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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


ý

 

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

For the quarterly period ended September 30, 2010

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 1-15081

UnionBanCal Corporation
(Exact name of registrant as specified in its charter)


Delaware

 

94-1234979
(State of Incorporation)   (I.R.S. Employer Identification No.)

400 California Street, San Francisco, California

 

94104-1302
(Address of principal executive offices)   (Zip Code)

Registrant's telephone number: (415) 765-2969

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ    No o

        Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes o    No o

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

  Large accelerated filer o   Accelerated filer o

 

Non-accelerated filer þ (Do not check if a smaller reporting company)

 

Smaller reporting company o

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o    No þ

        Number of shares of Common Stock outstanding at October 31, 2010: 136,330,829

        THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H (1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.


Table of Contents


UnionBanCal Corporation and Subsidiaries

Table of Contents

PART I. FINANCIAL INFORMATION

  5
 

Item 1. Financial Statements

 
5
   

Consolidated Statements of Income

 
5
   

Consolidated Balance Sheets

  6
   

Consolidated Statements of Changes in Stockholder's Equity

  7
   

Consolidated Statements of Cash Flows

  8
   

Note 1—Basis of Presentation and Nature of Operations

  9
   

Note 2—Recently Issued Accounting Pronouncements

  9
   

Note 3—Business Combinations

  11
   

Note 4—Securities

  16
   

Note 5—Loans and Allowance for Loan Losses

  23
   

Note 6—Goodwill and Intangible Assets

  26
   

Note 7—Variable Interest Entities

  28
   

Note 8—Private Capital and Other Investments

  31
   

Note 9—Employee Pension and Other Postretirement Benefits

  32
   

Note 10—Other Noninterest Expense

  33
   

Note 11—Borrowed Funds

  34
   

Note 12—Long-Term Debt

  35
   

Note 13—Fair Value Measurement and Fair Value of Financial Instruments

  36
   

Note 14—Derivative Instruments and Other Financial Instruments Used For Hedging

  46
   

Note 15—Accumulated Other Comprehensive Loss

  53
   

Note 16—Commitments, Contingencies and Guarantees

  54
   

Note 17—Business Segments

  56
   

Note 18—Subsequent Events

  59
 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

  60
   

Consolidated Financial Highlights

  60
   

Introduction

  62
   

Executive Overview

  62
   

Critical Accounting Estimates

  64
   

Net Interest Income

  67
   

Provision for Loan Losses

  70
   

Noninterest Income and Noninterest Expense

  70
   

Income Tax Expense

  73
   

Loans

  73
   

Provision for Credit Losses

  76
   

Allowances for Credit Losses

  76
   

Nonperforming Assets

  80
   

Loans 90 Days or More Past Due and Still Accruing

  82
   

Securities

  82
   

Deposits

  84
   

Fair Value of Financial Instruments

  85
   

Quantitative and Qualitative Disclosures About Market Risk

  85
   

Liquidity Risk

  89
   

Capital

  92
   

Business Segments

  93
 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

  101
 

Item 4. Controls and Procedures

  101

PART II. OTHER INFORMATION

  102
 

Item 1. Legal Proceedings

  102
 

Item 1A. Risk Factors

  102
 

Item 6. Exhibits

  111
 

SIGNATURES

  112

2


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NOTE REGARDING FORWARD-LOOKING STATEMENTS

        This report includes forward-looking statements, which include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly compared to our forecasts and expectations. See Part I, Item 1A. "Risk Factors," in our 2009 Annual Report on Form 10-K, Part II, Item 1A. "Risk Factors" in this report, and the other risks described in this report and in our 2009 Annual Report on Form 10-K for factors to be considered when reading any forward-looking statements in this filing.

        This report includes forward-looking statements, which are subject to the "safe harbor" created by section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended. We may make forward-looking statements in our Securities and Exchange Commission (SEC) filings, press releases, news articles and when we are speaking on behalf of UnionBanCal Corporation. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include the words "believe," "expect," "target," "anticipate," "intend," "plan," "seek," "estimate," "potential," "project," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," "might," or "may." These forward-looking statements are intended to provide investors with additional information with which they may assess our future potential. All of these forward-looking statements are based on assumptions about an uncertain future and are based on information known to our management at the date of these statements. We do not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made.

        In this document, for example, we make forward-looking statements, which discuss our expectations about:

    Our business objectives, strategies and initiatives, our organizational structure, the growth of our business and our competitive position and prospects

    Our assessment of significant factors and developments that have affected or may affect our results

    Our assessment of economic conditions and trends and credit cycles and their impact on our business

    The continued weak or uncertain economic outlook for the U.S. and global economy

    The impact of changes in interest rates and our strategy to manage our interest rate risk profile

    Our sensitivity to and management of market risk, including changes in interest rates, and the economic outlook for the U.S. in general and for any particular region of the U.S. including, in particular, California, Oregon, Texas and Washington

    Our strategies and expectations regarding capital levels and liquidity, our funding base, core deposits and intent to fund our operations on an independent basis

    Pending and recent legislative and regulatory actions, and future legislative and regulatory developments, including the effects of legislation and governmental measures introduced in response to the financial crises affecting the banking system, financial markets and the U.S. economy, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), and changes to the Federal Deposit Insurance Corporation's deposit insurance assessment policies and anticipated costs or other impacts on our business and operations as a result of these developments

    Regulatory controls and processes and their impact on our business

    The costs and effects of legal actions, investigations, regulatory actions, criminal proceedings or similar matters, or adverse facts and developments related thereto

3


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    Credit quality and provision for credit losses, including our expectation that elevated levels of charge- offs, which we began to experience in the latter half of 2008, will continue during the remainder of 2010

    Our allowance for credit losses, including the conditions we consider in determining the unallocated allowance and our portfolio credit quality, underwriting standards, risk grade and credit migration trends and loss reserves for FDIC-covered loans

    Loan portfolio composition and risk grade trends, expected charge-offs, delinquency rates compared to the industry average, our underwriting standards and our intent to sell or hold loans we originate

    Our intent to sell or hold, and the likelihood that we would be required to sell, or expectations regarding recovery of the amortized cost basis of, various investment securities

    Expected rates of return, maturities, yields, loss exposure and projected results

    Tax rates and taxes, the possible effect of changes in Mitsubishi UFJ Financial Group, Inc.'s taxable profits on our California State tax obligations and of expected tax credits or benefits, and tax treatment of FDIC-assisted acquisitions

    Critical accounting policies and estimates, the impact or anticipated impact of recent accounting pronouncements or change in accounting principle and future recognition of impairments for the fair value of assets, including goodwill, financial instruments, intangible assets and other assets acquired in our recent FDIC-assisted acquisitions

    Decisions to downsize, sell or close units, dissolve subsidiaries, expand our branch network, pursue acquisitions, purchase banking facilities and equipment, or otherwise restructure, reorganize or change our business mix, and their timing and their impact on our business

    Our expectations regarding the impact of acquisitions on our business and results of operations and amounts we will receive from the FDIC, or must pay to the FDIC, under loss share agreements

    The impact of changes in our credit rating

    The relationship between our business and that of BTMU and Mitsubishi UFJ Financial Group, Inc., the impact of their credit ratings, operations or prospects on our credit ratings and actions that may or may not be taken by The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU) and Mitsubishi UFJ Financial Group, Inc.

    Descriptions of assumptions underlying or relating to any of the foregoing

        There are numerous risks and uncertainties that could cause actual outcomes and results to differ materially from those discussed in our forward-looking statements. Many of these factors are beyond our ability to control or predict and could have a material adverse effect on our financial condition and results of operations or prospects. Such risks and uncertainties include, but are not limited to, those listed in Item 1A "Risk Factors" of Part II and Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part I of this Form 10-Q.

        Readers of this document should not rely unduly on any forward-looking statements, which reflect only our management's belief as of the date of this report and should consider all uncertainties and risks disclosed throughout this document and in our other reports to the SEC, including, but not limited to, those discussed below. Any factor described in this report could by itself, or together with one or more other factors, adversely affect our business, future prospects, results of operations or financial condition.

4


Table of Contents


PART I. FINANCIAL INFORMATION

Item 1.   Financial Statements


UnionBanCal Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)

 
  For the Three Months
Ended September 30,
  For the Nine Months
Ended September 30,
 
(Dollars in thousands)   2009   2010   2009   2010  

Interest Income

                         
 

Loans

  $ 576,166   $ 581,740   $ 1,762,540   $ 1,690,166  
 

Securities

    109,279     131,955     310,561     409,882  
 

Interest bearing deposits in banks

    4,956     1,513     9,406     9,264  
 

Federal funds sold and securities purchased under resale agreements

    110     146     348     415  
 

Trading account assets

    250     518     610     1,922  
                   
   

Total interest income

    690,761     715,872     2,083,465     2,111,649  
                   

Interest Expense

                         
 

Deposits

    101,374     69,498     306,598     233,537  
 

Federal funds purchased and securities sold under repurchase agreements

    41     70     113     148  
 

Commercial paper

    355     398     2,901     927  
 

Other borrowed funds

    604     438     17,697     2,812  
 

Long-term debt

    27,351     27,413     84,771     81,424  
                   
   

Total interest expense

    129,725     97,817     412,080     318,848  
                   

Net Interest Income

    561,036     618,055     1,671,385     1,792,801  
 

Provision for loan losses

    314,000     8,000     923,000     222,000  
                   
   

Net interest income after provision for loan losses

    247,036     610,055     748,385     1,570,801  
                   

Noninterest Income

                         
 

Service charges on deposit accounts

    74,888     62,472     218,053     192,455  
 

Trust and investment management fees

    34,506     33,209     102,543     98,873  
 

Trading account activities

    10,513     31,906     49,456     78,378  
 

Securities gains, net

    12,694     10,683     12,522     71,820  
 

Merchant banking fees

    14,601     19,011     48,357     54,910  
 

Card processing fees, net

    8,559     9,877     24,219     31,353  
 

Brokerage commissions and fees

    8,611     10,195     25,424     29,629  
 

Other

    19,557     40,590     61,284     114,724  
                   
   

Total noninterest income

    183,929     217,943     541,858     672,142  
                   

Noninterest Expense

                         
 

Salaries and employee benefits

    233,981     292,736     710,601     892,013  
 

Net occupancy and equipment

    60,984     65,162     178,142     187,723  
 

Professional and outside services

    39,866     53,878     117,075     143,396  
 

Intangible asset amortization

    40,641     30,774     121,809     93,180  
 

Regulatory agencies

    30,739     29,132     101,513     89,506  
 

(Reversal of) provision for losses on off-balance sheet commitments

    6,000     (8,000 )   47,000     (12,000 )
 

Other

    93,604     98,937     283,116     277,573  
                   
   

Total noninterest expense

    505,815     562,619     1,559,256     1,671,391  
                   
 

Income (loss) before income taxes and including noncontrolling interests

    (74,850 )   265,379     (269,013 )   571,552  
 

Income tax expense (benefit)

    (57,821 )   99,388     (162,169 )   181,053  
                   

Net Income (Loss) including Noncontrolling Interests

    (17,029 )   165,991     (106,844 )   390,499  

Deduct: Net loss from noncontrolling interests

        3,788         10,383  
                   

Net Income (Loss) attributable to UNBC

  $ (17,029 ) $ 169,779   $ (106,844 ) $ 400,882  
                   

See accompanying notes to consolidated financial statements.

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UnionBanCal Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
 

Assets

                   

Cash and due from banks

  $ 1,155,497   $ 1,198,258   $ 1,172,194  

Interest bearing deposits in banks (includes $9,538 at September 30, 2010 related to consolidated variable interest entities (VIEs))

    2,659,460     6,585,029     2,418,508  

Federal funds sold and securities purchased under resale agreements

    437,328     442,552     595,328  
               
     

Total cash and cash equivalents

    4,252,285     8,225,839     4,186,030  

Trading account assets:

                   
 

Pledged as collateral

    60,816     15,168     37,301  
 

Held in portfolio

    879,734     710,480     1,133,640  

Securities available for sale:

                   
 

Pledged as collateral

        2,500      
 

Held in portfolio

    18,210,574     22,556,329     18,327,048  

Securities held to maturity (Fair value: September 30, 2009, $1,269,934; December 31, 2009, $1,457,654; and September 30, 2010, $1,494,941)

    1,193,337     1,227,718     1,303,472  

Loans:

                   
 

Loans, excluding Federal Deposit Insurance Corporation (FDIC) covered loans

    48,169,508     47,228,508     46,217,555  
 

FDIC covered loans

            1,693,554  
               
   

Total loans

    48,169,508     47,228,508     47,911,109  
   

Allowance for loan losses

    (1,260,307 )   (1,357,000 )   (1,276,845 )
               
     

Loans, net

    46,909,201     45,871,508     46,634,264  

Due from customers on acceptances

    12,842     8,514     7,407  

Premises and equipment, net

    667,005     674,298     674,301  

Intangible assets

    601,140     561,040     486,688  

Goodwill

    2,369,326     2,369,326     2,431,583  

FDIC indemnification asset

            833,939  

Other assets (includes $291,243 at September 30, 2010 related to consolidated VIEs)

    2,996,947     3,375,408     3,786,404  
               
     

Total assets

  $ 78,153,207   $ 85,598,128   $ 79,842,077  
               

Liabilities

                   

Noninterest bearing

  $ 14,472,375   $ 14,558,989   $ 15,425,621  

Interest bearing

    46,218,993     53,958,664     46,114,925  
               
     

Total deposits

    60,691,368     68,517,653     61,540,546  

Federal funds purchased and securities sold under repurchase agreements

    229,268     150,453     139,602  

Commercial paper

    423,499     888,541     701,135  

Other borrowed funds

    164,861     591,934     136,441  

Trading account liabilities

    715,075     538,894     1,009,888  

Acceptances outstanding

    12,842     8,514     7,407  

Other liabilities (includes $2,001 at September 30, 2010 related to consolidated VIEs)

    1,306,097     1,096,095     1,441,929  

Long-term debt (includes $7,853 at September 30, 2010 related to consolidated VIEs)

    5,135,193     4,225,711     4,457,830  
               
     

Total liabilities

    68,678,203     76,017,795     69,434,778  
               

Commitments, contingencies and guarantees—See Note 16

                   

Equity

                   

UNBC Stockholder's Equity:

                   
 

Preferred stock:

                   
   

Authorized 5,000,000 shares; no shares issued or outstanding

             
 

Common stock, par value $1 per share:

                   
   

Authorized 300,000,000 shares; 136,330,829 shares issued

    136,331     136,331     136,331  
 

Additional paid-in capital

    5,195,023     5,195,023     5,195,023  
 

Retained earnings

    4,857,958     4,899,841     5,295,866  
 

Accumulated other comprehensive loss

    (714,308 )   (650,862 )   (492,539 )
               
     

Total UNBC stockholder's equity

    9,475,004     9,580,333     10,134,681  

Noncontrolling interests

            272,618  
               
     

Total equity

    9,475,004     9,580,333     10,407,299  
               
     

Total liabilities and equity

  $ 78,153,207   $ 85,598,128   $ 79,842,077  
               

See accompanying notes to consolidated financial statements.

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UnionBanCal Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholder's Equity
(Unaudited)

(Dollars in thousands)   Common
stock
  Additional
paid-in
capital
  Retained
earnings
  Accumulated
other
comprehensive
income (loss)
  Noncontrolling
interests(1)
  Total
stockholder's
equity
 

BALANCE DECEMBER 31, 2008

  $ 136,331   $ 3,195,023   $ 4,964,802   $ (811,851 ) $   $ 7,484,305  
                           

Comprehensive loss:

                                     
 

Net loss—For the nine months ended September 30, 2009

                (106,844 )               (106,844 )
 

Other comprehensive income (loss), net of tax:

                                     
   

Net change in unrealized gains on cash flow hedges

                      (34,492 )         (34,492 )
   

Net change in unrealized losses on securities

                      120,758           120,758  
   

Foreign currency translation adjustment

                      1,085           1,085  
   

Net change in pension and other benefits

                      10,192           10,192  
                                     

Total comprehensive loss, net of tax

                                  (9,301 )
 

Capital contribution from Bank of Tokyo-Mitsubishi UFJ, Ltd. 

          2,000,000                       2,000,000  
                           

Net change

        2,000,000     (106,844 )   97,543         1,990,699  
                           

BALANCE SEPTEMBER 30, 2009

  $ 136,331   $ 5,195,023   $ 4,857,958   $ (714,308 ) $   $ 9,475,004  
                           

BALANCE DECEMBER 31, 2009

  $ 136,331   $ 5,195,023   $ 4,899,841   $ (650,862 ) $   $ 9,580,333  
                           

Cumulative effect from change in accounting for VIEs(1)

                            271,923     271,923  

Cumulative effect from change in accounting for

                                     
 

embedded credit derivatives, net of tax(2)

                (4,857 )   6,472           1,615  

Comprehensive income:

                                     
 

Net income (loss)—For the nine months ended September 30, 2010

                400,882           (10,383 )   390,499  
 

Other comprehensive income (loss), net of tax:

                                     
   

Net change in unrealized gains on cash flow hedges

                      (49,886 )         (49,886 )
   

Net change in unrealized losses on securities

                      190,240           190,240  
   

Foreign currency translation adjustment

                      457           457  
   

Net change in pension and other benefits

                      11,040           11,040  
                                     

Total comprehensive income, net of tax

                                  542,350  

Other

                            11,078     11,078  
                           

Net change

            396,025     158,323     272,618     826,966  
                           

BALANCE SEPTEMBER 30, 2010

  $ 136,331   $ 5,195,023   $ 5,295,866   $ (492,539 ) $ 272,618   $ 10,407,299  
                           

(1)
For additional information on the consolidated VIEs, refer to Note 7 to these consolidated financial statements.
(2)
For additional information on the change in accounting for embedded derivatives, refer to Note 2 to these consolidated financial statements.

See accompanying notes to consolidated financial statements.

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UnionBanCal Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)

 
  For the Nine Months
Ended September 30,
 
(Dollars in thousands)   2009   2010  

Cash Flows from Operating Activities:

             
 

Net income (loss) including noncontrolling interests

  $ (106,844 ) $ 390,499  
 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

             
   

Provision for loan losses

    923,000     222,000  
   

(Reversal of) provision for losses on off-balance sheet commitments

    47,000     (12,000 )
   

Depreciation, amortization and accretion, net

    133,428     184,726  
   

Deferred income taxes

    (123,938 )   30,823  
   

Net gains on sales of securities

    (12,522 )   (71,820 )
   

Net decrease (increase) in trading account assets

    276,229     (445,293 )
   

Net increase in prepaid expenses

    (27,199 )   (10,309 )
   

Net increase in fees and other receivable

    (79,607 )   (160,811 )
   

Net decrease (increase) in other assets

    (276,914 )   237,534  
   

Net increase (decrease) in accrued expenses

    (251,218 )   78,378  
   

Net increase (decrease) in trading account liabilities

    (319,588 )   456,949  
   

Net increase (decrease) in other liabilities

    (200,736 )   104,927  
   

Loans originated for resale

    (65,337 )    
   

Net proceeds from sale of loans originated for resale

    37,915      
   

Other, net

    28,211     (778 )
   

Discontinued operations, net

    (6,027 )    
           
     

Total adjustments

    82,697     614,326  
           
 

Net cash provided by (used in) operating activities

    (24,147 )   1,004,825  
           

Cash Flows from Investing Activities:

             
 

Proceeds from sales of securities available for sale

    3,164,329     3,137,465  
 

Proceeds from matured and called securities available for sale

    1,738,034     8,217,896  
 

Purchases of securities available for sale and held to maturity

    (15,882,619 )   (6,721,367 )
 

Proceeds from matured securities held to maturity

    3,768     4,835  
 

Purchases of premises and equipment, net

    (83,825 )   (71,591 )
 

Net decrease in loans

    1,034,102     900,770  
 

Net cash acquired from acquisitions

        272,175  
 

Other, net

    (1,576 )   (6,532 )
           
 

Net cash provided by (used in) investing activities

    (10,027,787 )   5,733,651  
           

Cash Flows from Financing Activities:

             
 

Net increase (decrease) in deposits

    14,641,599     (9,865,055 )
 

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

    56,510     (12,791 )
 

Net decrease in commercial paper and other borrowed funds

    (7,772,564 )   (644,179 )
 

Capital contribution from The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU)

    2,000,000      
 

Proceeds from issuance of long-term debt

    1,625,000     1,250,000  
 

Repayment of long-term debt

    (750,000 )   (1,518,535 )
 

Other, net

    1,085     457  
 

Change in noncontrolling interests

        11,078  
 

Discontinued operations, net

    (1,929 )    
           
 

Net cash provided by (used in) financing activities

    9,799,701     (10,779,025 )
           

Net decrease in cash and cash equivalents

    (252,233 )   (4,040,549 )

Cash and cash equivalents at beginning of period

    4,504,345     8,225,839  

Effect of exchange rate changes on cash and cash equivalents

    173     740  
           

Cash and cash equivalents at end of period

  $ 4,252,285   $ 4,186,030  
           

Cash Paid During the Period For:

             
 

Interest

  $ 416,511   $ 299,576  
 

Income taxes, net

    208,972     99,168  

Supplemental Schedule of Noncash Investing and Financing Activities:

             
 

Acquisitions:

             
   

Fair value of assets acquired

  $   $ 3,227,260  
   

Fair value of liabilities assumed

        3,499,435  
 

Securities available for sale transferred to securities held to maturity

    1,144,036      
 

Loans transferred to foreclosed assets (OREO)

    55,367     77,803  

See accompanying notes to consolidated financial statements.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)


Note 1—Basis of Presentation and Nature of Operations

        The unaudited consolidated financial statements of UnionBanCal Corporation and subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Rules and Regulations of the Securities and Exchange Commission (SEC). However, they do not include all of the disclosures necessary for annual financial statements in conformity with US GAAP. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. The results of operations for the nine months ended September 30, 2010 are not necessarily indicative of the operating results anticipated for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in UnionBanCal Corporation's Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Form 10-K). The preparation of financial statements in conformity with US GAAP also requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Although such estimates contemplate current conditions and management's expectations of how they may change in the future, it is reasonably possible that actual results could differ significantly from those estimates. This could materially affect the Company's results of operations and financial condition in the near term. Significant estimates made by management in the preparation of the Company's financial statements include, but are not limited to, the evaluation of other-than-temporary impairment on investment securities (Note 4), allowance for credit losses (Note 5), purchased credit-impaired loans (Note 5), annual goodwill impairment analysis (Note 6), pension accounting (Note 9), valuing financial instruments (Note 13), and income taxes.

        UnionBanCal Corporation is a financial holding company and commercial bank holding company whose major subsidiary, Union Bank, N.A. (the Bank), is a commercial bank. UnionBanCal Corporation and its subsidiaries (the Company) provide a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, primarily in California, Oregon, Washington, and Texas as well as nationally and internationally.

        On April 16 and April 30, 2010, the Bank entered into Purchase and Assumption Agreements (Agreements) with the Federal Deposit Insurance Corporation (FDIC) to acquire certain assets and assume certain liabilities of Tamalpais Bank and Frontier Bank, respectively. Pursuant to the Agreements, the Bank acquired $571.9 million and $2.9 billion of assets at fair value related to Tamalpais Bank and Frontier Bank, respectively. See Note 3 to these consolidated financial statements in this Form 10-Q for additional information about the transactions.

        On November 4, 2008, the Company became a privately held company (privatization transaction). All of the Company's issued and outstanding shares of common stock are owned by The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU). Prior to the privatization transaction, BTMU owned approximately 64 percent of the Company's outstanding shares of common stock.


Note 2—Recently Issued Accounting Pronouncements

    Accounting for Transfers of Financial Assets

        In December 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2009-16, Accounting for Transfers of Financial Assets, which formally codifies Statement of Financial Accounting Standards (SFAS) No. 166, Accounting for Transfers of Financial Assets—an

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 2—Recently Issued Accounting Pronouncements (Continued)

amendment of FASB Statement 140, which was issued in June 2009. The guidance eliminates the concept of qualifying special purpose entities (QSPEs) and modifies financial asset derecognition criteria. The elimination of the exception for QSPEs will likely result in the consolidation of vehicles that were formerly not subject to consolidation as a QSPE. The derecognition modifications require that companies consider all arrangements made contemporaneously with, or in contemplation of, a transfer by the Company or any of its consolidated affiliates when determining whether derecognition is appropriate for a transferred financial asset. For a transfer of a portion of a financial asset to be derecognized, it must meet the definition of a participating interest. The guidance also requires that all beneficial interests retained in transferred financial assets be initially measured at fair value. Additional disclosures are required for transferors with continuing involvement in a transferred financial asset. The guidance was effective January 1, 2010. At adoption, there was no impact on the Company's financial position or results of operations.

    Consolidation Criteria for Variable Interest Entities

        In December 2009, the FASB issued ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, which formally codifies SFAS No. 167, Amendments to FASB Interpretation No. 46(R), which was issued in June 2009. The guidance amends the method of analyzing which party should consolidate a variable interest entity (VIE) by providing revised criteria for determining the primary beneficiary. A company would be required to determine the primary beneficiary of a VIE on an ongoing basis based on a qualitative assessment of which party, if any, has the power to direct activities that have the most significant economic impact and the right to receive benefits or the obligation to absorb losses, where such rights or obligations could potentially be significant to the VIE. New disclosures required for continuing involvement with VIEs and judgments used in the consolidation analysis including the method, significant judgments and assumptions used for determining the primary beneficiary. The guidance was effective January 1, 2010. This guidance did not have a material impact on the Company's results of operations. Disclosures required under this guidance are included in Note 7 to these consolidated financial statements.

    Improving Disclosures about Fair Value Measurements

        In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements. This guidance amends FASB Accounting Standards Codification (ASC) 820-10, Fair Value Measurements and Disclosures, to require the disclosure of transfers in and out of Level 1 and Level 2 and a gross presentation within the Level 3 rollforward. This guidance also clarifies that the information should be presented by class of financial asset or liability. A discussion of valuation techniques and inputs is required for Level 2 and Level 3, for both recurring and nonrecurring measurements. The guidance applies only to disclosures and was effective March 31, 2010, except for the gross presentation within the Level 3 rollforward, which will be effective March 31, 2011. Disclosures required under this guidance are included in Note 13 to these consolidated financial statements.

    Scope Exception Related to Embedded Derivatives

        In March 2010, the FASB issued ASU 2010-11, Scope Exception Related to Embedded Derivatives. This guidance limits the scope exception for embedded credit derivatives in securitized financial assets and clarifies when embedded credit derivatives should be evaluated for bifurcation. Upon the July 1, 2010

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 2—Recently Issued Accounting Pronouncements (Continued)

adoption of this guidance, the Company recorded a $4.9 million decrease to retained earnings and a related increase to accumulated other comprehensive income of $6.5 million as a cumulative effect adjustment.

    Effect of a Loan Modification When the Loan is Part of a Pool that is Accounted for as a Single Asset

        In April 2010, the FASB issued ASU 2010-18, Effect of a Loan Modification When the Loan is Part of a Pool that is Accounted for as a Single Asset: a Consensus of the FASB Emerging Issues Task Force. This guidance states that troubled debt restructuring accounting cannot be applied to individual loans within purchased credit-impaired loan pools. This guidance was effective for modifications of loans accounted for within pools after July 1, 2010. At adoption, there was no impact on the Company's financial position or results of operations.

    Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses

        In July 2010, the FASB issued ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This guidance requires expanded disclosures related to the credit quality of financing receivables and the related allowance for credit losses. The new disclosures require an aging of past due receivables and credit quality indicators at the end of each reporting period. This guidance also requires that new and existing disclosures be disaggregated by portfolio segment or class of financing receivable including existing disclosures related to the allowance for credit losses, nonaccrual status and impairment. The guidance, related to disclosures as of the end of the reporting period, is effective as of December 31, 2010. The guidance, related to disclosures about activity occurring during the reporting period, is effective beginning in January 1, 2011.


Note 3—Business Combinations

Frontier Bank:

        On April 30, 2010, the Bank entered into a purchase and assumption agreement with the FDIC to acquire certain assets and assume certain liabilities of Frontier Bank (Frontier), a Washington state-chartered commercial bank headquartered in Everett, Washington. This acquisition increased the Bank's market share in the Pacific Northwest. Frontier operated 50 locations in Washington and Oregon.

        Excluding the effects of purchase accounting adjustments, the Bank acquired total assets of $3.2 billion, including $2.7 billion in loans, $173.9 million of other real estate owned (OREO) and $78.6 million of securities available for sale. Additionally, the Bank assumed $2.5 billion of deposits and $372.0 million of borrowings and other liabilities. The assets were acquired at an 11 percent discount to Frontier's book value and the deposits were assumed without a premium. The Bank recorded a payable to the FDIC totaling $9.4 million, which is included in other liabilities on the consolidated balance sheet, for consideration of the net assets acquired (i.e., the net difference between the assets acquired and the liabilities assumed). This amount is payable within one year of the acquisition date and is outstanding at September 30, 2010.

        In connection with the acquisition, the Bank also entered into two loss share agreements with the FDIC—one for single-family residential mortgage loans and one for commercial loans, the related unfunded commitments and other covered assets. All acquired loans and OREO, totaling $2.9 billion, are covered by loss share agreements (covered assets) between the FDIC and the Bank. Pursuant to the terms of these loss share

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 3—Business Combinations (Continued)


agreements, the FDIC's obligation to reimburse the Bank for losses on the covered assets begins with the first dollar of loss incurred. The terms of the loss share agreements with respect to all covered assets provide for the FDIC to reimburse the Bank for 80 percent of covered losses, plus three months of foregone interest. Gains and recoveries on covered assets will offset losses, or be paid to the FDIC, at the loss share percentage at the time of recovery. The covered OREO is included in other assets on the consolidated balance sheet.

        The following table presents the covered assets and the estimated fair value at the acquisition date:

(Dollars in thousands)   Amount
Covered
  Fair
Value
 

Loans held for investment

  $ 2,710,370   $ 1,544,269  

OREO

    173,905     154,566  
           

Total

  $ 2,884,275   $ 1,698,835  
           

        The amounts covered by the loss share agreements are the pre-acquisition book values of the underlying assets, the contractual balance of unfunded commitments that were acquired, and certain future expenses associated with managing defaulted loans and OREO. The loss share agreement applicable to single-family residential mortgage loans provides for FDIC loss sharing and the Bank reimbursement of recoveries to the FDIC, in each case as described above, for ten years. The loss share agreement applicable to commercial loans, the related unfunded commitments, and other covered assets provides for FDIC loss sharing for five years and the Bank reimbursement of recoveries to the FDIC for eight years, in each case as described above. The agreements with the FDIC also include a provision that may result in a lump-sum payment to the FDIC approximately ten years from the acquisition date by the Bank if net losses on covered assets are less than the original loss estimates established by the FDIC at acquisition, subject to certain adjustments.

        The purchase and assumption and loss share agreements have specific and detailed compliance, servicing, notification and reporting requirements. Any failure to comply with the requirements of the loss share agreements, or to properly service the loans and OREO covered by any loss share arrangement, may cause individual loans or loan pools to lose their eligibility for loss share payments from the FDIC. The fair value of the loss share agreements was recorded as an indemnification asset at an estimated fair value of $868 million as of the acquisition date and is included on the consolidated balance sheet. The difference between the present value and the undiscounted cash flows that we expect to collect from the FDIC is accreted into noninterest income over the life of the FDIC indemnification asset. The FDIC indemnification asset is adjusted for any changes in expected cash flows based on loan performance. Any increases in cash flows of the loans due to decreases in expected credit losses over those originally expected will lower the accretion rate recorded in noninterest income. Any decreases in cash flows of the loans over those originally expected will increase the FDIC indemnification asset.

        The contribution of the Frontier transaction to the Company's results of operations for the period May 1 to September 30, 2010 is as follows: revenue (which consists of net interest income and noninterest income) of $59.9 million, noninterest expense of $33.3 million and income before income taxes of $26.6 million. The contribution during the three months ended September 30, 2010 is as follows: revenue of $34.3 million, noninterest expense of $22.2 million and income before income taxes of $12.1 million. These amounts include the accretion related to the covered assets and FDIC indemnification asset recorded during the period ended September 30, 2010.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 3—Business Combinations (Continued)

    Assets Acquired and Liabilities Assumed:

        The assets acquired and liabilities assumed were recorded at their estimated, provisional fair values on the acquisition date. During the third quarter of 2010, management reviewed and, where necessary, adjusted the acquisition date fair values. Management may further adjust the acquisition date fair values for a period of up to one year from the date of acquisition (defined as the measurement period). The assets and liabilities that continue to be provisional include, but are not limited to, loans, core deposit intangibles, OREO, the FDIC indemnification asset, the FDIC indemnification liability, and the residual effects that those adjustments would have on goodwill. In addition, the tax treatment of FDIC-assisted acquisitions is complex and subject to interpretations that may result in future adjustments of deferred taxes as of the acquisition date.

        The following table presents the net assets acquired from Frontier and the estimated purchase accounting adjustments, which include the effects of measurement period adjustments that were applied to the acquisition date fair values (primarily FDIC covered loans) during the third quarter of 2010. These adjustments resulted in additional goodwill of $11.8 million.

(Dollars in thousands)   Acquisition
Date
 

Net assets acquired

  $ 362,717  

Purchase accounting adjustments:

       
 

FDIC covered loans

    (1,166,101 )
 

FDIC indemnification asset

    868,005  
 

Other assets/liabilities, net

    (77,648 )
       
   

Total purchase accounting adjustments

    (375,744 )
       

Fair value of net assets acquired

    (13,027 )

FDIC payable

    (9,459 )
       

Goodwill

  $ 22,486  
       

        The goodwill arising from the acquisition reflects the increased market share and related synergies that are expected to be gained. The goodwill was assigned to the Company's Retail Banking and Corporate Banking reportable business segments. See Note 6 to these consolidated financial statements for additional information on the goodwill allocation. All of the goodwill and core deposit intangible assets recognized are deductible for income tax purposes.

        The Bank did not immediately acquire the banking facilities, including furniture, fixtures, and equipment, as part of the Agreement. However, the Bank had the option to purchase these assets and assume leases from the FDIC for a term expiring 90 days after the acquisition date, unless extended. The FDIC extended the option to purchase these assets to September 30, 2010. During the third quarter of 2010, the Bank exercised its option and assumed certain premises leases and committed to purchase certain owned properties, furniture and equipment. These commitments are expected to be finalized during the fourth quarter of 2010. Assets not yet assumed are currently leased from the FDIC on a month-to-month basis.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 3—Business Combinations (Continued)

        The following table reflects the estimated fair values of the assets acquired and liabilities assumed for the Frontier transaction on the acquisition date:

(Dollars in thousands)    
 

Assets:

       
 

Cash and due from banks

  $ 35,953  
 

Interest bearing deposits in banks

    5,000  
 

Federal funds sold

    178,395  
       
     

Total cash and cash equivalents

    219,348  
 

Securities available for sale

    78,587  
 

FDIC covered loans

    1,544,269  
 

Goodwill

    22,486  
 

Core deposit intangible

    12,650  
 

FDIC indemnification asset

    868,005  
 

FDIC covered OREO

    154,566  
 

Other assets

    27,593  
       
   

Total assets acquired

  $ 2,927,504  
       

Liabilities:

       
 

Deposits:

       
   

Noninterest bearing

  $ 303,433  
   

Interest bearing

    2,184,304  
       
     

Total deposits

    2,487,737  
 

Federal funds purchased and securities sold under repurchase agreement

    1,940  
 

Advances from FHLB

    383,359  
 

Other borrowed funds

    1,280  
 

Other liabilities

    53,188  
       
   

Total liabilities assumed

  $ 2,927,504  
       

        The following is a description of the methods used to determine the acquisition date fair values of significant assets and liabilities presented above.

