

Other

 

5,551

 

6,028

 

17,621

 

16,532

 

Total noninterest income

 

45,268

 

34,178

 

129,296

 

108,859

 

Noninterest Expense

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

55,261

 

49,109

 

161,582

 

146,221

 

Net occupancy of premises

 

8,142

 

6,837

 

22,973

 

19,512

 

Professional fees

 

6,821

 

5,418

 

20,026

 

15,829

 

Information services

 

4,749

 

4,200

 

13,304

 

13,221

 

Depreciation

 

3,315

 

3,268

 

9,453

 

9,996

 

Marketing and advertising

 

3,060

 

3,259

 

9,725

 

9,358

 

Office services

 

2,504

 

2,231

 

7,472

 

7,060

 

Amortization of intangibles

 

2,365

 

1,976

 

6,568

 

5,547

 

Equipment

 

528

 

599

 

1,832

 

1,870

 

Other operating

 

5,588

 

5,258

 

16,126

 

15,116

 

Total noninterest expense

 

92,333

 

82,155

 

269,061

 

243,730

 

Minority interest in net income of consolidated subsidiaries

 

1,717

 

217

 

3,257

 

374

 

Income before income taxes

 

79,879

 

62,830

 

211,980

 

199,048

 

Income taxes

 

27,376

 

14,145

 

69,741

 

60,367

 

Net income

 

52,503

 

48,685

 

142,239

 

138,681

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on securities available-for-sale

 

(29,393

)

22,600

 

(31,828

)

50,843

 

Unrealized gain (loss) on cash flow hedges

 

(1,191

)

1,593

 

(706

)

(342

)

Less reclassification adjustment for gain included in net income

 

1,055

 

988

 

169

 

1,413

 

Income taxes (benefit)

 

(13,304

)

9,756

 

(13,749

)

20,640

 

Other comprehensive income (loss)

 

(18,335

)

13,449

 

(18,954

)

28,448

 

Comprehensive income

 

$

34,168

 

$

62,134

 

$

123,285

 

$

167,129

 

Net income per share, basic

 

$

1.08

 

$

0.97

 

$

2.93

 

$

2.80

 

Net income per share, diluted

 

$

1.05

 

$

0.94

 

$

2.85

 

$

2.69

 

Shares used to compute income per share, basic

 

48,537

 

50,107

 

48,541

 

49,587

 

Shares used to compute income per share, diluted

 

50,177

 

51,899

 

49,942

 

51,595

 

 

 

 

 

 

 

 

 

 

 

Dividends per share

 

$

0.280

 

$

0.195

 

$

0.690

 

$

0.585

 

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

3



 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

 

 

 

For the nine months ended
September 30,

 

Dollars in thousands

 

2003

 

2002

 

 

 

 

 

 

 

Cash Flows From Operating Activities

 

 

 

 

 

Net income

 

$

142,239

 

$

138,681

 

Adjustments to net income:

 

 

 

 

 

Provision for credit losses

 

29,000

 

49,500

 

Amortization of intangibles

 

6,568

 

5,547

 

Depreciation

 

9,453

 

9,996

 

Deferred income tax (benefit)

 

(18,065

)

31,693

 

(Gain) loss on sales of loans and assets

 

(118

)

757

 

Gain on sales of securities

 

(2,538

)

(2,078

)

Net decrease (increase) in other assets

 

20,554

 

(46,128

)

Net decrease in trading securities

 

80,187

 

11,685

 

Other, net

 

1,623

 

(5,419

)

Net cash provided by operating activities

 

268,903

 

194,234

 

 

 

 

 

 

 

Cash Flows From Investing Activities

 

 

 

 

 

Purchase of securities

 

(2,588,462

)

(688,468

)

Sales of securities available-for-sale

 

188,525

 

164,205

 

Maturities and paydowns of securities

 

1,181,395

 

440,974

 

Sales of loans

 

11,744

 

12,531

 

Loan principal collections (originations), net

 

432,375

 

(486,057

)

Purchase of premises and equipment

 

(14,628

)

(6,715

)

Net cash from (for) acquisitions

 

(39,907

)

35,633

 

Other, net

 

(2

)

4

 

Net cash used by investing activities

 

(828,960

)

(527,893

)

 

 

 

 

 

 

Cash Flows From Financing Activities

 

 

 

 

 

Net increase in deposits

 

946,003

 

557,057

 

Net (decrease) increase in federal funds purchased and securities sold under repurchase agreements

 

(163,381

)

59,858

 

Net decrease in short-term borrowings, net of transfers from long-term debt

 

(125,000

)

(246,000

)

Repayment of long-term debt

 

(6,575

)

 

Net proceeds of issuance of senior debt

 

221,749

 

 

Proceeds from exercise of stock options

 

23,728

 

24,088

 

Stock repurchases

 

(45,616

)

(6,629

)

Cash dividends paid

 

(33,532

)

(28,849

)

Net cash provided by financing activities

 

817,376

 

359,525

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

257,319

 

25,866

 

Cash and cash equivalents at beginning of year

 

957,273

 

723,018

 

Cash and cash equivalents at end of period

 

$

1,214,592

 

$

748,884

 

 

 

 

 

 

 

Supplemental Disclosures of Cash Flow Information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

52,643

 

$

51,029

 

Income taxes

 

64,000

 

43,500

 

 

 

 

 

 

 

Non-cash investing activities:

 

 

 

 

 

Transfer from loans to foreclosed assets

 

$

 

$

1,664

 

Transfer from long-term debt to short-term borrowings

 

15,000

 

125,000

 

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

4



 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

 

 

For the nine months ended
September 30,

 

Dollars in thousands

 

2003

 

2002

 

 

 

 

 

 

 

Common Stock

 

 

 

 

 

Balance, beginning of period

 

$

50,283

 

$

48,150

 

Stock issued for acquisitions

 

 

1,208

 

Stock options exercised

 

 

918

 

Restricted stock and units issued

 

171

 

 

Balance, end of period

 

50,454

 

50,276

 

 

 

 

 

 

 

Additional paid-in capital

 

 

 

 

 

Balance, beginning of period

 

400,866

 

301,022

 

Tax benefit from stock options

 

5,465

 

9,552

 

Stock options exercised

 

(12,216

)

21,642

 

Restricted stock and units issued

 

7,497

 

 

Excess of market value of shares issued for acquisitions over historical cost

 

 

68,778

 

Balance, end of period

 

401,612

 

400,994

 

 

 

 

 

 

 

Accumulated other comprehensive income (loss)

 

 

 

 

 

Balance, beginning of period

 

40,400

 

10,674

 

Other comprehensive income (loss) net of income taxes

 

(18,954

)

28,448

 

Balance, end of period

 

21,446

 

39,122

 

 

 

 

 

 

 

Retained earnings

 

 

 

 

 

Balance, beginning of period

 

675,195

 

530,731

 

Net income

 

142,239

 

138,681

 

Dividends paid

 

(33,532

)

(28,849

)

Balance, end of period

 

783,902

 

640,563

 

 

 

 

 

 

 

Deferred equity compensation

 

 

 

 

 

Balance, beginning of period

 

 

 

Restricted stock and units issued

 

(7,668

)

 

Amortization of restricted stock awards

 

510

 

 

 

Balance, end of period

 

(7,158

)

 

 

 

 

 

 

 

Treasury shares

 

 

 

 

 

Balance, beginning of period

 

(56,785

)

 

Purchase of shares

 

(45,616

)

(6,629

)

Issuance of shares for stock options

 

35,944

 

1,529

 

Balance, end of period

 

(66,457

)

(5,100

)

 

 

 

 

 

 

Total shareholders’ equity

 

$

1,183,799

 

$

1,125,855

 

 

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 periods 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 September 30, 2003.  Reserves established as a purchase price adjustment for the February 28, 2002 acquisition of Civic BanCorp of $0.6 million for exit costs relating to surplus space remain as of September 30, 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 100 percent of the Senior Notes were exchanged for the registered notes in an exchange offering with the Senior Notes which closed on May 29, 2003.