Loans

        Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, risk classification, fixed or variable interest rate, term of loan and whether or not the loan was performing, and current discount rates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. The discount rates used for loans are based on current market rates for new originations of comparable loans, where available, and include adjustments for liquidity concerns. To the extent comparable market rates are not readily available, a discount rate was derived based on the assumptions of market participants' cost of funds, servicing costs, and return requirements for comparable risk assets.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 3—Business Combinations (Continued)

Other real estate owned

        OREO is measured at the estimated value that management expects to receive when the property is sold, net of related costs of disposal.

FDIC indemnification asset

        The FDIC indemnification asset is measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable with the assets should the Bank choose to sell them. The fair value was estimated using projected cash flows related to the loss share agreements based on the expected reimbursements for losses and the applicable loss share percentages. The expected reimbursements do not include reimbursable amounts related to future covered expenditures. These cash flows were discounted to reflect the uncertainty of the timing and receipt of the loss share reimbursements from the FDIC.

Deposits

        The fair values used for the demand, transaction accounts and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered to the interest rates embedded on such time deposits.

Advances from the Federal Home Loan Bank

        The advances from FHLB were recorded at their estimated fair value, which was based on quoted prices supplied by the FHLB. Subsequent to the acquisition dates, all of these advances were repaid in full.

Tamalpais Bank:

        On April 16, 2010, the Bank entered into a purchase and assumption agreement with the FDIC to acquire certain assets and assume certain liabilities of Tamalpais Bank of San Rafael, California (Tamalpais). Tamalpais operated 7 branches in California. Excluding the effects of purchase accounting adjustments, the Bank acquired total assets of $616.8 million, including $497.8 million in loans, and assumed $421.0 million of deposits. Certain of the assumed deposits were acquired at a premium of 2 percent and the assets were acquired at a discount to Tamalpais' book value of 10 percent.

        In connection with the acquisition, the Bank also entered into two loss share agreements, which have terms similar to those contained in the Frontier transaction with the FDIC. At Tamalpais' acquisition date, covered assets totaled $506.2 million with a fair value of $378.1 million. The assets acquired and liabilities assumed were recorded at their estimated, provisional fair values on acquisition date. During the third quarter of 2010, management reviewed and, where necessary, adjusted the acquisition date fair values. Management may further adjust the acquisition date fair values for a period of up to one year from the date of acquisition (defined as the measurement period).

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)


Note 4—Securities

        The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities are presented below.

Securities Available for Sale

 
  September 30, 2009  
(Dollars in thousands)   Amortized
Cost(1)
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
 

U.S. Treasury

  $ 299,247   $ 12   $   $ 299,259  

Other U.S. government

    6,063,641     18,218     3,883   $ 6,077,976  

Residential mortgage-backed securities—agency

    10,918,439     223,749     3,966     11,138,222  

Residential mortgage-backed securities—non-agency

    492,025     93     60,192     431,926  

State and municipal

    47,640     2,409     9     50,040  

Asset-backed and debt securities

    113,017     1,290     8,117     106,190  

Equity securities

    106,882     415     336     106,961  
                   
 

Total securities available for sale

  $ 18,040,891   $ 246,186   $ 76,503   $ 18,210,574  
                   

 

 
  December 31, 2009  
(Dollars in thousands)   Amortized
Cost(1)
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
 

U.S. Treasury

  $ 299,488   $ 189   $   $ 299,677  

Other U.S. government

    12,311,626     13,165     47,373     12,277,418  

Residential mortgage-backed securities—agency

    9,215,771     171,513     25,161     9,362,123  

Residential mortgage-backed securities—non-agency

    454,646     36     63,243     391,439  

State and municipal

    43,287     1,830     21     45,096  

Asset-backed and debt securities

    112,609     1,598     6,072     108,135  

Equity securities

    74,791     441     291     74,941  
                   
 

Total securities available for sale

  $ 22,512,218   $ 188,772   $ 142,161   $ 22,558,829  
                   

 

 
  September 30, 2010  
(Dollars in thousands)   Amortized
Cost(1)
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
 

U.S. Treasury

  $ 150,639   $ 35   $   $ 150,674  

Other U.S. government

    8,014,636     140,027     21     8,154,642  

Residential mortgage-backed securities—agency

    9,040,356     202,013     1,514     9,240,855  

Residential mortgage-backed securities—non-agency

    564,299     5,811     38,512     531,598  

State and municipal

    44,930     2,196     8     47,118  

Asset-backed and debt securities

    117,517     8,270     1,760     124,027  

Equity securities

    77,592     705     163     78,134  
                   
 

Total securities available for sale

  $ 18,009,969   $ 359,057   $ 41,978   $ 18,327,048  
                   

(1)
Amortized cost reflects fair value adjustments as a result of the Company's privatization transaction.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 4—Securities (Continued)

Securities Held to Maturity

 
  September 30, 2009  
 
   
  Recognized in Other
Comprehensive
Income (OCI)(2)
   
  Not Recognized in
OCI(2)
   
 
(Dollars in thousands)   Amortized
Cost(1)
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Carrying
Value
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
 

Collateralized loan obligations (CLOs)

  $ 1,741,408   $   $ 548,166   $ 1,193,242   $ 101,055   $ 24,458   $ 1,269,839  

Foreign securities

    95             95             95  
                               
 

Total securities held to maturity

  $ 1,741,503   $   $ 548,166   $ 1,193,337   $ 101,055   $ 24,458   $ 1,269,934  
                               

 

 
  December 31, 2009  
 
   
  Recognized in Other
Comprehensive
Income (OCI)(2)
   
  Not Recognized in
OCI(2)
   
 
(Dollars in thousands)   Amortized
Cost(1)
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Carrying
Value
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
 

CLOs

  $ 1,758,716   $   $ 531,094   $ 1,227,622   $ 231,135   $ 1,199   $ 1,457,558  

Foreign securities

    96             96             96  
                               
 

Total securities held to maturity

  $ 1,758,812   $   $ 531,094   $ 1,227,718   $ 231,135   $ 1,199   $ 1,457,654  
                               

 

 
  September 30, 2010  
 
   
  Recognized in Other
Comprehensive
Income (OCI)(2)
   
  Not Recognized in
OCI(2)
   
 
(Dollars in thousands)   Amortized
Cost(1)
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Carrying
Value
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
 

CLOs

  $ 1,774,632   $   $ 471,258   $ 1,303,374   $ 195,915   $ 4,446   $ 1,494,843  

Foreign securities

    98             98             98  
                               
 

Total securities held to maturity

  $ 1,774,730   $   $ 471,258   $ 1,303,472   $ 195,915   $ 4,446   $ 1,494,941  
                               

(1)
For securities transferred to held to maturity from available for sale, amortized cost is defined as the original purchase cost, plus or minus any accretion or amortization of a purchase discount or premium, less payments and any impairment previously recognized in earnings. The amortized cost reflects fair value adjustments as a result of the Company's privatization transaction.
(2)
The amount recognized in OCI reflects the unrealized loss at date of transfer to the held to maturity classification, net of amortization, while the amount not recognized in OCI reflects the incremental change in value after such transfer.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 4—Securities (Continued)

        The amortized cost, fair value, and carrying value of securities, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.

Maturity Schedule of Securities

Securities Available for Sale(1)

 
  September 30, 2010  
(Dollars in thousands)   Amortized
Cost(3)
  Fair
Value
 

Due in one year or less

  $ 744,568   $ 748,021  

Due after one year through five years

    7,683,623     7,829,870  

Due after five years through ten years

    981,325     1,017,315  

Due after ten years

    8,522,861     8,653,708  

Equity securities(2)

    77,592     78,134  
           
 

Total securities available for sale

  $ 18,009,969   $ 18,327,048  
           

Securities Held to Maturity

 
  September 30, 2010  
(Dollars in thousands)   Amortized
Cost(3)(4)
  Carrying
Value
  Fair
Value
 

Due in one year or less

  $ 1,745   $ 1,745   $ 2,499  

Due after one year through five years

    92,013     70,787     84,767  

Due after five years through ten years

    1,411,449     1,055,278     1,203,909  

Due after ten years

    269,523     175,662     203,766  
               
 

Total securities held to maturity

  $ 1,774,730   $ 1,303,472   $ 1,494,941  
               

(1)
The remaining contractual maturities of residential mortgage-backed securities are classified without regard to prepayments.The contractual maturity of these securities is not a reliable indicator of their expected life since borrowers have the right to repay their obligations at any time.
(2)
Equity securities do not have a stated maturity.
(3)
Amortized cost reflects fair value adjustments as a result of the Company's privatization transaction.
(4)
For securities transferred to held to maturity from available for sale, amortized cost is defined as the original purchase cost, plus or minus any accretion or amortization of a purchase discount or premium, less payments and any impairment previously recognized in earnings.

        The proceeds from sales of securities available for sale, gross realized gains and gross realized losses are shown below. The specific identification method is used to calculate realized gains and losses on sales.

 
  For the Three Months Ended
September 30,
  For the Nine Months Ended
September 30,
 
(Dollars in thousands)   2009   2010   2009   2010  

Proceeds from sales

  $ 3,140,095   $ 1,047,322   $ 3,164,329   $ 3,137,465  

Gross realized gains

    12,699     13,994     13,304     78,534  

Gross realized losses

                435  

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 4—Securities (Continued)

Analysis of Unrealized Losses on Securities

        At September 30, 2009, December 31, 2009 and September 30, 2010, the Company's securities with a continuous unrealized loss position are shown below, separately for periods less than and greater than 12 months.

Securities Available for Sale

 
  September 30, 2009  
 
  Less than 12 months   12 months or more   Total  
(Dollars in thousands)   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count  

Other U.S. government

  $ 3,363,942   $ 3,883     48   $   $       $ 3,363,942   $ 3,883     48  

Residential mortgage-backed securities—agency

    295,365     948     12     297,647     3,018     42     593,012     3,966     54  

Residential mortgage-backed securities—non-agency

                399,413     60,192     17     399,413     60,192     17  

State and municipal

    524         2     685     9     4     1,209     9     6  

Asset-backed and debt securities

    2,647     839     1     77,687     7,277     10     80,334     8,117     11  

Equity securities

                119     336     2     119     336     2  
                                       
 

Total securities available for sale

  $ 3,662,478   $ 5,670     63   $ 775,551   $ 70,832     75   $ 4,438,029   $ 76,503     138  
                                       

 

 
  December 31, 2009  
 
  Less than 12 months   12 months or more   Total  
(Dollars in thousands)   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count  

Other U.S. government

  $ 8,682,501   $ 47,373     106   $   $       $ 8,682,501   $ 47,373     106  

Residential mortgage-backed securities—agency

    2,928,456     24,628     61     232,670     533     28     3,161,126     25,161     89  

Residential mortgage-backed securities—non-agency

                362,471     63,243     17     362,471     63,243     17  

State and municipal

    760     1     2     1,498     20     6     2,258     21     8  

Asset-backed and debt securities

    27,325     2,219     3     62,427     3,853     9     89,752     6,072     12  

Equity securities

                164     291     2     164     291     2  
                                       
 

Total securities available for sale

  $ 11,639,042   $ 74,221     172   $ 659,230   $ 67,940     62   $ 12,298,272   $ 142,161     234  
                                       

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Table of Contents


UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 4—Securities (Continued)

 

 
  September 30, 2010  
 
  Less than 12 months   12 months or more   Total  
(Dollars in thousands)   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count  

Other U.S. government

  $ 984   $ 21     1   $   $       $ 984   $ 21     1  

Residential mortgage-backed securities—agency

    386,552     1,315     35     69,621     199     4     456,173     1,514     39  

Residential mortgage-backed securities—non-agency

    30,641     577     6     154,825     37,935     10     185,466     38,512     16  

State and municipal

    2,248     1     6     131     7     1     2,379     8     7  

Asset-backed and debt securities

    17,089     861     1     5,168     899     3     22,257     1,760     4  

Equity securities

    1,121     3     1     296     160     2     1,417     163     3  
                                       
 

Total securities available for sale

  $ 438,635   $ 2,778     50   $ 230,041   $ 39,200     20   $ 668,676   $ 41,978     70  
                                       

Securities Held to Maturity

 
  September 30, 2009  
 
  Less than 12 months   12 months or more   Total  
(Dollars in thousands)   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count  

CLOs

  $ 82,208   $ 30,199     20   $ 1,187,631   $ 542,425     201   $ 1,269,839   $ 572,624     221  
                                       

 

 
  December 31, 2009  
 
  Less than 12 months   12 months or more   Total  
(Dollars in thousands)   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count  

CLOs

  $ 103,921   $ 26,412     21   $ 1,353,637   $ 505,881     201   $ 1,457,558   $ 532,293     222  
                                       

 

 
  September 30, 2010  
 
  Less than 12 months   12 months or more   Total  
(Dollars in thousands)   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count   Fair
Value
  Unrealized
Losses
  Count  

CLOs

  $   $       $ 1,479,167   $ 475,704     220   $ 1,479,167   $ 475,704     220  
                                       

        The Company's securities are primarily investments in debt securities. Debt securities available for sale and debt securities held to maturity are subject to quarterly impairment testing when a security's fair value is lower than its amortized cost. Debt securities with unrealized losses are considered other-than-temporarily impaired if the Company intends to sell the security, if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or the Company does not expect to recover the entire amortized cost basis of the security. Any impairment on securities the Company intends, or is more likely than not required, to sell is recognized in earnings as the entire difference between the amortized cost and its fair value. Any impairment on securities the Company does not intend, or it is not more likely than not required, to sell before recovery is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income. The credit loss is measured as the difference between the present value of expected cash flows, discounted using the security's effective interest rate, and the amortized cost of the security.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 4—Securities (Continued)

        The following describes the nature of the Company's investments, the causes of impairment, the severity and duration of the impairment, if applicable, and the conclusions reached on the temporary or other-than-temporary status of the unrealized losses.

        At September 30, 2010, the Company did not have the intent to sell temporarily impaired securities until a recovery of the amortized cost, which may be at maturity, and it is not more likely than not that the Company will have to sell the securities prior to recovery of amortized cost.

    Other U.S. Government Securities

        Other U.S. Government securities are securities issued by one of the several Government-Sponsored Enterprises (GSEs) such as Fannie Mae, Freddie Mac, Federal Home Loan Banks or Federal Farm Credit Banks. They are not backed by the full faith and credit of the United States government. These securities are issued with a stated interest rate and mature in less than five years. The unrealized losses on other U.S. Government securities resulted from higher interest rates subsequent to purchase and not credit quality. As a result, the securities were not other-than-temporarily impaired at September 30, 2010.

    Residential Mortgage-Backed Securities—Agency

        Agency residential mortgage-backed securities consist of securities guaranteed by a GSE such as Fannie Mae, Freddie Mac, and Ginnie Mae. These securities are collateralized by residential mortgage loans and may be prepaid at par prior to maturity. The unrealized losses on agency residential mortgage-backed securities resulted from higher interest rates subsequent to purchase and not credit quality. As a result, the securities were not other-than-temporarily impaired at September 30, 2010.

    Residential Mortgage-Backed Securities—Non-Agency

        Non-agency residential mortgage-backed securities are issued by financial institutions with no guarantee from GSEs. These securities are collateralized by residential mortgage loans and may be prepaid at par prior to maturity. The securities are primarily rated investment grade. The unrealized losses on non-agency residential mortgage-backed securities resulted from declining credit quality of underlying collateral and additional credit spread widening since purchase. The Company estimated loss projections for each security by assessing the loans collateralizing each security. The Company estimates the portion of loss attributable to credit based on the expected cash flows of the underlying collateral using industry consensus estimates of current key assumptions, such as default rates, loss severity and prepayment rates. Based on this assessment of expected credit losses of each security, an insignificant amount of impairment was recognized on three securities during the nine months ended September 30, 2010. With respect to the remaining portfolio at September 30, 2010, the Company expects to recover the entire amortized cost basis of these securities.

    State and Municipal Securities

        State and municipal securities are primarily securities issued by state and local governments to finance operating expenses and various projects. These securities are issued at a stated interest rate and have varying expected maturities ranging up to 30 years. The unrealized losses on the state and municipal securities resulted from higher interest rates subsequent to purchase and not from credit quality. As a result, the securities were not other-than-temporarily impaired at September 30, 2010.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 4—Securities (Continued)

    Asset-Backed and Debt Securities

        Asset-backed and debt securities in a loss position at September 30, 2010 primarily consist of privately placed debt securities issued by power and utilities companies. Expected cash flows of these debt securities are assessed to determine if the amortized cost basis of these securities is recoverable. Based on this assessment, an insignificant amount of impairment was recognized on one commercial mortgage-backed security during the nine months ended September 30, 2010.

    Collateralized Loan Obligations

        The Company's CLOs primarily consist of Cash Flow CLOs. A Cash Flow CLO is a structured finance product that securitizes a diversified pool of loan assets into multiple classes of notes. Cash Flow CLOs pay the note holders through the receipt of interest and principal repayments from the underlying loans unlike other types of CLOs that pay note holders through the trading and sale of underlying collateral. During the first quarter of 2009, the Company reclassified its CLOs from available for sale to held to maturity. The Company considers the held to maturity classification to be more appropriate because the Company has the ability and the intent to hold these securities to maturity.

        Certain of these CLOs are highly illiquid securities for which fair values are difficult to obtain. Unrealized losses arise from widening credit spreads, credit quality of the underlying collateral, uncertainty regarding the valuation of such securities and the market's opinion of the performance of the fund managers. Cash flow analysis of the underlying collateral provides an estimate of other-than-temporary impairment, which is performed quarterly when the fair value of a security is lower than its amortized cost. The fair value of the CLO portfolio was adversely impacted in 2009 and the nine months ended September 30, 2010 by the overall financial market crisis. Based on the analysis performed as of September 30, 2010 to determine whether any of the unrealized losses related to CLOs were believed to be other-than-temporary, the Company expects to recover the entire amortized cost basis of these securities.

    Securities Pledged as Collateral

        Transactions involving purchases of securities under agreements to resell (reverse repurchase agreements or reverse repos) or sales of securities under agreements to repurchase (repurchase agreements or repos) are accounted for as collateralized financings except where the Company does not have an agreement to sell (or purchase) the same or substantially the same securities before maturity at a fixed or determinable price. The Company's policy is to obtain possession of collateral with a market value equal to or in excess of the principal amount loaned under resale agreements. Collateral is valued daily, and the Company may require counterparties to deposit additional collateral or return collateral pledged, when appropriate.

        The Company separately identifies in the consolidated balance sheets, securities pledged as collateral in secured borrowings and other arrangements when the secured party can sell or repledge the securities. If the secured party cannot resell or repledge the securities that have been placed as collateral, those securities are not separately identified. At September 30, 2010, the Company had $5.2 billion of securities available for sale pledged as collateral where the secured party cannot resell or repledge such securities. These available for sale securities have been pledged to secure borrowings ($0.3 million), to support unrealized losses on derivative transactions reported in trading liabilities ($0.7 million) and to secure public and trust department deposits ($4.2 billion).

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 4—Securities (Continued)

        At September 30, 2009, December 31, 2009, and September 30, 2010, the Company accepted securities as collateral that it is permitted by contract to sell or repledge of $294.9 million (none of which has been repledged to secure public agency or bankruptcy deposits or to cover short sales), $442.6 million ($434.6 million of which has been repledged to secure public agency or bankruptcy deposits and to cover short sales), and $476.9 million ($442.7 million of which has been repledged to secure bankruptcy deposits and to cover short sales), respectively. These securities were received as collateral for secured lending and to obtain qualified securities to meet the Company's collateral needs.


Note 5—Loans and Allowance for Loan Losses

        A summary of loans, net of unearned discount and deferred fees (costs) of $46 million, $53 million and $58 million at September 30, 2009 and December 31, 2009 and September 30, 2010, respectively, is as follows:

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
 

Loans held for investment, excluding FDIC covered loans:

                   
 

Commercial, financial and industrial

  $ 15,994,997   $ 15,258,081   $ 14,650,250  
 

Construction

    2,691,515     2,429,009     1,849,805  
 

Residential mortgage

    16,576,052     16,716,048     17,295,349  
 

Commercial mortgage

    8,320,374     8,245,778     7,892,900  
 

Consumer:

                   
   

Installment

    2,303,897     2,244,239     2,054,863  
   

Revolving lines of credit

    1,599,112     1,672,842     1,835,376  
               
     

Total consumer

    3,903,009     3,917,081     3,890,239  
 

Lease financing

    658,708     653,743     635,267  
               
     

Total loans held for investment, excluding FDIC covered loans

    48,144,655     47,219,740     46,213,810  

Loans held for sale

    24,853     8,768     3,745  
               
     

Total loans, excluding FDIC covered loans

    48,169,508     47,228,508     46,217,555  

FDIC covered loans(1)

            1,693,554  
               
       

Total loans

    48,169,508     47,228,508     47,911,109  
       

Allowance for loan losses

    1,260,307     1,357,000     1,276,845  
               
       

Loans, net

  $ 46,909,201   $ 45,871,508   $ 46,634,264  
               

(1)
Represents the acquired loans that are covered by the loss share agreements with the FDIC.

        The Company evaluated loans acquired in the Frontier and Tamalpais transactions in accordance with accounting guidance related to loans acquired with deteriorated credit quality as of the acquisition date. Acquired loans are considered impaired if there is evidence of deterioration of credit quality since origination and it is probable, at the acquisition date, that the Company will be unable to collect all contractually required payments receivable. Management elected to account for all acquired loans, except for revolving lines of credit,

23


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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 5—Loans and Allowance for Loan Losses (Continued)


within the scope of the accounting guidance using the same methodology. The following table reflects the carrying value of loans, pursuant to accounting standards for purchased credit-impaired loans and other purchased loans as of September 30, 2010:

 
  September 30, 2010  
(Dollars in thousands)   Purchased
credit-impaired
loans
  Other
purchased
loans
  Total  

Commercial, financial and industrial

  $ 370,877   $ 116,726   $ 487,603  

Construction

    317,664     2,476     320,140  

Residential mortgage

    87,595         87,595  

Commercial mortgage

    729,214     20,308     749,522  

Consumer:

                   
 

Installment

    24,777         24,777  
 

Revolving lines of credit

        23,917     23,917  
               
   

Total consumer

    24,777     23,917     48,694  
               
     

Total FDIC covered loans

  $ 1,530,127   $ 163,427   $ 1,693,554  
               

        The acquired loans are referred to as "covered loans" as the Bank will be reimbursed for a substantial portion of any future losses on them under the terms of the FDIC loss share agreements. As of acquisition dates, the estimated fair value of the purchased credit-impaired loan portfolio of Frontier and Tamalpais subject to the loss share agreements was $1.7 billion, which represents the present value of expected cash flows from the portfolio. The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is the nonaccretable difference. The nonaccretable difference represents the estimated credit losses in the acquired loan portfolio at the acquisition date.

        The accounting guidance for purchased credit-impaired loans provides that the excess of the cash flows initially expected to be collected over the fair value of the loans at the acquisition date (i.e., the accretable yield) is accreted into interest income over the estimated remaining life of the purchased credit-impaired loans using the effective yield method, provided that the timing and amount of future cash flows is reasonably estimable. The initial estimate of cash flows expected to be collected must be updated each subsequent reporting period based on updated assumptions regarding default rates, loss severities, and other factors that are reflective of current market conditions. Probable decreases in expected cash flows after acquisition result in the recognition of impairment, which would be recorded as a charge to the provision for loan losses. Probable and significant increases in expected cash flows would first reverse any related allowance for loan losses and any remaining increases would be recognized prospectively as interest income over the estimated remaining lives of the loans. The impact of changes in variable interest rates are recognized prospectively as adjustments to interest income.

24


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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 5—Loans and Allowance for Loan Losses (Continued)

        The following table presents the fair value of loans pursuant to accounting standards for purchased credit-impaired loans as of the respective acquisition dates:

(Dollars in thousands)    
 

Contractually required payments including interest

  $ 3,789,578  

Nonaccretable difference

    1,774,301  
       

Cash flows expected to be collected (undiscounted)

    2,015,277  

Accretable yield

    296,696  
       
 

Fair value of purchased credit-impaired loans

  $ 1,718,581  
       

        The accretable yield for purchased credit-impaired loans was as follows for both the three and nine months ended September 30, 2010:

(Dollars in thousands)   For the Three
Months Ended
September 30, 2010
  For the Nine
Months Ended
September 30, 2010
 

Accretable yield, beginning of period

  $ 274,417   $  
 

Additions

        296,696  
 

Accretion

    (29,879 )   (52,158 )
 

Other

    218     218  
           

Accretable yield, end of period

  $ 244,756   $ 244,756  
           

        The carrying value and outstanding balance for the purchased credit-impaired loans as of the respective acquisition dates and at September 30, 2010 were as follows:

(Dollars in thousands)   Acquisition
Date
  September 30,
2010
 

Total outstanding balance

  $ 3,153,424   $ 2,975,932  
           

Carrying value

  $ 1,718,581   $ 1,530,127  
           

        As of the respective acquisition dates, the contractually required payments receivable, including interest, for all other purchased loans was $270.1 million, the contractual cash flows not expected to be collected was $53.7 million, and the estimated fair value of the loans was $196.3 million. The difference between the acquisition date fair value and the expected cash flows is being accreted to interest income over the remaining life of the loans for all loans that are currently performing.

        All acquired loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the respective acquisition dates. The acquired loans are and will continue to be subject to the Bank's internal credit review. As a result, if credit deterioration is noted subsequent to the respective acquisition dates, such deterioration will be measured through the Bank's loss reserving methodology and a provision for loan losses will be recorded. During the third quarter of 2010, there was no provision recorded related to the acquired loans, as there was no incremental credit deterioration identified.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 5—Loans and Allowance for Loan Losses (Continued)

        Changes in the allowance for loan losses were as follows:

 
  For the Three Months
Ended September 30,
  For the Nine Months
Ended September 30,
 
(Dollars in thousands)   2009   2010   2009   2010  

Allowance for loan losses, beginning of period

  $ 1,081,633   $ 1,357,869   $ 737,767   $ 1,357,000  

Loans charged off

    143,280     102,129     414,330     349,243  

Recoveries of loans previously charged off

    6,607     12,689     9,700     46,861  
                   
 

Total net loans charged off

    136,673     89,440     404,630     302,382  

Provision for loan losses

    314,000     8,000     923,000     222,000  

Other

    1,347     416     4,170     227  
                   

Allowance for loan losses, end of period

    1,260,307     1,276,845     1,260,307     1,276,845  

Allowance for losses on off-balance sheet commitments

    172,374     164,374     172,374     164,374  
                   

Allowances for credit losses, end of period

  $ 1,432,681   $ 1,441,219   $ 1,432,681   $ 1,441,219  
                   

        The provision for loan losses decreased $306 million to $8 million for the third quarter of 2010 from $314 million for the third quarter of 2009, primarily due to improved credit quality of the loan portfolio, as well as a change in the category mix and lower projected loss component of nonaccrual loans during the third quarter of 2010 compared to the third quarter of 2009.

        Nonaccrual loans totaled $1.3 billion, at September 30, 2009 and December 31, 2009 and at September 30, 2010, respectively. There were $17.8 million, $20.8 million, and $173.9 million (of which $1.9 million, $3.8 million and $24.6 million were on accrual status at September 30, 2009, December 31, 2009 and September 30, 2010, respectively) of troubled debt restructured loans at September 30, 2009, December 31, 2009 and September 30, 2010, respectively. Loans 90 days or more past due and still accruing totaled $5.4 million, $5.0 million and $17.5 million at September 30, 2009, December 31, 2009 and September 30, 2010, respectively.


Note 6—Goodwill and Intangible Assets

        As a result of the acquisition of certain assets and liabilities of Frontier and Tamalpais, the Company recorded goodwill and core deposit intangible assets totaling $62.3 million and $14.7 million, respectively. Goodwill of $45.3 million and $17.0 million was assigned to the Company's Retail Banking and Corporate Banking reportable business segments, respectively. The amount of goodwill recorded represents the residual difference in fair values of the assets acquired net of the liabilities assumed and the payable to the FDIC for the net assets acquired. The core deposit intangible assets will be amortized over approximately 10 years based upon the total economic benefits received. See Note 3 to these consolidated financial statements for information on the Company's business combinations.

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 6—Goodwill and Intangible Assets (Continued)

    Goodwill

        The changes in the carrying amount of goodwill during the nine months ended September 30, 2009 and 2010 are shown below:

(Dollars in thousands)   2009   2010  

Balance, January 1,

  $ 2,369,326   $ 2,369,326  

Acquisitions

        62,257  
           

Balance, September 30,

  $ 2,369,326   $ 2,431,583  
           

 

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
 

Goodwill by reportable business segment:

                   
 

Retail Banking

  $ 1,152,648   $ 1,152,648   $ 1,197,914  
 

Corporate Banking

    1,216,678     1,216,678     1,233,669  
               

Goodwill, end of period

  $ 2,369,326   $ 2,369,326   $ 2,431,583  
               

        The Company reviews its goodwill for impairment on an annual basis and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The annual goodwill impairment test as of April 1, 2010 was performed during the second quarter of 2010, and no impairment was recognized.

    Intangible Assets

        The table below reflects the Company's identifiable intangible assets and accumulated amortization at September 30, 2009, December 31, 2009 and September 30, 2010.

 
  September 30, 2009   December 31, 2009   September 30, 2010  
(Dollars in thousands)   Gross
Carrying
Amount
  Accumulated
Amortization
  Net
Carrying
Amount
  Gross
Carrying
Amount
  Accumulated
Amortization
  Net
Carrying
Amount
  Gross
Carrying
Amount
  Accumulated
Amortization
  Net
Carrying
Amount
 

Core deposit intangibles

  $ 619,398   $ (194,678 ) $ 424,720   $ 619,398   $ (233,042 ) $ 386,356   $ 637,196   $ (319,724 ) $ 317,472  

Trade name

    108,733     (2,744 )   105,989     108,733     (3,430 )   105,303     108,733     (5,491 )   103,242  

Customer relationships

    53,761     (4,479 )   49,282     53,761     (5,531 )   48,230     53,761     (8,715 )   45,046  

Other

    9,555     (1,500 )   8,055     9,555     (1,498 )   8,057     10,585     (2,751 )   7,834  
                                       

Subtotal—intangibles with a definite useful life

  $ 791,447   $ (203,401 ) $ 588,046   $ 791,447   $ (243,501 ) $ 547,946   $ 810,275   $ (336,681 ) $ 473,594  
                                       

Other intangibles with an indefinite useful life

    13,094         13,094     13,094         13,094     13,094         13,094  
                                       

Total intangibles

  $ 804,541   $ (203,401 ) $ 601,140   $ 804,541   $ (243,501 ) $ 561,040   $ 823,369   $ (336,681 ) $ 486,688  
                                       

        Total amortization expense for the third quarters of 2009 and 2010 was $40.6 million and $30.8 million, respectively. Total amortization expense for the nine months ended September 30, 2009 and 2010 was $121.8 million and $93.2 million, respectively.

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 6—Goodwill and Intangible Assets (Continued)

        Estimated future amortization expense at September 30, 2010 is as follows:

(Dollars in thousands)   Core Deposit
Intangibles (CDI)
  Trade Name   Customer
Relationships
  Other   Total Identifiable
Intangible Assets
with a Definite
Useful Life
 

Estimated amortization expense for the years ending:

                               
 

Remaining 2010

  $ 28,633   $ 686   $ 1,061   $ 436   $ 30,816  
 

2011

    90,273     2,747     3,968     1,616     98,604  
 

2012

    71,835     2,747     3,679     1,055     79,316  
 

2013

    47,459     2,747     3,436     1,071     54,713  
 

2014

    34,151     2,747     3,232     771     40,901  
 

Thereafter

    45,121     91,568     29,670     2,885     169,244  
                       
 

Total estimated amortization expense

  $ 317,472   $ 103,242   $ 45,046   $ 7,834   $ 473,594  
                       


Note 7—Variable Interest Entities

        Effective January 1, 2010, the Company adopted ASU 2009-17, "Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities." At adoption of this guidance, the Company recorded increases in total assets of $281 million, liabilities of $9 million and stockholder's equity attributable to noncontrolling interests of $272 million. The cumulative effect on retained earnings was not significant.

        The Company is involved in various structures that are considered to be VIEs. Generally, a VIE is a corporation, partnership, trust or any other legal structure that has equity investors that: 1) do not have sufficient equity at risk for the entity to independently finance its activities; 2) lack the power to direct the activities that significantly impact the entity's economic success; and/or 3) do not have an obligation to absorb the entity's losses or the right to receive the entity's returns. The Company's investments in VIEs primarily consist of equity investments in low income housing credit (LIHC) structures and renewable energy projects, which are designed to generate a return primarily through the realization of federal tax credits, and private capital investments.

Consolidated VIEs

        The Company is required to consolidate VIEs in which it is the primary beneficiary. The Company is determined to be the primary beneficiary of a VIE when it has the power to direct matters that most significantly impact the activities of the VIE and has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE.

        At September 30, 2010, $301 million in assets and $10 million in liabilities were consolidated by the Company on its consolidated balance sheet related to two LIHC investment fund structures because the Company sponsors, manages and syndicates the funds. The assets are included in other assets as well as interest bearing deposits in banks, the liabilities are primarily included in long-term debt, and third-party investor interests are included in stockholder's equity as noncontrolling interests. Neither creditors nor equity

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 7—Variable Interest Entities (Continued)


investors in the LIHC investments have any recourse to the general credit of the Company and the Company's creditors do not have any recourse to the assets of the consolidated LIHC investments.

        For the three months and nine months ended September 30, 2010, the Company recorded $6 million and $17 million of expenses related to its consolidated VIEs, respectively. The expenses are included in other noninterest expense on the Company's consolidated statements of income.

    LIHC Unguaranteed Syndicated Investment Funds

        The Company is a sponsor and syndicator of low-income housing tax credit investments. In these syndication transactions, the Company creates the investment funds, serves as the managing investor member, and sells limited investor member interests to third parties. The Company receives benefits through income from the structuring of these funds, servicing fees for managing the funds and, as an investor member, tax benefits and tax credits to reduce the Company's tax liability. As sponsor and managing member of the funds, the Company's activities include selecting, evaluating, structuring, negotiating and closing the fund investment in operating limited partnerships, as well as oversight of the ongoing operations of the fund portfolio. There is no single third-party investor with the power to remove the Company as managing member. In this role, the Company directs the activities that most significantly impact the fund's economic performance and receives benefits from the fund.

    LIHC Guaranteed Syndicated Investment Funds

        The Company also forms limited liability companies (LLCs), which in turn invest in low income housing tax credit operating partnerships. Interests in these funds are sold to third parties who pay a premium for a guaranteed return. The Company earns structuring fees from the sale of these funds and asset management fees. The Company also serves as the funds' non-member asset manager and guarantor. As sponsor and non-member asset manager of the funds, the Company's activities include selecting, evaluating, structuring, negotiating and closing investments in operating limited partnerships, as well as oversight of the ongoing operations of the fund portfolio. As guarantor, the Company guarantees a minimum rate of return throughout the investment term. There is no single third-party investor with the power to remove the Company as asset manager. In the Company's role as sponsor and asset manager, it directs the activities that most significantly impact the fund's economic performance. Separately, it has an obligation to absorb losses pertaining to its minimum rate of return guarantee to investors. For details of the guarantee, see Note 16 to these consolidated financial statements.

Unconsolidated VIEs in Which the Company has a Variable Interest

        The Company holds variable interests in other VIEs that it is not required to consolidate as it is not the primary beneficiary. In such cases, it does not hold the power, through its equity investments or otherwise, to direct the VIE's significant activities. The following table presents the Company's carrying amounts related to the unconsolidated VIEs and location on the consolidated balance sheet at September 30, 2010. The table also presents the Company's maximum exposure to loss resulting from its involvement with these VIEs. The

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 7—Variable Interest Entities (Continued)


maximum exposure to loss represents the carrying value of the Company's involvement plus any legally binding unfunded commitments in the unlikely event that all of the assets in the VIEs become worthless.

 
  September 30, 2010  
(Dollars in thousands)   Total
Assets
  Total
Liabilities
  Maximum
Exposure to
Loss
 

LIHC investments

  $ 485,426   $ 16,408   $ 605,636  

Renewable energy investments

    301,876         301,876  

Private capital investments

    167,324         251,146  
               
 

Total unconsolidated VIEs

  $ 954,626   $ 16,408   $ 1,158,658  
               

    LIHC Investments

        The Company makes equity investments in various private investment partnership funds and limited partnerships that sponsor qualified affordable housing projects. As a limited partner and non-managing investor member in these operating partnerships, the Company is allocated tax credits and tax deductions from operating losses associated with the underlying properties. The power to direct the activities of the investments resides with the general partner and/or managing member of these partnerships. As a result, the Company does not consolidate these investments. These LIHC investments are accounted for under the equity or effective yield method and are reflected in other assets on the Company's consolidated balance sheet. The Company increases the LIHC investment carrying amount and recognizes a liability for all unconditional unfunded equity commitments. These liabilities are reflected in other liabilities on the Company's consolidated balance sheet. In addition, the Company has $120 million in off-balance sheet conditional unfunded commitments that may be drawn when specific conditions are achieved, including the completion of construction of low income housing units. These unfunded commitments are included in the maximum exposure to loss attributable to LIHC investments in the table above.

    Renewable Energy Investments

        The Company makes equity investments in LLCs created to operate and manage renewable energy projects. The managing member or general partner of the LLC identifies and selects the assets of the entity and provides management and/or oversight of the ongoing operations of the renewable energy project. As a passive and limited investor member, the Company is allocated production tax credits and taxable income or losses associated with the projects. These renewable energy investments are accounted for under the equity method with the investments reflected in other assets on the Company's consolidated balance sheet.

    Private Capital Investments

        The Company makes equity investments in various private capital investment funds either directly in privately held companies or indirectly through private equity funds. As a passive investor, the Company has no rights that provide the power to direct the activities of the investments. The power to identify and select the assets of the investments resides with the managing member or general partner of each direct and fund investment. These private capital investments are accounted for under either the cost or equity method and are reflected in other assets on the Company's consolidated balance sheet. In addition, the Company has

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 7—Variable Interest Entities (Continued)

off-balance sheet unfunded commitments of $84 million to provide additional liquidity as required by the funds. These unfunded commitments are reflected in the maximum exposure to loss attributable to private capital investments in the table above.


Note 8—Private Capital and Other Investments

        The following table shows the balances of private capital and other investments, which are recorded in other assets, at September 30, 2009, December 31, 2009 and September 30, 2010.

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
 

Private capital and other investments:

                   
 

Private capital investments—cost basis

  $ 174,730   $ 119,121   $ 117,233  
 

Private capital investments—equity method

        46,296     61,863  
 

LIHC investments—guaranteed

    198,561     185,779     163,834  
 

LIHC investments—unguaranteed

    320,617     319,031     324,203  
 

Consolidated VIEs

            291,243  
 

Renewable energy investments

    303,726     305,917     301,876  
               
   

Total private capital and other investments

  $ 997,634   $ 976,144   $ 1,260,252  
               

        The Company invests in the equity instruments of privately held companies with fund managers (general partners) through limited partnership interests. These investments are made directly in privately held companies (direct investments) or indirectly through private equity funds (fund investments). These investments are accounted for based on the cost or equity method depending on whether the Company has significant influence over the investee. The investments' fair value is estimated when events or conditions indicate that it is probable that the carrying value of the investment will not be fully recovered in the foreseeable future. Fair value is estimated based on the company's business model, current and projected financial performance, liquidity and overall economic and market conditions. As a practical expedient, fair value can also be estimated as the net asset value (NAV) of the fund. If fair value is estimated to be below cost, an evaluation for other-than-temporary impairment is performed. If any of the factors used to determine fair value indicate that a recovery is unlikely or will not occur for a reasonable period of time, an other-than-temporary impairment is recorded. Based on this analysis, the Company recorded $5.5 million of other-than-temporary impairment on its private capital investments during the nine months ended September 30, 2010.

        The Company also invests in limited liability partnerships and other entities operating qualified affordable housing projects. These LIHC investments provide tax benefits to investors in the form of tax deductions from operating losses and tax credits. The unguaranteed LIHC investments are accounted for under the equity method. As of September 30, 2010, this category also included $29.7 million of investments in real estate private equity funds that are compliant with the Community Reinvestment Act (CRA investments). These investments are tested quarterly for impairment. The Company had no other-than-temporary impairment on its unguaranteed LIHC and CRA investments during the nine months ended September 30, 2010.

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 8—Private Capital and Other Investments (Continued)

        The Company also invests in guaranteed LIHC investments where the availability of tax credits are guaranteed by a creditworthy entity. The investments are initially recorded at cost and amortized over the period the tax credits are allocated to provide a constant effective yield. These investments are tested quarterly for impairment. The Company had no other-than-temporary impairment on its guaranteed LIHC investments during the nine months ended September 30, 2010. For details on the consolidated VIEs, see Note 7 to these consolidated financial statements.

        The Company invests in limited liability partnerships that operate renewable energy projects. Tax credits, taxable income and distributions associated with these renewable energy projects are allocated to investors according to the terms of the partnership agreements. These investments are accounted for under the equity method, with the initial investment recorded at cost and the carrying value adjusted for the Company's share of partnership net income and distributions received. These investments are tested annually for impairment, based on projected operating results and expected realizability of tax credits. The Company had no other-than-temporary impairment on its renewable energy investments during the nine months ended September 30, 2010.


Note 9—Employee Pension and Other Postretirement Benefits

        The following table summarizes the components of net periodic benefit cost for the three and nine months ended September 30, 2009 and 2010.

 
  Pension Benefits   Other Benefits   Superannuation, SERP(1) and ESBP(2)  
 
  For the Three Months
Ended September 30,
  For the Three Months
Ended September 30,
  For the Three Months
Ended September 30,
 
(Dollars in thousands)   2009   2010   2009   2010   2009   2010  

Components of net periodic benefit cost:

                                     

Service cost

  $ 13,094   $ 12,476   $ 1,614   $ 2,403   $ 256   $ 263  

Interest cost

    20,767     22,646     2,353     3,377     941     556  

Expected return on plan assets

    (35,153 )   (36,501 )   (2,501 )   (3,092 )        

Amortization of prior service cost

            (16 )   (16 )        

Amortization of transition amount

            328     327          

Recognized net actuarial loss

    3,045     3,642     936     1,522     305     218  
                           
 

Total net periodic benefit cost

  $ 1,753   $ 2,263   $ 2,714   $ 4,521   $ 1,502   $ 1,037  
                           

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 9—Employee Pension and Other Postretirement Benefits (Continued)

 

 
  Pension Benefits   Other Benefits   Superannuation, SERP and ESBP  
 
  For the Nine Months
Ended September 30,
  For the Nine Months
Ended September 30,
  For the Nine Months
Ended September 30,
 
(Dollars in thousands)   2009   2010   2009   2010   2009   2010  

Components of net periodic benefit cost:

                                     

Service cost

  $ 39,282   $ 37,430   $ 6,278   $ 7,098   $ 767   $ 789  

Interest cost

    62,300     67,937     8,462     9,952     2,823     2,424  

Expected return on plan assets

    (105,458 )   (109,502 )   (7,500 )   (9,277 )        

Amortization of prior service cost

            (47 )   (47 )        

Amortization of transition amount

            983     983          

Recognized net actuarial loss

    9,136     10,927     5,241     4,247     1,476     655  
                           
 

Total net periodic benefit cost

  $ 5,260   $ 6,792   $ 13,417   $ 12,956   $ 5,066   $ 3,868  
                           

(1)
Supplemental Executives Retirement Plan (SERP).
(2)
Executive Supplemental Benefit Plans (ESBP).


Note 10—Other Noninterest Expense

        The detail of other noninterest expense is as follows:

 
  For the Three Months Ended   For the Nine Months Ended  
(Dollars in thousands)   September 30,
2009
  September 30,
2010
  September 30,
2009
  September 30,
2010
 

Software

  $ 16,502   $ 18,266   $ 45,745   $ 48,824  

Low income housing credit investment amortization

    13,064     13,251     34,256     41,024  

Advertising and public relations

    14,562     12,853     36,532     34,495  

Communications

    9,494     10,323     27,404     29,579  

Other

    39,982     44,244     139,179     123,651  
                   
 

Total other noninterest expense

  $ 93,604   $ 98,937   $ 283,116   $ 277,573  
                   

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)


Note 11—Borrowed Funds

        The following is a summary of the major categories of borrowed funds:

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
 

Federal funds purchased and securities sold under repurchase agreements, with weighted average interest rates of 0.12%, 0.07% and 0.16% at September 30, 2009, December 31, 2009 and September 30, 2010, respectively

  $ 229,268   $ 150,453   $ 139,602  

Commercial paper, with weighted average interest rates of 0.29%, 0.16%, and 0.24% at September 30, 2009, December 31, 2009 and September 30, 2010, respectively

    423,499     888,541     701,135  

Other borrowed funds:

                   
 

Term federal funds purchased, with weighted average interest rates of 0.19% at both September 30, 2009 and December 31, 2009, and 0.33% at September 30, 2010

    50,000     505,000     25,000  
 

All other borrowed funds, with weighted average interest rates of 1.45%, 1.75% and 0.71% at September 30, 2009, December 31, 2009 and September 30, 2010, respectively

    114,861     86,934     111,441  
               
     

Total borrowed funds

  $ 817,628   $ 1,630,928   $ 977,178  
               

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(Unaudited)


Note 12—Long-Term Debt

        The following is a summary of the Company's long-term debt:

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
 

Senior debt:

                   
 

Fixed rate Federal Home Loan Bank Advances. These notes bear a combined weighted-average rate of 2.19% at September 30, 2009, 2.93% at December 31, 2009 and 2.19% at September 30, 2010

  $ 2,901,000   $ 2,001,000   $ 2,251,000  
 

Floating rate notes due March 2011. These notes, which bear interest at 0.08% above 3-month LIBOR, had a rate of 0.38% at September 30, 2009, 0.33% at December 31, 2009, and 0.37% at September 30, 2010

    500,000     500,000     500,000  
 

Floating rate notes due March 2012. These notes, which bear interest at 0.20% above 3-month LIBOR, had a rate of 0.50% at September 30, 2009, 0.45% at December 31, 2009 and 0.49% at September 30, 2010

    500,000     500,000     500,000  

Note payable:

                   
 

Fixed rate 6.03% notes due July 2014 (related to consolidated VIE)

            7,853  

Subordinated debt:

                   
 

Fixed rate 5.25% notes due December 2013

    437,859     434,362     424,868  
 

Fixed rate 5.95% notes due May 2016

    782,694     776,822     760,706  

Junior subordinated debt payable to subsidiary grantor trust:

                   
 

Fixed rate 10.875% notes due March 2030

    10,458     10,369     10,310  
 

Fixed rate 10.60% notes due September 2030

    3,182     3,158     3,093  
               
   

Total long-term debt

  $ 5,135,193   $ 4,225,711   $ 4,457,830  
               

        As of September 30, 2009, December 31, 2009 and September 30, 2010, the Company had pledged loans and securities of $38.6 billion, $38.0 billion, and $ 33.5 billion, respectively, as collateral for short-and medium-term advances from the Federal Reserve Bank and Federal Home Loan Bank.

        In October 2008, the FDIC established the Temporary Liquidity Guarantee (TLG) Program. On March 16, 2009, the Bank issued $1.0 billion principal amount of Senior Floating Rate Notes under the TLG Program. The proceeds thereof were used for general corporate purposes. Of the $1.0 billion of senior notes, $500 million in principal amount bear interest at a rate equal to three-month LIBOR plus 0.08 percent per annum and mature on March 16, 2011 (2011 Notes). The remaining $500 million in principal amount bear interest at a rate equal to three-month LIBOR plus 0.20 percent per annum and mature on March 16, 2012 (2012 Notes). In connection with the FDIC guarantee under the TLG Program, a fee of 1 percent per annum is

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 12—Long-Term Debt (Continued)


charged to the Bank on the $1.0 billion of senior notes. The interest on the 2011 Notes and the 2012 Notes is payable and reset quarterly on the 16th of March, June, September and December of each year.

        Under the TLG Program, as amended on June 3, 2009, the Bank's senior unsecured debt with a maturity of more than 30 days and issued between October 14, 2008 and October 31, 2009 is guaranteed by the full faith and credit of the United States. For debt issued prior to April 1, 2009, the FDIC guarantee expires upon the earlier of either the maturity date of the debt or June 30, 2012. For debt issued on or after April 1, 2009, the FDIC guarantee expires upon the earlier of either the maturity date of the debt or December 31, 2012.


Note 13—Fair Value Measurement and Fair Value of Financial Instruments

    Fair Value Hierarchy

        Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., an exit price) in an orderly transaction between willing market participants at the measurement date. In determining fair value, the Company maximizes the use of observable market inputs and minimizes the use of unobservable inputs. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect the Company's estimate about market data. Based on the observability of the significant inputs used, the Company classifies its fair value measurements in accordance with the three-level hierarchy. This hierarchy is based on the quality and reliability of the information used to determine fair value.

    Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities. Since the valuations are based on quoted prices that are readily available in an active market, they do not entail a significant degree of judgment.

    Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.

    Level 3: Valuations are based on at least one significant unobservable input that is supported by little or no market activity and is significant to the fair value measurement. Values are determined using pricing models and discounted cash flow models that include management judgment and estimation, which may be significant.

        In assigning the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are measured at fair value. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. The level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Therefore, an item may be classified in Level 3 even though there may be many significant inputs that are readily observable.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

    Valuation Methodologies

        The Company has an established and documented process for determining fair value for financial assets and financial liabilities that are measured at fair value on either a recurring or nonrecurring basis. When available, quoted market prices are used to determine fair value. If quoted market prices are not available, fair value is based upon valuation techniques that use, where possible, current market-based or independently sourced parameters, such as interest rates, yield curves, foreign exchange rates, volatilities and credit curves. Valuation adjustments may be made to ensure the financial instruments are recorded at fair value. These adjustments include amounts that reflect counterparty credit quality and that consider the Company's creditworthiness in determining the fair value of its trading liabilities. A description of the valuation methodologies used for certain financial assets and financial liabilities measured at fair value is as follows:

Recurring Fair Value Measurements:

    Trading Account Assets: Trading account assets are recorded at fair value and primarily consist of securities and derivatives held for trading purposes. See discussion below on securities available for sale, which utilize the same valuation methodology as trading account securities. See also discussion below on derivatives valuation.

    Securities Available for Sale: Securities available for sale are recorded at fair value based on readily available quoted market prices, if available. If such quoted market prices are not available, management utilizes third-party pricing services and broker quotations from dealers in the specific instruments. If no market prices or broker quotes are available, external pricing models are used. To the extent possible, these pricing model valuations utilize observable market inputs obtained for similar securities. Typical inputs include LIBOR and U.S. Treasury yield curves, benchmark yields, consensus prepayment estimates and credit spreads. Level 1 measured securities include U.S. Government and agency securities. Level 2 measured securities include residential mortgage-backed securities and certain asset-backed securities.

    Derivatives: The Company's derivatives are primarily traded in over-the-counter markets where quoted market prices are not readily available. The Company values its derivatives using pricing models that are widely accepted in the financial services industry with inputs that are observable in the market or can be derived from or corroborated by observable market data. These models reflect the contractual terms of the derivatives including the period to maturity and market observable inputs such as yield curves and option volatility. Valuation adjustments are made to reflect counterparty credit quality and to consider the creditworthiness of the Company. Derivatives, which are included in trading account assets, trading account liabilities and other assets, are generally measured as Level 2.

    Trading Account Liabilities: Trading account liabilities are recorded at fair value and primarily consist of derivatives and securities sold, not yet purchased. See discussion above on derivatives valuation. Securities sold, not yet purchased consist of U.S. Government securities and are measured as Level 1.

Nonrecurring Fair Value Measurements:

    Loans Held for Sale: Residential mortgage and commercial loans held for sale are recorded at the lower of cost or fair value. The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from GSEs. These loans are classified as Level 2. The fair value of commercial loans held for sale

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

    may be based on secondary market offerings for loans with similar characteristics or a valuation methodology utilizing the appraised value to outstanding loan balance ratio. These loan values are classified as Level 3.

    Individually Impaired Loans: Individually impaired loans are valued at the time the loan is identified as impaired based on the present value of the remaining expected cash flows. Because the discount factor applied is based on the loan's original effective yield rather than a current market rate, that present value does not represent fair value. However, as a practical expedient, an impaired loan may be measured based on a loan's observable market price or the underlying collateral securing the loan (provided that the loan is collateral dependent), which does approximate fair value. Collateral may be real estate or business assets including equipment. The value of collateral is determined based on independent appraisals. Appraised values may be adjusted based on management's historical knowledge, changes in market conditions from the time of valuation, and management's knowledge of the client and the client's business. The loan's market price is determined using market pricing for similar assets, adjusted for management judgment. Impaired loans are reviewed and evaluated at least quarterly for additional impairment and adjusted accordingly. Impaired loans that are adjusted to fair value based on underlying collateral or the loan's market price are classified as Level 3.

    Private Equity and CRA Investments: Private equity and CRA investments are recorded either at cost or using the equity method and are evaluated for impairment. The valuation of these investments requires significant management judgment due to the absence of quoted market prices, lack of liquidity and the long-term nature of these assets. When required, the fair value of the investments was estimated using the NAV of the fund or based on the investee's business model, current and projected financial performance, liquidity and overall economic and market conditions. Private equity and CRA investment measurements are generally classified as Level 3.

    OREO: OREO represents collateral acquired through foreclosure and is initially recorded at fair value, adjusted for disposition costs. Subsequently, OREO is measured at lower of cost or fair value. OREO values are reviewed on an ongoing basis and any change in value is recorded as a fair value adjustment. The value of OREO is determined based on independent appraisals and is generally classified as Level 3.

    LIHC Investments: LIHC investments represent guaranteed and unguaranteed funds that are recorded using the effective yield or equity method of accounting, with the investment amortized over the period the tax credits are allocated. These investments are evaluated for impairment based on the realizability of the tax credits and benefits from operating losses. Realizability of the tax credits is based on the qualification of low-income status for the underlying properties. These investments are generally classified as Level 3.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

    Fair Value Measurements on a Recurring Basis

        The following tables present financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2009, December 31, 2009 and September 30, 2010, by major category and by valuation hierarchy level.

 
  September 30, 2009  
(Dollars in thousands)   Level 1   Level 2   Level 3   Netting
Adjustment(1)
  Fair Value  

Assets

                               
 

Trading account assets:

                               
   

U.S. Treasury

  $ 53,592   $   $   $   $ 53,592  
   

Other U.S. government

    50,847                 50,847  
   

State and municipal

        46,617             46,617  
   

Commercial paper

        56,519             56,519  
   

Derivative contracts

    471     779,330         (46,826 )   732,975  
                       
 

Total trading account assets

    104,910     882,466         (46,826 )   940,550  
 

Securities available for sale:

                               
   

U.S. Treasury

    299,259                 299,259  
   

Other U.S. government

    6,077,976                 6,077,976  
   

Residential mortgage-backed securities—agency

        11,138,222             11,138,222  
   

Residential mortgage-backed securities—non-agency

        431,926             431,926  
   

State and municipal

        44,813     5,227         50,040  
   

Asset-backed and debt securities

        106,190             106,190  
   

Equity securities

    105,542         1,419         106,961  
                       
 

Total securities available for sale

    6,482,777     11,721,151     6,646         18,210,574  
 

Other assets(2)

        118,666         (55,267 )   63,399  
                       
   

Total assets

  $ 6,587,687   $ 12,722,283   $ 6,646   $ (102,093 ) $ 19,214,523  
                       

Liabilities

                               
 

Trading account liabilities:

                               
   

Derivatives

  $ 6,560   $ 767,183   $   $ (102,093 ) $ 671,650  
   

Securities sold, not yet purchased

    43,425                 43,425  
                       
 

Total trading account liabilities

    49,985     767,183         (102,093 )   715,075  
                       
   

Total liabilities

  $ 49,985   $ 767,183   $   $ (102,093 ) $ 715,075  
                       

(1)
Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.
(2)
Other assets include nontrading derivatives.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

 
  December 31, 2009  
(Dollars in thousands)   Level 1   Level 2   Level 3   Netting
Adjustment(1)
  Fair Value  

Assets

                               
 

Trading account assets:

                               
   

U.S. Treasury

  $ 15,430   $   $   $   $ 15,430  
   

Other U.S. government

    28,649                 28,649  
   

State and municipal

        24,878             24,878  
   

Commercial paper

        74,594             74,594  
   

Derivative contracts

    1,453     648,227         (67,583 )   582,097  
                       
 

Total trading account assets

    45,532     747,699         (67,583 )   725,648  
 

Securities available for sale:

                               
   

U.S. Treasury

    299,677                 299,677  
   

Other U.S. government

    12,277,418                 12,277,418  
   

Residential mortgage-backed securities—agency

        9,362,123             9,362,123  
   

Residential mortgage-backed securities—non-agency

        391,439             391,439  
   

State and municipal

        39,637     5,459         45,096  
   

Asset-backed and debt securities

        108,135             108,135  
   

Equity securities

    73,522         1,419         74,941  
                       
 

Total securities available for sale

    12,650,617     9,901,334     6,878         22,558,829  
 

Other assets(2)

        97,186         (68,302 )   28,884  
                       
   

Total assets

  $ 12,696,149   $ 10,746,219   $ 6,878   $ (135,885 ) $ 23,313,361  
                       

Liabilities

                               
 

Trading account liabilities:

                               
   

Derivatives

  $ 1,978   $ 630,951   $   $ (101,958 ) $ 530,971  
   

Securities sold, not yet purchased

    7,923                 7,923  
                       
 

Total trading account liabilities

    9,901     630,951         (101,958 )   538,894  
 

Other liabilities(2)

        12,164         (9,927 )   2,237  
                       
   

Total liabilities

  $ 9,901   $ 643,115   $   $ (111,885 ) $ 541,131  
                       

(1)
Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.
(2)
Other assets and other liabilities include nontrading derivatives.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

 
  September 30, 2010  
(Dollars in thousands)   Level 1   Level 2   Level 3   Netting
Adjustment(1)
  Fair Value  

Assets

                               
 

Trading account assets:

                               
   

U.S. Treasury

  $ 37,301   $   $   $   $ 37,301  
   

Other U.S. government

    74,253                 74,253  
   

State and municipal

        21,983             21,983  
   

Commercial paper

        30,996             30,996  
   

Foreign exchange derivative contracts

    263     32,211         (8,545 )   23,929  
   

Commodity derivative contracts

        224,831         (40,712 )   184,119  
   

Interest rate derivative contracts

    234     802,261         (32,987 )   769,508  
   

Equity derivative contracts

        30,658         (1,806 )   28,852  
                       
 

Total trading account assets

    112,051     1,142,940         (84,050 )   1,170,941  
 

Securities available for sale:

                               
   

U.S. Treasury

    150,674                 150,674  
   

Other U.S. government

    8,154,642                 8,154,642  
   

Residential mortgage-backed securities—agency

        9,240,855             9,240,855  
   

Residential mortgage-backed securities—non-agency

        531,598             531,598  
   

State and municipal

        38,264     8,854         47,118  
   

Asset-backed and debt securities

        124,027             124,027  
   

Equity securities

    76,737         1,397         78,134  
                       
 

Total securities available for sale

    8,382,053     9,934,744     10,251         18,327,048  
 

Other assets:

                               
   

Interest rate hedging contracts

        3,228         (1,192 )   2,036  
                       
 

Total other assets

        3,228         (1,192 )   2,036  
                       
   

Total assets

  $ 8,494,104   $ 11,080,912   $ 10,251   $ (85,242 ) $ 19,500,025  
                       

Liabilities

                               
 

Trading account liabilities:

                               
   

Foreign exchange derivative contracts

  $ 293   $ 37,018   $   $ (11,197 ) $ 26,114  
   

Commodity derivative contracts

        222,953         (36,605 )   186,348  
   

Interest rate derivative contracts

    1,674     761,512         (53,144 )   710,042  
   

Equity derivative contracts

        30,658             30,658  
   

Credit derivative contracts

            14,045         14,045  
   

Securities sold, not yet purchased

    42,681                 42,681  
                       
 

Total trading account liabilities

    44,648     1,052,141     14,045     (100,946 )   1,009,888  
 

Other liabilities

        12,567     40,956     (1,173 )   52,350  
                       
   

Total liabilities

  $ 44,648   $ 1,064,708   $ 55,001   $ (102,119 ) $ 1,062,238  
                       

(1)
Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

        The following tables present a reconciliation of the assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2009 and 2010. Level 3 available for sale securities primarily consist of community redevelopment bonds. These bonds were carried at cost, which approximates fair value.

Securities Available for Sale

 
  For the Three Months
Ended September 30,
  For the Nine Months
Ended September 30,
 
(Dollars in thousands)   2009   2010   2009   2010  

Balance, beginning of period

  $ 6,308   $ 8,643   $ 1,203,092   $ 6,878  
 

Total gains/(losses) (realized/unrealized):

                         
   

Included in income before taxes

    44         64      
   

Included in other comprehensive income (loss)

    (10 )   (1 )   (54,721 )   (21 )
 

Purchases, sales, issuances and settlements

    304     1,609     2,025     3,394  
 

Transfers in (out) Level 3(1)

            (1,143,814 )    
                   

Balance, end of period

  $ 6,646   $ 10,251   $ 6,646   $ 10,251  
                   

Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period

  $   $   $   $  

(1)
The CLO portfolio was transferred out of Level 3 during the first quarter of 2009 as a result of the reclassification from available for sale to held to maturity. Held to maturity securities are not measured at fair value on a recurring basis and therefore are not subject to this fair value disclosure requirement.

Trading Liabilities

 
  For the Three Months
Ended September 30,
  For the Nine Months
Ended September 30,
 
(Dollars in thousands)   2010   2010  

Balance, beginning of period

  $   $  
 

Cumulative effect from change in accounting for embedded credit derivatives

    14,045     14,045  
           

Balance, end of period

  $ 14,045   $ 14,045  
           

Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period

  $   $  

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

Other Liabilities

 
  For the Three Months
Ended September 30,
  For the Nine Months
Ended September 30,
 
(Dollars in thousands)   2010   2010  

Balance, beginning of period

  $ 40,799   $  
 

Total gains/(losses) (realized/unrealized):

             
   

Included in income before taxes

    157     157  
   

Purchases, sales, issuances and settlements

        40,799  
           

Balance, end of period

  $ 40,956   $ 40,956  
           

Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period

  $ 157   $ 157  

        There were no transfers in or out of the Level 1 and 2 valuation hierarchies during the nine months ended September 30, 2010.

    Fair Value Measurement on a Nonrecurring Basis

        Certain assets may be measured at fair value on a nonrecurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis during the nine months ended September 30, 2009 and 2010 that were still held on the consolidated balance sheet as of the respective periods ended, the following tables present the carrying value of such financial instruments by the level of valuation assumptions used to determine each fair value adjustment.

 
  September 30, 2009    
   
 
(Dollars in thousands)   Carrying
Value
  Level 1   Level 2   Level 3   Loss for the
Three Months Ended
September 30, 2009
  Loss for the
Nine Months Ended
September 30, 2009
 

Securities:

                                     
 

Held to Maturity Investments

  $ 1,670   $   $   $ 1,670   $   $ (767 )

Loans:

                                     
 

Loans Held for Sale

    13,320         4,635     8,685     (5,487 )   (5,572 )
 

Impaired Loans

    590,593             590,593     (74,009 )   (189,644 )

Other Assets:

                                     
 

OREO

    13,082             13,082     (1,529 )   (4,413 )
 

CRA Investments

    7,595             7,595     (1,879 )   (7,372 )
 

Private Equity Investments

    26,769             26,769     (520 )   (5,347 )
                           
   

Total

  $ 653,029   $   $ 4,635   $ 648,394   $ (83,424 ) $ (213,115 )
                           

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Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)


 
  September 30, 2010    
   
 
(Dollars in thousands)   Carrying
Value
  Level 1   Level 2   Level 3   Loss for the
Three Months Ended
September 30, 2010
  Loss for the
Nine Months Ended
September 30, 2010
 

Loans:

                                     
 

Impaired Loans

  $ 561,376   $   $   $ 561,376   $ (55,900 ) $ (79,738 )

Other Assets:

                                     
 

OREO

    51,298             51,298     (10,667 )   (12,442 )
 

Private Equity Investments

    15,796             15,796     (842 )   (5,483 )
                           
   

Total

  $ 628,470   $   $   $ 628,470   $ (67,409 ) $ (97,663 )
                           

        Loans include residential mortgage and commercial loans held for sale measured at the lower of cost or fair value and individually impaired loans that are measured based on the fair value of the underlying collateral or the fair value of the loan. The fair value of fixed-rate residential mortgage loans was determined using whole loan forward prices obtained from GSEs. The fair value of commercial loans was determined using market pricing for similar assets, adjusted for management judgment. The fair value of impaired loans was determined based on appraised values of the underlying collateral or market pricing for the loan, adjusted for management judgment.

        Other assets consist of private equity investments that were written down to fair value due to impairment, and OREO that was measured at the lower of cost or fair value, net of cost of disposal. The fair value of OREO was primarily based on independent appraisals.

        Private equity investments with a total fair value of $15.8 million at September 30, 2010 relate to five funds that invest in the communications and media, middle market and real estate industries. The fair value of these investments was estimated using NAV. There was $1.1 million in unfunded commitments related to these investments included in the above nonrecurring fair value table at September 30, 2010.

        In addition to financial instruments recorded at fair value in the Company's financial statements, the disclosure of the estimated fair value of financial instruments that are not carried at fair value is also required. Excluded from this disclosure requirement are lease financing arrangements, investments accounted for under the equity method, employee pension and other postretirement obligations and all nonfinancial assets and liabilities, including goodwill and other intangible assets such as long-term customer relationships. The fair values presented are estimates for certain individual financial instruments and do not represent an estimate of the fair value of the Company as a whole.

        Certain financial instruments that are not recognized at fair value on the consolidated balance sheet are carried at amounts that approximate fair value due to their short-term nature. These financial instruments include cash and due from banks, interest bearing deposits in banks, federal funds sold and purchased, securities purchased under resale agreements, securities sold under repurchase agreements and commercial paper. In addition, the fair value of deposits with no stated maturity, such as noninterest bearing demand deposits, interest bearing checking, and market rate and other savings are deemed to equal their carrying values.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

        Private equity investments including direct investments in privately held companies and indirect investments in private equity funds are carried at amounts that approximate fair value. Due to the unavailability of quoted market prices, the investments are initially valued based on cost and subsequently valued utilizing available market data to determine if the carrying value of these investments should be adjusted. Valuations are based on the investee's recent financial performance and future potential, the value of underlying investee's assets, the risks associated with the particular business, current market conditions, and other relevant factors.

        Financial instruments for which their carrying values do not approximate fair value include loans, interest bearing deposits with stated maturities, other borrowed funds, long-term debt, and trust notes.

        Securities held to maturity:    The fair value of CLOs classified as held to maturity was estimated using a pricing model and broker quotes. The model is based on internally developed assumptions using available market data obtained from market participants and credit rating agencies.

        Loans:    The fair value of FDIC covered loans was estimated using a discounted cash flow methodology that considered factors including the type of loan and related collateral, risk classification, fixed or variable interest rate, term of loan, performance status and current discount rates. The fair values of mortgage loans were estimated based on quoted market prices for loans with similar credit and interest rate risk characteristics. The fair values of other types of loans were estimated based upon the type of loan and maturity. The fair value of these loans was determined by discounting the future expected cash flows using the current origination rates for similar loans made to borrowers with similar credit ratings.

        FDIC indemnification asset:    The fair value of the FDIC indemnification asset was estimated using the present value of the cash flows that the Bank expects to collect from the FDIC under the loss share agreements.

        Interest bearing deposits:    The fair values of savings accounts and certain money market accounts were based on the amounts payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit was estimated using a discounted cash flow calculation that applies current interest rates being offered on certificates with similar maturities.

        Other borrowed funds:    The fair values of Federal Reserve Bank term borrowings, Federal Home Loan Bank borrowings and term federal funds purchased were estimated using a discounted cash flow calculation that applies current market rates for applicable maturities. The carrying values of other short-term borrowed funds were assumed to approximate their fair value due to their limited duration.

        Long-term debt:    The fair value of senior and subordinated debt was estimated using either a discounted cash flow analysis based on current market interest rates for debt with similar maturities and credit quality or estimated using market quotes. The fair value of junior subordinated debt payable to subsidiary grant trust was estimated using market quotes of similar securities.

45


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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 13—Fair Value Measurement and Fair Value of Financial Instruments (Continued)

        The table below presents the carrying value and estimated fair value of certain financial instruments held by the Company as of December 31, 2009 and September 30, 2010.

 
  December 31, 2009   September 30, 2010  
(Dollars in thousands)   Carrying
Value
  Fair
Value
  Carrying
Value
  Fair
Value
 

Assets

                         
 

Securities held to maturity

  $ 1,227,718   $ 1,457,558   $ 1,303,472   $ 1,494,941  
 

Loans, net of allowance for loan losses(1)

    45,222,765     44,924,749     46,005,097     46,120,365  
 

FDIC indemnification asset

            833,939     838,032  

Liabilities

                         
 

Interest bearing deposits

    53,958,664     53,969,991     46,114,925     46,200,847  
 

Other borrowed funds

    591,934     591,953     136,441     136,442  
 

Long-term debt

    4,225,711     4,193,404     4,457,830     4,555,978  

(1)
Excludes lease financing, net of related allowance.

        Off-balance sheet commitments, which include commitments to extend credit and standby and commercial letters of credit, are excluded from the above table. These instruments generate ongoing fees, which are recognized over the term of the commitment period. In situations where the credit quality of the counterparty to a commitment has declined, the Company records a reserve. A reasonable estimate of the fair value of these instruments is the carrying value of deferred fees plus the related reserve. This totaled $305.1 million and $291.2 million at December 31, 2009 and September 30, 2010, respectively.


Note 14—Derivative Instruments and Other Financial Instruments Used For Hedging

        The Company is a party to certain derivative and other financial instruments that are entered into for the purpose of trading, meeting the needs of customers, and changing the impact on the Company's operating results due to market fluctuations in currency and/or interest rates.

        Credit and market risks are inherent in derivative instruments. Credit risk is defined as the possibility that a loss may occur from the failure of another party to perform in accordance with the terms of the contract, which exceeds the value of the existing collateral, if any. The Company utilizes master netting and collateral support annex (CSA) agreements in order to reduce its exposure to credit risk. Master netting agreements mitigate credit risk by permitting the offset of amounts due from and to individual counterparties in the event of default. The CSA requires the counterparty with derivatives in a net loss position to provide collateral as prescribed by such agreement. Additionally, the Company considers the potential loss in the event of counterparty default in estimating the fair value amount of the derivative instrument. Market risk is the possibility that future changes in market conditions may make the financial instrument less valuable.