 

7.               On January 22, 2003, the Board of Directors authorized a 1 million-share stock buyback program.  No shares were repurchased during the third quarter of 2003.  A total number of 750,100 shares have been repurchased under this program at an average price of $42.47 per share leaving 249,900 shares available for repurchase.  Shares will be repurchased on a selective basis from time to time in open market transactions.  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 1,545,450 treasury shares at September 30, 2003.

 

On July 15, 2003, the Board of Directors authorized the repurchase of 500,000 additional shares of City National Corporation stock, following completion of the Company’s current buyback initiative.

 

Basic earnings per share is based on the weighted average shares of common stock outstanding less unvested restricted shares and units.  Diluted earnings per share gives effect to all dilutive potential common shares which consists of stock options and restricted shares and units that were outstanding during the period.  At September 30, 2003, 50,950 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
September 30,

 

For the nine months ended
September 30,

 

Dollars in thousands, except for per share amounts

 

2003

 

2002

 

2003

 

2002

 

Net income, as reported

 

$

52,503

 

$

48,685

 

$

142,239

 

$

138,681

 

Proforma net income

 

50,807

 

46,143

 

137,524

 

131,057

 

Net income per share, basic, as reported

 

1.08

 

0.97

 

2.93

 

2.80

 

Proforma net income per share, basic

 

1.05

 

0.92

 

2.83

 

2.64

 

Net income per share, diluted, as reported

 

1.05

 

0.94

 

2.85

 

2.69

 

Proforma net income per share, diluted

 

1.01

 

0.89

 

2.75

 

2.54

 

Percentage reduction in net income per share, diluted

 

3.81

%

5.32

%

3.51

%

5.58

%

 

During the latter part of the second quarter of 2003, stock-based compensation performance awards for 2002 were granted to colleagues of the Company.  These performance awards for the first time included restricted stock grants with fewer stock options, which reduced the total number of shares awarded but better aligned the interests of shareholders and colleagues.  The Company recorded $381,000 in expense for restricted stock awards in the third quarter of 2003 and $510,000 for the first nine months of 2003 out of the original $7,668,000 grant.

 

9.               In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities.  The recognition and measurement provisions of this Interpretation are effective for newly created VIEs formed after January 31, 2003.  On October 9, 2003, the FASB issued FIN 46-6 which delayed the recognition and measurement provisions of FIN 46 for existing VIEs to the first interim or annual reporting period ending after December 15, 2003.  The Company adopted the disclosure provisions of FIN 46 effective December 31, 2002.  The Company adopted the recognition and measurement provisions of FIN 46 for newly formed VIEs effective February 1, 2003, which did not have a material effect on the Company’s financial statements. The Company intends to adopt the recognition and measurement provisions of FIN 46 for existing VIEs on December 31, 2003.  The Company does not expect that the adoption of FIN 46 will have a material effect 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 $7.3 billion as of September 30, 2003.  The purchase price was $49.0 million, comprised of cash and the assumption of approximately $7.5 million of debt.  The acquisition preliminarily resulted in $25.8 million in customer contract intangibles, which is being amortized over 20 years, and $21.5 million in goodwill.

 

7



 

CITY NATIONAL CORPORATION

FINANCIAL HIGHLIGHTS

(Unaudited)

 

 

 

At or for the three months ended

 

Percentage change
September 30, 2003 from

 

Dollars in thousands, except per share amounts

 

September 30,
2003

 

June 30,
2003

 

September 30,
2002

 

June 30,
2003

 

September 30,
2002

 

 

 

 

 

 

 

 

 

 

 

 

 

For The Quarter

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

52,503

 

$

46,081

 

$

48,685

 

14

%

8

%

Net income per common share, basic

 

1.08

 

0.95

 

0.97

 

14

 

11

 

Net income per common share, diluted

 

1.05

 

0.93

 

0.94

 

13

 

12

 

Dividends, per common share

 

0.280

 

0.205

 

0.195

 

37

 

44

 

 

 

 

 

 

 

 

 

 

 

 

 

At Quarter End

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

12,830,528

 

$

12,354,833

 

$

11,273,767

 

4

 

14

 

Deposits

 

10,785,701

 

10,166,806

 

9,126,722

 

6

 

18

 

Loans

 

7,542,147

 

7,590,226

 

7,966,801

 

(1

)

(5

)

Securities

 

3,501,398

 

3,080,721

 

2,046,020

 

14

 

71

 

Shareholders’ equity

 

1,183,799

 

1,144,690

 

1,125,855

 

3

 

5

 

Book value per share

 

24.29

 

23.77

 

22.44

 

2

 

8

 

 

 

 

 

 

 

 

 

 

 

 

 

Average Balances

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

12,418,660

 

$

11,914,869

 

$

10,964,142

 

4

 

13

 

Deposits

 

10,320,828

 

9,774,905

 

8,772,826

 

6

 

18

 

Loans

 

7,558,799

 

7,793,863

 

7,958,258

 

(3

)

(5

)

Securities

 

3,247,019

 

2,900,785

 

1,936,582

 

12

 

68

 

Shareholders’ equity

 

1,139,440

 

1,131,682

 

1,094,381

 

1

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

Selected Ratios

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

1.68

%

1.55

%

1.76

%

8

 

(5

)

Return on average shareholders’ equity

 

18.28

 

16.33

 

17.65

 

12

 

4

 

Corporation’s tier 1 leverage

 

7.37

 

7.17

 

7.88

 

3

 

(6

)

Corporation’s tier 1 risk-based capital

 

10.76

 

10.21

 

10.16

 

5

 

6

 

Corporation’s total risk-based capital

 

14.94

 

14.45

 

14.61

 

3

 

2

 

Dividend payout ratio, per share

 

25.94

 

21.51

 

20.03

 

21

 

30

 

Net interest margin

 

4.61

 

4.79

 

5.35

 

(4

)

(14

)

Efficiency ratio *

 

52.92

 

52.53

 

48.65

 

1

 

9

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset Quality Ratios

 

 

 

 

 

 

 

 

 

 

 

Nonaccrual loans to total loans

 

0.72

%

0.91

%

0.63

%

(21

)

14

 

Nonaccrual loans and ORE to toal loans and ORE

 

0.72

 

0.92

 

0.64

 

(22

)

13

 

Allowance for credit losses to total loans

 

2.20

 

2.25

 

2.00

 

(2

)

10

 

Allowance for credit losses to non accrual loans

 

304.08

 

246.37

 

317.25

 

23

 

(4

)

Net charge-offs to average loans - annualized

 

(0.25

)

(0.52

)

(0.95

)

(52

)

(74

)

 


* 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 Statements in the Company’s 2002 Form 10-K.

 

Overview

 

The Corporation recorded net income of $52.5 million, or $1.05 per common share, for the third quarter of 2003, compared with net income of $48.7 million, or $0.94 per share, for the third quarter of 2002 on fewer common shares outstanding this year.

 

For the first nine months of 2003, City National Corporation recorded net income of $142.2 million, or $2.85 per share, compared with net income of $138.7 million, or $2.69 per share, reported for the first nine months of 2002.

 

HIGHLIGHTS

 

                  In light of improved credit quality, no provision for credit losses was recorded in the third quarter of 2003 compared with $20.5 million in the prior year as nonaccrual loans declined 21 percent; selected higher-risk credits were paid, charged off or sold; charge-offs were lower and recoveries were higher than expected; and loans declined by 1 percent from the end of the prior quarter.  The year-to-date provision for credit losses was $29.0 million compared with $49.5 million for the first nine months of 2002. The allowance for credit losses to total loans was 2.20 percent at September 30, 2003.

 

                  Average core deposits for the first nine months were up 23 percent from the same period last year.  Third-quarter average core deposits were up 23 percent from a year ago and 6 percent from the prior quarter.

 

                  Average securities for the first nine months were up 46 percent from the same period last year due to significantly higher deposit balances and modest loan demand.  The average duration of total available-for-sale securities at September 30, 2003 was 3.2 years.  Average loans for the first nine months were essentially unchanged from the same period last year and period-end loan balances were down  $48.1 million from the last quarter.

 

                  Net interest income for the first nine months of 2003 increased slightly over the first nine months of 2002, but was 2 percent lower in the third quarter compared with the same period last year.  This decline is consistent with the 18-basis-point compression in the net interest margin to 4.61 percent during the third quarter of 2003.

 

9



 

                  Noninterest income excluding gains on sale of loans, assets and securities rose 18 percent for the first nine months over the same period last year.  This continued increase was primarily due to the acquisition of Convergent Capital Management (“CCM”) on April 1, 2003.  Third-quarter noninterest income, excluding gains on the sale of loans, assets and securities, was 23 percent higher than the third quarter of 2002 and 3 percent higher than the second quarter of 2003.

 

                  Exposure to syndicated non-relationship commercial and purchased media and telecommunication loans declined 40 percent from June 30, 2003 to $31.2 million at September 30, 2003 out of a total loan portfolio of $7.5 billion.

 

Dollars in millions,
except per share

 

For the three months ended
September 30,

 

%
Change

 

For the three
months ended
June 30, 2003

 

For the nine months ended
September 30,

 

%
Change

 

2003

 

2002

2003

 

2002

Earnings Per Share

 

$

1.05

 

$

0.94

 

12

 

$

0.93

 

$

2.85

 

$

2.69

 

6

 

Net Income

 

52.5

 

48.7

 

8

 

46.1

 

142.2

 

138.7

 

3

 

Average Assets

 

12,418.7

 

10,964.1

 

13

 

11,914.9

 

11,941.5

 

10,749.8

 

11

 

Return on Average Assets

 

1.68

%

1.76

%

(5

)

1.55

%

1.59

%

1.72

%

(8

)

Return on Average Equity

 

18.28

 

17.65

 

4

 

16.33

 

16.83

 

18.01

 

(7

)

 

Return on average assets for the third quarter and the first nine months of 2003 declined compared with the same periods last year due to an increase in average assets, primarily lower-yielding securities.  The lower return on average shareholders’ equity for the first nine months 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 October 15, 2003 third quarter earnings release, management currently expects net income per diluted common share for 2003 to be approximately 8 to 10 percent higher than net income per diluted common share for 2002 based on the business indicators below:

 

Average loan growth

 

flat to 2 percent

 

Average deposit growth

 

13 to 16 percent

 

Net interest margin

 

4.75 to 4.85 percent

 

Provision for credit losses

 

$29 million to $35 million

 

Noninterest income growth

 

18 to 21 percent

 

Noninterest expense growth

 

9 to 12 percent

 

Effective tax rate

 

32 to 34 percent

 

 

Revenues

 

Revenues (net interest income plus noninterest income) for the first nine months of 2003, increased 4 percent to $513.3 million compared with $492.7 million for the first nine months of 2002, primarily due to the acquisition of CCM.  Third-quarter revenues increased 5 percent to $173.9 million from $165.7 million in the third quarter of 2002.  Revenues increased 1 percent from the second quarter of 2003.

 

Net Interest Income

 

Fully taxable-equivalent net interest income for the first nine months of 2003 was $395.0 million compared with $394.9 million for the first nine months of 2002.  Net interest income for the third quarter of 2003 was $132.4 million on a fully taxable-equivalent basis, a 2 percent decrease from $135.2 million in the third quarter of 2002 due to lower interest rates and lower commercial loan demand.

 

10



 

 

Dollars  in millions

 

For the three months ended
September 30,

 

%
Change

 

For the three
months ended
June 30, 2003

 

For the nine months ended
September 30,

 

%
Change

 

2003

 

2002

2003

 

2002

Average Loans

 

$

7,558.8

 

$

7,958.3

 

(5

)

$

7,793.9

 

$

7,770.8

 

$

7,772.7

 

0

 

Average Securities

 

3,247.0

 

1,936.6

 

68

 

2,900.8

 

2,866.2

 

1,963.7

 

46

 

Average Deposits

 

10,320.8

 

8,772.8

 

18

 

9,774.9

 

9,826.7

 

8,422.3

 

17

 

Average Core Deposits

 

9,323.5

 

7,565.7

 

23

 

8,763.1

 

8,808.0

 

7,138.6

 

23

 

Fully Taxable-Equivalent
Net Interest Income

 

132.4

 

135.2

 

(2

)

130.8

 

395.0

 

394.9

 

0

 

Net Interest Margin

 

4.61

%

5.35

%

(14

)

4.79

%

4.82

%

5.35

%

(10

)

 

Average loans for the first nine months of 2003 were just slightly lower than the same period last year.  However, average loans for the third quarter of 2003 declined 5 percent compared with the same period last year and 3 percent from the prior quarter, due to continued modest loan demand. Compared with the first nine months of 2002 averages, commercial loans decreased 5 percent, residential first mortgage loans rose 3 percent, real estate mortgage loans rose 5 percent, and real estate construction loans rose 5 percent.  Compared with the prior-year third-quarter averages, commercial loans declined 11 percent, residential first mortgage loans rose 1 percent, real estate mortgage loans declined 1 percent, and real estate construction loans declined 3 percent due to payoffs on completed construction projects.  Compared with the prior quarter, average residential first mortgage loans and installment loans increased while all other loan categories decreased.

 

Period-end September 30, 2003 loans declined $48.1 million from June 30, 2003, representing a slowing in the decline in the total loan portfolio and the modest growth seen in certain areas, compared with the $242.6 million decline between June 30, 2003 and March 31, 2003.

 

Average securities, principally with low current yields and short maturities, for the first nine months and third quarter of 2003 increased 46 percent and 68 percent over the same periods last year due to higher deposit balances and modest loan demand.  As of September 30, 2003, unrealized gains on securities available-for-sale were $27.7 million.  In addition, the average duration of total available-for-sale securities at September 30, 2003 was 3.2 years compared to 2.3 years at June 30, 2003, consistent with our expectations given the change in interest rates from June to September.

 

Average deposits continued to increase over the prior-year periods as well as from the prior quarter.  Average core deposits represented 90 percent of the total average deposit base for the third quarter of 2003, compared with 86 percent for the third quarter of 2002 and 90 percent for the second quarter of 2003.  New clients and higher client balances maintained as deposits to pay for services contributed to the continued growth of deposits.

 

The net interest margin narrowed due to prepayment and refinancing activity and low interest rates.

 

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 $1,051.4 million, added $8.1 million to net interest income in the third quarter of 2003.  That compared with $8.2 million in the third quarter of 2002 and $7.5 million for the second quarter of 2003.  These net interest income amounts included $5.8 million, $3.7 million and $5.2 million, respectively, for interest swaps qualifying as fair-value hedges.  Income from swaps qualifying as cash-flow hedges was $2.3 million for the third quarter of 2003, compared with $4.5 million for the third quarter of 2002 and $2.3 million for the second quarter of 2003.  For the first nine months of 2003, interest rate swaps added $23.1 million to net interest income, compared with $24.6 million for the first nine months of 2002.  These amounts included $15.5 million and $10.6 million, respectively, for interest swaps qualifying as fair value hedges.  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 $7.8 million.