        Derivatives are used to manage exposure to interest rate and foreign currency risk, generate profits from proprietary trading and assist customers with their risk management objectives. The Company designates derivative instruments as those used for hedge accounting purposes, and those for trading or economic hedge purposes. All derivative instruments are recognized as assets or liabilities on the consolidated balance sheet at fair value.

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 14—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)

        The tables below present the notional amounts, and the location and fair value amounts of the Company's derivative instruments reported on the consolidated balance sheet, segregated between derivative instruments designated and qualifying as hedging instruments and all other derivative instruments as of September 30, 2009, December 31, 2009 and September 30, 2010.

 
  September 30, 2009  
 
   
  Asset Derivatives(1)   Liability Derivatives(1)  
(Dollars in thousands)   Notional
Amount
  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value
 

Total derivatives designated as hedging instruments:

                           
   

Interest rate contracts(2)

  $ 7,050,000   Other assets   $ 118,666   Other liabilities   $  
                       

Derivatives not designated as hedging instruments:

                           
   

Foreign exchange contracts

  $ 2,981,215   Trading account assets   $ 27,625   Trading account liabilities   $ 43,707  
   

Commodity contracts

    3,544,518   Trading account assets     193,972   Trading account liabilities     199,677  
   

Interest rate contracts

    24,941,719   Trading account assets     547,988   Trading account liabilities     520,143  
   

Equity contracts

    193,158   Trading account assets     10,216   Trading account liabilities     10,216  
                       

Total derivatives not designated as hedging instruments

  $ 31,660,610       $ 779,801       $ 773,743  
                       

 

 
  December 31, 2009  
 
   
  Asset Derivatives(1)   Liability Derivatives(1)  
(Dollars in thousands)   Notional
Amount
  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value
 

Total derivatives designated as hedging instruments:

                           
   

Interest rate contracts(2)

  $ 8,800,000   Other assets   $ 97,186   Other liabilities   $ 12,164  
                       

Derivatives not designated as hedging instruments:

                           
   

Foreign exchange contracts

  $ 2,701,925   Trading account assets   $ 22,398   Trading account liabilities   $ 27,097  
   

Commodity contracts

    3,405,389   Trading account assets     166,395   Trading account liabilities     167,640  
   

Interest rate contracts

    25,226,564   Trading account assets     446,756   Trading account liabilities     424,060  
   

Equity contracts

    254,372   Trading account assets     14,133   Trading account liabilities     14,133  
                       

Total derivatives not designated as hedging instruments

  $ 31,588,250       $ 649,682       $ 632,930  
                       

47


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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 14—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)

 

 
  September 30, 2010  
 
   
  Asset Derivatives(1)   Liability Derivatives(1)  
(Dollars in thousands)   Notional
Amount
  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value
 

Total derivatives designated as hedging instruments:

                           
   

Interest rate contracts

  $ 5,966,773   Other assets   $ 3,228   Other liabilities   $ 12,567  
                       

Derivatives not designated as hedging instruments:

                           
   

Foreign exchange contracts

  $ 2,557,415   Trading account assets   $ 32,474   Trading account liabilities   $ 37,311  
   

Commodity contracts

    3,550,464   Trading account assets     224,831   Trading account liabilities     222,953  
   

Interest rate contracts

    29,192,499   Trading account assets     802,495   Trading account liabilities     763,186  
   

Equity contracts

    1,011,084   Trading account assets     30,658   Trading account liabilities     30,658  
   

Credit contracts

    60,000           Trading account liabilities     14,045  
                       

Total derivatives not designated as hedging instruments

  $ 36,371,462       $ 1,090,458       $ 1,068,153  
                       

(1)
Asset and liability values are presented gross, excluding the impact of legally enforceable master netting and CSA agreements.
(2)
The fair value includes unamortized premium of $4.4 million and $3.0 million related to terminated contracts at September 30, 2009 and December 31, 2009, respectively.

        Certain of the Company's derivative instruments contain provisions that require the Company to maintain a specified credit rating. If the Company's credit rating was to fall below the specified rating, the counterparties to these derivative instruments could terminate the contract and demand immediate payment or demand immediate and ongoing full overnight collateralization for those derivative instruments in net liability positions. At September 30, 2010, the aggregate fair value (including net interest payable/receivable) of all derivative instruments with credit-risk mitigated contingent features that are in a liability position was $24.9 million. At September 30, 2010, the Company had not pledged any collateral to secure these obligations. If all of the credit-risk-related contingent features underlying these agreements had been triggered on September 30, 2010, the Company would have been required to provide collateral of $24.9 million to settle these contracts.

        Derivative instruments are integral components of the Company's asset and liability management activities. The Company uses interest rate derivatives to manage the Company's net interest income sensitivity to changes in market interest rates. These instruments are used to manage interest rate risk relating to specified groups of assets and liabilities, primarily LIBOR-based commercial loans, certificates of deposit, borrowings, and fixed rate subordinated debt. The following describes the significant hedging strategies of the Company.

        The Company engages in several types of cash flow hedging strategies related to forecasted future interest payments, with the hedged risk being the variability in those payments due to changes in the designated

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 14—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)

benchmark rate (i.e., U.S. dollar LIBOR). In these strategies, the hedging instruments are matched with groups of similar variable rate instruments such that the reset tenor of the variable rate instruments and that of the hedging instrument are identical at inception. Cash flow hedging strategies include the utilization of purchased floor, cap, collars and corridor options and interest rate swaps. At September 30, 2010, the weighted average remaining life of the currently active cash flow hedges was approximately 2.9 years.

        In the third quarter of 2010, the Company entered into $1.0 billion notional amount of interest rate swaps to hedge interest rate variability of a forecasted fixed rate debt issuance in the first half of 2011. The swaps are accounted for as a cash flow hedge and the Company expects to terminate the swaps when the debt is issued. Upon termination of the swaps, any unrealized gain or loss on these swaps will be amortized into interest expense over the life of the debt.

        The Company uses purchased interest rate floors to hedge the variable cash flows associated with 1-month or 3-month LIBOR indexed loans. Payments received under the floor contract offset the decline in loan interest income if the relevant LIBOR index falls below the floor's strike rate.

        The Company uses interest rate floor corridors to hedge the variable cash flows associated with 1-month or 3-month LIBOR indexed loans. Net payments to be received under the floor corridor contracts offset the decline in loan interest income if the relevant LIBOR index falls below the corridor's upper strike rate but only to the extent the index remains above the lower strike rate. The corridor will not provide protection from declines in the relevant LIBOR index to the extent it falls below the corridor's lower strike rate.

        The Company uses interest rate collars to hedge the variable cash flows associated with 1-month or 3-month LIBOR indexed loans. Net payments received under the collar contract offset declines in loan interest income if the relevant LIBOR index falls below the collar's floor strike rate, while net payments paid reduce the increase in loan interest income if the LIBOR index rises above the collar's cap strike rate.

        The Company uses interest rate swaps to hedge the variable cash flows associated with 1-month or 3-month LIBOR indexed loans. Payments received (or paid) under the swap contract offset fluctuations in loan interest income caused by changes in the relevant LIBOR index. As such, these instruments hedge all fluctuations in the loans' interest income caused by changes in the relevant LIBOR index.

        The Company uses purchased interest rate caps to hedge the variable interest cash flows associated with 1-month or 3-month LIBOR indexed borrowings. Payments received under the cap contract offset the increase in borrowing interest expense if the relevant LIBOR index rises above the cap's strike rate.

        The Company uses purchased interest rate caps to hedge the variable interest cash flows associated with the forecasted issuance and rollover of short-term, fixed rate CDs. In these hedging relationships, the Company hedges the change in interest rates based on 1-month, 3-month, and 6-month LIBOR, which is consistent with the CDs' original term to maturity and reflects their repricing frequency. Net payments to be received under the cap contract offset increases in interest expense caused by the relevant LIBOR index rising above the cap's strike rate.

        The Company uses interest rate cap corridors to hedge the variable cash flows associated with the forecasted issuance and rollover of short-term, fixed rate CDs. In these hedging relationships, the Company hedges changes in interest rates, either 1-month, 3-month, or 6-month LIBOR, based on the original term to maturity of the CDs. Net payments received under the cap corridor contract offset increases in deposit interest expense caused by the relevant LIBOR index rising above the corridor's lower strike rate but only to the extent

49


Table of Contents


UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 14—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)


the index does not exceed the upper strike rate. The corridor will not provide protection from increases in the relevant LIBOR index to the extent it rises above the corridor's upper strike rate.

        Hedging transactions are structured at inception so that the notional amounts of the hedging instruments are matched to an equal principal amount of loans, CDs, or borrowings, the index and repricing frequencies of the hedging instruments match those of the loans, CDs, or borrowings and the period in which the designated hedged cash flows occurs is equal to the term of the hedge instruments. As such, most of the ineffectiveness in the hedging relationship results from the mismatch between the timing of reset dates on the hedging instruments versus those of the loans, CDs or borrowings.

        For cash flow hedges, the effective portion of the gain or loss on the hedging instruments is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged cash flows are recognized in net interest income. Gains and losses representing hedge ineffectiveness or hedge components excluded from the assessment of hedge effectiveness are recognized in noninterest expense in the period in which they arise. Based upon amounts included in accumulated other comprehensive income at September 30, 2010, the Company expects to realize approximately $1.3 million in net interest income during the twelve months ending September 30, 2011. This amount could differ from amounts actually realized due to changes in interest rates and the addition of other hedges subsequent to September 30, 2010.

        The following tables present the amount and location of the net gains and losses recorded in the Company's consolidated statements of income and changes in stockholder's equity for derivatives designated as cash flow hedges for the three and nine months ended September 30, 2009 and September 30, 2010.

 
  Amount of Gain or
(Loss) Recognized in
OCI on Derivative
Instruments
(Effective Portion)
  Gain or (Loss) Reclassified
from Accumulated OCI into
Income (Effective Portion)
  Gain or (Loss) Recognized in
Income on Derivative
Instruments (Ineffective
Portion and Amount Excluded
from Effectiveness Testing)
 
 
  For the Three Months
Ended September 30,
   
  For the Three Months
Ended September 30,
   
  For the Three Months
Ended September 30,
 
(Dollars in thousands)   2009   2010   Location   2009   2010   Location   2009   2010  

Derivatives in cash flow hedging relationships

                                             

              Interest income   $ 34,110   $ 15,143                  
 

Interest rate contracts

  $ 6,715   $ (14,945 ) Interest expense           Noninterest expense   $ 2   $  
                                   
   

Total

  $ 6,715   $ (14,945 )     $ 34,110   $ 15,143       $ 2   $  
                                   

50


Table of Contents


UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 14—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)


 
  Amount of Gain or
(Loss) Recognized in
OCI on Derivative
Instruments
(Effective Portion)
  Gain or (Loss) Reclassified
from Accumulated OCI into
Income (Effective Portion)
  Gain or (Loss) Recognized in
Income on Derivative
Instruments (Ineffective
Portion and Amount Excluded
from Effectiveness Testing)
 
 
  For the Nine Months
Ended September 30,
   
  For the Nine Months
Ended September 30,
   
  For the Nine Months
Ended September 30,
 
(Dollars in thousands)   2009   2010   Location   2009   2010   Location   2009   2010  

Derivatives in cash flow hedging relationships

                                             

              Interest income   $ 99,446   $ 52,524                  
 

Interest rate contracts

  $ 42,372   $ (29,648 ) Interest expense     15       Noninterest expense   $ 77   $ (5 )
                                   
   

Total

  $ 42,372   $ (29,648 )     $ 99,461   $ 52,524       $ 77   $ (5 )
                                   

        In the third quarter of 2010, the Company began hedging $966.8 million of fixed rate available for sale securities. The company entered into $966.8 million of interest rate swaps to hedge the changes in fair value of certain fixed rate debt securities held as available for sale. The changes in value of the fixed rate securities and swaps are recorded to securities gains (losses), net, and any ineffectiveness on the hedge is recorded to noninterest expense.

        The following table presents the amount and location of the net gains and losses as reported in the consolidated statement of income for derivative instruments classified as hedging instruments and the related hedged item for the three and nine months ended September 30, 2010.

 
  Gain or (Loss) Recognized  
(Dollars in thousands)   Location   For the Three and Nine Months Ended
September 30, 2010
 
 

Fair Value Interest Rate Contract

  Securities gains (losses), net   $ (6,286 )
 

Fixed Rate Securities

  Securities gains (losses), net     6,286  
 

Hedge Ineffectiveness

  Noninterest expense      
           

Total

      $  
           

        Derivative instruments classified as trading include both derivatives entered into for the Company's own account and as an accommodation for customers. Derivatives held for trading purposes are included in trading assets or trading liabilities with changes in fair value reflected in trading income or losses. The majority of the Company's derivative transactions for customers were essentially offset by contracts with third parties that reduce or eliminate market risk exposures.

        The Company offers market-linked certificates of deposit, which allow the client to earn the higher of either a minimum fixed rate of interest or a return tied to either equity, commodity or currency indices. The

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 14—Derivative Instruments and Other Financial Instruments Used For Hedging (Continued)


Company hedges its exposure to the embedded derivative contained in market-linked CDs with a perfectly matched over-the-counter call option. Both the embedded derivative and call option are recorded at fair value with the realized and unrealized changes in fair value recorded in noninterest income within trading account activities.

        The following tables present the amount and location of the net gains and losses reported in the consolidated statement of income for derivative instruments classified as trading and derivatives used as economic hedges for the three and nine months ended September 30, 2009 and September 30, 2010.

 
  Gain or (Loss) Recognized in Income on Derivative Instruments  
(Dollars in thousands)   Location   For the Three Months Ended
September 30, 2009
  For the Nine Months Ended
September 30, 2009
 

Trading Derivatives and Economic Hedges:

                 
   

Interest rate contracts

  Trading account activities   $ (3,972 ) $ 4,561  
   

Foreign exchange contracts

  Trading account activities     9,171     26,618  
   

Commodity contracts

  Trading account activities     (824 )   (371 )
   

Equity contracts

  Trading account activities     659     1,767  
               

Total

      $ 5,034   $ 32,575  
               

 

 
  Gain or (Loss) Recognized in Income on Derivative Instruments  
(Dollars in thousands)   Location   For the Three Months Ended
September 30, 2010
  For the Nine Months Ended
September 30, 2010
 

Trading Derivatives and Economic Hedges:

                 
   

Interest rate contracts

  Trading account activities   $ 16,473   $ 24,508  
   

Foreign exchange contracts

  Trading account activities     6,311     23,006  
   

Commodity contracts

  Trading account activities     1,206     6,438  
   

Equity contracts

  Trading account activities     3,820     9,941  
               

Total

      $ 27,810   $ 63,893  
               

52


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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)


Note 15—Accumulated Other Comprehensive Loss

        The following table presents the change in each of the components of other comprehensive loss and the related tax effect of the change allocated to each component.

(Dollars in thousands)   Before
Tax
Amount
  Tax
Effect
  Net of
Tax
 

For the Nine Months Ended September 30, 2009:

                   

Cash flow hedge activities:

                   
 

Unrealized net gains on hedges arising during the period

  $ 42,372   $ (16,648 ) $ 25,724  
 

Less: accretion of privatization-related fair value adjustment

    10,829     (4,088 )   6,741  
 

Less: reclassification adjustment for net gains on hedges included in net income

    (110,290 )   43,333     (66,957 )
               

Net change in unrealized gains on hedges

    (57,089 )   22,597     (34,492 )
               

Securities:

                   
 

Unrealized holding gains arising during the period on securities available for sale

    182,191     (71,583 )   110,608  
 

Reclassification adjustment for net gains on securities available for sale included in net income

    (13,303 )   5,227     (8,076 )
 

Less: accretion of privatization-related fair value adjustment on securities available for sale

    (10,567 )   4,152     (6,415 )
 

Less: accretion of privatization-related fair value adjustment on held-to-maturity securities

    (13,021 )   5,116     (7,905 )
 

Less: accretion of net unrealized losses on held to maturity securities

    53,609     (21,063 )   32,546  
               

Net change in unrealized losses on securities

    198,909     (78,151 )   120,758  
               

Foreign currency translation adjustment

    1,787     (702 )   1,085  
               

Reclassification adjustment for pension and other benefits included in net income:

                   
 

Amortization of prior service costs

    (47 )   18     (29 )
 

Amortization of transition amount

    983     (386 )   597  
 

Recognized net actuarial loss

    15,853     (6,229 )   9,624  
               

Net change in pension and other benefits

    16,789     (6,597 )   10,192  
               

Net change in accumulated other comprehensive loss

  $ 160,396   $ (62,853 ) $ 97,543  
               

For the Nine Months Ended September 30, 2010:

                   

Cash flow hedge activities:

                   
 

Unrealized net losses on hedges arising during the period

  $ (29,648 ) $ 11,649   $ (17,999 )
 

Less: accretion of privatization-related fair value adjustment

    2,377     (934 )   1,443  
 

Less: Reclassification adjustment for net gains on hedges included in net income

    (54,901 )   21,571     (33,330 )
               

Net change in unrealized gains on hedges

    (82,172 )   32,286     (49,886 )
               

Securities:

                   
 

Cumulative effect from change in accounting for embedded credit derivatives

    10,660     (4,188 )   6,472  
 

Unrealized holding gains arising during the period on securities available for sale

    338,046     (132,818 )   205,228  
 

Reclassification adjustment for net gains on securities available for sale included in net income

    (71,839 )   28,226     (43,613 )
 

Less: accretion of privatization-related fair value adjustment on securities available for sale

    (2,024 )   795     (1,229 )
 

Less: accretion of privatization-related fair value adjustment on held to maturity securities

    (19,643 )   7,718     (11,925 )
 

Less: accretion of net unrealized losses on held to maturity securities

    68,817     (27,038 )   41,779  
               

Net change in unrealized losses on securities

    324,017     (127,305 )   196,712  
               

Foreign currency translation adjustment

    752     (295 )   457  
               

Reclassification adjustment for pension and other benefits included in net income:

                   
 

Amortization of prior service costs

    (47 )   18     (29 )
 

Amortization of transition amount

    983     (386 )   597  
 

Recognized net actuarial loss

    15,829     (5,357 )   10,472  
               

Net change in pension and other benefits

    16,765     (5,725 )   11,040  
               

Net change in accumulated other comprehensive loss

  $ 259,362   $ (101,039 ) $ 158,323  
               

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 15—Accumulated Other Comprehensive Loss (Continued)

        The following table presents the change in accumulated other comprehensive loss balances.

(Dollars in thousands)   Net
Unrealized
Gains (Losses)
on Cash Flow
Hedges
  Net
Unrealized
Gains (Losses)
on Securities
  Foreign
Currency
Translation
Adjustment
  Pension and
Other
Benefits
Adjustment
  Accumulated
Other
Comprehensive
Loss
 

Balance, December 31, 2008

  $ 73,308   $ (352,710 ) $ (1,113 ) $ (531,336 ) $ (811,851 )

Change during the period

    (34,492 )   120,758     1,085     10,192     97,543  
                       

Balance, September 30, 2009

  $ 38,816   $ (231,952 ) $ (28 ) $ (521,144 ) $ (714,308 )
                       

Balance, December 31, 2009

  $ 19,298   $ (296,309 ) $ 263   $ (374,114 ) $ (650,862 )

Change during the period

    (49,886 )   196,712     457     11,040     158,323  
                       

Balance, September 30, 2010

  $ (30,588 ) $ (99,597 ) $ 720   $ (363,074 ) $ (492,539 )
                       


Note 16—Commitments, Contingencies and Guarantees

        The following table summarizes the Company's significant commitments.

(Dollars in thousands)   September 30, 2010  

Commitments to extend credit

  $ 22,491,379  

Standby letters of credit

    4,891,369  

Standby bond purchase agreements

    75,838  

Commercial letters of credit

    51,828  

Commitments to fund principal investments

    85,572  

Commitments to fund LIHC investments

    120,209  

Commitments to fund CLO securities

    11,339  

        Commitments to extend credit are legally binding agreements to lend to a customer provided there are no violations of any condition established in the contract. Commitments have fixed expiration dates or other termination clauses and may require maintenance of compensatory balances. Since many of the commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements.

        Standby and commercial letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party, while commercial letters of credit are issued specifically to facilitate foreign or domestic trade transactions. Standby bond purchase agreements are commitments to purchase bonds in the event that our customer's bonds cannot be remarketed. Additionally, the Company enters into risk participations in bankers' acceptances wherein a fee is received to guarantee a portion of the credit risk on an acceptance of another bank. The majority of these types of commitments have terms of one year or less. At September 30, 2010, the carrying value of the Company's risk participations in bankers' acceptances, standby bond purchase agreements and standby and commercial letters of credit totaled $6.4 million. Estimated exposure to loss related to these commitments is covered by the allowance for losses on off-balance sheet commitments. The carrying value of the standby and

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 16—Commitments, Contingencies and Guarantees (Continued)


commercial letters of credit and the allowance for losses on off-balance sheet commitments are included in other liabilities on the consolidated balance sheet.

        The credit risk involved in issuing loan commitments and standby and commercial letters of credit is essentially the same as that involved in extending loans to customers and is represented by the contractual amount of these instruments. Collateral may be obtained based on management's credit assessment of the customer.

        Principal investments include direct investments in private and public companies and indirect investments in private equity funds. The Company issues commitments to provide equity and mezzanine capital financing to private and public companies through either direct investments in specific companies or through investment funds and partnerships. The timing of future cash requirements to fund such commitments is generally dependent on the investment cycle. This cycle, the period over which privately-held companies are funded by private equity investors and ultimately sold, merged, or taken public through an initial offering, can vary based on overall market conditions as well as the nature and type of industry in which the companies operate.

        The Company invests in either guaranteed or unguaranteed LIHC investments. The guaranteed LIHC investments carry a minimum rate of return guarantee by a creditworthy entity. The unguaranteed LIHC investments carry partial guarantees covering the timely completion of projects, availability of tax credits and operating deficit thresholds from the issuer. For these LIHC investments, the Company has committed to provide additional funding as stipulated by its investment participation.

        The Company is a fund manager for limited liability companies issuing LIHC investments. LIHC investments provide tax benefits to investors in the form of tax deductions from operating losses and tax credits. To facilitate the sale of these LIHC investments, the Company guarantees a minimum rate of return throughout the investment term of over a twelve-year weighted average period. Additionally, the Company receives guarantees, which include the timely completion of projects, availability of tax credits and operating deficit thresholds, from the limited liability partnerships/corporations issuing the LIHC investments that reduce the Company's ultimate exposure to loss. As of September 30, 2010, the Company's maximum exposure to loss under these guarantees is limited to a return of investor capital and minimum investment yield, or $206.3 million. The risk that the Company would be required to pay investors for a yield deficiency is low, based on the continued satisfactory performance of the underlying properties. At September 30, 2010, the Company had a reserve of $7.4 million recorded related to these guarantees, which represents the remaining unamortized fair value of the guarantee fees that were recognized at inception. For information on the Company's LIHC investments that were consolidated, refer to Note 7 to these consolidated financial statements.

        The Company guarantees its subsidiaries' leveraged lease transactions with terms ranging from fifteen to thirty years. Following the original funding of these leveraged lease transactions, the Company does not have any material obligation to be satisfied. As of September 30, 2010, we had no exposure to loss for these agreements.

        The Company conducts securities lending transactions for institutional customers as a fully disclosed agent. At times, securities lending indemnifications are issued to guarantee that a security lending customer will be made whole in the event the borrower does not return the security subject to the lending agreement and collateral held is insufficient to cover the market value of the security. All lending transactions are

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 16—Commitments, Contingencies and Guarantees (Continued)


collateralized, primarily by cash. The amount of securities lent with indemnifications was $1.9 billion at September 30, 2010. The market value of the associated collateral was $2.0 billion at September 30, 2010. As of September 30, 2010, the Company had no exposure that would require it to pay under this securities lending indemnification, since the collateral market value exceeded the securities lent.

        The Company occasionally enters into financial guarantee contracts where a premium is received from another financial institution counterparty to guarantee a portion of the credit risk on interest rate swap contracts entered into between the financial institution and its customer. The Company becomes liable to pay the financial institution only if the financial institution is unable to collect amounts owed to them by their customer. As of September 30, 2010, the maximum exposure to loss under these contracts totaled $48.1 million. The risk that the Company would be required to perform under these guarantees varies based on the creditworthiness of the other financial institution's customer. Credit risk grades are assigned by the Company based on the estimated probability of default. The risk of default is considered low for those with superior to good credit ratings, moderate for those with satisfactory to adequate credit ratings, and high for those considered special mention, substandard, doubtful and loss. Based on these criteria, at September 30, 2010, the Company had a maximum exposure to loss under these contracts with a low, moderate, and high risk of payment exposure of $1.2 million, $32.9 million, and $14.0 million, respectively. At September 30, 2010, the Company maintained a reserve of $2.1 million for losses related to these guarantees.

        The Company is subject to various pending and threatened legal actions that arise in the normal course of business. Reserves for losses from legal actions that are both probable and estimable are recorded at the time of that determination. Management believes that the disposition of all claims currently pending will not have a material adverse effect on the Company's consolidated financial condition, operating results or liquidity.


Note 17—Business Segments

        As a result of a corporate reorganization in the fourth quarter of 2009, the Company reevaluated its business segments. Under the new organizational structure, the Company has three operating segments: Retail Banking Group, Corporate Banking Group and Pacific Rim Corporate Group. The Corporate Banking Group and Pacific Rim Corporate Group segments have been aggregated together. The Company has two reportable business segments: Retail Banking and Corporate Banking.

        Prior to this reorganization, the various operating segments were aggregated into two reportable business segments formerly known as "Retail Banking" and "Wholesale Banking." The Company's new reportable business segment structure is similar to the previous structure. However, the Global and Wealth Markets division, which was previously included in Retail Banking, is now included in Corporate Banking. Additionally, the goodwill, intangible assets, and related amortization/accretion associated with the privatization transaction, which was previously allocated to the Company's operating segments, is reported in "Other."

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 17—Business Segments (Continued)

        "Other" is comprised of certain non-bank subsidiaries of UnionBanCal Corporation; the transfer pricing center; the amount of the provision for credit losses over/(under) the risk-adjusted return on capital (RAROC) expected loss for the period; the residual costs of support groups; goodwill, intangible assets, and the related amortization/accretion associated with the Company's privatization transaction; the elimination of the fully taxable-equivalent basis amount; and the difference between the marginal tax rate and the consolidated effective tax rate. In addition, "Other" includes Corporate Treasury, which is responsible for Asset-Liability Management (ALM), wholesale funding, and the ALM investment securities and derivatives hedging portfolios.

        The information, set forth in the tables that follow, is prepared using various management accounting methodologies to measure the performance of the individual segments. Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to US GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies, and they are not necessarily indicative of the results that would be reported by our business units if they were unique economic entities. The management reporting accounting methodologies, which are enhanced from time to time, measure segment profitability by assigning balance sheet and income statement items to each operating segment. Methodologies that are applied to the measurement of segment profitability include:

        The Company reflects a "market view" perspective in measuring the business segments. The market view is a measurement of customer markets aggregated to show all revenues generated and expenses incurred from all products and services sold to those customers regardless of where product areas organizationally report. Therefore, revenues and expenses are included in both the business segment that provides the service and the business segment that manages the customer relationship. The duplicative results from this internal management accounting view are reflected in "Reconciling Items."

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 17—Business Segments (Continued)

        The business segment results for prior periods have been restated to reflect changes in the transfer pricing methodology, the organizational changes that have occurred and the market view contribution.

 
  Retail Banking   Corporate Banking  
 
  As of and for the
Three Months Ended
September 30,
  As of and for the
Three Months Ended
September 30,
 
 
  2009   2010   2009   2010  

Results of operations—Market View (dollars in thousands):

                         
 

Net interest income (expense)

  $ 220,970   $ 272,579   $ 353,514   $ 380,515  
 

Noninterest income (expense)

    73,080     67,309     116,817     136,375  
                   
 

Total revenue

    294,050     339,888     470,331     516,890  
 

Noninterest expense (income)

    212,561     235,146     241,541     246,266  
 

Credit expense (income)

    7,016     6,760     91,512     65,079  
                   
 

Income (loss) before income taxes and including noncontrolling interests

    74,473     97,982     137,278     205,545  
 

Income tax expense (benefit)

    29,119     38,311     32,191     55,787  
                   
 

Net income (loss) including noncontrolling interests

    45,354     59,671     105,087     149,758  
 

Less: Net income (loss) from noncontrolling interests

                 
                   
 

Net income (loss) attributable to UNBC

  $ 45,354   $ 59,671   $ 105,087   $ 149,758  
                   
 

Total assets, end of period—Market View (dollars in millions):

  $ 22,341   $ 23,041   $ 32,446   $ 30,132  
                   

 

 
  Other   Reconciling Items   UnionBanCal Corporation  
 
  As of and for the
Three Months Ended
September 30,
  As of and for the
Three Months Ended
September 30,
  As of and for the
Three Months Ended
September 30,
 
 
  2009   2010   2009   2010   2009   2010  

Results of operations—Market View (dollars in thousands):

                                     
 

Net interest income (expense)

  $ 5,041   $ (18,413 ) $ (18,489 ) $ (16,626 ) $ 561,036   $ 618,055  
 

Noninterest income (expense)

    8,939     28,440     (14,907 )   (14,181 )   183,929     217,943  
                           
 

Total revenue

    13,980     10,027     (33,396 )   (30,807 )   744,965     835,998  
 

Noninterest expense (income)

    62,065     93,316     (10,352 )   (12,109 )   505,815     562,619  
 

Credit expense (income)

    215,609     (63,654 )   (137 )   (185 )   314,000     8,000  
                           
 

Income (loss) before income taxes and including noncontrolling interests

    (263,694 )   (19,635 )   (22,907 )   (18,513 )   (74,850 )   265,379  
 

Income tax expense (benefit)

    (110,174 )   12,528     (8,957 )   (7,238 )   (57,821 )   99,388  
                           
 

Net income (loss) including noncontrolling interests

    (153,520 )   (32,163 )   (13,950 )   (11,275 )   (17,029 )   165,991  
 

Less: Net income (loss) from noncontrolling interests

        (3,788 )               (3,788 )
                           
 

Net income (loss) attributable to UNBC

  $ (153,520 ) $ (28,375 ) $ (13,950 ) $ (11,275 ) $ (17,029 ) $ 169,779  
                           
 

Total assets, end of period—Market View (dollars in millions):

  $ 25,210   $ 28,648   $ (1,844 ) $ (1,979 ) $ 78,153   $ 79,842  
                           

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UnionBanCal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Continued)

(Unaudited)

Note 17—Business Segments (Continued)

 

 
  Retail Banking   Corporate Banking  
 
  As of and for the
Nine Months Ended
September 30,
  As of and for the
Nine Months Ended
September 30,
 
 
  2009   2010   2009   2010  

Results of operations—Market View (dollars in thousands):

                         
 

Net interest income (expense)

  $ 617,423   $ 777,951   $ 963,444   $ 1,147,410  
 

Noninterest income (expense)

    212,440     207,757     363,144     398,798  
                   
 

Total revenue

    829,863     985,708     1,326,588     1,546,208  
 

Noninterest expense (income)

    614,598     681,324     654,548     735,727  
 

Credit expense (income)

    21,353     20,115     246,798     218,020  
                   
 

Income (loss) before income taxes and including noncontrolling interests

    193,912     284,269     425,242     592,461  
 

Income tax expense (benefit)

    75,820     111,149     101,998     160,868  
                   
 

Net income (loss) including noncontrolling interests

    118,092     173,120     323,244     431,593  
 

Less: Net income (loss) from noncontrolling interests

                 
                   
 

Net income (loss) attributable to UNBC

  $ 118,092   $ 173,120   $ 323,244   $ 431,593  
                   
 

Total assets, end of period—Market View (dollars in millions):

  $ 22,341   $ 23,041   $ 32,446   $ 30,132  
                   

 

 
  Other   Reconciling Items   UnionBanCal Corporation  
 
  As of and for the
Nine Months Ended
September 30,
  As of and for the
Nine Months Ended
September 30,
  As of and for the
Nine Months Ended
September 30,
 
 
  2009   2010   2009   2010   2009   2010  

Results of operations—Market View (dollars in thousands):

                                     
 

Net interest income (expense)

  $ 133,791   $ (84,741 ) $ (43,273 ) $ (47,819 ) $ 1,671,385   $ 1,792,801  
 

Noninterest income (expense)

    2,385     107,392     (36,111 )   (41,805 )   541,858     672,142  
                           
 

Total revenue

    136,176     22,651     (79,384 )   (89,624 )   2,213,243     2,464,943  
 

Noninterest expense (income)

    317,518     289,754     (27,408 )   (35,414 )   1,559,256     1,671,391  
 

Credit expense (income)

    655,323     (15,672 )   (474 )   (463 )   923,000     222,000  
                           
 

Income (loss) before income taxes and including noncontrolling interests

    (836,665 )   (251,431 )   (51,502 )   (53,747 )   (269,013 )   571,552  
 

Income tax expense (benefit)

    (319,850 )   (69,949 )   (20,137 )   (21,015 )   (162,169 )   181,053  
                           
 

Net income (loss) including noncontrolling interests

    (516,815 )   (181,482 )   (31,365 )   (32,732 )   (106,844 )   390,499  
 

Less: Net income (loss) from noncontrolling interests

        (10,383 )               (10,383 )
                           
 

Net income (loss) attributable to UNBC

  $ (516,815 ) $ (171,099 ) $ (31,365 ) $ (32,732 ) $ (106,844 ) $ 400,882  
                           
 

Total assets, end of period—Market View (dollars in millions):

  $ 25,210   $ 28,648   $ (1,844 ) $ (1,979 ) $ 78,153   $ 79,842  
                           


Note 18—Subsequent Events

        The Company has evaluated the potential disclosure of subsequent events through the filing date of this Form 10-Q and has determined that there are no subsequent events required to be disclosed.