 

Interest recovered on nonaccrual and charged-off loans included in net interest income for the first nine months of 2003 was $2.3 million compared with $1.4 million for the first nine months of 2002.  Interest income

 

11



 

recovered was $1.3 million for the third quarter of 2003, compared with $0.4 million for the third quarter of 2002 and $0.4 million for the second quarter of 2003, respectively.

 

The Bank’s prime rate was 4.00 percent as of September 30, 2003, compared with 4.75 percent a year earlier.

 

The following tables present the components of net interest income on a fully taxable-equivalent basis for the three and nine months ended September 30, 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.

 

12



 

Net Interest Income Summary

 

 

 

For the three months ended
September 30, 2003

 

For the three months ended
September 30, 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

 

$

3,191,405

 

$

42,658

 

5.30

%

$

3,598,795

 

$

54,422

 

6.00

%

Real estate mortgages

 

1,890,996

 

30,582

 

6.42

 

1,900,612

 

34,481

 

7.20

 

Residential first mortgages

 

1,754,877

 

26,383

 

5.96

 

1,733,693

 

29,454

 

6.74

 

Real estate construction

 

634,300

 

7,925

 

4.96

 

651,174

 

9,254

 

5.64

 

Installment

 

87,221

 

1,579

 

7.18

 

73,984

 

1,602

 

8.59

 

Total loans

(1)

 

7,558,799

 

109,127

 

5.73

 

7,958,258

 

129,213

 

6.44

 

Securities available-for-sale

 

3,146,971

 

35,268

 

4.45

 

1,882,231

 

28,350

 

5.98

 

Federal funds sold and securities purchased under resale agreements

 

584,552

 

1,511

 

1.03

 

120,279

 

540

 

1.78

 

Trading account securities

 

100,048

 

175

 

0.69

 

54,351

 

163

 

1.19

 

Total interest-earning assets

 

11,390,370

 

146,081

 

5.09

 

10,015,119

 

158,266

 

6.27

 

Allowance for credit losses

 

(173,822

)

 

 

 

 

(160,026

)

 

 

 

 

Cash and due from banks

 

438,968

 

 

 

 

 

440,226

 

 

 

 

 

Other nonearning assets

 

763,144

 

 

 

 

 

668,823

 

 

 

 

 

Total assets

 

$

12,418,660

 

 

 

 

 

$

10,964,142

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest checking accounts

 

$

750,513

 

292

 

0.15

 

$

626,469

 

408

 

0.26

 

Money market accounts

 

3,289,234

 

5,541

 

0.67

 

2,680,730

 

9,128

 

1.35

 

Savings deposits

 

211,623

 

71

 

0.13

 

221,227

 

441

 

0.79

 

Time deposits - under $100,000

 

207,362

 

819

 

1.57

 

223,853

 

1,277

 

2.26

 

Time deposits - $100,000 and over

 

997,287

 

3,322

 

1.32

 

1,207,127

 

6,512

 

2.14

 

Total interest - bearing deposits

 

5,456,019

 

10,045

 

0.73

 

4,959,406

 

17,766

 

1.42

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds purchased and securities sold under repurchase agreements

 

132,731

 

292

 

0.87

 

211,321

 

845

 

1.59

 

Other borrowings

 

660,830

 

3,363

 

2.02

 

750,319

 

4,481

 

2.37

 

Total interest - bearing liabilities

 

6,249,580

 

13,700

 

0.87

 

5,921,046

 

23,092

 

1.55

 

Noninterest - bearing deposits

 

4,864,809

 

 

 

 

 

3,813,420

 

 

 

 

 

Other liabilities

 

164,831

 

 

 

 

 

135,295

 

 

 

 

 

Shareholders’ equity

 

1,139,440

 

 

 

 

 

1,094,381

 

 

 

 

 

Total liabilities and shareholders' equity

 

$

12,418,660

 

 

 

 

 

$

10,964,142

 

 

 

 

 

Net interest spread

 

 

 

 

 

4.22

%

 

 

 

 

4.72

%

Fully taxable-equivalent net interest income

 

 

 

$

132,381

 

 

 

 

 

$

135,174

 

 

 

Net interest margin

 

 

 

 

 

4.61

%

 

 

 

 

5.35

%

 


(1)   Includes average nonaccrual loans of $59,319 and $57,025 for 2003 and 2002, respectively.

(2)   Loan income includes loan fees of $5,899 and $6,486 for 2003 and 2002, respectively.

 

13



 

Net Interest Income Summary

 

 

 

For the nine months ended
September 30, 2003

 

For the nine months ended
September 30, 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

 

$

3,383,367

 

$

134,157

 

5.30

%

$

3,573,657

 

$

163,287

 

6.11

%

Real estate mortgages

 

1,902,117

 

93,531

 

6.57

 

1,803,924

 

98,029

 

7.27

 

Residential first mortgages

 

1,748,237

 

81,284

 

6.22

 

1,695,501

 

87,201

 

6.88

 

Real estate construction

 

659,157

 

25,668

 

5.21

 

628,239

 

26,428

 

5.62

 

Installment

 

77,970

 

4,488

 

7.70

 

71,382

 

4,767

 

8.93

 

Total loans

(1)

 

7,770,848

 

339,128

 

5.83

 

7,772,703

 

379,712

 

6.53

 

Securities available-for-sale

 

2,794,975

 

101,168

 

4.84

 

1,908,674

 

87,583

 

6.14

 

Federal funds sold and securities purchased under resale agreements

 

323,021

 

2,693

 

1.11

 

133,042

 

1,751

 

1.76

 

Trading account securities

 

71,175

 

373

 

0.70

 

54,992

 

555

 

1.35

 

Total interest-earning assets

 

10,960,019

 

443,362

 

5.41

 

9,869,411

 

469,601

 

6.36

 

Allowance for credit losses

 

(172,522

)

 

 

 

 

(157,022

)

 

 

 

 

Cash and due from banks

 

436,605

 

 

 

 

 

426,203

 

 

 

 

 

Other nonearning assets

 

717,387

 

 

 

 

 

611,190

 

 

 

 

 

Total assets

 

$

11,941,489

 

 

 

 

 

$

10,749,782

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest checking accounts

 

$

712,588

 

933

 

0.18

 

$

606,326

 

1,166

 

0.26

 

Money market accounts

 

3,126,353

 

20,371

 

0.87

 

2,403,092

 

25,387

 

1.41

 

Savings deposits

 

205,147

 

572

 

0.37

 

231,216

 

1,672

 

0.97

 

Time deposits - under $100,000

 

211,673

 

2,760

 

1.74

 

228,059

 

4,214

 

2.47

 

Time deposits - $100,000 and over

 

1,018,647

 

11,431

 

1.50

 

1,283,647

 

22,438

 

2.34

 

Total interest - bearing deposits

 

5,274,408

 

36,067

 

0.91

 

4,752,340

 

54,877

 

1.54

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds purchased and securities sold under repurchase agreements

 

165,765

 

1,331

 

1.07

 

204,712

 

2,430

 

1.59

 

Other borrowings

 

662,054

 

10,970

 

2.22

 

974,785

 

17,385

 

2.38

 

Total interest - bearing liabilities

 

6,102,227

 

48,368

 

1.06

 

5,931,837

 

74,692

 

1.68

 

Noninterest - bearing deposits

 

4,552,251

 

 

 

 

 

3,669,914

 

 

 

 

 

Other liabilities

 

157,366

 

 

 

 

 

118,420

 

 

 

 

 

Shareholders’ equity

 

1,129,645

 

 

 

 

 

1,029,611

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

11,941,489

 

 

 

 

 

$

10,749,782

 

 

 

 

 

Net interest spread

 

 

 

 

 

4.35

%

 

 

 

 

4.68

%

Fully taxable-equivalent net interest income

 

 

 

$

394,994

 

 

 

 

 

$

394,909

 

 

 

Net interest margin

 

 

 

 

 

4.82

%

 

 

 

 

5.35

%

 


(1)          Includes average nonaccrual loans of $74,058 and $52,942 for 2003 and 2002, respectively.