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Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations

UnionBanCal Corporation and Subsidiaries
Consolidated Financial Highlights

 
  As of and for the
Three Months Ended
   
 
(Dollars in thousands)   September 30,
2009
  September 30,
2010
  Percent
Change
 

Results of operations:

                   
 

Net interest income(1)

  $ 564,296     620,639     9.98 %
 

Provision for loan losses

    314,000     8,000     (97.45 )
 

Noninterest income

    183,929     217,943     18.49  
 

Noninterest expense

    505,815     562,619     11.23  
                 
 

Income (loss) before income taxes and including noncontrolling interests(1)

    (71,590 )   267,963     nm  
 

Taxable-equivalent adjustment

    3,260     2,584     (20.74 )
 

Income tax expense (benefit)

    (57,821 )   99,388     nm  
                 
 

Net income (loss) including noncontrolling interests

    (17,029 )   165,991     nm  
 

Deduct: Net loss from noncontrolling interests

        3,788     nm  
                 
 

Net income (loss) attributable to UnionBanCal Corporation (UNBC)

  $ (17,029 ) $ 169,779     nm  
                 

Balance sheet (end of period):

                   
 

Total assets

  $ 78,153,207   $ 79,842,077     2.16 %
 

Total securities(2)

    19,403,911     19,630,520     1.17  
 

Total loans

    48,169,508     47,911,109     (0.54 )
 

Nonperforming assets

    1,367,691     1,509,720     10.38  
 

Total deposits

    60,691,368     61,540,546     1.40  
 

Long-term debt

    5,135,193     4,457,830     (13.19 )
 

UNBC Stockholder's equity

    9,475,004     10,134,681     6.96  

Balance sheet (period average):

                   
 

Total assets

  $ 74,352,649   $ 82,265,037     10.64 %
 

Total securities(2)

    10,774,972     22,486,682     nm  
 

Total loans

    48,764,826     48,104,954     (1.35 )
 

Earning assets

    68,235,083     74,497,629     9.18  
 

Total deposits

    59,453,936     64,822,479     9.03  
 

UNBC Stockholder's equity

    7,358,773     9,912,847     34.71  

Financial ratios:

                   
 

Return on average assets(3)

    (0.09 )%   0.82 %      
 

Return on average UNBC stockholder's equity(3)

    (0.92 )   6.80        
 

Core efficiency ratio(4)

    65.07     63.69        
 

Net interest margin(1)(3)

    3.31     3.33        
 

Tier 1 risk-based capital ratio

    11.60     12.27        
 

Total risk-based capital ratio

    14.42     14.97        
 

Leverage ratio

    10.39     9.86        
 

Tier 1 common capital ratio(6)

    11.58     12.25        
 

Tangible common equity ratio(5)

    8.94     9.59        
 

Allowance for loan losses to total loans(7)

    2.62     2.67        
 

Allowance for loan losses to nonaccrual loans(7)

    95.15     96.79        
 

Allowance for credit losses to total loans(8)

    2.97     3.01        
 

Allowance for credit losses to nonaccrual loans(8)

    108.16     109.25        
 

Net loans charged off to average total loans(3)

    1.11     0.74        
 

Nonperforming assets to total loans, OREO and distressed loans held for sale

    2.84     3.14        
 

Nonperforming assets to total assets

    2.75     1.89        
 

Nonaccrual loans to total loans

    1.75     2.75        

Excluding FDIC covered assets(9):

                   
 

Allowance for loan losses to total loans(7)

    N/A     2.76 %      
 

Allowance for loan losses to nonaccrual loans(7)

    N/A     110.48        
 

Allowance for credit losses to total loans(8)

    N/A     3.12        
 

Allowance for credit losses to nonaccrual loans(8)

    N/A     124.70        
 

Net loans charged off to average total loans(3)

    N/A     0.77        
 

Nonperforming assets to total loans, OREO and distressed loans held for sale

    N/A     2.60        
 

Nonperforming assets to total assets

    N/A     1.54        
 

Nonaccrual loans to total loans

    N/A     2.50        

(1)
Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
(2)
Total securities consist of securities available for sale and securities held to maturity.
(3)
Annualized.
(4)
The core efficiency ratio is net noninterest expense (noninterest expense excluding foreclosed asset expense (income), the provision for (reversal of) losses on off-balance sheet commitments, LIHC investment amortization expense, expenses of the consolidated variable interest entities (VIEs) and merger costs related to the acquisitions of certain assets and liabilities of Frontier and Tamalpais), as a percentage of total revenue (net interest income (taxable-equivalent basis) and noninterest income). Refer to "Noninterest Expense" in this Form 10-Q for further information.
(5)
The tangible common equity ratio, a non-GAAP financial measure, is calculated as tangible equity divided by tangible assets. The methodology of determining tangible common equity may differ among companies. The tangible common equity ratio has been included to facilitate the understanding of the Company's capital structure and for use in assessing and comparing the quality and composition of UNBC's capital structure to other financial institutions. Refer to "Capital" in this Form 10-Q for further information.
(6)
The Tier 1 common capital ratio is the ratio of Tier 1 capital, less qualifying trust preferred securities, to risk weighted assets. The Tier 1 common capital ratio, a non-GAAP financial measure, has been included to facilitate the understanding of the Company's capital structure and for use in assessing and comparing the quality and composition of UNBC's capital structure to other financial institutions. Refer to "Capital" in this Form 10-Q for further information.
(7)
The allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans or total nonaccrual loans, as appropriate.
(8)
The allowance for credit losses ratios are calculated using the sum of the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans or total nonaccrual loans, as appropriate.
(9)
These ratios exclude the impact of the acquired loans and OREO, which are covered under loss share agreements between Union Bank, N.A. and the FDIC. Such agreements are related to the April 2010 acquisitions of certain assets and assumption of certain liabilities of Frontier and Tamalpais.

nm = not meaningful

N/A = not applicable for periods prior to the April 2010 Frontier and Tamalpais transactions.

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UnionBanCal Corporation and Subsidiaries
Consolidated Financial Highlights

 
  As of and for the
Nine Months Ended
   
 
(Dollars in thousands)   September 30,
2009
  September 30,
2010
  Percent
Change
 

Results of operations:

                   
 

Net interest income(1)

  $ 1,680,010   $ 1,800,208     7.15 %
 

Provision for loan losses

    923,000     222,000     (75.95 )
 

Noninterest income

    541,858     672,142     24.04  
 

Noninterest expense

    1,559,256     1,671,391     7.19  
                 
 

Income (loss) before income taxes and including noncontrolling interests(1)

    (260,388 )   578,959     nm  
 

Taxable-equivalent adjustment

    8,625     7,407     (14.12 )
 

Income tax expense (benefit)

    (162,169 )   181,053     nm  
                 
 

Net income (loss) including noncontrolling interests

    (106,844 )   390,499     nm  
 

Deduct: Net loss from noncontrolling interests

        10,383     nm  
                 
 

Net income (loss) attributable to UNBC

  $ (106,844 ) $ 400,882     nm  
                 

Balance sheet (end of period):

                   
 

Total assets

  $ 78,153,207   $ 79,842,077     2.16 %
 

Total securities(2)

    19,403,911     19,630,520     1.17  
 

Total loans

    48,169,508     47,911,109     (0.54 )
 

Nonperforming assets

    1,367,691     1,509,720     10.38  
 

Total deposits

    60,691,368     61,540,546     1.40  
 

Long-term debt

    5,135,193     4,457,830     (13.19 )
 

UNBC Stockholder's equity

    9,475,004     10,134,681     6.96  

Balance sheet (period average):

                   
 

Total assets

  $ 71,000,250   $ 84,185,942     18.57 %
 

Total securities(2)

    9,261,342     23,036,729     nm  
 

Total loans

    49,366,280     47,597,790     (3.58 )
 

Earning assets

    64,593,827     76,967,666     19.16  
 

Total deposits

    53,526,802     66,910,632     25.00  
 

UNBC Stockholder's equity

    7,332,747     9,693,370     32.19  

Financial ratios:

                   
 

Return on average assets(3)

    (0.20 )%   0.64 %      
 

Return on average UNBC stockholder's equity(3)

    (1.95 )   5.53        
 

Core efficiency ratio(4)

    66.34     64.50        
 

Net interest margin(1)(3)

    3.47     3.12        
 

Tier 1 risk-based capital ratio

    11.60     12.27        
 

Total risk-based capital ratio

    14.42     14.97        
 

Leverage ratio

    10.39     9.86        
 

Tier 1 common capital ratio(6)

    11.58     12.25        
 

Tangible common equity ratio(5)

    8.94     9.59        
 

Allowance for loan losses to total loans(7)

    2.62     2.67        
 

Allowance for loan losses to nonaccrual loans(7)

    95.15     96.79        
 

Allowance for credit losses to total loans(8)

    2.97     3.01        
 

Allowance for credit losses to nonaccrual loans(8)

    108.16     109.25        
 

Net loans charged off to average total loans(3)

    1.10     0.85        
 

Nonperforming assets to total loans, OREO and distressed loans held for sale

    2.84     3.14        
 

Nonperforming assets to total assets

    1.75     1.89        
 

Nonaccrual loans to total loans

    1.75     2.75        

Excluding FDIC covered assets(9):

                   
 

Allowance for loan losses to total loans(7)

    N/A     2.76 %      
 

Allowance for loan losses to nonaccrual loans(7)

    N/A     110.48        
 

Allowance for credit losses to total loans(8)

    N/A     3.12        
 

Allowance for credit losses to nonaccrual loans(8)

    N/A     124.70        
 

Net loans charged off to average total loans(3)

    N/A     0.87        
 

Nonperforming assets to total loans, OREO and distressed loans held for sale

    N/A     2.60        
 

Nonperforming assets to total assets

    N/A     1.54        
 

Nonaccrual loans to total loans

    N/A     2.50        

(1)
Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
(2)
Total securities consist of securities available for sale and securities held to maturity.
(3)
Annualized.
(4)
The core efficiency ratio is net noninterest expense (noninterest expense excluding foreclosed asset expense (income), the provision for (reversal of) losses on off-balance sheet commitments, LIHC investment amortization expense, expenses of the consolidated VIEs and merger costs related to the acquisitions of certain assets and liabilities of Frontier and Tamalpais), as a percentage of total revenue (net interest income (taxable-equivalent basis) and noninterest income). Refer to "Nointerest Expense" in this Form 10-Q for further information.
(5)
The tangible common equity ratio, a non-GAAP financial measure, is calculated as tangible equity divided by tangible assets. The methodology of determining tangible common equity may differ among companies. The tangible common equity ratio has been included to facilitate the understanding of the Company's capital structure and for use in assessing and comparing the quality and composition of UNBC's capital structure to other financial institutions. Refer to "Capital" in this Form 10-Q for further information.
(6)
The Tier 1 common capital ratio is the ratio of Tier 1 capital, less qualifying trust preferred securities, to risk weighted assets. The Tier 1 common capital ratio, a non-GAAP financial measure, has been included to facilitate the understanding of the Company's capital structure and for use in assessing and comparing the quality and composition of UNBC's capital structure to other financial institutions. Refer to "Capital" in this Form 10-Q for further information.
(7)
The allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans or total nonaccrual loans, as appropriate.
(8)
The allowance for credit losses ratios are calculated using the sum of the allowance for loan losses and for losses on off-balance sheet commitments against end of period total loans or total nonaccrual loans, as appropriate.
(9)
These ratios exclude the impact of the acquired loans and OREO, which are covered under loss share agreements between Union Bank, N.A. and the FDIC. Such agreements are related to the April 2010 acquisitions of certain assets and assumption of certain liabilities of Frontier and Tamalpais.

nm = not meaningful

N/A = not applicable for periods prior to the April 2010 Frontier and Tamalpais transactions.

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        This report includes forward-looking statements, which include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly compared to our forecasts and expectations. Please refer to Part II Item 1A "Risk Factors" of our Quarterly Report on Form 10-Q (this Form 10-Q) for a discussion of some factors that may cause results to differ.

        Please refer to our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Form 10-K) along with the following discussion and analysis of our consolidated financial condition and results of operations for the period ended September 30, 2010 in this Form 10-Q. Averages, as presented in the following tables, are substantially all based upon daily average balances.

        As used in this Form 10-Q, the term "UnionBanCal" and terms such as "we," "us" and "our" refer to UnionBanCal Corporation, Union Bank, N.A., one or more of their consolidated subsidiaries, or to all of them together.


Introduction

        We are a California-based financial holding company and bank holding company whose major subsidiary, Union Bank, N.A. (the Bank), is a commercial bank. We provide a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, primarily in California, Oregon, Washington and Texas as well as nationally and internationally. We had consolidated assets of $79.8 billion at September 30, 2010.

        On November 4, 2008, we became a privately held company (privatization transaction). All of our issued and outstanding shares of common stock are owned by The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU). Prior to the privatization transaction, BTMU owned approximately 64 percent of our outstanding shares of common stock.


Executive Overview

        We are providing you with an overview of what we believe are the most significant factors and developments that impacted our third quarter 2010 results and that could impact our future results. Further detailed information can be found elsewhere in this Form 10-Q. In addition, we ask that you carefully read this entire document and any other reports that we refer to in this Form 10-Q for more detailed information that will assist your understanding of trends, events and uncertainties that impact us.

        On April 30, 2010, Union Bank acquired certain assets and assumed certain liabilities of Frontier Bank (Frontier) from the Federal Deposit Insurance Corporation (FDIC) in an FDIC-assisted transaction. Additionally on April 16, 2010, Union Bank acquired certain assets and assumed certain liabilities of Tamalpais Bank (Tamalpais) from the FDIC in an FDIC-assisted transaction. For both acquisitions, we entered into loss share agreements with the FDIC, whereby the FDIC will cover a substantial portion of any future losses on acquired loans and other real estate owned (OREO). We refer to the acquired assets subject to the loss share agreements collectively as "covered assets."

        The acquisitions have been accounted for under the acquisition method of accounting. The assets acquired and liabilities assumed were recorded at their estimated, provisional fair values at their respective acquisition dates. See Note 3 to our consolidated financial statements in this Form 10-Q for additional information regarding these acquisitions.

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        Over the past three years, the U.S. and global economies experienced a serious recession and unprecedented volatility in the financial markets. There was significant deterioration in sectors of the U.S. consumer and business economy, which continued to present challenges for the banking and financial services industry during the first nine months of 2010 and are expected to continue to do so for the remainder of 2010, as the economic outlook remains uncertain.

        Our sources of revenue are net interest income (predominantly from loans and deposits, as well as from investment securities and other funding sources) and noninterest income. For the third quarter of 2010, total revenue was comprised of 74 percent net interest income and 26 percent noninterest income. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that impact our revenue sources.

        Our primary sources of liquidity are core deposits and wholesale funding. Core deposits consist of total deposits, excluding brokered deposits and time deposits of $100,000 and over. Wholesale funding includes unsecured funds raised from interbank and other sources, both domestic and international, and secured funds raised by selling securities under repurchase agreements and by borrowing from the Federal Home Loan Bank of San Francisco (FHLB). We evaluate and monitor the stability and reliability of our various funding sources to help ensure that we have sufficient liquidity when adverse situations arise.

        In the third quarter of 2010, our net interest income (on a taxable-equivalent basis) increased 10 percent from the third quarter of 2009 to $620.6 million. Our net interest margin of 3.33 percent increased 2 basis points compared to the same period last year, primarily due to lower rates paid on interest bearing liabilities and investment securities growth, partially offset by lower yields on investment securities. The growth in U.S. Government and agency securities was primarily funded by an increase in deposit liabilities.

        In the third quarter of 2010, our noninterest income of $217.9 million increased 19 percent from the third quarter of 2009 primarily due to higher trading account activities revenue and accretion of income for the acquisition-related indemnification asset. In the third quarter of 2010, our noninterest expense of $562.6 million increased 11 percent from the third quarter of 2009 primarily due to higher base salaries and incentive compensation accruals and acquisition-related expenses. These increases were partially offset by lower provision for losses on off-balance sheet commitments and lower privatization-related intangible asset amortization.

        Our effective tax rate was 37.5 percent in the third quarter of 2010, compared to (77.3) percent in the third quarter of 2009. The change in the effective tax rate was primarily due to pre-tax loss in the prior year compared to pre-tax income in the current year, as well as the impact of tax credits and state income taxes.

        Our total assets decreased $5.8 billion, or 7 percent, to $79.8 billion at September 30, 2010 from December 31, 2009, primarily as a result of our efforts to enhance the composition of our assets and liabilities. Securities available for sale declined $4.2 billion, or 19 percent, to $18.3 billion at September 30, 2010 and lower yielding interest bearing deposits in banks declined $4.2 billion, or 63 percent, to $2.4 billion at September 30, 2010 from the corresponding balances at December 31, 2009. Offsetting these decreases was a $7.8 billion, or 15 percent, decrease in interest bearing deposits at September 30, 2010, compared to December 31, 2009, due to a planned deposit runoff resulting from targeted rate reductions. Our stockholder's equity of $10.1 billion at September 30, 2010 grew $0.7 billion, or 7 percent, from September 30, 2009.

        Total loans increased $0.7 billion, or 1 percent, to $47.9 billion at September 30, 2010, from December 31, 2009, primarily resulting from the Frontier and Tamalpais acquisitions. Total loans, excluding FDIC covered loans and loans managed by our Special Assets Division, remained relatively flat as compared to December 31, 2009.

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        In the third quarter of 2010, our average total loans decreased 1 percent from the third quarter of 2009 to $48.1 billion. This decrease was primarily in the commercial, financial and industrial sectors, due to tighter underwriting standards, proactive portfolio management, and lower loan demand.

        In the third quarter of 2010, our average total deposits increased 9 percent to $64.8 billion compared to the third quarter of 2009. In the third quarter of 2010, our average noninterest bearing deposits increased 7 percent to $15.4 billion compared to the third quarter of 2009. In the third quarter of 2010, our average interest bearing deposits increased by 10 percent to $49.4 billion compared to the third quarter of 2009. These increases reflect the results of targeted retail and corporate deposit-gathering marketing initiatives throughout Union Bank. Average noninterest bearing deposits represented 24 percent of average total deposits in both of the third quarters of 2010 and 2009. The annualized average all-in-cost of funds decreased to 0.55 percent in the third quarter of 2010, compared to 0.79 percent in the third quarter of 2009.

        During the third quarter of 2010, the total provision for credit losses was zero compared to $320 million in the third quarter of 2009. The decrease was primarily due to improved credit quality of the loan portfolio, as well as a change in the category mix and lower projected loss component of our nonaccrual loans during the third quarter of 2010 compared to the third quarter of 2009. See further discussion below in "Allowances for Credit Losses."

        Our nonperforming assets totaled $1.4 billion, $1.3 billion and $1.5 billion at September 30, 2009, December 31, 2009 and September 30, 2010, respectively. Our nonperforming assets, excluding FDIC covered assets, totaled $1.4 billion, $1.3 billion and $1.2 billion at September 30, 2009, December 31, 2009 and September 30, 2010, respectively. The decrease in nonperforming assets, excluding FDIC covered assets, from September 30, 2009 resulted from lower levels of nonaccrual loans primarily in our commercial, financial, and industrial portfolio and our construction portfolio as a result of increased sales and charge-offs of problem loans in 2010. Net charge-offs were $137 million, $95 million and $89 million in the third quarter of 2009, the fourth quarter of 2009 and the third quarter of 2010, respectively.

        At September 30, 2009, December 31, 2009 and September 30, 2010, our allowances for credit losses as a percentage of total loans were 2.97 percent, 3.25 percent and 3.01 percent, respectively. At September 30, 2009, December 31, 2009 and September 30, 2010, our allowances for credit losses as a percentage of nonaccrual loans were 108 percent, 116 percent and 109 percent, respectively. At September 30, 2009, December 31, 2009 and September 30, 2010, our allowance for loan losses as a percentage of total loans was 2.62 percent, 2.87 percent and 2.67 percent, respectively. At September 30, 2009, December 31, 2009 and September 30, 2010, our allowance for loan losses as a percentage of nonaccrual loans was 95 percent, 103 percent and 97 percent, respectively.


Critical Accounting Estimates

        UnionBanCal Corporation's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) and the general practices of the banking industry, which include management estimates and judgments.

        Our most significant estimates are approved by our Risk & Capital Committee, which is comprised of selected senior officers of the Bank. For each financial reporting period, a review of these estimates is presented to and discussed with the Risk Committee and Audit & Finance Committee of our Board of Directors.

        Understanding our accounting policies is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly, both our Critical Accounting Estimates and our significant accounting policies are discussed in detail in our 2009 Form 10-K filed with the Securities and Exchange Commission (the SEC). Other than the changes discussed below, there have been no material changes to these critical accounting estimates during the nine months ended September 30, 2010.

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        Acquired loans are recorded at fair value at acquisition date in accordance with the Financial Accounting Standards Board Accounting Standards Codification (ASC) 805 "Business Combinations," factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date.

        In conjunction with the FDIC-assisted acquisitions of Frontier and Tamalpais, we acquired certain loans with evidence of credit quality deterioration subsequent to their origination and for which it was probable, at acquisition, that we would be unable to collect all contractually required payments receivable. We elected to account for all acquired loans, except for revolving lines of credit, within the scope of the accounting guidance using the same methodology. In accordance with applicable accounting guidance, we may aggregate loans that have common risk characteristics into pools and thereby use a composite interest rate and estimate of cash flows expected to be collected for the pools. We have aggregated all of the purchased credit-impaired loans into pools based on common risk characteristics, which then become the unit of account. Once a pool is assembled, the integrity of the pool must be maintained. Significant judgment is required in evaluating whether individual loans have common risk characteristics for purposes of establishing pools of loans.

        At the time of the acquisition, all acquired loans were recorded at fair value, including an estimate of losses that are expected to be incurred over the estimated remaining lives of the loans. Many of the assumptions and estimates underlying the estimation of the initial fair value and the ongoing updates to management's expectation of future cash flows are both significant and subjective, particularly considering the current economic environment. The economic environment and the lack of market liquidity and transparency are factors that have influenced, and may continue to affect, these assumptions and estimates.

        We estimated the fair value of acquired loans at the acquisition date based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, risk classification, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. The discount rates used for loans are based on current market rates for new originations of comparable loans, where available, and include adjustments for liquidity concerns. To the extent comparable market rates are not readily available, a discount rate was derived based on the assumptions of market participants' cost of funds, servicing costs and return requirements for comparable risk assets. In either case, the discount rate does not include a factor for credit losses as that has been included in the estimated cash flows. The initial estimate of cash flows to be collected was derived from assumptions such as default rates and loss severities.

        The accounting guidance for purchased credit-impaired loans provides that the excess of the cash flows initially expected to be collected over the fair value of the loans at the acquisition date (i.e., the accretable yield) should be accreted into interest income at a level rate of return over the term of the loan, provided that the timing and amount of future cash flows is reasonably estimable. The initial estimate of cash flows expected to be collected must be updated each subsequent reporting period based on updated assumptions regarding default rates, loss severities, and other factors that are reflective of current market conditions. Probable decreases in expected loan principal cash flows after acquisition trigger the recognition of impairment, through the provision and allowance for loan losses, which is then measured based on the present value of the expected principal loss, plus any related foregone interest cash flows discounted at the loan pool's effective interest rate. Probable and significant increases in expected principal cash flows would first reverse any related allowance for loan losses; any remaining increases must be recognized prospectively as interest income over the remaining lives of the loans. The impacts of changes in variable interest rates are recognized prospectively as adjustments to interest income. As described above, the process of estimating cash flows expected to be collected has a significant impact on the initial recorded amount of the purchased credit-impaired loans and on subsequent recognition of impairment losses and interest income. Estimating these cash flows requires a

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significant level of management judgment. In addition, certain of the underlying assumptions are highly subjective.

        In conjunction with the FDIC-assisted acquisitions of Frontier and Tamalpais, we entered into loss share agreements with the FDIC. The purchase and assumption and loss share agreements have specific compliance, servicing, notification and reporting requirements. Any failure to comply with the requirements of the loss share agreements, or to properly service the loans and OREO covered by any loss share arrangement, may cause individual loans or loan pools to lose their eligibility for loss share payments from the FDIC, potentially resulting in material losses that are currently not anticipated. At the date of the acquisition, we recorded amounts receivable under the loss share agreements as an indemnification asset. Subsequent to the acquisition, the indemnification asset is tied to the loss in the covered loans and is not being accounted for under fair value. The FDIC indemnification asset is accounted for on the same basis as the related covered loans and is the present value of the cash flows that we expect to collect from the FDIC under the loss share agreements. The difference between the present value and the undiscounted cash flows that we expect to collect from the FDIC is accreted into noninterest income over the life of the FDIC indemnification asset. The FDIC indemnification asset is adjusted for any changes in expected cash flows based on the loan performance. Any increases in cash flows of the loans due to decreases in expected credit losses over those originally expected will lower the accretion rate recorded in noninterest income. Any decreases in cash flows of the loans over those originally expected will increase the FDIC indemnification asset.

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Financial Performance

Net Interest Income

        The following tables show the major components of net interest income and net interest margin.

 
  For the Three Months Ended   Increase (Decrease) in  
 
  September 30, 2009   September 30, 2010    
   
  Interest
Income/
Expense(1)
 
 
  Average Balance  
 
  Average
Balance
  Interest
Income/
Expense(1)
  Average
Yield/
Rate(1)(2)
  Average
Balance
  Interest
Income/
Expense(1)
  Average
Yield/
Rate(1)(2)
 
(Dollars in thousands)   Amount   Percent   Amount   Percent  

Assets

                                                             

Loans:(3)

                                                             
 

Commercial, financial and industrial

  $ 16,805,449   $ 188,974     4.46 % $ 14,628,126   $ 176,212     4.78 % $ (2,177,323 )   (13 )% $ (12,762 )   (7 )%
 

Construction

    2,772,804     20,828     2.98     1,946,412     15,290     3.12     (826,392 )   (30 )   (5,538 )   (27 )
 

Residential mortgage

    16,380,014     230,210     5.62     17,196,030     225,937     5.26     816,016     5     (4,273 )   (2 )
 

Commercial mortgage

    8,261,161     88,998     4.31     8,005,988     84,702     4.23     (255,173 )   (3 )   (4,296 )   (5 )
 

Consumer

    3,882,929     44,042     4.50     3,900,424     43,528     4.43     17,495     0     (514 )   (1 )
 

Lease financing

    662,469     5,462     3.30     638,469     6,013     3.77     (24,000 )   (4 )   551     10  
                                                   
 

Total loans, excluding FDIC covered loans

    48,764,826     578,514     4.73     46,315,449     551,682     4.75     (2,449,377 )   (5 )   (26,832 )   (5 )

FDIC covered loans

                1,789,505     32,238     7.17     1,789,505     nm     32,238     nm  
                                                   

Total loans

    48,764,826     578,514     4.73     48,104,954     583,920     4.84     (659,872 )   (1 )   5,406     1  

Securities—taxable

    10,590,200     107,171     4.05     22,441,990     131,368     2.34     11,851,790     nm     24,197     23  

Securities—tax-exempt

    184,772     2,999     6.49     44,692     918     8.21     (140,080 )   (76 )   (2,081 )   (69 )

Interest bearing deposits in banks

    7,496,380     4,956     0.26     2,406,880     1,513     0.25     (5,089,500 )   (68 )   (3,443 )   (69 )

Federal funds sold and securities purchased under resale agreements

    282,457     110     0.15     389,999     146     0.15     107,542     38     36     33  

Trading account assets

    916,448     271     0.12     1,109,114     591     0.21     192,666     21     320     nm  
                                                   
   

Total earning assets

    68,235,083     694,021     4.06     74,497,629     718,456     3.85     6,262,546     9     24,435     4  
                                                         

Allowance for loan losses

    (1,044,533 )               (1,374,656 )               (330,123 )   (32 )            

Cash and due from banks

    1,135,794                 1,184,365                 48,571     4              

Premises and equipment, net

    668,699                 671,632                 2,933     0              

Other assets

    5,357,606                 7,286,067                 1,928,461     36              
                                                         
   

Total assets

  $ 74,352,649               $ 82,265,037               $ 7,912,388     11 %            
                                                         

Liabilities

                                                             

Interest bearing deposits:

                                                             
 

Transaction and money market accounts

  $ 33,064,944   $ 72,837     0.87   $ 32,722,785   $ 33,335     0.40   $ (342,159 )   (1 ) $ (39,502 )   (54 )
 

Savings and consumer time

    4,486,545     12,572     1.11     7,944,796     16,605     0.83     3,458,251     77     4,033     32  
 

Large time

    7,430,960     15,965     0.85     8,722,935     19,558     0.89     1,291,975     17     3,593     23  
                                                   
   

Total interest bearing deposits

    44,982,449     101,374     0.89     49,390,516     69,498     0.56     4,408,067     10     (31,876 )   (31 )
                                                   

Federal funds purchased and securities sold under repurchase agreements

    169,267     41     0.09     167,652     70     0.17     (1,615 )   (1 )   29     71  

Commercial paper

    472,246     355     0.30     661,913     398     0.24     189,667     40     43     12  

Other borrowed funds(4)

    262,441     604     0.91     196,474     438     0.88     (65,967 )   (25 )   (166 )   (27 )

Long-term debt

    5,112,517     27,351     2.12     4,527,669     27,413     2.40     (584,848 )   (11 )   62      
                                                   
   

Total borrowed funds

    6,016,471     28,351     1.87     5,553,708     28,319     2.02     (462,763 )   (8 )   (32 )    
                                                   
   

Total interest bearing liabilities

    50,998,920     129,725     1.01     54,944,224     97,817     0.71     3,945,304     8     (31,908 )   (25 )
                                                         

Noninterest bearing deposits

    14,471,487                 15,431,963                 960,476     7              

Other liabilities

    1,523,469                 1,697,695                 174,226     11              
                                                         
   

Total liabilities

    66,993,876                 72,073,882                 5,080,006     8              

Equity

                                                             

UNBC Stockholder's equity

    7,358,773                 9,912,847                 2,554,074     35              

Noncontrolling interests

                    278,308                 278,308     nm              
                                                         
   

Total equity

    7,358,773                 10,191,155                 2,832,382     38              
                                                         
   

Total liabilities and equity

  $ 74,352,649               $ 82,265,037               $ 7,912,388     11 %            
                                                         

Net interest income/spread (taxable-equivalent basis)

          564,296     3.05 %         620,639     3.14 %               56,343     10 %

Impact of noninterest bearing source

                0.26                 0.19                          

Net interest margin

                3.31                 3.33                          

Less: taxable-equivalent adjustment

          3,260                 2,584                       (676 )   (21 )
                                                         
   

Net interest income

        $ 561,036               $ 618,055                     $ 57,019     10 %
                                                         

(1)
Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
(2)
Annualized.
(3)
Average balances on loans outstanding include all nonperforming loans and loans held for sale. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield.
(4)
Includes interest bearing trading liabilities.
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  For the Nine Months Ended   Increase (Decrease) in  
 
  September 30, 2009   September 30, 2010    
   
  Interest
Income/
Expense(1)
 
 
  Average Balance  
 
  Average
Balance
  Interest
Income/
Expense(1)
  Average
Yield/
Rate(1)(2)
  Average
Balance
  Interest
Income/
Expense(1)
  Average
Yield/
Rate(1)(2)
 
(Dollars in thousands)   Amount   Percent   Amount   Percent  

Assets

                                                             

Loans:(3)

                                                             
 

Commercial, financial and industrial

  $ 17,737,052   $ 577,321     4.35 % $ 14,721,915   $ 505,667     4.59 % $ (3,015,137 )   (17 )% $ (71,654 )   (12 )%
 

Construction

    2,765,178     60,747     2.94     2,132,098     47,750     2.99     (633,080 )   (23 )   (12,997 )   (21 )
 

Residential mortgage

    16,132,655     694,917     5.74     16,989,812     680,297     5.34     857,157     5     (14,620 )   (2 )
 

Commercial mortgage

    8,256,389     283,076     4.57     8,139,165     256,904     4.21     (117,224 )   (1 )   (26,172 )   (9 )
 

Consumer

    3,816,050     134,697     4.72     3,911,734     129,386     4.42     95,684     3     (5,311 )   (4 )
 

Lease financing

    658,956     18,713     3.79     642,835     18,408     3.82     (16,121 )   (2 )   (305 )   (2 )
                                                   
   

Total loans, excluding FDIC covered loans

    49,366,280     1,769,471     4.78     46,537,559     1,638,412     4.70     (2,828,721 )   (6 )   (131,059 )   (7 )
 

FDIC covered loans

                1,060,231     58,034     7.31     1,060,231     nm     58,034     nm  
                                                   
   

Total loans

    49,366,280     1,769,471     4.78     47,597,790     1,696,446     4.76     (1,768,490 )   (4 )   (73,025 )   (4 )

Securities—taxable

    9,166,395     307,165     4.47     22,992,783     408,142     2.37     13,826,388     nm     100,977     33  

Securities—tax-exempt

    94,947     5,040     7.08     43,946     2,727     8.27     (51,001 )   (54 )   (2,313 )   (46 )

Interest bearing deposits in banks

    4,664,896     9,406     0.27     4,959,386     9,264     0.25     294,490     6     (142 )   (2 )

Federal funds sold and securities

                                                             
 

purchased under resale agreements

    227,832     348     0.20     413,946     415     0.13     186,114     82     67     19  

Trading account assets

    1,073,477     660     0.08     959,815     2,062     0.29     (113,662 )   (11 )   1,402     nm  
                                                   
   

Total earning assets

    64,593,827     2,092,090     4.32     76,967,666     2,119,056     3.67     12,373,839     19     26,966     1  
                                                         

Allowance for loan losses

    (865,208 )               (1,413,666 )               (548,458 )   (63 )            

Cash and due from banks

    1,244,981                 1,197,159                 (47,822 )   (4 )            

Premises and equipment, net

    670,884                 672,600                 1,716     0              

Other assets

    5,355,766                 6,762,183                 1,406,417     26              
                                                         
   

Total assets

  $ 71,000,250               $ 84,185,942               $ 13,185,692     19 %            
                                                         

Liabilities

                                                             

Interest bearing deposits:

                                                             
 

Transaction and money market accounts

  $ 28,397,683   $ 200,483     0.94   $ 36,704,458   $ 144,415     0.53   $ 8,306,775     29   $ (56,068 )   (28 )
 

Savings and consumer time

    4,394,706     42,057     1.28     7,119,678     43,908     0.82     2,724,972     62     1,851     4  
 

Large time

    7,090,250     64,058     1.21     8,207,186     45,214     0.74     1,116,936     16     (18,844 )   (29 )
                                                   
   

Total interest bearing deposits

    39,882,639     306,598     1.03     52,031,322     233,537     0.60     12,148,683     30     (73,061 )   (24 )
                                                   

Federal funds purchased and securities sold under repurchase agreements

    194,562     113     0.08     170,413     148     0.12     (24,149 )   (12 )   35     31  

Commercial paper

    586,754     2,901     0.66     604,153     927     0.21     17,399     3     (1,974 )   (68 )

Other borrowed funds(4)

    2,472,324     17,697     0.96     529,289     2,812     0.71     (1,943,035 )   (79 )   (14,885 )   (84 )

Long-term debt

    5,008,468     84,771     2.26     4,610,874     81,424     2.36     (397,594 )   (8 )   (3,347 )   (4 )
                                                   
   

Total borrowed funds

    8,262,108     105,482     1.71     5,914,729     85,311     1.93     (2,347,379 )   (28 )   (20,171 )   (19 )
                                                   
   

Total interest bearing liabilities

    48,144,747     412,080     1.14     57,946,051     318,848     0.74     9,801,304     20     (93,232 )   (23 )
                                                         

Noninterest bearing deposits

    13,644,163                 14,879,310                 1,235,147     9              

Other liabilities

    1,878,593                 1,448,563                 (430,030 )   (23 )            
                                                         
   

Total liabilities

    63,667,503                 74,273,924                 10,606,421     17              

Equity

                                                             

UNBC Stockholder's equity

    7,332,747                 9,693,370                 2,360,623     32              

Noncontrolling interests

                    218,648                 218,648     nm              
                                                         
   

Total equity

    7,332,747                 9,912,018                 2,579,271     35              
                                                         
   

Total liabilities and equity

  $ 71,000,250               $ 84,185,942               $ 13,185,692     19 %            
                                                         

Net interest income/spread (taxable-equivalent basis)

          1,680,010     3.18 %         1,800,208     2.93 %               120,198     7 %

Impact of noninterest bearing source

                0.29                 0.19                          

Net interest margin

                3.47                 3.12                          

Less: taxable-equivalent adjustment

          8,625                 7,407                       (1,218 )   (14 )
                                                         
   

Net interest income

        $ 1,671,385               $ 1,792,801                     $ 121,416     7 %
                                                         

(1)
Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
(2)
Annualized.
(3)
Average balances on loans outstanding include all nonperforming loans and loans held for sale. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield.
(4)
Includes interest bearing trading liabilities.
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        Net interest income in the third quarter of 2010, on a taxable-equivalent basis, increased $56.3 million, or 10 percent, compared to the third quarter of 2009. Our net interest margin in the third quarter of 2010 increased by 2 basis points to 3.33 percent compared to the third quarter of 2009. These results were primarily due to the following:

        Our efforts to enhance the composition of our assets and liabilities are demonstrated in the current quarter as compared to the prior sequential quarter. Net interest income in the third quarter of 2010, on a taxable equivalent basis, increased $17.9 million, or 3 percent, compared to the second quarter of 2010. Our net interest margin increased 24 basis points to 3.33 percent compared to the second quarter of 2010. Net interest margin increased primarily due to the planned runoff of interest bearing deposits resulting from targeted rate reductions, lower average deposit rates and higher average loan yields driven primarily by fees.

        Net interest income for the nine months ended September 30, 2010, on a taxable-equivalent basis, increased $120.2 million, or 7 percent, compared to the nine months ended September 30, 2009. Our net interest margin for the nine months ended September 30, 2010 decreased by 35 basis points to 3.12 percent compared to the nine months ended September 30, 2009. These results were primarily due to the following:

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Provision for Loan Losses

        We recorded a total provision for credit losses of zero ($8 million for loan losses and $8 million reversal of provision for losses on off-balance sheet commitments) in the third quarter of 2010, compared to a total provision of $320 million in the third quarter of 2009 ($314 million for loan losses and $6 million for losses on off-balance sheet commitments). We recorded a total provision of $210 million for credit losses ($222 million for loan losses and a $12 million reversal of provision for losses on off-balance sheet commitments) in the nine months ended September 30, 2010, compared to a total provision of $970 million ($923 million for loan losses and $47 million for losses on off-balance sheet commitments) in the nine months ended September 30, 2009.

        The provision decreases were primarily due to improved credit quality of the loan portfolio, as well as a change in the category mix and lower projected loss component of our nonaccrual loans during the three and nine months ended September 30, 2010 compared to the three and nine months ended September 30, 2009.


Noninterest Income and Noninterest Expense

        The following tables detail our noninterest income and noninterest expense items that exceeded one percent of our total revenues for the three and nine months ended September 30, 2009 and 2010.

Noninterest Income

 
  For the Three Months Ended   For the Nine Months Ended  
 
   
   
  Increase
(Decrease)
   
   
  Increase
(Decrease)
 
(Dollars in thousands)   September 30,
2009
  September 30,
2010
  September 30,
2009
  September 30,
2010
 
  Amount   Percent   Amount   Percent  

Service charges on deposit accounts

  $ 74,888   $ 62,472   $ (12,416 )   (16.6 )% $ 218,053   $ 192,455   $ (25,598 )   (11.7 )%

Trust and investment management fees

    34,506     33,209     (1,297 )   (3.8 )   102,543     98,873     (3,670 )   (3.6 )

Trading account activities

    10,513     31,906     21,393     nm     49,456     78,378     28,922     58.5  

Securities gains, net

    12,694     10,683     (2,011 )   (15.8 )   12,522     71,820     59,298     nm  

Merchant banking fees

    14,601     19,011     4,410     30.2     48,357     54,910     6,553     13.6  

Card processing fees, net

    8,559     9,877     1,318     15.4     24,219     31,353     7,134     29.5  

Brokerage commissions and fees

    8,611     10,195     1,584     18.4     25,424     29,629     4,205     16.5  

Other

    19,557     40,590     21,033     nm     61,284     114,724     53,440     87.2  
                                       
 

Total noninterest income

  $ 183,929   $ 217,943   $ 34,014     18.5 % $ 541,858   $ 672,142   $ 130,284     24.0 %
                                       

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Noninterest Expense

 
  For the Three Months Ended   For the Nine Months Ended  
 
   
   
  Increase
(Decrease)
   
   
  Increase
(Decrease)
 
(Dollars in thousands)   September 30,
2009
  September 30,
2010
  September 30,
2009
  September 30,
2010
 
  Amount   Percent   Amount   Percent  

Salaries and other compensation

  $ 198,768   $ 250,838   $ 52,070     26.2 % $ 578,095   $ 744,987   $ 166,892     28.9 %

Employee benefits

    35,213     41,898     6,685     19.0     132,506     147,026     14,520     11.0  
                                       
 

Salaries and employee benefits

    233,981     292,736     58,755     25.1     710,601     892,013     181,412     25.5  

Net occupancy and equipment

    60,984     65,162     4,178     6.9     178,142     187,723     9,581     5.4  

Professional and outside services

    39,866     53,878     14,012     35.1     117,075     143,396     26,321     22.5  

Intangible asset amortization

    40,641     30,774     (9,867 )   (24.3 )   121,809     93,180     (28,629 )   (23.5 )

Regulatory agencies

    30,739     29,132     (1,607 )   (5.2 )   101,513     89,506     (12,007 )   (11.8 )

Software

    16,502     18,266     1,764     10.7     45,745     48,824     3,079     6.7  

Low income housing credit investment amortization

    13,064     13,251     187     1.4     34,256     41,024     6,768     19.8  

Advertising and public relations

    14,562     12,853     (1,709 )   (11.7 )   36,532     34,495     (2,037 )   (5.6 )

Communications

    9,494     10,323     829     8.7     27,404     29,579     2,175     7.9  

(Reversal of) provision for losses on off-balance sheet commitments

    6,000     (8,000 )   (14,000 )   nm     47,000     (12,000 )   (59,000 )   nm  

Other

    39,982     44,244     4,262     10.7     139,179     123,651     (15,528 )   (11.2 )
                                       
 

Total noninterest expense

  $ 505,815   $ 562,619   $ 56,804     11.2 % $ 1,559,256   $ 1,671,391   $ 112,135     7.2 %
                                       

Nm=
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        The following table shows the calculation of our core efficiency ratio for the three months and nine months ended September 30, 2009 and 2010.

 
  For the Three Months Ended   For the Nine Months Ended  
(Dollars in thousands)   September 30,
2009
  September 30,
2010
  September 30,
2009
  September 30,
2010
 

Noninterest Expense

  $ 505,815   $ 562,619   $ 1,559,256   $ 1,671,391  
 

Less: Foreclosed asset expense (income)

    (144 )   5,898     4,024     6,571  
 

Less: Provision for (reversal of) losses on off-balance sheet commitments

    6,000     (8,000 )   47,000     (12,000 )
 

Less: Low income housing credit investment amortization expense

    13,064     13,251     34,256     41,024  
 

Less: Expenses of the consolidated VIEs

        6,238         17,102  
 

Less: Merger costs related to acquisitions

        11,177         23,996  
                   
   

Net noninterest expense (a)

  $ 486,895   $ 534,055   $ 1,473,976   $ 1,594,698  
                   

Total Revenue (b)

  $ 748,225   $ 838,582   $ 2,221,868   $ 2,472,350  

Core efficiency ratio (a)/(b)

    65.07 %   63.69 %   66.34 %   64.50 %

        The primary contributors to the changes in our noninterest income and noninterest expense for the third quarter of 2010 compared to the third quarter of 2009 are presented below.

        The increase in our noninterest income was the result of several factors:

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        The increase in our noninterest expense was the result of several factors:

        The primary contributors to the changes in noninterest income and noninterest expense for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 are presented below.

        The increase in our noninterest income was the result of several factors:

        The increase in our noninterest expense was the result of several factors:

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Income Tax Expense

        Our effective tax rate in the third quarter of 2010 was 37.5 percent, compared to (77.3) percent for the third quarter of 2009. Our effective tax rate in the nine months ended September 30, 2010 was 31.7 percent, compared to (60.3) percent for the nine months ended September 30, 2009. A negative effective tax rate indicates a net income tax benefit. The change in the effective tax rate was primarily due to a pre-tax loss in the prior year compared to pre-tax income in the current year, as well as the impact of tax credits, state income taxes, and an adjustment to our unrecognized tax benefits.

        Our quarterly effective tax rate for the third quarters of 2009 and 2010 was computed on an individual quarterly basis, and therefore may not be indicative of the effective tax rate for future quarters and the full year.

        For further information regarding income tax expense, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Income Tax Expense"and "Changes in our tax rates could affect our future results" in "Risk Factors" in Part II, Item 1A of this Form 10-Q and Note 11 to the consolidated financial statements in our 2009 Form 10-K.


Loans

        The following table shows loans outstanding by loan type at the end of each period presented.

 
   
   
   
  Increase (Decrease)
September 30, 2010 From:
 
 
   
   
   
  September 30, 2009   December 31, 2009  
 
  September 30,
2009
  December 31,
2009
  September 30,
2010
 
(Dollars in thousands)   Amount   Percent   Amount   Percent  

Loans held for investment, excluding FDIC covered loans:

                                           
 

Commercial, financial and industrial

  $ 15,994,997   $ 15,258,081   $ 14,650,250   $ (1,344,747 )   (8.4 )% $ (607,831 )   (4.0 )%
 

Construction

    2,691,515     2,429,009     1,849,805     (841,710 )   (31.3 )   (579,204 )   (23.8 )
 

Residential mortgage

    16,576,052     16,716,048     17,295,349     719,297     4.3     579,301     3.5  
 

Commercial mortgage

    8,320,374     8,245,778     7,892,900     (427,474 )   (5.1 )   (352,878 )   (4.3 )
 

Consumer:

                                           
   

Installment

    2,303,897     2,244,239     2,054,863     (249,034 )   (10.8 )   (189,376 )   (8.4 )
   

Revolving lines of credit

    1,599,112     1,672,842     1,835,376     236,264     14.8     162,534     9.7  
                                   
     

Total consumer

    3,903,009     3,917,081     3,890,239     (12,770 )   (0.3 )   (26,842 )   (0.7 )
 

Lease financing

    658,708     653,743     635,267     (23,441 )   (3.6 )   (18,476 )   (2.8 )
                                   
     

Total loans held for investment, excluding FDIC covered loans

    48,144,655     47,219,740     46,213,810     (1,930,845 )   (4.0 )   (1,005,930 )   (2.1 )

Loans held for sale

    24,853     8,768     3,745     (21,108 )   (84.9 )   (5,023 )   (57.3 )
                                   
     

Total loans, excluding FDIC covered loans

    48,169,508     47,228,508     46,217,555     (1,951,953 )   (4.1 )   (1,010,953 )   (2.1 )

FDIC covered loans(1)

            1,693,554     1,693,554     100.0     1,693,554     100.0  
                                   
       

Total loans

    48,169,508     47,228,508     47,911,109     (258,399 )   (0.5 )   682,601     1.4  
       

Allowance for loan losses

    1,260,307     1,357,000     1,276,845     16,538     1.3     (80,155 )   (5.9 )
                                   
       

Loans, net

  $ 46,909,201   $ 45,871,508   $ 46,634,264   $ (274,937 )   (0.6 )% $ 762,756     1.7 %
                                   

(1)
Represents the acquired loans that are covered by the loss share agreements with the FDIC.

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        Commercial, financial and industrial loans represent one of the largest categories in our loan portfolio. These loans are extended principally to corporations, middle-market businesses and small businesses, with no industry concentration exceeding 10 percent of total loans.

        Our commercial market lending originates primarily through our commercial banking offices. These offices, which rely extensively on relationship-oriented banking, provide a variety of services including cash management services, lines of credit, accounts receivable and inventory financing. Separately, we originate or participate in a wide variety of financial services to major corporations. These services include traditional commercial banking and specialized financing tailored to the needs of each customer's specific industry. We are active in, among other sectors, the oil and gas, communications, entertainment, healthcare, retailing, power and utilities, and financial services industries.

        The commercial, financial and industrial loan portfolio decreases from September 30, 2009 to September 30, 2010 and from December 31, 2009 to September 30, 2010 are mainly due to a decline in the utilization rate of revolving credit lines by existing customers, our proactive portfolio management, our tighter underwriting standards, and a decline in loan demand in many sectors as a result of the difficult economic environment.

        We engage in real estate lending that includes commercial mortgage loans and construction loans secured by deeds of trust.

        Construction loans are extended primarily to commercial property developers and to residential builders. As of September 30, 2010, the construction loan portfolio consisted of approximately 87 percent in the commercial income producing real estate industry and 13 percent with residential homebuilders. The construction loan portfolio decreased 31 percent from September 30, 2009 to September 30, 2010 due to declines of approximately $204 million, or 48 percent, in the homebuilder portfolio and $638 million, or 30 percent, in the income property portfolio. The income property portfolio reductions were concentrated mostly in the office and apartment property types. The construction loan portfolio decreased 24 percent from December 31, 2009 to September 30, 2010 due to reductions primarily in the income property portfolio with the largest reductions occurring in the office and apartment property types.

        Geographically, the outstanding construction loan portfolio was concentrated 43 percent in California and 57 percent out of state as of September 30, 2010. The largest out-of-state concentration was 11 percent in Washington. The California outstandings are distributed as follows: 46 percent in the Los Angeles/Orange County region, including the Inland Empire, 22 percent in the San Francisco Bay Area, 13 percent in Sacramento and the Central Valley, 12 percent in San Diego, and 7 percent in the Central Coast region.

        The commercial mortgage loan portfolio consists of loans secured by commercial income properties primarily in California. The commercial mortgage portfolio decreased from September 30, 2009 to September 30, 2010 due primarily to disposition of problem loans; early repayments; and normal loan paydowns partially offset by moderate new originations.

        We originate residential mortgage loans, secured by one-to-four family residential properties, through our multiple channel network (including branches, private bankers, mortgage brokers, and loan-by-phone) throughout California, Oregon and Washington, and we periodically purchase loans in our market area.

        At September 30, 2010, 72 percent of our residential mortgage loans were interest only, none of which are negative amortizing. At origination, these interest only loans had relatively high credit scores and had

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weighted average loan-to-value (LTV) ratios of approximately 67 percent. The remainder of the portfolio consists of a small amount of balloon loans and regular amortizing loans.

        We do not have a program for originating or purchasing subprime loan products. "Low doc" and "no doc" loans (which we discontinued making in 2008) comprise less than half of our residential loan portfolio, and the delinquency rates remain low compared to the industry average for California prime loans. At September 30, 2010, the total amount of "no doc" and "low doc" loans past due 30 days or more was $180 million, compared to $153 million at September 30, 2009. The total amount of residential mortgages delinquent 30 days or more was $359 million at September 30, 2010, compared to $312 million at September 30, 2009. Although delinquencies have risen since September 30, 2009 as a result of the declining real estate market and downturn in the economy, the delinquency rate remains low compared to the industry average for California prime loans. We believe that our underwriting standards remain conservative, and as described above, programs with higher risk have been discontinued.

        We hold most of the loans we originate. However, we do sell some of our 30-year, fixed rate loans, except for Community Reinvestment Act (CRA) qualifying loans.

        We originate consumer loans, such as home equity loans and lines, through our branch network and Private Banking Offices. The increase in consumer loans from September 30, 2009 was primarily in our FlexEquity line/loan product. The FlexEquity line/loan allows our customers the flexibility to manage a line of credit with as many as four fixed rate loans under a single product. When customers convert all or a portion of their FlexEquity lines to fixed rate loans, these new loans are classified as installment loans. As a result of the continuing decline in the overall property values in California, we have reduced our maximum loan to value limits on all second trust deed programs we offer. At origination, these loans had relatively high credit scores and had weighted-average LTV ratios of approximately 60 percent. Our total home equity loans and lines delinquent 30 days or more were $45 million at September 30, 2010, compared to $42 million at September 30, 2009. Our annual review program reviews all equity secured lines with a commitment amount of $200,000 or more and an origination date from 2004 and forward, and includes obtaining an updated credit report as well as an updated value on the property to reassess our LTV position. Action is taken to reduce or freeze limits, as applicable and pursuant to applicable laws and regulations, to minimize additional exposure in a declining market.

        We offer two types of leases to our customers: direct financing leases, where the assets leased are acquired without additional financing from other sources; and leveraged leases, where a substantial portion of the financing is provided by debt with no recourse to us. At September 30, 2010, we had leveraged leases of $547 million, which were net of non-recourse debt of approximately $1.1 billion. We utilize a number of special purpose entities for our leveraged leases. These entities do not function as vehicles to shift liabilities to other parties or to deconsolidate affiliates for financial reporting purposes. As allowed by US GAAP and by law, the gross lease receivable is offset by the qualifying non-recourse debt. In leveraged lease transactions, the third-party lender may only look to the collateral value of the leased assets for repayment in the event of lessee default.

        We acquired loans as part of the FDIC-assisted acquisitions of certain assets and assumption of certain liabilities of Frontier and Tamalpais during the second quarter of 2010. All of the acquired loans are covered under loss share agreements with the FDIC and are referred to as "covered loans." We will be reimbursed for a substantial portion of any future losses on the covered loans under the terms of the FDIC loss share agreements. Total covered loans outstanding at September 30, 2010 were $1.7 billion, which consisted of

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$750 million of commercial mortgage loans, $488 million of commercial, financial and industrial loans, $320 million of construction loans, and $136 million of other loans.

Cross-Border Outstandings

        Our cross-border outstandings reflect certain additional economic and political risks that are not reflected in domestic outstandings. These risks include those arising from exchange rate fluctuations and restrictions on the transfer of funds. Our total cross-border outstandings as of September 30 and December 31, 2009 for Canada, the only country where such outstandings exceeded one percent of total assets, were $931 million and $925 million, respectively. As of September 30, 2010, there were no countries where such cross-border outstandings exceeded one percent of total assets. The cross-border outstandings were compiled based upon category and domicile of ultimate risk and are comprised of balances with banks, trading account assets, securities available for sale, securities purchased under resale agreements, loans, accrued interest receivable, acceptances outstanding and investments with foreign entities. For Canada, any significant local currency outstandings are funded by local currency borrowings.


Provision for Credit Losses

        We recorded a provision for loan losses of $314 million and $8 million in the third quarters of 2009 and 2010, respectively. We recorded a provision for losses on off-balance sheet commitments of $6 million in the third quarter of 2009 and a reversal of provision for off-balance sheet commitments of $8 million in the third quarter of 2010. The provisions for loan losses and for losses on off-balance sheet commitments are charged to income to bring our total allowances for credit losses to a level deemed appropriate by management based on the factors discussed under "Allowances for Credit Losses" below.


Allowances for Credit Losses

        We maintain allowances for credit losses (defined as both the allowance for loan losses and the allowance for off-balance sheet commitment losses) to absorb losses inherent in the loan portfolio as well as for leases and off-balance sheet commitments. Understanding our policies on the allowances for credit losses is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly, our significant policies and methodology on the allowances for credit losses are discussed in detail in Note 1 to our consolidated financial statements and in the section "Allowances for Credit Losses" included in our "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2009 Form 10-K. Unless otherwise noted, all ratios that follow in this section include covered loans.

        At September 30, 2010, our total allowances for credit losses were $1,441 million, which consisted of $1,277 million for loan losses and $164 million for losses on off-balance sheet commitments. The allowances for credit losses consisted of $1,118 million and $323 million of allocated and unallocated allowance, respectively. At September 30, 2010, our allowances for credit loss coverage ratios were 3.01 percent of total loans and 109 percent of total nonaccrual loans, including FDIC covered loans. At December 31, 2009, our total allowances for credit losses were $1,533 million, or 3.25 percent of total loans, and 116 percent of total nonaccrual loans.

        At September 30, 2010, our allowance for credit losses did not include an allowance for FDIC covered loans. Acquired loans are recorded at fair value at acquisition date in accordance with applicable accounting guidance, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. The acquired loans are and will continue to be subject to the Bank's internal credit review. As a result, if credit deterioration is noted

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subsequent to the respective acquisition dates, such deterioration will be measured through the Bank's loss reserving methodology and a provision for loan losses will be charged to earnings with a partially offsetting noninterest income amount reflecting the increase to the FDIC indemnification asset for covered loans. There was no provision recorded for FDIC covered loans during the third quarter of 2010, as there was no incremental credit deterioration identified.

        In addition, the allowances incorporate the results of measuring impairment for specifically-identified impaired loans utilizing a methodology based on the present value of the remaining expected cash flows or as a practical expedient, the loan's observable market price or the underlying collateral securing the loan (provided that the loan is collateral dependent). At September 30, 2010 and December 31, 2009, total impaired loans (excluding FDIC covered loans) were $1.2 billion and $1.3 billion, respectively, and the associated allowances were $166 million and $223 million, respectively.

        At September 30, 2010 and December 31, 2009, the allowance for losses on off-balance sheet commitments included within our total allowances for credit losses was $164 million and $176 million, respectively. In determining the adequacy of our allowances for credit losses, we consider both the allowance for loan losses and for off-balance sheet commitment losses. Net charge-offs were $89 million in the third quarter of 2010, compared to $137 million in the third quarter of 2009. We expect the current elevated level of charge-offs, which we began to experience in the latter half of 2008, to continue during the remainder of 2010.

        As a result of management's assessment of the relevant factors, including the credit quality of our loan portfolio, the negative impact from the economic slowdown on our lending portfolios (especially our real estate portfolios), we recorded a provision for loan losses of $8 million in the third quarter of 2010, compared to a provision for loan losses of $314 million in the third quarter of 2009. The decrease in provision, which excludes FDIC covered loans, was primarily attributable to improved credit quality of the loan portfolio, as well as a change in the category mix and lower projected loss component of our nonaccrual loans, partially offset by higher loss content in the residential real estate.

        Consistent with our quarterly practice of reviewing and refining our estimates and assumptions regarding the effects of economic and business conditions on borrowers and other factors used for assessing the appropriateness of the formula and specific or unallocated allowances for credit losses, during the second quarter of 2010, we updated the periods that are included in the calculation of loss factors (the look-back period) and quantitative and qualitative factors, as described below.

        By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon the most recent information that has become available. During the second quarter of 2010, this included reducing the look-back period and adjusting the quantitative and qualitative factors to be more representative of the economic cycle that we expect will impact the portfolio. Management determined that a shorter and more recent look-back period used to determine loss factors for risk graded credits would better represent the current business cycle and more accurately estimate losses inherent in the current portfolio. Additionally, management updated the qualitative factor adjustment in line with heightened emphasis on qualitative factors, such as the economic conditions, credit concentrations, portfolio trends, and other external factors.

        Other than the above changes, there were no other significant changes in estimation methods or assumptions that affected our methodology for assessing the appropriateness of the formula and specific or unallocated allowances for credit losses.

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        At September 30, 2010, the formula allowance decreased to $944 million, compared to $1,110 million at December 31, 2009. The net decrease was primarily due to improved credit quality of the loan portfolio, as well as a change in the category mix, and lower projected loss component of the nonaccrual loans during the third quarter of 2010. At September 30, 2010, the specific allowance was $174 million, compared to $232 million at December 31, 2009.

        At September 30, 2010, the unallocated allowance increased to $323 million, compared to $191 million at December 31, 2009, primarily due to the negative impact of high unemployment, in particular in California, and foreclosures on residential real estate, the effect of continued fiscal challenges for the State of California and California local governments, the effect of commercial real estate property devaluations, the effect of the weak economy on retailers, and the continued effect of volatile natural gas prices and crude oil prices on energy companies.

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        The following table sets forth a reconciliation of changes in our allowances for credit losses.

 
  For the Three Months
Ended September 30,
  Increase (Decrease)   For the Nine Months
Ended September 30,
  Increase (Decrease)  
(Dollars in thousands)   2009   2010   Amount   Percent   2009   2010   Amount   Percent  

Balance, beginning of period

  $ 1,081,633   $ 1,357,869   $ 276,236     25.5 % $ 737,767   $ 1,357,000   $ 619,233     83.9 %

Loans charged off:

                                                 
 

Commercial, financial and industrial

    77,996     37,277     (40,719 )   (52.2 )   259,634     134,207     (125,427 )   (48.3 )
 

Construction

    13,892     1,897     (11,995 )   (86.3 )   39,361     27,808     (11,553 )   (29.4 )
 

Residential mortgage

    13,960     24,883     10,923     78.2     28,893     46,566     17,673     61.2  
 

Commercial mortgage

    26,298     27,780     1,482     5.6     54,167     110,306     56,139     nm  
 

Consumer

    11,134     10,292     (842 )   (7.6 )   32,275     30,356     (1,919 )   (5.9 )
                                       
   

Total loans charged off

    143,280     102,129     (41,151 )   (28.7 )   414,330     349,243     (65,087 )   (15.7 )
                                       

Recoveries of loans previously charged off:

                                                 
 

Commercial, financial and industrial

    6,129     4,328     (1,801 )   (29.4 )   8,405     25,753     17,348     nm  
 

Construction

        6,630     6,630     100.0     150     16,257     16,107     nm  
 

Residential mortgage

    30     1,244     1,214     nm     255     3,179     2,924     nm  
 

Commercial mortgage

    2     89     87     nm     22     374     352     nm  
 

Consumer

    446     396     (50 )   (11.2 )   868     1,296     428     49.3  
 

Lease financing

        2     2     nm         2     2     nm  
                                       
   

Total recoveries of loans previously charged off

    6,607     12,689     6,082     92.1     9,700     46,861     37,161     nm  
                                       
     

Net loans charged off

    136,673     89,440     (47,233 )   (34.6 )   404,630     302,382     (102,248 )   (25.3 )

Provision for loan losses

    314,000     8,000     (306,000 )   (97.5 )   923,000     222,000     (701,000 )   (75.9 )

Adjustments related to privatization

                    2,108         (2,108 )   (100.0 )

Other

    1,347     416     (931 )   (69.1 )   2,108     227     (1,881 )   (89.2 )
                                       

Ending balance of allowance for loan losses

  $ 1,260,307   $ 1,276,845   $ 16,538     1.3 % $ 1,260,353   $ 1,276,845   $ 16,492     1.3 %

Allowance for losses on off-balance sheet commitments

    172,374     164,374     (8,000 )   (4.6 )   172,374     164,374     (8,000 )   (4.6 )
                                       

Allowances for credit losses

  $ 1,432,681   $ 1,441,219   $ 8,538     0.6 % $ 1,432,727   $ 1,441,219   $ 8,492     0.6 %
                                       

Allowance for loan losses to total loans(1)

    2.62 %   2.67 %               2.62 %   2.67 %            

Allowances for credit losses to total loans(2)

    2.97     3.01                 2.97     3.01              

Provision for loan losses to net loans charged off

    229.75     8.94                 228.11     73.42              

Net loans charged off to average loans outstanding for the period(4)

    1.11     0.74                 1.10     0.85              

Excluding FDIC covered loans(3):

                                                 

Allowance for loan losses to total loans(1)

    N/A     2.76 %               N/A     2.76 %            

Allowances for credit losses to total loans(2)

    N/A     3.12                 N/A     3.12              

Net loans charged off to average loans outstanding for the period(4)

    N/A     0.77                 N/A     0.87              

(1)
The allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans or total nonperforming loans, as appropriate.
(2)
The allowance for credit losses ratios are calculated using the sum of the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans or total nonperforming loans, as appropriate.
(3)
These ratios exclude the impact of the acquired loans and OREO, which are covered under loss share agreements between Union Bank, N.A. and the FDIC. Such agreements are related to the April 2010 acquisitions of certain assets and the assumption of certain liabilities of Frontier and Tamalpais.
(4)
Annualized.
nm
= not meaningful
N/A
= not applicable for periods prior to the April 2010 Frontier and Tamalpais transactions.

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Nonperforming Assets

        Nonperforming assets consist of nonaccrual loans, restructured loans that are nonperforming and OREO. Nonaccrual loans are those for which management has discontinued accrual of interest because there exists significant uncertainty as to the full and timely collection of either principal or interest or such loans have become contractually past due 90 days with respect to principal or interest. For a more detailed discussion of the accounting for nonaccrual loans, see Note 1 to our consolidated financial statements included in the Company's 2009 Form 10-K.

        Restructured loans are loans in which the Bank has formally restructured all or a significant portion of the loan and provided a concession in the form of debt forgiveness, a modification of interest rate or payment terms. Any impairment, not previously recorded, is accounted for at the time of restructuring. Restructured loans are separately disclosed as nonperforming assets for the calendar year of restructuring. If a restructured loan was negotiated at a market rate at the date of restructuring and performs under the modified terms for a sustained period, it may be disclosed as performing assets in the subsequent calendar year.

        OREO includes property where the Bank acquired title through foreclosure or "deed in lieu" of foreclosure.

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        The following table sets forth an analysis of nonperforming assets.

 
   
   
   
  Increase (Decrease)
September 30, 2010 From:
 
 
   
   
   
  September 30,
2009
  December 31,
2009
 
 
  September 30,
2009
  December 31,
2009
  September 30,
2010
 
(Dollars in thousands)   Amount   Percent   Amount   Percent  

Commercial, financial and industrial

  $ 380,117   $ 335,581   $ 150,161   $ (229,956 )   (60.5 )% $ (185,420 )   (55.3 )%

Construction

    387,523     335,085     243,767     (143,756 )   (37.1 )   (91,318 )   (27.3 )

Residential mortgage

    164,683     194,482     201,387     36,704     22.3     6,905     3.6  

Commercial mortgage

    354,815     414,429     384,272     29,457     8.3     (30,157 )   (7.3 )

Consumer

    21,385     20,492     26,889     5,504     25.7     6,397     31.2  

Lease financing

    108     108         (108 )   (100.0 )   (108 )   (100.0 )

Restructured—nonaccrual

    15,962     16,954     149,273     133,311     nm     132,319     nm  
                                   
 

Total nonaccrual loans, excluding FDIC covered loans

    1,324,593     1,317,131     1,155,749     (168,844 )   (12.7 )   (161,382 )   (12.3 )
 

FDIC covered nonaccrual loans

            163,427     163,427     100.0     163,427     100.0  
                                   
   

Total nonaccrual loans

    1,324,593     1,317,131     1,319,176     (5,417 )   (0.4 )   2,045     0.2  

OREO, excluding FDIC covered OREO

    34,392     32,662     47,350     12,958     37.7     14,688     45.0  

FDIC covered OREO

            143,194     143,194     100.0     143,194     100.0  

Distressed loans held for sale

    8,706             (8,706 )   (100.0 )        
                                   
   

Total nonperforming assets

  $ 1,367,691   $ 1,349,793   $ 1,509,720   $ 142,029     10.4 % $ 159,927     11.8 %
                                   
   

Total nonperforming assets, excluding FDIC covered assets

  $ 1,367,691   $ 1,349,793   $ 1,203,099   $ (164,592 )   (12.0 )% $ (146,694 )   (10.9 )%
                                   

Restructured loans that continue to accrue interest

  $ 1,867   $ 3,811   $ 24,604   $ 22,737     nm   $ 20,793     nm  
                                   

Allowance for loan losses

  $ 1,260,307   $ 1,357,000   $ 1,276,845   $ 16,538     1.3 % $ (80,155 )   (5.9 )%
                                   

Allowances for credit losses

  $ 1,432,681   $ 1,533,374   $ 1,441,219   $ 8,538     0.6 % $ (92,155 )   (6.0 )%
                                   

Nonaccrual loans to total loans

    2.75 %   2.79 %   2.75 %                        

Allowance for loan losses to nonaccrual loans(1)

    95.15     103.03     96.79                          

Allowances for credit losses to nonaccrual loans(2)

    108.16     116.42     109.25                          

Nonperforming assets to total loans, OREO and distressed loans held for sale

    2.84     2.86     3.14                          

Nonperforming assets to total assets

    1.75     1.58     1.89                          

Excluding FDIC covered assets:(3)

                                           

Nonaccrual loans to total loans

    N/A     N/A     2.50 %                        

Nonperforming assets to total loans, OREO and distressed loans held for sale

    N/A     N/A     2.60                          

Nonperforming assets to total assets

    N/A     N/A     1.54                          

(1)
The allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans or total nonperforming loans, as appropriate.
(2)
The allowances for credit losses ratios are calculated using the sum of the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans or total nonaccrual loans, as appropriate.
(3)
These ratios exclude the impact of the acquired loans and foreclosed assets, which are covered under loss share agreement between Union Bank, N.A. and the FDIC. Such agreements are related to the April 2010 acquisitions of certain assets and the assumption of certain liabilities of Frontier and Tamalpais.
nm
= not meaningful
N/A
= not applicable for periods prior to the April 2010 Frontier and Tamalpais transactions.

        The decrease in nonaccrual loans, excluding FDIC covered loans, from September 30, 2009 to September 30, 2010 was primarily due to commercial, financial and industrial and construction nonaccrual loans. During the third quarters of 2009 and 2010, we had $13.3 million and $84.0 million in sales of nonperforming loans, respectively. Losses from these sales of $2.8 million and $19.7 million for the third quarters of 2009 and 2010, respectively, were reflected in charge-offs.

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        Covered nonperforming assets totaled $306.6 million, representing 0.38 percent of total assets, at September 30, 2010. Covered nonperforming assets are subject to loss share agreements with the FDIC.


Loans 90 Days or More Past Due and Still Accruing

 
   
   
   
  Increase (Decrease)
September 30, 2010 From:
 
 
   
   
   
  September 30,
2009
  December 31,
2009
 
 
  September 30,
2009
  December 31,
2009
  September 30,
2010
 
(Dollars in thousands)   Amount   Percent   Amount   Percent  

Commercial, financial and industrial

  $ 3,958   $ 4,393   $ 7,345   $ 3,387     85.6 % $ 2,952     67.2 %

Construction

    659             (659 )   (100 )       nm  

Residential mortgage(1)

    421             (421 )   (100 )       nm  

Commercial mortgage

        413     9,840     9,840     nm     9,427     nm  

Consumer and other(1)

    359     229     267     (92 )   (25.6 )   38     16.6  
                                   
   

Total loans 90 days or more past due and still accruing(2)

  $ 5,397   $ 5,035   $ 17,452   $ 12,055     nm % $ 12,417     nm %
                                   

(1)
Effective January 1, 2009, the Company changed its nonaccrual accounting policy to place consumer home equity loans and one-to-four single family residential loans on nonaccrual status when these loans are delinquent 90 days or more, or in foreclosure.
(2)
Excludes loans totaling $325.7 million that are 90 days or more past due and still accruing at September 30, 2010, which consisted of FDIC covered loans accounted for in accordance with the accounting standards for acquired impaired loans.
nm
= not meaningful


Securities

        Management of the securities portfolio involves the maximization of return while maintaining prudent levels of credit quality, market risk and liquidity. At September 30, 2010, approximately 96 percent of our securities, based upon carrying value, were investment grade. The amortized cost, gross unrealized gains, gross unrealized losses and fair values of securities are detailed in Note 4 to our consolidated financial statements included in this Form 10-Q.

        Our securities available for sale are recorded at fair value with the change in fair value recognized in accumulated other comprehensive income. Our Asset and Liability Management (ALM) Securities portfolio, which consists of available for sale U.S. Government, state and municipal, and mortgage-backed securities held for ALM purposes, totaled $18 billion at September 30, 2010. ALM Securities are valued at fair value by a pricing service whose prices can be corroborated by recent security trading activities.

        Our asset-backed securities primarily consist of collateralized loan obligations (CLO) securities, which are known as Cash Flow CLOs. A Cash Flow CLO is a structured finance product that securitizes a diversified pool of loan assets into multiple classes of notes from the cash flows generated by such loans. Cash Flow CLOs pay the note holders through the receipt of interest and principal repayments from the underlying loans unlike other types of CLOs that pay note holders through the trading and sale of underlying collateral. During the first quarter of 2009, we reclassified our CLOs from available for sale to held to maturity. We consider the held to maturity classification to be more appropriate because we have the ability and the intent to hold these securities to maturity.

        At September 30, 2010, the fair value of our CLO securities had increased by approximately $37.3 million from December 31, 2009, primarily due to an increase in liquidity in the marketplace. We estimate the fair value of our CLOs using a pricing model, as well as broker quotes. The model is based on internally-developed assumptions, utilizing market data derived from market participants and credit rating agencies. These assumptions include, but are not limited to, estimated default rates, recovery rates, prepayment rates and reinvestment rates.