(2)          Loan income includes loan fees of $16,985 and $18,377 for 2003 and 2002, respectively.

 

14



 

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 third quarter and the first nine months of 2003 and the third quarter and the first nine months of 2002, as well as between the third quarter and the first nine months of 2002 and the third quarter and the first nine months of 2001.

 

Changes In Net Interest Income

 

 

 

For the three months ended September 30,
2003 vs 2002

 

For the three months ended September 30,
2002 vs 2001

 

Dollars in thousands

 

Increase (decrease)
due to

 

Net
increase
(decrease)

 

Increase (decrease)
due to

 

Net
increase
(decrease)

 

Volume

 

Rate

Volume

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earned on:

 

$

(6,284

)

$

(13,802

)

$

(20,086

)

$

21,193

 

$

(22,323

)

$

(1,130

)

Securities available-for-sale

 

15,524

 

(8,606

)

6,918

 

2,315

 

(2,746

)

(431

)

Federal funds sold and securities pruchased under resale agreements

 

1,285

 

(314

)

971

 

266

 

(280

)

(14

)

Trading account securities

 

99

 

(87

)

12

 

52

 

(267

)

(215

)

Total interest-earning assets

 

10,624

 

(22,809

)

(12,185

)

23,826

 

(25,616

)

(1,790

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest paid on:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest checking deposits

 

74

 

(190

)

(116

)

87

 

(209

)

(122

)

Money market deposits

 

1,741

 

(5,328

)

(3,587

)

5,538

 

(7,485

)

(1,947

)

Savings deposits

 

(18

)

(352

)

(370

)

(163

)

(1,008

)

(1,171

)

Other time deposits

 

(1,092

)

(2,556

)

(3,648

)

(1,828

)

(7,491

)

(9,319

)

Other borrowings

 

(851

)

(820

)

(1,671

)

(4,448

)

(5,288

)

(9,736

)

Total interest-bearing liabilities

 

(146

)

(9,246

)

(9,392

)

(814

)

(21,481

)

(22,295

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

10,770

 

$

(13,563

)

$

(2,793

)

$

24,640

 

$

(4,135

)

$

20,505

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the nine months ended September 30,
2003 vs 2002

 

For the nine months ended September 30,
2002 vs 2001

 

Dollars in thousands

 

Increase (decrease)
due to

 

Net
increase
(decrease)

 

Increase (decrease)
due to

 

Net
increase
(decrease
)

 

Volume

 

Rate

Volume

 

Rate

Interest earned on:

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

(91

)

$

(40,493

)

$

(40,584

)

$

64,420

 

$

(86,266

)

$

(21,846

)

Securities

 

34,824

 

(21,239

)

13,585

 

13,859

 

(8,234

)

5,625

 

Federal funds sold and securities purchased under resale agreements

 

1,776

 

(834

)

942

 

1,356

 

(1,630

)

(274

)

Trading account securities

 

133

 

(315

)

(182

)

(160

)

(1,058

)

(1,218

)

Total interest-earning assets

 

36,642

 

(62,881

)

(26,239

)

79,475

 

(97,188

)

(17,713

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest paid on:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest checking deposits

 

179

 

(412

)

(233

)

138

 

(684

)

(546

)

Money market deposits

 

6,335

 

(11,351

)

(5,016

)

15,798

 

(25,414

)

(9,616

)

Savings deposits

 

(169

)

(931

)

(1,100

)

(352

)

(3,739

)

(4,091

)

Other time deposits

 

(4,347

)

(8,114

)

(12,461

)

(7,937

)

(31,832

)

(39,769

)

Other borrowings

 

(5,415

)

(2,099

)

(7,514

)

(4,965

)

(22,424

)

(27,389

)

Total interest-bearing liabilities

 

(3,417

)

(22,907

)

(26,324

)

2,682

 

(84,093

)

(81,411

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

40,059

 

$

(39,974

)

$

85

 

$

76,793

 

$

(13,095

)

$

63,698

 

 

15



 

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’s decision to make no provision for credit losses in the third quarter of 2003 was attributable to the improving credit quality of the portfolio; nonaccrual loan levels declining by 21%; selected higher risk credits being paid, charged off or sold; a lower level of charge-offs; higher-than-expected recoveries; loans declining by 1 percent from the prior quarter end; management’s ongoing assessment of the credit quality of the portfolio and a more stable economic environment.  Management believes the allowance for credit losses is adequate to cover risks in the portfolio at September 30, 2003.  See “— Allowance for Credit Losses.”

 

Noninterest Income

 

The Company continues to emphasize growth in noninterest income through both the development of its existing business and acquisitions.  For the first nine months of 2003, noninterest income including gains on the sale of loans, assets and securities increased 19 percent to $129.3 million, up from $108.9 million for the first nine months of 2002 primarily as a result of the acquisition of CCM.  Noninterest income increased 32 percent to $45.3 million for the third quarter of 2003, up from $34.2 million for the third quarter of 2002.  Noninterest income increased slightly over the second quarter of 2003.

 

Noninterest income as a percentage of total revenues for the first nine months and third quarter of 2003 was 25 percent and 26 percent, respectively, compared with 22 percent and 21 percent for the first nine months and third quarter of 2002 and 26 percent for the second quarter of 2003.

 

Trust and Investment Fee Revenue

 

 

 

At or for the
three months ended
September 30,

 

%

 

At or for the three
months ended

 

For the
nine months ended
September 30,

 

%

 

Dollars in millions

 

2003

 

2002

 

Change

 

June 30, 2003

 

2003

 

2002

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trust and Investment Fee Revenue

 

$

23.4

 

$

15.3

 

53

 

$

21.5

 

$

60.4

 

$

45.3

 

33

 

Assets Under Administration

 

27,485.8

 

19,067.2

 

44

 

26,237.3

 

 

 

 

 

 

 

Assets Under Management (1)(2)

 

12,653.0

 

7,022.0

 

80

 

12,531.3

 

 

 

 

 

 

 

 


(1) Included above in assets under administration

(2) Excludes $2,115 and $1,896 million of assets under management for the CCM minority owned asset managers as of September 30, 2003 and June 30, 2003, respectively

 

Assets under management at September 30, 2003 increased primarily due to the CCM acquisition in April of 2003.  New business, aided by strong relative investment performance and higher market values, also contributed to the increase.  The revenue increases for both the first nine months and third quarter of 2003 were driven by higher balances under management or administration.  Increases in market values are reflected in fee income primarily on a trailing-quarter basis.

 

Other Noninterest Income

 

Cash management and deposit transaction fees for the first nine months and third quarter of 2003 increased 6 percent and 7 percent over the same periods last year, respectively.  Strong growth in deposits and higher sales of cash management products contributed to this growth.  Cash management and deposit transaction fees for the third quarter of 2003 were essentially unchanged from the previous quarter.

 

For the first nine months of 2003, international services fees were 7 percent higher than the first nine months of 2002.  International services fees for the third quarter 2003 were up 2 percent over the same period last year and decreased 3 percent from the second quarter of 2003.  Higher foreign exchange income fueled the year-over-year revenue growth while trade-finance revenue was down from 2002.