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        We conduct a formal review of our securities available for sale and securities held to maturity portfolios on a quarterly basis for the presence of other-than-temporary impairment. We recognized an insignificant amount of impairment on three non-agency residential mortgage-backed securities and one commercial mortgage-backed security during the nine months ended September 30, 2010. Based on the review performed as of September 30, 2010, we expect to recover the entire amortized cost basis of our securities available for sale and securities held to maturity portfolios.


Analysis of Securities

        The following tables show the remaining contractual maturities and expected yields of the securities based upon amortized cost at September 30, 2010.


Securities Available For Sale

 
  September 30, 2010    
   
 
 
  Maturity    
   
 
 
  One Year or Less   Over One Year
Through
Five Years
  Over Five Years
Through
Ten Years
  Over Ten Years   Total Amortized Cost  
(Dollars in thousands)   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield  

U.S. Treasury

  $ 150,331     0.21 % $     % $ 308     2.75 % $     % $ 150,639     0.22 %

Other U.S. government

    590,493     1.12     7,423,339     1.60     804     7.80             8,014,636     1.57  

Residential mortgage-backed securities—agency(1)(2)

    1     4.41     230,569     3.82     931,310     3.80     7,878,476     3.87     9,040,356     3.86  

Residential mortgage-backed securities—non-agency(1)(2)

                    16,397     5.15     547,902     4.58     564,299     4.60  

State and municipal

    3,743     6.47     5,986     6.19     15,819     3.47     19,382     5.73     44,930     5.06  

Asset-backed and debt securities

            23,729     7.25     16,687     4.68     77,101     6.76     117,517     6.56  

Equity securities(3)

                                    77,592      
                                                     
 

Total securities available for sale

  $ 744,568     0.96 % $ 7,683,623     1.69 % $ 981,325     3.84 % $ 8,522,861     3.95 % $ 18,009,969     2.84 %
                                                     

Securities Held to Maturity

 
  September 30, 2010    
   
 
 
  Maturity    
   
 
 
  One Year or Less   Over One Year
Through
Five Years
  Over Five Years
Through
Ten Years
  Over Ten Years   Total Amortized Cost(4)  
(Dollars in thousands)   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield  

Collateralized loan obligations

  $ 1,647     6.79 % $ 92,013     1.94 % $ 1,411,449     1.19 % $ 269,523     1.19 % $ 1,774,632     1.23 %

Foreign securities

    98     0.25                             98     0.25  
                                                     
 

Total securities held to maturity

  $ 1,745     6.42 % $ 92,013     1.94 % $ 1,411,449     1.19 % $ 269,523     1.19 % $ 1,774,730     1.23 %
                                                     

(1)
Although the residential mortgage-backed securities have been ascribed to periods based upon their contractual maturities, principal payments are received prior to maturity because borrowers have the right to repay their obligations at any time.
(2)
See discussion of expected duration in "Quantitative and Qualitative Disclosures About Market Risk."
(3)
Equity securities do not have a stated maturity and are included in the total column only.
(4)
Amortized cost is defined as the original purchase cost, plus or minus any accretion or amortization of a purchase. Amortized cost reflects fair value adjustments as a result of the Company's privatization transaction.
(5)
For securities transferred to held to maturity from available for sale, amortized cost is defined as the original purchase cost, plus or minus any accretion or amortization of a purchase discount or premium, less payments and any impairment previously recognized its earnings. Amortized cost reflects fair value adjustments as a result of the Company's privatization transaction.

        Our securities available for sale portfolio at September 30, 2010 included ALM Securities with an fair value of $18 billion. These securities had an expected weighted average maturity of 2.7 years.

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Deposits

        The table below provides information on our deposits as of September 30, 2009, December 31, 2009 and September 30, 2010.

 
   
   
   
  Increase (Decrease) September 30, 2010 From December 31, 2009  
 
  September 30, 2009   December 31, 2009   September 30, 2010  
(Dollars in thousands)   Amount   Percent  

Interest checking

  $ 816,588   $ 849,283   $ 689,171   $ (160,112 )   (19 )%

Money market

    32,561,224     39,952,337     28,992,676     (10,959,661 )   (27 )
                         
 

Total interest bearing transaction accounts

    33,377,812     40,801,620     29,681,847     (11,119,773 )   (27 )

Savings

    2,706,344     3,716,566     4,521,957     805,391     22  

Time

    10,134,837     9,440,478     11,911,121     2,470,643     26  
                         
 

Total interest bearing deposits(1)

    46,218,993     53,958,664     46,114,925     (7,843,739 )   (15 )

Noninterest bearing deposits

    14,472,375     14,558,989     15,425,621     866,632     6  
                         
 

Total deposits

  $ 60,691,368   $ 68,517,653   $ 61,540,546   $ (6,977,107 )   (10 )%
                         

(1)Total interest bearing deposits include:

                               
 

Brokered deposits:

                               
   

Interest bearing transaction accounts

  $ 2,510,406   $ 5,340,452   $ 2,363,065   $ (2,977,387 )   (56 )%
   

Time

    1,470,146     979,352     1,533,557     554,205     57  
                         
     

Total brokered deposits

    3,980,552     6,319,804     3,896,622     (2,423,182 )   (38 )
 

Nonbrokered deposits

    42,238,441     47,638,860     42,218,303     (5,420,557 )   (11 )
                         
   

Total interest bearing deposits

  $ 46,218,993   $ 53,958,664   $ 46,114,925   $ (7,843,739 )   (15 )%
                         

Core Deposits:

                               

Total deposits

  $ 60,691,368   $ 68,517,653   $ 61,540,546   $ (6,977,107 )   (10 )%
 

Less: Total interest bearing brokered deposits

    3,980,552     6,319,804     3,896,622     (2,423,182 )   (38 )
 

Less: Total noninterest bearing brokered deposits

            19     19     nm  
 

Less: Total nonbrokered time deposits of $100,000 and over

    6,601,161     6,510,741     7,047,604     536,863     8  
                         
   

Total core deposits

  $ 50,109,655   $ 55,687,108   $ 50,596,301   $ (5,090,807 )   (9 )%
                         

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Fair Value of Financial Instruments

        The following table reflects financial instruments measured at fair value on a recurring basis as of September 30, 2009, December 31, 2009 and September 30, 2010. For additional information on the fair value of financial instruments, see Note 13 to the consolidated financial statements in this Form 10-Q.

 
  September 30, 2009   December 31, 2009   September 30, 2010  
(Dollars in thousands)   Fair Value   Percentage
of Total
  Fair Value   Percentage
of Total
  Fair Value   Percentage
of Total
 

Financial instruments recorded at fair value on a recurring basis

                                     

Assets:

                                     
 

Level 1

  $ 6,587,687     34 % $ 12,696,149     55 % $ 8,494,104     44 %
 

Level 2

    12,722,283     67     10,746,219     46     11,080,912     57  
 

Level 3

    6,646         6,878         10,251      
 

Netting Adjustment(1)

    (102,093 )   (1 )   (135,885 )   (1 )   (85,242 )   (1 )
                           
   

Total

  $ 19,214,523     100 % $ 23,313,361     100 % $ 19,500,025     100 %
                           
 

As a percentage of total Company assets

          25 %         27 %         24 %
                                 

Liabilities:

                                     
 

Level 1

  $ 49,985     7 % $ 9,901     2 % $ 44,648     4 %
 

Level 2

    767,183     107     643,115     119     1,064,708     101  
 

Level 3

                    55,001     5  
 

Netting Adjustment(1)

    (102,093 )   (14 )   (111,885 )   (21 )   (102,119 )   (10 )
                           
   

Total

  $ 715,075     100 % $ 541,131     100 % $ 1,062,238     100 %
                           
 

As a percentage of total Company liabilities

          1 %         1 %         2 %
                                 

(1)
Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.


Quantitative and Qualitative Disclosures About Market Risk

        Our exposure to market risk primarily exists in interest rate risk in our non-trading balance sheet and, to a much lesser degree, in price risk in our trading portfolio. The objective of market risk management is to mitigate any undue adverse impact on earnings and capital arising from changes in interest rates and other market variables and to ensure the Bank has adequate sources of liquidity. This risk management objective supports our broad objective of enhancing shareholder value, which encompasses stable earnings growth over time and capital stability.

        The Board of Directors, directly or through its appropriate committee, approves our Asset and Liability Management, Investment and Derivatives Policy (ALM Policy), which governs the management of market and liquidity risks and guides our investment, derivatives, trading and funding activities. The ALM Policy establishes the Bank's risk tolerance guidelines by outlining standards for measuring market and liquidity risks, creates Board-level limits for specific market risks, establishes guidelines for reporting market and liquidity risk and requires independent review and oversight of market and liquidity risk activities.

        The Risk & Capital Committee (RCC), comprised of selected senior officers of the Bank, among other things, strives to ensure that the Bank has an effective process to identify, measure, monitor, and manage market risk as required by the ALM Policy. The RCC provides the broad and strategic guidance of market risk management by formulating high-level strategies for market risk management and defining the risk/return direction for the Bank, and by approving the investment, derivatives and trading policies that govern the Bank's activities. The Asset Liability Management Committee (ALCO) as instructed by the RCC is responsible for the management of market risk and approves specific risk management programs to be recommended to the RCC

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for approval, including those related to interest rate hedging, investment securities, wholesale funding and trading activities. The RCC may delegate to ALCO various decisions pertaining to market risk management as it deems appropriate.

        The Treasurer is primarily responsible for the implementation of risk management strategies approved by the RCC and for operational management of market risk through the funding, investment and derivatives hedging activities of Corporate Treasury. The manager of the Global Capital Markets Division is responsible for operational management of price risk through the trading activities conducted in their respective divisions. The Market Risk Management (MRM) unit is responsible for the monitoring of market risk and MRM functions independently of all operating and management units.

        We have separate and distinct methods for managing the market risk associated with our asset and liability management activities and our trading activities, as described below. For additional information about our market risk management, please see "Quantitative and Qualitative Disclosures about Market Risk" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2009 Form 10-K.

        In order to measure the sensitivity of the Bank's financial position to interest rate risk, parallel rate shocks and gradual ramps over 12 months in both up and down scenarios are compared to current rates to generate earnings and economic value of equity impacts. During the first quarter of 2010, under RCC delegated authority to approve temporary changes to risk measurement, the -200 basis point parallel scenario was replaced with a -100 basis point parallel scenario. This change reflects the low probability associated with rate reductions of 200 basis points in the current extremely low rate environment, and the acceptance of a scenario that better reflects historically low rate levels achieved in the past. The +200 basis point scenario was not changed. The RCC will monitor the rate environment and will consider restoring the -200 basis point measure in the future when deemed appropriate.

        At September 30, 2010, Economic NII sensitivity was asset sensitive to parallel rate shifts. A +200 basis point parallel shift in rates would increase 12-month Economic NII by 3.61 percent, while a -100 basis point downward shift in rates would decrease it by 2.06 percent. At December 31, 2009, a +200 basis point parallel shift in rates would increase 12-month Economic NII by 0.03 percent, while a -100 basis point downward shift in rates would reduce it by 1.65 percent. We caution that significant low levels of current interest rates and ongoing enhancements to our interest rate risk modeling may make prior year comparisons of Economic NII less meaningful. Economic NII adjusts our reported NII for the effect of certain noninterest bearing deposit related fee and expense items. Those adjustment items are innately liability sensitive, meaning that reported NII is less liability sensitive than Economic NII.

Economic NII

(Dollars in millions)   September 30,
2009
  December 31,
2009
  September 30,
2010
 

+200 basis points

  $ 44.0   $ 0.9   $ 86.0  

as a percentage of base case NII

    1.69 %   0.03 %   3.61 %

-100 basis points

    N/A   $ (44.7 ) $ (49.0 )

as a percentage of base case NII

    N/A     (1.65 )%   (2.06 )%

        Generally, our short-term assets re-price faster than short-term non-maturity liabilities. As a result, higher short-term rates would improve Economic NII. Alternatively, gradually lower short-term rates would contract Economic NII. Regarding the curve shape, curve steepening would improve Economic NII while curve flattening has a negative marginal impact on NII.

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        During the first nine months of 2010, the Bank increased its asset sensitivity to position the Bank to benefit from rising rates in the future by the termination of positions in receive fixed interest rate swaps and floor derivative portfolios, the repositioning of mortgage securities from longer to shorter durations and the execution of term funding. Additionally, increased deposit balances, cash holdings and the effect of lower rates on the forecasted risk from mortgages and deposits contributed to the asset sensitive position. In managing the interest rate sensitivity of our balance sheet, we use the ALM investment securities portfolio and derivatives positions as the primary tools to adjust our interest rate risk profile, if necessary.

        At each of September 30, 2009 and 2010, our available for sale securities portfolio included $18.0 billion of securities for ALM purposes. At September 30, 2010, approximately $5.2 billion of the portfolio was pledged to secure trust and public deposits and for other purposes as required or permitted by law. During the third quarter of 2010, we purchased $2.5 billion and sold $1.0 billion par value of securities, as part of our investment portfolio strategy, while $5.1 billion par value of ALM securities matured or were called.

        Based on current prepayment projections, the estimated ALM Securities portfolio's effective duration was 1.3 at September 30, 2010, compared to 1.8 at September 30, 2009. Effective duration is a measure of price sensitivity of a bond portfolio to immediate parallel shifts in interest rates. An effective duration of 1.3 suggests an expected price decrease of approximately 1.3 percent for an immediate 1.0 percent parallel increase in interest rates.

        During the first nine months of 2010, the ALM derivatives portfolio decreased by $2.8 billion notional amount due to terminations of receive fixed interest rate swaps and LIBOR floor contracts and the offset by the addition of pay fixed interest rate swaps.

        The fair value of the ALM derivatives portfolio decreased primarily due to the termination of LIBOR floor contracts and the impact of a decline in interest rates on cap contracts and pay fixed swaps, which benefit from the expectation of higher future interest rates. The decrease was partially offset by the termination of receive fixed interest rate swaps. For additional discussion of derivative instruments and our hedging strategies, see Note 14 to our consolidated financial statements in this Form 10-Q and Note 18 to our consolidated financial statements included in our 2009 Form 10-K.

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        The following table provides the notional value and the fair value of our ALM derivatives portfolio as of September 30, 2009, December 31, 2009 and September 30, 2010 and the change in fair value between December 31, 2009 and September 30, 2010.

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
  Increase (Decrease)
From December 31, 2009
to September 30, 2010
 

Total gross notional amount of positions held for purposes other than trading:

  $ 7,050,000   $ 8,800,000   $ 5,966,773   $ (2,833,227 )
   

of which, interest rate swaps pay fixed rates of interest

                 
                   

Fair value of positions held for purposes other than trading:

                         
   

Gross positive fair value

  $ 118,166   $ 97,186   $ 3,228   $ (93,958 )
   

Gross negative fair value

        12,164     12,567     403  
                   
   

Positive (negative) value of positions, net

  $ 118,166   $ 85,022   $ (9,339 ) $ (94,361 )
                   

Trading Activities

        We enter into trading account activities primarily as a financial intermediary for customers and, to some extent, for our own account. By acting as a financial intermediary, we are able to provide our customers with access to a range of products supporting the securities, foreign exchange and derivatives markets. In acting for our own account, we may take positions in certain securities, foreign exchange and interest rate instruments, subject to various limits in amount, tenor and other respects, with the objective of generating trading profits.

        As of September 30, 2010, we had approximately $29.2 billion notional amount of interest rate derivative contracts. We enter into these agreements for customer accommodations and for our own account, accepting risks up to management approved Value-at-Risk levels.

        We market energy derivative contracts to existing energy industry customers, primarily oil and gas producers, in order to meet their hedging needs. All transactions are fully matched to offsetting (mirror) derivative contracts with third parties to remove our exposure to market risk, with income earned on the credit spread. As of September 30, 2010, we had approximately $3.6 billion notional amount of energy derivative contracts with approximately half of these energy derivative contracts entered into as an accommodation for customers and the remaining half entered into as matching contracts to remove our exposure to market risk on our customer accommodation transactions.

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        The following table provides the notional value and the fair value of our trading derivatives portfolio as of September 30, 2009, December 31, 2009 and September 30, 2010 and the change in fair value between December 31, 2009 and September 30, 2010.

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
  Increase (Decrease)
From December 31, 2009
to September 30, 2010
 

Total gross notional amount of positions held for trading purposes:

                         
   

Interest rate contracts

  $ 24,941,719   $ 25,226,564   $ 29,192,499   $ 3,965,935  
   

Foreign exchange contracts(1)

    2,644,418     2,407,178     2,149,295     (257,883 )
   

Equity contracts

    193,158     254,372     1,011,084     756,712  
   

Commodity contracts

    3,544,518     3,405,389     3,550,464     145,075  
   

Credit contracts

            60,000     60,000  
                   
   

Total

  $ 31,323,813   $ 31,293,503   $ 35,963,342   $ 4,669,839  
                   

Fair value of positions held for trading purposes:

                         
   

Gross positive fair value

  $ 779,376   $ 649,300   $ 1,089,928   $ 440,628  
   

Gross negative fair value

    773,471     632,426     1,067,972     435,546  
                   
   

Positive fair value of positions, net

  $ 5,905   $ 16,874   $ 21,956   $ 5,082  
                   

(1)
Excludes spot contracts with notional amounts of $0.3 billion, $0.3 billion and $0.4 billion at September 30, 2009, December 31, 2009 and September 30, 2010, respectively.


Liquidity Risk

        Liquidity risk is the risk that the Bank's financial condition or overall safety and soundness is adversely affected by an inability, or perceived inability, to meet its contractual obligations. The objective of liquidity risk management is to maintain a sufficient amount of liquidity and diversity of funding sources to allow the Bank to meet expected and unexpected obligations in both stable and adverse conditions.

        The management of liquidity risk is governed by the ALM Policy under the oversight of the RCC and the Audit & Finance Committee of the Board. ALCO oversees liquidity risk management activities. Corporate Treasury formulates the Bank's liquidity and contingency planning strategies and is responsible for identifying, monitoring and reporting on liquidity risk. Market Risk Management, which is part of the Enterprise Wide Risk Reporting and Analysis unit, partners with Corporate Treasury to establish sound policy and effective risk controls. RCC and ALCO also maintain a Contingency Funding Plan that identifies actions to be taken to help ensure adequate liquidity if an event should occur that disrupts or adversely affects the Bank's normal funding activities.

        Liquidity risk is managed using a total balance sheet perspective that analyzes all sources and uses of liquidity including loans, investments, deposits and borrowings, as well as off-balance sheet exposures. Various tools are used to measure and monitor liquidity, including pro-forma forecasting of the sources and uses of cash flows over a 12-month time horizon, stress testing of the pro-forma forecast and assessment of the Bank's capacity to raise incremental unsecured and secured funding. Stress testing, which incorporates both bank-specific and systemic market scenarios that would adversely affect the Bank's liquidity position, facilitates the identification of appropriate remedial measures to help ensure that the Bank maintains adequate liquidity in adverse conditions. Such measures may include extending the maturity profile of liabilities, optimizing liability levels through pricing strategies, adding new funding sources, altering dependency on certain funding sources and/or selling assets.

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        In March 2010, the federal bank regulators adopted (effective May 21, 2010) an Interagency Policy Statement on Funding and Liquidity Risk Management, which sets forth the regulators' supervisory expectations for all insured depository institutions for management of funding and liquidity risk. Under the guidance of this policy statement, banks are expected, among other measures, to adopt and observe sound practices for liquidity risk management, ensure oversight through the board of directors or appropriate committees, conduct regular stress testing, monitor and effectively manage collateral positions, ensure diversification in funding sources, to develop a formal contingency funding plan that clearly sets out the institution's strategies for addressing liquidity shortfalls in emergency situations and to establish a monitoring framework for contingent events by using early-warning indicators and event triggers. The Bank's Board of Directors has approved a number of measures aimed at assuring compliance with the policy statement, including a formal ALM Policy with specific governance on liquidity risk management.

        Our primary sources of liquidity are core deposits (described below), securities portfolio and wholesale funding. Wholesale funding includes unsecured funds raised from interbank and other sources, both domestic and international. Also included are secured funds raised by selling securities under repurchase agreements and by borrowing from the FHLB. We evaluate and monitor the stability and reliability of our various funding sources to help ensure that we have sufficient liquidity in adverse circumstances. We generally view our core deposits to be relatively stable. Secured borrowings via repurchase agreements and advances from the FHLB are also recognized as highly reliable funding sources, and we therefore maintain these sources primarily to meet our contingency funding needs.

        The acquisitions of certain assets and assumption of certain liabilities of Frontier and Tamalpais in the second quarter of 2010 resulted in the assumption of FHLB advances (including accrued interest) of $135 million from the FHLB of San Francisco and $385 million from the FHLB of Seattle, including prepayment fees payable of $4 million and $23 million, respectively. Shortly after the respective acquisition dates, the Bank repaid in full all outstanding FHLB advances assumed in connection with these acquisitions.

        Total deposits declined $7.0 billion from $68.5 billion at December 31, 2009 to $61.5 billion at September 30, 2010 largely due to planned deposit run off resulting from targeted rate reductions. The decline in deposits was coupled with a decrease in wholesale funding of $1.5 billion from $8.9 billion at December 31, 2009 to $7.4 billion at September 30, 2010.

        Core deposits, which consist of total deposits excluding brokered deposits and time deposits of $100,000 and over, provide us with a sizable source of relatively stable and low-cost funds. At September 30, 2010, our core deposits totaled $50.6 billion and our loan-to-total deposit ratio was 78 percent.

        The Bank maintains a variety of other funding sources, secured, and unsecured, which management believes will be adequate to meet the Bank's liquidity needs, including the following:

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        We believe that these sources, in addition to our core deposits and equity capital, provide a stable funding base. Management does not rely on any one source of liquidity and manages availability in response to changing balance sheet needs.

        Our costs and ability to raise funds in the capital markets are influenced by our credit ratings. Our credit ratings could be impacted by changes in the credit ratings of BTMU and MUFG. The following table provides our credit ratings as of September 30, 2010.

 
   
  Union Bank, N.A.   UnionBanCal
Corporation

Standard & Poor's

  Long-term   A+   A

  Short-term   A-1   A-1

Moody's

 

Long-term

 

A2

 

  Short-term   P-1  

Fitch

 

Long-term

 

A

 

A

  Short-term   F1   F1

DBRS

 

Long-term

 

A (high)

 

A

  Short-term   R-1 (middle)   R-1 (low)

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Capital

        The following tables summarize our risk-based capital, risk-weighted assets, and risk-based capital ratios.

UnionBanCal Corporation

(Dollars in thousands)   September 30,
2009
   
  December 31,
2009
   
  September 30,
2010
   
   
   
   
 

Capital Components

                                                       

Tier 1 capital

  $ 7,416,069         $ 7,484,516         $ 7,861,362                          

Tier 2 capital

    1,804,532           1,718,807           1,730,495                          
                                                   

Total risk-based capital

  $ 9,220,601         $ 9,203,323         $ 9,591,857                          
                                                   

Risk-weighted assets

  $ 63,956,189         $ 63,298,173         $ 64,079,581                          
                                                   

Quarterly average assets

  $ 71,384,950         $ 79,226,967         $ 79,718,783                          
                                                   

 

 
  September 30,
2009
  December 31,
2009
  September 30,
2010
  Minimum
Regulatory
Requirement
   
   
 
(Dollars in thousands)   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio    
   
 

Capital Ratios

                                                             

Total capital (to risk-weighted assets)

  $ 9,220,601     14.42 % $ 9,203,323     14.54 % $ 9,591,857     14.97 % ³$ 5,126,366     8.0 %            

Tier 1 capital (to risk-weighted assets)

    7,416,069     11.60     7,484,516     11.82     7,861,362     12.27     ³  2,563,213     4.0              

Leverage(1)

    7,416,069     10.39     7,484,516     9.45     7,861,362     9.86     ³  3,188,751     4.0              

(1)
Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).

Union Bank, N.A.

(Dollars in thousands)   September 30,
2009
   
  December 31,
2009
   
  September 30,
2010
   
   
   
   
 

Capital Components

                                                       

Tier 1 capital

  $ 6,906,944         $ 7,207,264         $ 7,253,252                          

Tier 2 capital

    1,484,451           1,478,697           1,483,837                          
                                                   

Total risk-based capital

  $ 8,391,395         $ 8,685,961         $ 8,737,089                          
                                                   

Risk-weighted assets

  $ 63,915,458         $ 63,272,931         $ 63,554,751                          
                                                   

Quarterly average assets

  $ 71,484,168         $ 79,609,326         $ 79,382,411                          
                                                   

 

 
  September 30,
2009
  December 31,
2009
  September 30,
2010
  Minimum
Regulatory
Requirement
  "Well-Capitalized"
Regulatory
Requirement
 
(Dollars in thousands)   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio  

Capital Ratios

                                                             

Total capital (to risk-weighted assets)

  $ 8,391,395     13.13 % $ 8,685,961     13.73 % $ 8,737,089     13.75 % ³$ 5,084,380     8.0 % ³$ 6,355,475     10.0 %

Tier 1 capital (to risk-weighted assets)

    6,906,944     10.81     7,207,264     11.39     7,253,252     11.41     ³  2,542,190     4.0     ³  3,813,285     6.0  

Leverage(1)

    6,906,944     9.66     7,207,264     9.05     7,253,252     9.14     ³  3,175,296     4.0     ³  3,969,121     5.0  

(1)
Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).

        We and Union Bank are subject to various regulations of the federal banking agencies, including minimum capital requirements. We are required to maintain minimum ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to quarterly average assets (the Leverage ratio).

        As of September 30, 2010, management believes the capital ratios of Union Bank met all regulatory requirements of "well-capitalized" institutions, which are 10 percent for the Total risk-based capital ratio, 6 percent for the Tier 1 risk-based capital ratio and 5 percent for the Leverage ratio.

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        In addition to capital ratios determined in accordance with regulatory requirements, we consider various other measures when evaluating capital utilization and adequacy. These non-regulatory capital ratios are viewed by management, and presented below, to further facilitate the understanding of our capital structure and for use in assessing and comparing the quality and composition of UNBC's capital structure to other financial institutions. These ratios are not defined by US GAAP or federal banking regulations. Therefore, these non-regulatory capital ratios disclosed are considered to be non-GAAP financial measures. Our calculation methods may differ from those used by other financial services companies. Also, there may be limits as to the usefulness of these measures. As a result, consider the consolidated financial statements and other financial information contained in this report in its entirety, and do not rely on any single financial measure.

        The following table summarizes the calculation of our tangible common equity ratio and Tier 1 common capital ratio as of September 30, 2009, December 31, 2009 and September 30, 2010.

(Dollars in thousands)   September 30,
2009
  December 31,
2009
  September 30,
2010
 

Total UNBC stockholder's equity

  $ 9,475,004   $ 9,580,333   $ 10,134,681  

Goodwill

    (2,369,326 )   (2,369,326 )   (2,431,583 )

Intangible assets

    (601,140 )   (561,040 )   (486,688 )

Deferred tax liabilities related to goodwill and intangible assets

    231,449     215,847     179,818  
               

Tangible common equity (a)

  $ 6,735,987   $ 6,865,814   $ 7,396,228  
               

Tier 1 capital, determined in accordance with regulatory requirements

  $ 7,416,069   $ 7,484,516   $ 7,861,362  

Trust preferred securities

    (13,000 )   (13,000 )   (13,000 )
               

Tier 1 common equity (b)

  $ 7,403,069   $ 7,471,516   $ 7,848,362  
               

Total assets

  $ 78,153,207   $ 85,598,128   $ 79,842,077  

Goodwill

    (2,369,326 )   (2,369,326 )   (2,431,583 )

Intangible assets

    (601,140 )   (561,040 )   (486,688 )

Deferred tax liabilities related to goodwill and intangible assets

    192,569     179,589     179,818  
               

Tangible assets (c)

  $ 75,375,310   $ 82,847,351   $ 77,103,624  
               

Risk-weighted assets, determined in accordance with regulatory requirements (d)

  $ 63,956,189   $ 63,298,173   $ 64,079,581  
               

Tangible common equity ratio (a)/(c)

    8.94 %   8.29 %   9.59 %

Tier 1 common capital ratio (b)/(d)

    11.58 %   11.80 %   12.25 %


Business Segments

        As a result of a corporate reorganization in the fourth quarter of 2009, we reevaluated our business segments. Under the new organizational structure, we have three operating segments: Retail Banking Group, Corporate Banking Group and Pacific Rim Corporate Group. The Corporate Banking Group and Pacific Rim Corporate Group segments have been aggregated together. We have two reportable business segments: Retail Banking and Corporate Banking.

        Prior to this reorganization, the various operating segments were aggregated into two reportable business segments formerly known as "Retail Banking" and "Wholesale Banking." Our new reportable business segment structure is similar to the previous structure. However, the Global and Wealth Markets Division, which was previously included in Retail Banking, is now included in Corporate Banking. Additionally, the goodwill, intangible assets, and related amortization/accretion associated with our privatization transaction, which was previously allocated to our operating segments, is reported in "Other."

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        We recorded $62.3 million of goodwill as a result of our second quarter 2010 FDIC-assisted acquisitions of certain assets and assumption of certain liabilities of Frontier and Tamalpais. Goodwill of $45.3 million and $17.0 million was assigned to the Retail Banking and Corporate Banking reportable business segments, respectively.

        The risk-adjusted return on capital (RAROC) methodology used seeks to attribute economic capital to business units consistent with the level of risk they assume. These risks are primarily credit and operational, given that most of the market risk is not assumed by the business unit. Credit risk is the potential loss in economic value due to the likelihood that the obligor will not perform as agreed. Operational risk is the potential loss due to all other factors, such as failures in internal control, system failures or external events. Market risk is the potential loss in fair value due to changes in interest rates, currency rates and equity prices. RAROC may be one of several measures that is used to measure business unit compensation.

        We reflect a "market view" perspective in measuring our business segments. The market view is a measurement of our customer markets aggregated to show all revenues generated and expenses incurred from all products and services sold to those customers regardless of where product areas organizationally report. Therefore, revenues and expenses are included in both the business segment that provides the service and the business segment that manages the customer relationship. The duplicative results from this internal management accounting view are reflected in "Reconciling Items." The market view approach fosters cross-selling with a total profitability view of the products and services being managed. For example, the Institutional Brokerage unit within the Global and Wealth Markets Division is a business unit that manages the fixed income securities activities for all retail and corporate customers throughout the Bank. This unit retains and also allocates revenues and expenses to divisions responsible for such retail and commercial customer relationships.

        Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to US GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies, and they are not necessarily indicative of the results that would be reported by our business units if they were unique economic entities.

        The table that follows reflects the condensed income statements, selected average balance sheet items, and selected financial ratios, including changes from the prior year, for each of our reportable business segments. Business unit results are prepared using various management accounting methodologies to measure the performance of the individual units. Our management accounting methodologies, which are enhanced from time to time, measure segment profitability by assigning balance sheet and income statement items for each business unit. Methodologies that are applied to the measurement of segment profitability include:

        The reportable business segment results for the prior periods have been adjusted to reflect changes in the transfer pricing methodology, the organizational changes that have occurred and the market view contribution.