 

16



 

For the first nine months of 2003, $2.7 million in gains on the sale of loans and other assets and gains on the sale of securities were realized compared with $1.3 million in gains for the first nine months of 2002.  There were essentially no gains for the third quarter of 2003 compared with a loss of $2.6 million for the third quarter of 2002 and a gain of $1.3 million for the second quarter of 2003.

 

Noninterest Expense

 

Noninterest expense for the first nine months of 2003 increased 10 percent to $269.1 million, up from $243.7 million for the first nine months of 2002.  Noninterest expense was $92.3 million in the third quarter of 2003, up 12 percent from $82.2 million for the third quarter of 2002 and up 1 percent from $91.3 million for the second quarter of 2003.  Expenses grew primarily because of the addition of CCM, the issuance of restricted stock awards in the second quarter of 2003 and to a lesser extent the Company’s expansion, principally into New York.  Excluding the expenses of CCM and the New York office, expenses were up less than 5 percent for the first nine months of 2003 over 2002.

 

For the first nine months of 2003, the Company’s efficiency ratio was 51.93 percent compared with the more favorable 48.49 percent for the same period last year.  The efficiency ratio for the third quarter of 2003 was  52.92 percent, compared with 48.65 percent for the third quarter of 2002 and 52.53 percent for the second quarter of 2003.  The increase in the efficiency ratio is primarily attributable to the acquisition of CCM.

 

Minority Interest

 

Minority interest consists of preferred stock dividends on the Bank’s real estate investment trust subsidiaries and the minority ownership share of earnings of the Corporation’s majority owned asset management firms.

 

Income Taxes

 

The effective tax rate for the first nine months of 2003 was 32.9 percent, compared with 30.1 percent for all of 2002.  The higher effective tax rate for this year reflects the absence of certain tax benefits recognized in 2002.  The third quarter of 2002 included $4.6 million of such benefits that contributed to an effective tax rate of 22.5 percent for that quarter.

 

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.

 

The Company’s tax returns are being audited 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 for the first nine months of 2003, were $11.9 billion, 11 percent higher than the $10.7 billion in average assets for the first nine months of 2002.  For the third quarter 2003, average assets reached $12.4 billion, an increase of 13 percent over the $11.0 billion in average assets for the third quarter of 2002 and 4 percent over the $11.9 billion in average assets for the second quarter of 2003.  Total assets at September 30, 2003 increased 14 percent to $12.8 billion from $11.3 billion at September 30, 2002.  Total assets at December 31, 2002 were  $11.9 billion.

 

Total average interest-earning assets for the first nine months of 2003 were $11.0 billion, an increase of 11 percent over the $9.9 billion in total average interest-earning assets for the first nine months of 2002.  For the third quarter of 2003, total average interest-earning assets were $11.4 billion, an increase of 14 percent over the $10.0 billion in average interest-earning assets for the third quarter of 2002 and 4 percent higher than the $10.9 billion in average interest-earning assets for the second quarter of 2003.

 

17



 

Securities

 

Comparative period-end security portfolio balances are presented below:

 

Securities Available-for-Sale

 

Dollars in thousands

 

September 30,
2003

 

December 31,
2002

 

September 30,
2002

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

U.S. Government and federal agency

 

$

350,161

 

$

354,534

 

$

317,183

 

$

324,223

 

$

255,078

 

$

262,308

 

Mortgage-backed

 

2,594,976

 

2,606,317

 

1,448,673

 

1,491,489

 

1,227,969

 

1,264,548

 

State and Municipal

 

256,541

 

269,651

 

224,013

 

236,591

 

218,627

 

232,611

 

Other

 

109,019

 

109,296

 

5,451

 

4,600

 

31,887

 

32,429

 

Total debt securities

 

3,310,697

 

3,339,798

 

1,995,320

 

2,056,903

 

1,733,561

 

1,791,896

 

Marketable equity securities

 

70,979

 

69,576

 

174,124

 

169,753

 

192,253

 

187,543

 

Total securities

 

$

3,381,676

 

$

3,409,374

 

$

2,169,444

 

$

2,226,656

 

$

1,925,814

 

$

1,979,439

 

 

Average securities available-for-sale continued to increase primarily due to strong deposit growth.  At September 30, 2003, securities available-for-sale totaled $3.4 billion, an increase of $1.4 billion compared with holdings at September 30, 2002 and an increase of $1.2 billion from December 31, 2002.  At September 30, 2003 the portfolio had an unrealized net gain of $27.7 million compared with $57.2 million and $53.6 million at December 31, 2002 and September 30, 2002, respectively.  The average duration of total available-for-sale securities at September 30, 2003 was an expected 3.2 years.  Duration provides a measure of fair value sensitivity to changes in interest rates.  The 3.2 expected duration compares with 2.1 at December 31, 2002 and 2.2 at September 30, 2002.  This is within the investment guidelines set by the Company’s Asset/Liability Committee and the interest rate risk guidelines set by the Board of Directors.  See “— Asset /Liability Management” for a discussion of the Company’s interest rate position.

 

The following table provides the contractual remaining maturities and yields (taxable-equivalent basis) of debt securities within the securities portfolio as of September 30, 2003.  Contractual maturities of mortgage-backed securities are substantially longer than their expected maturities due to scheduled and unscheduled principal payments.  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.

 

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

 

$

623

 

5.86

 

$

327,959

 

3.23

 

$

25,952

 

3.69

 

$

 

 

$

354,534

 

3.27

 

Mortgage-backed

 

 

 

 

 

222,283

 

4.02

 

2,384,034

 

4.66

 

2,606,317

 

4.61

 

State and Municipal

 

9,225

 

6.94

 

100,345

 

6.59

 

108,052

 

6.48

 

52,029

 

6.15

 

269,651

 

6.47

 

Other

 

26,893

 

3.63

 

82,403

 

5.04

 

 

 

 

 

109,296

 

4.69

 

Total debt securities

 

$

36,741

 

4.50

 

$

510,707

 

4.18

 

$

356,287

 

4.74

 

$

2,436,063

 

4.69

 

$

3,339,798

 

4.62

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

$

36,683

 

 

 

$

 499,291

 

 

 

$

 349,001

 

 

 

$

 2,425,722

 

 

 

$

 3,310,697

 

 

 

 

Dividend income included in interest income on securities in the Unaudited Consolidated Statement of Income and Comprehensive Income for the third quarters of 2003 and 2002 was $1.9 million and $2.3 million and $6.0 million and $7.4 million for the first nine months of 2003 and 2002, respectively.

 

18



 

Loan Portfolio

 

A comparative period-end loan table is presented below:

 

Loans

 

Dollars in thousands

 

September 30,
2003

 

December 31,
2002

 

September 30,
2002

 

 

 

 

 

 

 

 

 

Commercial

 

$

3,143,489

 

$

3,609,053

 

$

3,572,267

 

Residential first mortgages

 

1,803,424

 

1,738,909

 

1,746,649

 

Real estate mortgages

 

1,887,423

 

1,934,409

 

1,910,277

 

Real estate construction

 

622,941

 

640,861

 

661,698

 

Installment

 

84,870

 

76,238

 

75,910

 

Total loans, gross

 

7,542,147

 

7,999,470

 

7,966,801

 

Less allowance for credit losses

 

166,209

 

164,502

 

159,173

 

Total loans, net

 

$

7,375,938

 

$

7,834,968

 

$

7,807,628

 

 

Total loans at September 30, 2003 were 5 percent and 1 percent lower than total loans at September 30, 2002 and June 30, 2003, respectively. At September 30, 2003, the Company’s loan portfolio included approximately  $950.0 million of credits to borrowers located in Northern California, including approximately $500.0 million of loans managed in Northern California offices.  In addition, the portfolio included approximately $150.0 million in outstanding dairy loans and $31.2 million of syndicated non-relationship commercial and purchased media and telecommunication loans, the latter down from $52.2 million at June 30, 2003.