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  Retail Banking    
   
  Corporate Banking    
   
 
 
  As of and for the
Three Months Ended
September 30,
  Increase/(Decrease)   As of and for the
Three Months Ended
September 30,
  Increase/(Decrease)  
 
  2009   2010   Amount   Percent   2009   2010   Amount   Percent  

Results of operations—Market View (dollars in thousands):

                                                 
 

Net interest income (expense)

  $ 220,970   $ 272,579   $ 51,609     23 % $ 353,514   $ 380,515   $ 27,001     8 %
 

Noninterest income (expense)

    73,080     67,309     (5,771 )   (8 )   116,817     136,375     19,558     17  
                                       
 

Total revenue

    294,050     339,888     45,838     16     470,331     516,890     46,559     10  
 

Noninterest expense (income)

    212,561     235,146     22,585     11     241,541     246,266     4,725     2  
 

Credit expense (income)

    7,016     6,760     (256 )   (4 )   91,512     65,079     (26,433 )   (29 )
                                       
 

Income (loss) before income taxes and including noncontrolling interests

    74,473     97,982     23,509     32     137,278     205,545     68,267     50  
 

Income tax expense (benefit)

    29,119     38,311     9,192     32     32,191     55,787     23,596     73  
                                       
 

Net income (loss) including noncontrolling interests

    45,354     59,671     14,317     32     105,087     149,758     44,671     43  
 

Less: Net loss from noncontrolling interests(2)

                na                 na  
                                       
 

Net income (loss) attributable to UNBC

  $ 45,354   $ 59,671   $ 14,317     32 % $ 105,087   $ 149,758   $ 44,671     43 %
                                       

Average balances—Market View (dollars in millions):

                                                 
 

Total loans

  $ 21,297   $ 22,028   $ 731     3   $ 29,453   $ 26,299   $ (3,154 )   (11 )
 

Total assets

    22,108     22,937     829     4     32,990     30,088     (2,902 )   (9 )
 

Total deposits

    19,812     24,516     4,704     24     38,032     39,096     1,064     3  

Financial ratios—Market View

                                                 
 

Risk adjusted return on capital(1)

    32 %   41 %               12 %   19 %            
 

Return on average assets(1)

    0.81     1.03                 1.26     1.97              
 

Efficiency ratio(3)

    72.34     69.10                 48.58     44.70              

 

 
  Other    
   
  Reconciling Items   UnionBanCal Corporation    
   
 
 
  As of and for the
Three Months Ended
September 30,
  Increase/(Decrease)   As of and for the
Three Months Ended
September 30,
  As of and for the
Three Months Ended
September 30,
  Increase/(Decrease)  
 
  2009   2010   Amount   Percent   2009   2010   2009   2010   Amount   Percent  

Results of operations—Market View (dollars in thousands):

                                                             
 

Net interest income (expense)

  $ 5,041   $ (18,413 ) $ (23,454 )   nm % $ (18,489 ) $ (16,626 ) $ 561,036   $ 618,055   $ 57,019     10 %
 

Noninterest income (expense)

    8,939     28,440     19,501     nm     (14,907 )   (14,181 )   183,929     217,943     34,014     18  
                                               
 

Total revenue

    13,980     10,027     (3,953 )   (28 )   (33,396 )   (30,807 )   744,965     835,998     91,033     12  
 

Noninterest expense (income)

    62,065     93,316     31,251     50     (10,352 )   (12,109 )   505,815     562,619     56,804     11  
 

Credit expense (income)

    215,609     (63,654 )   (279,263 )   (130 )   (137 )   (185 )   314,000     8,000     (306,000 )   (97 )
                                               
 

Income (loss) before income taxes and including noncontrolling interests

    (263,694 )   (19,635 )   244,059     93     (22,907 )   (18,513 )   (74,850 )   265,379     340,229     nm  
 

Income tax expense (benefit)

    (110,174 )   12,528     122,702     111     (8,957 )   (7,238 )   (57,821 )   99,388     157,209     nm  
                                               
 

Net income (loss) including noncontrolling interests

    (153,520 )   (32,163 )   121,357     79     (13,950 )   (11,275 )   (17,029 )   165,991     183,020     nm  
 

Less: Net loss from noncontrolling interests(2)

        (3,788 )   (3,788 )   nm                 (3,788 )   (3,788 )   nm  
                                               
 

Net income (loss) attributable to UNBC

  $ (153,520 ) $ (28,375 ) $ 125,145     82 % $ (13,950 ) $ (11,275 ) $ (17,029 ) $ 169,779   $ 186,808     nm  
                                               

Average balances—Market View (dollars in millions):

                                                             
 

Total loans

  $ (201 ) $ 1,710   $ 1,911     nm   $ (1,784 ) $ (1,932 ) $ 48,765   $ 48,105   $ (660 )   (1 )
 

Total assets

    21,056     31,189     10,133     48     (1,801 )   (1,949 )   74,353     82,265     7,912     11  
 

Total deposits

    2,956     2,962     6     0     (1,346 )   (1,751 )   59,454     64,823     5,369     9  

Financial ratios—Market View

                                                             
 

Risk adjusted return on capital(1)

    na     na                 na     na     na     na              
 

Return on average assets(1)

    na     na                 na     na     (0.09 )%   0.82 %            
 

Efficiency ratio(3)

    na     na                 na     na     65.07     63.69              

(1)
Annualized.
(2)
Reflects net loss attributed to noncontrolling interest related to our consolidated variable interest entities (VIE).
(3)
The efficiency ratio is net noninterest expense (noninterest expense excluding foreclosed asset expense (income), the provision for (reversal of) losses on off-balance sheet commitments, LIHC investment amortization expense, expenses of the consolidated VIEs and merger costs related to the acquisitions of certain assets and liabilities of Frontier and Tamalpais) as a percentage of total revenue (net interest income (taxable-equivalent basis) and noninterest income.)

na = not applicable

nm = not meaningful

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  Retail Banking    
   
  Corporate Banking    
   
 
 
  As of and for the
Nine Months Ended
September 30,
  Increase/(Decrease)   As of and for the
Nine Months Ended
September 30,
  Increase/(Decrease)  
 
  2009   2010   Amount   Percent   2009   2010   Amount   Percent  

Results of operations—Market View (dollars in thousands):

                                                 
 

Net interest income (expense)

  $ 617,423   $ 777,951   $ 160,528     26 % $ 963,444   $ 1,147,410   $ 183,966     19 %
 

Noninterest income (expense)

    212,440     207,757     (4,683 )   (2 )   363,144     398,798     35,654     10  
                                       
 

Total revenue

    829,863     985,708     155,845     19     1,326,588     1,546,208     219,620     17  
 

Noninterest expense (income)

    614,598     681,324     66,726     11     654,548     735,727     81,179     12  
 

Credit expense (income)

    21,353     20,115     (1,238 )   (6 )   246,798     218,020     (28,778 )   (12 )
                                       
 

Income (loss) before income taxes and including noncontrolling interests

    193,912     284,269     90,357     47     425,242     592,461     167,219     39  
 

Income tax expense (benefit)

    75,820     111,149     35,329     47     101,998     160,868     58,870     58  
                                       
 

Net income (loss) including noncontrolling interests

    118,092     173,120     55,028     47     323,244     431,593     108,349     34  
 

Less: Net loss from noncontrolling interests(2)

                na                 na  
                                       
 

Net income (loss) attributable to UNBC

  $ 118,092   $ 173,120   $ 55,028     47 % $ 323,244   $ 431,593   $ 108,349     34 %
                                       

Average balances—Market View (dollars in millions):

                                                 
 

Total loans

  $ 21,029   $ 21,835   $ 806     4   $ 30,208   $ 26,703   $ (3,505 )   (12 )
 

Total assets

    21,836     22,719     883     4     33,906     30,354     (3,552 )   (10 )
 

Total deposits

    19,264     22,613     3,349     17     33,009     42,644     9,635     29  

Financial ratios—Market View

                                                 
 

Risk adjusted return on capital(1)

    29 %   41 %               13 %   18 %            
 

Return on average assets(1)

    0.72     1.02                 1.27     1.90              
 

Efficiency ratio(3)

    73.98     69.03                 46.76     44.85              

 

 
  Other    
   
  Reconciling Items   UnionBanCal Corporation    
   
 
 
  As of and for the
Nine Months Ended
September 30,
  Increase/(Decrease)   As of and for the
Nine Months Ended
September 30,
  As of and for the
Nine Months Ended
September 30,
  Increase/(Decrease)  
 
  2009   2010   Amount   Percent   2009   2010   2009   2010   Amount   Percent  

Results of operations—Market View (dollars in thousands):

                                                             
 

Net interest income (expense)

  $ 133,791   $ (84,741 ) $ (218,532 )   nm % $ (43,273 ) $ (47,819 ) $ 1,671,385   $ 1,792,801   $ 121,416     7 %
 

Noninterest income (expense)

    2,385     107,392     105,007     nm     (36,111 )   (41,805 )   541,858     672,142     130,284     24  
                                               
 

Total revenue

    136,176     22,651     (113,525 )   (83 )   (79,384 )   (89,624 )   2,213,243     2,464,943     251,700     11  
 

Noninterest expense (income)

    317,518     289,754     (27,764 )   (9 )   (27,408 )   (35,414 )   1,559,256     1,671,391     112,135     7  
 

Credit expense (income)

    655,323     (15,672 )   (670,995 )   (102 )   (474 )   (463 )   923,000     222,000     (701,000 )   (76 )
                                               
 

Income (loss) before income taxes and including noncontrolling interests

    (836,665 )   (251,431 )   585,234     70     (51,502 )   (53,747 )   (269,013 )   571,552     840,565     nm  
 

Income tax expense (benefit)

    (319,850 )   (69,949 )   249,901     78     (20,137 )   (21,015 )   (162,169 )   181,053     343,222     nm  
                                               
 

Net income (loss) including noncontrolling interests

    (516,815 )   (181,482 )   335,333     65     (31,365 )   (32,732 )   (106,844 )   390,499     497,343     nm  
 

Less: Net loss from noncontrolling interests(2)

        (10,383 )   (10,383 )   nm                 (10,383 )   (10,383 )   nm  
                                               
 

Net income (loss) attributable to UNBC

  $ (516,815 ) $ (171,099 ) $ 345,716     67 % $ (31,365 ) $ (32,732 ) $ (106,844 ) $ 400,882   $ 507,726     nm  
                                               

Average balances—Market View (dollars in millions):

                                                             
 

Total loans

  $ (283 ) $ 962   $ 1,245     nm   $ (1,588 ) $ (1,902 ) $ 49,366   $ 47,598   $ (1,768 )   (4 )
 

Total assets

    16,866     33,033     16,167     96     (1,608 )   (1,920 )   71,000     84,186     13,186     19  
 

Total deposits

    2,473     3,300     827     33     (1,219 )   (1,646 )   53,527     66,911     13,384     25  

Financial ratios—Market View

                                                             
 

Risk adjusted return on capital(1)

    na     na                 na     na     na     na              
 

Return on average assets(1)

    na     na                 na     na     (0.20 )%   0.64 %            
 

Efficiency ratio(3)

    na     na                 na     na     66.34     64.50              

(1)
Annualized.
(2)
Reflects net loss attributed to noncontrolling interest related to our consolidated variable interest entities (VIE).
(3)
The efficiency ratio is net noninterest expense (noninterest expense excluding foreclosed asset expense (income), the provision for (reversal of) losses on off-balance sheet commitments, LIHC investment amortization expense, expenses of the consolidated VIEs and merger costs related to the acquisitions of certain assets and liabilities of Frontier and Tamalpais) as a percentage of total revenue (net interest income (taxable-equivalent basis) and noninterest income.)

na = not applicable

nm = not meaningful

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        Retail Banking provides deposit and lending products delivered through our branches and relationship managers to individuals and small businesses. Retail Banking is focused on executing a strategy that will identify targeted opportunities within the consumer and small business markets, and develop product, marketing and sales strategies to attract new customers in these identified target markets.

        During the nine months ended September 30, 2010, net income of Retail Banking increased compared to the same period in 2009, resulting from a 26 percent increase in net interest income, partially offset by an 11 percent increase in noninterest expense. The increase in net interest income was primarily due to increased margin combined with the growth in loans and interest bearing deposits.

        Average asset growth for the nine months ended September 30, 2010 compared to the same period in 2009 was primarily driven by a 4 percent growth in average loans, mainly in residential mortgages.

        Average deposits increased 17 percent during the nine months ended September 30, 2010 compared to the same period in 2009. This increase was primarily due to Retail Banking's strategy, which continues to focus on marketing activities to attract new consumer and small business deposits, customer cross-sell, relationship management, sales resources, and new products and locations. We expect that a larger branch network, combined with this Retail Banking strategy will improve growth prospects.

        Noninterest income decreased by 2 percent during the nine months ended September 30, 2010 compared to the same period in 2009. Noninterest expense increased by 11 percent during the nine months ended September 30, 2010 compared to the same period in 2009. This increase was primarily due to increased staff costs, acquisition related expenses, and overhead allocation costs.

        Retail Banking is comprised of the following major divisions: Community Banking and Consumer Lending.

        The Community Banking Division is organized geographically. We serve our customers in the following ways:

        Through alliances with other financial institutions, the Consumer Lending Division offers additional products and services, such as credit cards and merchant services.

        Our Community Banking and Consumer Lending Divisions compete with larger banks by attempting to provide service quality superior to that of our major competitors. The primary means of competing with community banks include our branch network and our technology to deliver banking services. We also offer convenient banking hours to consumers through our drive-through banking locations and selected branches that are open seven days a week.

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        These divisions compete with a number of commercial banks, internet banks, savings associations and credit unions, as well as more specialized financial service providers such as investment brokerage companies, consumer finance companies, and residential real estate lenders.

        Corporate Banking offers a wide array of financial products to both middle market and corporate businesses headquartered throughout the United States. Corporate Banking focuses its activities on specific specialized industries, such as power and utilities, petroleum, real estate, healthcare, equipment leasing and commercial finance as well as general corporate and middle-market lending in regional markets throughout the United States. Corporate Banking relationship managers provide credit services including commercial loans, accounts receivable and inventory financing, project financing, trade financing and real estate financing. In addition to credit services, Corporate Banking offers its customers a broad range of noncredit services, which include global treasury management solutions, foreign exchange and various interest rate risk and energy risk management products. These products are delivered through deposit managers and product specialists with significant industry expertise and experience in businesses of all sizes including numerous vertical industry niches such as U.S. correspondent banks and certain government entities. One of the primary strategies of our Corporate Banking business units is to target industries and companies for which we can reasonably expect to be one of a customer's primary banks. Consistent with this strategy, Corporate Banking business units attempt to serve a large part of the targeted customers' credit and depository needs. The Corporate Banking business units compete with other banks primarily on the basis of the quality of our relationship managers, the level of industry expertise, the delivery of quality customer service, and our reputation as a "commercial bank." We also compete with a variety of other financial services companies as well as non-bank companies. Competitors include other major California banks, as well as regional, national and international banks. In addition, we compete with investment banks, commercial finance companies, leasing companies and insurance companies. Competition in our principal markets may further intensify as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which, among other things, permits de novo branching into California by national banks, state banks and foreign banks from other states (see Part II, Item IA, "Risk Factors—Substantial competition could adversely affect us" in this Form 10-Q for additional information about the Dodd-Frank Act).

        During the nine months ended September 30, 2010, net income of Corporate Banking increased 34 percent, compared to the same period of 2009, resulting from a 19 percent increase in net interest income mainly from higher margins on deposits and a 10 percent increase in noninterest income, partially offset by a 12 percent increase in noninterest expense. During the nine months ended September 30, 2010, average loans decreased 12 percent compared to the same period of 2009 primarily due to decreases in our commercial and industrial loan portfolio and real estate construction portfolio.

        During the nine months ended September 30, 2010, average deposits increased 29 percent compared to the same period of 2009. Money market deposits experienced significant growth as a result of long-term corporate deposit-gathering strategies, a "flight to quality" and entry into new business niches. These new niches provided funding from large institutional accounts, including brokerage firms. These relationships reflect execution of a business strategy to obtain deposits from brokerage and institutional clients. In addition, state and local government and Corporate Banking deposits experienced significant growth.

        Noninterest income increased 10 percent during the nine months ended September 30, 2010, compared to the same period of 2009, primarily due to higher amortized fees on standby letters of credit, trading income, merchant banking fees, gain on private capital investments, partially offset by lower trust and deposit fees. Noninterest expense increased 12 percent during the nine months ended September 30, 2010 compared to the same period of 2009 primarily due to increased staff costs and low income housing amortization expense.

        Corporate Banking initiatives continue to include expanding commercial and loan relationship strategies that include originating, underwriting and syndicating loans in core competency markets, such as in our West

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Coast commercial lending markets, as well as our national specialty markets including real estate, energy, equipment leasing and commercial finance.

        Corporate Banking is comprised of the following main divisions:

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        Our net loss decreased by $345.7 million in the nine months ended September 30, 2010, compared to the same period in 2009, primarily due to lower loan loss provision, and higher noninterest income; partially offset by lower net interest income.

        "Other" includes the following items:

        The financial results for the nine months ended September 30, 2010 were impacted by the following factors:

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        The financial results for the nine months ended September 30, 2009 were impacted by the following factors:

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

        A discussion of our market risk exposure is incorporated by reference to Part I, Item 2 of this Form 10-Q under the caption "Quantitative and Qualitative Disclosures About Market Risk" and to Part II, Item 1A of this Form 10-Q under the caption "Risk Factors."

Item 4.   Controls and Procedures

        Our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) have concluded that the design and operation of our disclosure controls and procedures are effective as of September 30, 2010. This conclusion is based on an evaluation conducted under the supervision and with the participation of management. Disclosure controls and procedures are those controls and procedures which ensure that information required to be disclosed in this filing is accumulated and communicated to management and is recorded, processed, summarized and reported in a timely manner and in accordance with Securities and Exchange Commission rules and regulations.

        During the quarter ended September 30, 2010, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 1.   Legal Proceedings

        Cynthia Larsen v. Union Bank, N.A.:    This putative class action was filed on July 15, 2009 by Union Bank customer Cynthia Larsen. In October of 2009, the action was transferred from the Northern District of California to the Multidistrict Litigation action (MDL) in the Southern District of Florida. Omnibus motions to dismiss the complaints in many of the suits included in the MDL, including Larsen, were denied on March 12, 2010. Plaintiffs allege that, by posting charges to their accounts in order from highest to lowest amount, the Bank charged them more overdraft fees than it would have charged them had the Bank posted items to their accounts in chronological order.

        Plaintiffs' complaint asserts common-law causes of action for: breach of contract/breach of duty of an implied duty of good faith, unconscionability, conversion, and unjust enrichment, and statutory violation of the California Business & Professions Code section 17200 et seq. Plaintiffs seek unspecified damages, return or refund of all improper overdraft fees, disgorgement of profits derived from the Bank's alleged conduct, injunctive relief, and attorneys' fees and costs. Plaintiffs seek to represent a putative class of other Union Bank customers who were charged overdraft charges as a result of "re-sequencing" within the applicable statute of limitations period. Union Bank intends to vigorously defend the case. Trial is currently scheduled for March 2012.

        We are subject to various pending and threatened legal actions that arise in the normal course of business. We maintain reserves for losses from legal actions that are both probable and estimable. In addition, we believe the disposition of all claims currently pending will not have a material adverse effect on our consolidated financial condition, operating results or liquidity.

Item 1A.   Risk Factors

        For a discussion of risk factors relating to our business, please refer to Item 1A of Part I of our 2009 Form 10-K, which is incorporated by reference herein, in addition to the following information.

Industry Factors

        U.S. and global economies have experienced a serious recession, unprecedented volatility in the financial markets, and significant deterioration in sectors of the U.S. consumer and business economy, all of which continue to present challenges for the banking and financial services industry and for UnionBanCal Corporation; the U.S. Government has responded to these circumstances with a variety of measures; there can be no assurance that these measures will successfully address these circumstances.

        Over the past three years, adverse financial and economic developments have impacted the U.S. and global economies and financial markets and present challenges for the banking and financial services industry and for UnionBanCal Corporation. These developments include a general recession both globally and in the U.S. and have contributed to substantial volatility in the financial markets.

        In response, various significant economic and monetary stimulus measures were enacted by the U.S. Congress. Refer to "Supervision and Regulation" in Item 1 of our 2009 Form 10-K for discussion of these measures.

        It cannot be predicted whether the U.S. Governmental actions in the past two years will result in lasting improvement in financial and economic conditions affecting the U.S. banking industry and the U.S. economy. It also cannot be predicted whether and to what extent the efforts of the U.S. Government to combat the recessionary conditions will continue. If, notwithstanding the government's fiscal and monetary measures, the U.S. economy were to remain in a recessionary condition for an extended period, this would present additional significant challenges for the U.S. banking and financial services industry and for our company. In addition, as a wholly-owned subsidiary of a foreign bank, we have not been eligible to participate in some federal programs

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such as the Department of Treasury's Capital Purchase Program and may not qualify for participation in future federal programs.

        Recently, certain sovereign borrowers have encountered difficulties in financing renewals of their indebtedness. If this trend continues or worsens, it could have adverse impacts on costs in the global debt markets which could increase funding costs for banks generally. Further, European regulators have recently announced findings from capital stress tests on many European banks. The confidence in the transparency and robustness in these stress tests remains unclear. These combined factors, if continuing to worsen, could further increase the uncertainty in global markets.

        Difficult market conditions have adversely affected the U.S. banking industry

        Dramatic declines in the housing market in the U.S. in general, and in California in particular, during 2008 and continuing in 2009 and 2010, with falling or sluggish home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities as well as commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, residential and commercial real estate loans and small business and other commercial loans, in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. These adverse economic conditions have led to an increased level of commercial and consumer delinquencies, reduced consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets adversely affected our business, financial condition and results of operations in 2009 and this effect has continued, although to a lessened degree, in 2010. In addition, turbulent political and economic conditions in foreign countries have negatively impacted the U.S. financial markets and economy in general. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events:

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        The effects of changes of or increases in, or supervisory enforcement of, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us

        We are subject to significant federal and state regulation and supervision, which is primarily for the benefit and protection of our customers and the Deposit Insurance Fund and not for the benefit of investors in our securities. In the past, our business has been materially affected by these regulations. This will continue and likely intensify in the future. Laws, regulations or policies, including accounting standards and interpretations, currently affecting us and our subsidiaries may change at any time. Regulatory authorities may also change their interpretation of these statutes and regulations. Therefore, our business may be adversely affected by changes in laws, regulations, policies or interpretations or regulatory approaches to compliance and enforcement, as well as by supervisory action or criminal proceedings taken as a result of noncompliance which could result in the imposition of significant civil money penalties or fines. Changes in laws and regulations may also increase our expenses by imposing additional fees or taxes or restrictions on our operations. Compliance with laws and regulations, especially new laws and regulations, increases our expenses and diverts management attention from our business operations.

        On July 21, 2010, President Obama signed into law the Dodd-Frank Act. This new legislation will affect U.S. financial institutions, including Union Bank, in many ways, some of which will likely increase the cost of doing business and present other challenges to the financial services industry. Many of the new law's provisions will be implemented by rules and regulations of the federal banking agencies over the coming months, the scope and impact of which cannot yet be determined. The new law contains many provisions

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which may have particular relevance to the business of Union Bank. While the effect of these provisions of the Dodd-Frank Act on Union Bank cannot be predicted at this time, they may result in increased FDIC deposit insurance premiums, increased capital and liquidity requirements, increased regulatory and compliance costs and other operational costs and expenses, reduced fee-based revenues and restrictions on some aspects of our operations, increased interest expense on our demand deposits (after July 2011), any or all of which may be material.

        International laws, regulations and policies affecting us, our subsidiaries and the business we conduct may change at any time and affect our business opportunities and competitiveness in these jurisdictions. Due to our ownership by BTMU, laws, regulations, policies, fines and other supervisory actions adopted or enforced by the Government of Japan and the Federal Reserve Board may adversely affect our activities and investments and those of our subsidiaries in the future. In September 2010, the Basel Committee on Banking Supervision ("the Basel Committee") announced that new liquidity risk metrics would become minimum standards in January 2015 (the "Liquidity Coverage Ratio") and January 2018 (the "Net Stable Funding Ratio") after observation periods that would commence in January 2011 and January 2012, respectively. The announcement was preceded by a consultative document issued for comment in December 2009 and an annex in July 2010 that revised some of the definitions in the original consultative document. Many aspects of the standards are uncertain and are subject to interpretation. Also in September 2010, the Basel Committee announced new, higher capital standards that increase minimum capital ratios plus add a capital conservation buffer. The revised standards call for a fully phased-in minimum common equity ratio of 4.5% plus a capital conservation buffer of 2.5%, and also introduce new deductions from allowable equity capital. As with the liquidity risk metrics, many aspects of the standards are uncertain and are subject to interpretation, with further clarification required by U.S. regulators. The new standards are to be fully phased-in by January 2019, with observation periods beginning in January 2011. It is expected that clarifying guidance for U.S. banks will be provided by the U.S. bank regulatory agencies through customary rulemaking procedures. Refer to "Supervision and Regulation" in Item 1 of our 2009 Form 10-K for additional information regarding the Basel Committee capital standards.

        We maintain systems and procedures designed to comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of criminal or civil penalties (which can be substantial) for noncompliance. In some cases, liability may attach even if the noncompliance was inadvertent or unintentional and even if compliance systems and procedures were in place at the time. There may be other negative consequences from a finding of noncompliance, including restrictions on certain activities and damage to our reputation.

        Additionally, our business is affected significantly by the fiscal and monetary policies of the U.S. federal government and its agencies. We are particularly affected by the policies of the Federal Reserve Board, which regulates the supply of money and credit in the U.S. Under long-standing policy of the Federal Reserve Board, a bank holding company is expected to act as a source of financial and managerial strength for its subsidiary banks. As a result of that policy, we may be required to commit financial and other resources to our subsidiary bank in circumstances where we might not otherwise do so. Among the instruments of monetary policy available to the Federal Reserve Board are (a) conducting open market operations in U.S. Government securities, (b) changing the discount rates on borrowings by depository institutions and the federal funds rate, and (c) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the Federal Reserve Board may have a material effect on our business, prospects, results of operations and financial condition.

        Refer to "Supervision and Regulation" in Item 1 of our 2009 Form 10-K for discussion of certain recently enacted and proposed laws and regulations that may affect our business.

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        Our deposit customers may pursue alternatives to bank deposits or seek higher yielding deposits, which may increase our funding costs and adversely affect our liquidity position

        Checking and savings account balances and other forms of deposits can decrease when our deposit customers perceive alternative investments, such as the stock market, other non-depository investments or higher yielding deposits, as providing superior expected returns. Technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments or other deposit accounts, including products offered by other financial institutions or non-bank service providers. Future increases in short-term interest rates could increase such transfers of deposits to higher yielding deposits or other investments either with us or with external providers. In addition, our level of deposits may be affected by lack of consumer confidence in financial institutions, which have caused fewer depositors to be willing to maintain deposits that are not fully insured by the FDIC. Depositors may withdraw certain deposits from Union Bank and place them in other institutions or invest uninsured funds in investments perceived as being more secure, such as securities issued by the U.S. Treasury. These consumer preferences may force us to pay higher interest rates or reduce fees to retain certain deposits and may constrain liquidity as we seek to meet funding needs caused by reduced deposit levels.

        In addition, we have benefited from a "flight to quality" by consumers and businesses seeking the relative safety of bank deposits over the past two years. As interest rates rise from historically low levels during the current period, our newly acquired deposits may not be as stable or as interest rate insensitive as similar deposits may have been in the past, and as a recovery in the economy ensues, some existing or prospective deposit customers of banks generally, including Union Bank, may be inclined to pursue other investment alternatives.

        Efforts and initiatives we undertake to retain and increase deposits, including deposit pricing, can increase our costs. When bank customers move money out of bank deposits in favor of alternative investments or into higher yielding deposits, we can lose a relatively inexpensive source of funds, increasing our funding cost.

        Substantial competition could adversely affect us

        Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business in California, Oregon and Washington, as well as nationally and internationally. Our competitors include a large number of state and national banks, thrift institutions, credit unions and major foreign-affiliated or foreign banks, as well as many financial and nonfinancial firms that offer services similar to those offered by us, including many large securities firms. Some of our competitors are community or regional banks that have strong local market positions. Other competitors include large financial institutions that have substantial capital, technology and marketing resources that are well in excess of ours. Competition in our industry may further intensify as a result of the recent and increasing level of consolidation of financial services companies, including in our principal markets resulting from adverse economic and market conditions. Such large financial institutions may have greater access to capital at a lower cost than us, which may adversely affect our ability to compete effectively. Competition in our principal markets may further intensify as a result of the Dodd-Frank Act, which, among other things, permits de novo branching into California by national banks, state banks and foreign banks from other states. We also experience competition, especially for deposits, from internet-based banking institutions, which have grown rapidly in recent years.

        Adverse economic factors affecting certain industries we serve could adversely affect our business

        We are subject to certain industry-specific economic factors. For example, a significant portion of our total loan portfolio is related to residential real estate, especially in California. Increases in residential mortgage loan interest rates could have an adverse effect on our operations by depressing new mortgage loan originations, and could negatively impact our title and escrow deposit levels. Additionally, a continued or further downturn

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in the residential real estate and housing industries in California could have an adverse effect on our operations and the quality of our real estate loan portfolio. These factors could adversely impact the quality of our residential construction and residential mortgage portfolios in various ways, including by decreasing the value of the collateral for our mortgage loans. These factors could also negatively affect the economy in general and thereby our overall loan portfolio.

        We provide financing to businesses in a number of other industries that may be particularly vulnerable to industry-specific economic factors and are impacting the performance of our commercial real estate and commercial and industrial portfolios. The commercial real estate industry in the U.S., and in California in particular, has been increasingly adversely impacted by the recessionary environment and lack of liquidity in the financial markets. The home building and mortgage industry in California has been especially adversely impacted by the deterioration in residential real estate markets. Poor economic conditions and financial access for commercial real estate developers and homebuilders could continue to adversely affect property values, resulting in higher nonperforming assets and charge-offs in this sector. Our commercial and industrial portfolio, and the communications and media industry, the retail industry, the energy industry and the technology industry in particular, are also being impacted by recessionary market conditions. Continued volatility in fuel prices and energy costs could adversely affect businesses in several of these industries. Conditions and credit markets remain uncertain and are expected to continue producing elevated charge-offs. Industry-specific risks are beyond our control and could adversely affect our portfolio of loans, potentially resulting in an increase in nonperforming loans or charge-offs and a slowing of growth or reduction in our loan portfolio.

        Adverse California economic conditions could adversely affect our business

        The government of the State of California currently faces economic and fiscal challenges, the long-term impact of which on the State's economy cannot be predicted with any certainty. A substantial majority of our assets, deposits and fee income are generated in California. As a result, poor economic conditions in California may cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio. Economic conditions in California are subject to various uncertainties at this time, including significant deterioration in the residential real estate sector and the California state government's budgetary and fiscal difficulties.

        Governor Schwarzenegger declared a fiscal emergency on January 8, 2010, calling the State legislature into special session to begin taking action on the State's $19.1 billion reported deficit. On October 8, 2010, after 100 days past the state's statutory deadline without a budget, Governor Schwarzenegger signed into law a 2010-2011 budget plan which had been approved by the California Legislature. The budget includes $7.5 billion in spending cuts to services and program eliminations (less than the $12.4 billion in cuts in Governor Schwarzenegger's proposed budget plan). The budget assumes that California will receive $5.3 billion in federal assistance (more than the $3.4 billion in federal assistance assumed in all three of the proposed budget plans); however, there have been no assurances from the federal government that such amount will be furnished to California. If such funds are not awarded, California may be forced to further cut state services or raise taxes or fees. The approved budget also reduces the State's deficit by $1.4 billion by using more optimistic tax revenue forecasts, limits some business tax breaks, and assumes $1.2 billion in revenues from the required sale of certain State-owned office buildings. The financial and economic consequences of this situation cannot be predicted with any certainty at this time.

        If the California state government's budgetary and fiscal difficulties continue or economic conditions in California decline further, we expect that our level of problem assets could increase and our prospects for growth could be impaired.

        Risks associated with potential acquisitions or divestitures or restructurings may adversely affect us

        We have in the past, and may in the future, seek to expand our business by acquiring other businesses which we believe will enhance our business. We cannot predict the frequency, size or timing of our

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acquisitions, as this will depend on the availability of prospective target opportunities at valuation levels we find attractive and the competition for such opportunities from other parties. There can be no assurance that our acquisitions will have the anticipated positive results, including results related to: the total cost of integration; the time required to complete the integration; the amount of longer-term cost savings; continued growth; or the overall performance of the acquired company or combined entity. We also may encounter difficulties in obtaining required regulatory approvals and unexpected contingent liabilities can arise from the businesses we acquire. Our purchase and assumption and loss share agreements with the FDIC relating to our Frontier Bank and Tamalpais Bank transactions have specific compliance, servicing, notification and reporting requirements. Any failure to comply with the requirements of the loss share agreements, or to properly service the loans and OREO covered by any loss share arrangement, may cause individual loans or loan pools to lose their eligibility for loss share payments from the FDIC, potentially resulting in material losses that are currently not anticipated.

        Integration of an acquired business can be complex and costly. If we are not able to integrate successfully past or future acquisitions, there is a risk that results of operations could be adversely affected.

        In addition, we continue to evaluate the performance of all of our businesses and may sell or restructure a business. Any divestitures or restructurings may result in significant write-offs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our business, results of operations and financial condition and may involve additional risks including difficulties in obtaining any required regulatory approvals, the diversion of management's attention from other business concerns, the disruption of our business and the potential loss of key employees.

        We may not be successful in addressing these or any other significant risks encountered in connection with any acquisition, divestiture or restructuring we might make.

        Our business could suffer if we fail to attract, retain and successfully integrate skilled personnel

        Our success depends, in large part, on our ability to attract and retain key personnel, including executives. Any of our current employees, including our senior management, may terminate their employment with us at any time. Competition for qualified personnel in our industry can be intense. We may not be successful in attracting and retaining sufficient qualified personnel. We may also incur increased expenses and be required to divert the attention of other senior executives to recruit replacements for the loss of any key personnel.

        In the past few years, we have experienced significant turnover among members of management, primarily due to retirement. We must successfully integrate any new management personnel that we bring into the organization in order to achieve our operating objectives as new management becomes familiar with our business.

        In 2010, the federal banking agencies jointly adopted new guidance relating to incentive compensation policies at insured depository institutions. In general, the new guidance is principles-based and requires insured depository institutions to seek to assure that their incentive compensation policies do not encourage undue risk-taking by management officials and other employees. Over time, these guidelines could have the effect of making it more difficult for banks to attract and retain skilled personnel.

        The challenging operating environment and current operational initiatives may strain our available resources

        There are an increasing number of matters in addition to our core operations which require our attention and resources. These matters include implementation of our integrated banking platform, adoption of the Basel II capital guidelines, various strategic initiatives, integration of the operations of our recent FDIC-assisted acquisitions, a disruptive economic environment, a challenging regulatory environment, including the possible effects of the Dodd-Frank Act and regulations adopted thereunder, and integration of new employees, including key members of management. Our ability to execute our core operations and to implement other important

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initiatives may be adversely affected if our resources are insufficient or if we are unable to allocate available resources effectively. Also, our ability to constrain or reduce operating expense levels may be limited by the costs of increasing regulatory requirements and expectations.

        We rely on third parties for important products and services

        Third-party vendors provide key components of our business infrastructure such as internet connections, network access and mutual fund distribution and we do not control their actions. Among other services provided by these vendors, third-party vendors play a key role in the design and implementation of our integrated banking platform. Any problems caused by these third parties, including those as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers, implement our integrated banking platform and otherwise to conduct our business. In addition, any such performance issues with our vendors could result in delays in implementing our initiatives, as well as cost overruns, and, if it should become necessary to discontinue or significantly modify a project, there could be charges arising from the write-off of previous investments that would adversely affect our results of operations. Replacing these third-party vendors could also entail significant delay and expense.

        We are subject to operational risks

        We are subject to many types of operational risks throughout our organization. Operational risk is the potential loss from our operations due to factors, such as failures in internal control, systems failures or external events, that do not fall into the market risk or credit risk categories described in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Business Segments." Operational risk includes execution risk related to operational initiatives, including implementation of our integrated banking platform, reputational risk, legal and compliance risk, the risk of fraud or theft by employees, customers or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. A discussion of risks associated with regulatory compliance appears above under the caption "The effects of changes in, or supervisory enforcement of, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us."

        We depend on the continued efficacy of our technical systems, operational infrastructure, relationships with third parties and our employees in our day-to-day and ongoing operations. Our dependence upon automated systems to record and process transactions may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. Changes in our automated systems also may involve complex technical challenges that could be difficult to overcome, potentially resulting in unexpected expense and ongoing issues with the functionality of our systems. Failures in our internal control or operational systems could impair our ability to operate our business and result in potential liability to customers, reputational damage and regulatory intervention, any of which could harm our operating results and financial condition.

        We may also be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control, such as computer hacking or viruses, electrical or telecommunications outages or unexpected difficulties with the implementation of our integrated banking platform, which may give rise to disruption of service to customers and to financial loss or liability. Our business recovery plan may not work as intended or may not prevent significant interruptions of our operations.

        Changes in our tax rates could affect our future results

        Under an election we have made, we are required to file our California franchise tax returns as a member of a unitary group that includes MUFG's U.S. operations, including its branch activities and its U.S. affiliates. Increases or decreases in the taxable profits of MUFG's U.S. operations could increase or decrease our effective

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tax rate. We review MUFG's financial information on a quarterly basis to determine the rate at which to recognize our California income taxes. However, all of the information relevant to determining the effective California tax rate may not be available until after the end of the period to which the tax relates, primarily due to MUFG's March 31 fiscal year-end. Our California effective tax rate can change during the calendar year, or between calendar years, as additional information becomes available. If we understate our tax obligations, we could be subject to penalties. Our effective tax rates also could be affected by valuation changes in our deferred tax assets and liabilities, changes in tax laws or their interpretation and by the outcomes of examinations of our income tax returns by the tax authorities.

        We may take actions to maintain client satisfaction that may result in losses or adversely affect our earnings

        We may find it necessary to take actions or incur expenses in order to maintain client satisfaction even though we are not required to do so by law. The risk that we will need to take such actions and incur the resulting losses or reductions in earnings is greater in periods when financial markets and the broader economy are performing poorly or are particularly volatile. As a result, such actions may adversely affect our business, financial condition, results of operations or prospects, perhaps materially.

        We may be adversely affected by the soundness of other financial institutions

        As a result of trading, clearing or other relationships, we have exposure to many different counterparties and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers, dealers and investment banks. Many of these transactions expose us to credit risk in the event of a default by a counterparty. In addition, our credit risk may be exacerbated when the collateral we hold cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on our business, results of operations, financial condition or prospects.

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Item 6.   Exhibits

No.   Description
  31.1   Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)
  31.2   Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)
  32.1   Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)
  32.2   Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

(1)
Filed herewith.

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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.

    UNIONBANCAL CORPORATION (Registrant)

Date:    November 10, 2010

 

By:

 

/s/ MASASHI OKA

Masashi Oka
President and Chief Executive Officer
(Principal Executive Officer)

Date:    November 10, 2010

 

By:

 

/s/ JOHN F. WOODS

John F. Woods
Vice Chairman and Chief Financial Officer
(Principal Financial Officer)

Date:    November 10, 2010

 

By:

 

/s/ DAVID A. ANDERSON

David A. Anderson
Executive Vice President and Controller
(Chief Accounting Officer)

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EXHIBIT INDEX

No.   Description
  31.1   Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

 

31.2

 

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

 

32.1

 

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

 

32.2

 

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

(1)
Filed herewith.

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