 

Following is a breakdown of the syndicated non-relationship commercial loans and purchased media and telecommunication loans as of September 30, 2003:

 

Dollars in thousands

 

Number

 

Commitments

 

Outstanding

 

Percentage

 

Commercial

 

7

 

$

20,998

 

$

17,124

 

55

%

Telecommunications

 

3

 

10,323

 

3,689

 

12

 

Publishing

 

2

 

11,850

 

4,426

 

14

 

Television Broadcasting

 

1

 

5,000

 

4,152

 

13

 

Wireless

 

1

 

4,564

 

1,821

 

6

 

 

 

14

 

$

52,735

 

$

31,212

 

100

%

 

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.

 

19



 

Nonaccrual Loans, ORE and Restructured Loans

 

Dollars in thousands

 

September 30,
2003

 

December 31,
2002

 

September 30,
2002

 

 

 

 

 

 

 

 

 

Nonaccrual loans:

 

 

 

 

 

 

 

Commercial

 

$

40,218

 

$

52,890

 

$

37,725

 

Real estate

 

14,088

 

17,992

 

10,989

 

Installment

 

353

 

475

 

1,459

 

Total

 

54,659

 

71,357

 

50,173

 

ORE

 

 

670

 

460

 

Total nonaccrual loans and ORE

 

$

54,659

 

$

72,027

 

$

50,633

 

 

 

 

 

 

 

 

 

Total non accrual loans as a percentage of total loans

 

0.72

%

0.89

%

0.63

%

Total non accrual loans and ORE as a percentage of total loans and ORE

 

0.72

 

0.90

 

0.64

 

Allowance for credit losses to total loans

 

2.20

 

2.06

 

2.00

 

Allowance for credit losses to nonaccrual loans

 

304.08

 

230.53

 

317.25

 

 

 

 

 

 

 

 

 

Loans past due 90 days or more on accrual status:

 

 

 

 

 

 

 

Commercial

 

$

2,582

 

$

5,854

 

$

5,905

 

Real estate

 

441

 

104

 

2,858

 

Installment

 

 

198

 

143

 

Total

 

$

3,023

 

$

6,156

 

$

8,906

 

 

Nonaccrual loans fell this quarter primarily due to payoffs. Approximately 27 percent of the nonperforming assets were loans to Northern California clients as of September 30, 2003.  Approximately 16 percent were three syndicated non-relationship commercial and purchased media and telecommunication loans totaling $8.7 million, which compared with four loans totaling $14.7 million at June 30, 2003 and 4 percent was one dairy relationship for $2.2 million.  The remaining 53 percent were loans to other borrowers with no major industry concentrations.

 

At September 30, 2003, nonaccrual loans included $42.8 million of impaired loans which had an allowance for credit losses of $5.7 million allocated to them.  At June 30, 2003, nonaccrual loans included $68.6 million of impaired loans which had an allowance of $10.7 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 flow 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.

 

The Company’s policy is to record cash receipts on impaired loans where it is probable that it will be unable to collect all principal amounts, first as reductions in principal and then as interest income.

 

The following table summarizes the changes in nonaccrual loans for the three and nine months ended September 30, 2003 and 2002.

 

20



 

Changes in Nonaccrual Loans

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

Dollars in thousands

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

69,377

 

$

64,432

 

$

71,357

 

$

38,563

 

Additions from acquisitions

 

 

 

 

3,510

 

Loans placed on nonaccrual

 

17,528

 

17,350

 

89,175

 

70,277

 

Charge-offs

 

(4,510

)

(20,050

)

(27,293

)

(39,696

)

Loans returned to accrual status

 

(394

)

(4,420

)

(394

)

(5,639

)

Repayments (including interest applied to principal) and sales

 

(27,342

)

(6,006

)

(78,186

)

(15,178

)

Transferred to ORE

 

 

(1,133

)

 

(1,664

)

Balance, end of period

 

$

54,659

 

$

50,173

 

$

54,659

 

$

50,173

 

 

In addition to loans disclosed above as nonaccrual or restructured, management has also identified $4.7 million of credits to 11 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 September 30, 2003.  Estimated losses from these potential problem loans have been provided for in determining the adequacy of the allowance for credit losses at September 30, 2003.

 

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 September 30, 2003 totaled $166.2 million, or 2.20 percent of outstanding loans.  This compares with an allowance of $159.2 million, or 2.00 percent at September 30, 2002 and an allowance of $170.9 million, or 2.25 percent at June 30, 2003.  The allowance for credit losses as a percentage of nonaccrual loans was 304 percent at September 30, 2003, compared with 317 percent at September 30, 2002 and 246 percent at June 30, 2003.

 

For the first nine months of 2003, net charge-offs were $27.3 million, down from $42.0 million for the same period last year.  Net charge-offs for the third quarter of 2003 were $4.7 million, including $4.5 million relating to the Company’s syndicated non-relationship commercial and purchased media and telecommunication loan portfolio.  This compares with $19.0 million and $2.0 million, respectively, for the third quarter of 2002.  As an annualized percentage of average loans, net charge-offs were 0.25 percent, 0.95 percent and 0.52 percent for the third quarters of 2003 and 2002 and the second quarter of 2003, 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 changes 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 September 30, 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.

 

21



 

The table below summarizes the changes in the allowance for credit losses for the three and nine months ended September 30, 2003 and 2002.

 

Changes in Allowance for Credit Losses

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

Dollars in thousands

 

2003

 

2002

 

2003

 

2002

 

Loans outstanding

 

$

7,542,147

 

$

7,966,801

 

$

7,542,147

 

$

7,966,801

 

Average amount of loans outstanding

 

$

7,558,799

 

$

7,958,258

 

$

7,770,848

 

$

7,772,703

 

Balance of allowance for credit losses, beginning of period

 

$

170,927

 

$

157,647

 

$

164,502

 

$

142,862

 

Loans charged off:

 

 

 

 

 

 

 

 

 

Commercial

 

(7,561

)

(17,364

)

(34,999

)

(41,747

)

Real estate and other

 

(38

)

(2,904

)

(1,693

)

(5,678

)

Total loans charged off

 

(7,599

)

(20,268

)

(36,692

)

(47,425

)

Less recoveries of loans previously charged off:

 

 

 

 

 

 

 

 

 

Commercial

 

2,734

 

658

 

8,752

 

2,694

 

Real estate and other

 

147

 

636

 

647

 

2,755

 

Total recoveries

 

2,881

 

1,294

 

9,399

 

5,449

 

Net loans charged off

 

(4,718

)

(18,974

)

(27,293

)

(41,976

)

Additions to allowance charged to operating expense

 

 

20,500

 

29,000

 

49,500

 

Additions to allowance from acquisition

 

 

 

 

8,787

 

Balance, end of period

 

$

166,209

 

$

159,173

 

$

166,209

 

$

159,173

 

 

 

 

 

 

 

 

 

 

 

Total net charge-offs to average loans (annualized)

 

(0.25

)%

(0.95

)%

(0.47

)%

(0.72

)%

 

 

 

 

 

 

 

 

 

 

Ratio of allowance for credit losses to total period end loans

 

 

 

 

 

2.20

%

2.00

%

 

Other Assets

 

Other assets included the following:

 

Other Assets

 

Dollars in thousands

 

September 30,
2003

 

December 31,
2002

 

September 30,
2002

 

 

 

 

 

 

 

 

 

Interest rate swap mark-to-market

 

$

52,231

 

$

56,690

 

$

55,445

 

Accrued interest receivable

 

43,716

 

45,124

 

46,122

 

Claim in receivership and other assets

 

23,758

 

23,142

 

23,067

 

Loans held-for-sale

 

 

18,155

 

37,236

 

Income tax refund

 

 

3,464

 

810

 

Other

 

52,967

 

40,191

 

42,216

 

Total other assets

 

$

172,672

 

$

186,766

 

$

204,896

 

 

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.

 

See — “Net Interest Income” for a discussion of interest rate swaps that result in the swap mark-to-market asset of $52.2 million.

 

22



 

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 and unfunded loan commitments aggregating  $3,416.1 million at September 30, 2003.  In addition, the Company had $359.2 million outstanding in bankers’ acceptances and letters of credit of which $304.3 million relate to standby letters of credit at September 30, 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 $10.8 billion at September 30, 2003, an increase of 18 percent compared with $9.1 billion at September 30, 2002, and increased 6 percent over the $10.2 billion at June 30, 2003.  New clients, additional trust and escrow deposits and a lower earnings credit on analyzed deposit accounts resulting from lower interest rates, contributed to the growth of deposits.

 

Demand deposits accounted for 50 percent of total deposits at September 30, 2003.  Core deposits, which continued to provide substantial benefits to the Bank’s cost of funds, were 91 percent of total deposits at September 30, 2003.  See “¾ Net Interest Income.”

 

Other Borrowings

 

Other borrowings have declined by $63.8 million from December 31, 2002 and $195.8 million from September 30, 2002 to $700.5 million at September 30, 2003 as deposits have increased.  This is despite the $225 million of 5.125 percent Senior Notes due 2013 issued by the Corporation in February 2003.

 

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 September 30, 2003, December 31, 2002 and September 30, 2002.

 

 

 

Regulatory
Well Capitalized
Standards

 

September 30,
2003

 

December 31,
2002

 

September 30,
2002

 

City National Corporation

 

 

 

 

 

 

 

 

 

Tier 1 leverage

 

 

%

7.37

%

7.55

%

7.88

%

Tier 1 risk-based capital

 

6.00

 

10.76

 

9.87

 

10.16

 

Total risk-based capital

 

10.00

 

14.94

 

14.26

 

14.61

 

 

 

 

 

 

 

 

 

 

 

City National Bank

 

 

 

 

 

 

 

 

 

Tier 1 leverage

 

5.00

 

7.82

 

7.24

 

7.22

 

Tier 1 risk-based capital

 

6.00

 

11.35

 

9.46

 

9.32

 

Total risk-based capital

 

10.00

 

15.53

 

13.85

 

13.79

 

 

Tier 1 capital ratios include the impact of $26.0 million of preferred stock issued by real estate investment trust subsidiaries of the Bank which is included in minority interest in consolidated subsidiaries.

 

23



 

On January 22, 2003, the Board of Directors authorized a 1 million-share stock buyback program.  No shares were repurchased during the third quarter of 2003.  A total number of 750,100 shares have been repurchased under this program at an average price of $42.47 per share leaving 249,900 shares available for repurchase.  Shares will be repurchased on a selective basis from time to time in open market transactions.  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 1,545,450 treasury shares at September 30, 2003.

 

On July 15, 2003, the Board of Directors authorized the repurchase of 500,000 additional shares of City National Corporation stock, following completion of the Company’s current buyback initiative.

 

On October 22, 2003, the Corporation declared a regular quarterly cash dividend on common stock at a rate of $0.28 per share to shareholders of record on November 5, 2003, payable on November 17, 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 84 percent of total funding of average assets in the third quarter of 2003, compared with 79 percent in the third quarter of 2002.  This increase allowed the Company to decrease its use of more costly alternative funding sources. See “— 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.

 

Net Interest Simulation: During the first nine months of 2003, the Company maintained a moderate asset sensitive interest rate position. Based on the balance sheet at September 30, 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. Assuming a static balance sheet, a gradual 100 basis point decline in interest rates over a twelve-month horizon would result in a decrease in projected net interest income of approximately 3.1 percent.  The 3.1 percent at-risk amount is up slightly from the previous two quarters, which were 2.3 percent and 3.0 percent at March 31, 2003, and June 30, 2003 respectively.  (Note: The 100 basis point decline could cause some rates to be negative.  We assume that discount rates may fall to zero but no further.)  A gradual 100 basis point increase in interest rates over the next 12-month period would result in an increase in projected net interest income of approximately 2.3 percent.  This is little changed from the March 31, 2003 and June 30, 2003 results which were 2.3 percent and 2.4 percent respectively.  Exposure remains within ALCO guidelines.  The Company continues to use a variety of other tools to manage its asset sensitivity.

 

Present Value of Equity: The model indicates that the Present Value of Equity (PVE) is somewhat vulnerable to a sudden and substantial change in interest rates.  As of September 30, 2003, a 200 basis point increase in interest rates results in a 6.1 percent decline in PVE.  This compares to a 2.6 percent decline at December 31, 2002,

 

24



 

and reflects the Company’s fixed income investment portfolio.  PVE improves slightly as rates decrease due to their very low starting levels.

 

As of September 30, 2003, the Company had $1,051.4 million of notional principal in receive fixed-pay LIBOR interest rate swaps, of which $866.4 million have maturities greater than one year. The Company’s interest-rate risk-management instruments had a fair value and credit exposure risk of $52.2 million and  $70.2 million at September 30, 2003 and June 30, 2003, 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 September 30, 2003, the Company held securities with a total market value of $37.1 million to reduce counterparty exposure.

 

At September 30, 2003 the Company’s outstanding foreign exchange contracts for both those purchased as well as sold totaled $114.1 million, all with maturities less than 1 year.  Total outstanding foreign exchange contracts for both those purchased as well as sold were $123.8 million including $2.4 million of foreign exchange contracts with maturities over 1 year at June 30, 2003.  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.

 

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 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.  As part of the Company’s system of disclosure controls and procedures, we have created a disclosure committee which consists of certain members of the Company’s senior management.  The Company’s disclosure controls and procedures are designed to ensure that material information related to the Company, including its consolidated subsidiaries, is made known to management, including the chief executive officer, chief financial officer and other members of the disclosure committee, in a timely manner.

 

The Company has carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report.  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 CONTROL OVER FINANCIAL REPORTING

 

There have not been any changes in the Company’s internal control over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

25



 

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 issues, (2) earthquake or other natural disasters impacting the condition of real estate collateral or business operations and (3) the effect of acquisitions and integration of acquired businesses, 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 changes 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

 

26



 

the banking services that we offer in our service area. These competitors include national, regional, and community banks. We also face competition from 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 proposed and/or recently adopted changes in regulatory, judicial, or legislative tax matters, including recent changes in California legislative tax treatment of business transactions.

 

27



 

PART II.

 

OTHER INFORMATION

 

 

 

ITEM 6.

 

EXHIBITS AND REPORTS ON FORM 8-K

 

 

 

 

 

 

 

 

(a)

 

Exhibits

 

 

 

 

 

 

 

 

 

 

No.

 

 

 

 

 

 

 

 

 

 

 

31.1

Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

 

 

 

 

 

 

 

31.2

Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

 

 

 

 

 

 

 

32.0

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

 

 

 

 

 

 

 

 

(b)

 

Report on Form 8-K

 

 

 

 

 

 

 

 

 

On October 15, 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 regarding the financial results for the quarter and nine months ended September 30, 2003.  Included in the report was a press release dated October 15, 2003.

 

 

SIGNATURES

 

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

 

 

 

 

CITY NATIONAL CORPORATION

 

 

 

 

(Registrant)

 

 

 

 

 

 

 

 

DATE:

     November 14, 2003

 

/s/ Frank P. Pekny

 

 

 

 

 

 

 

 

FRANK P. PEKNY
Executive Vice President and
Chief Financial Officer/Treasurer
(Authorized Officer and
Principal Financial Officer)

 

28