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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
|X| THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
OR
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 and zip code of principal executive offices)
Registrant's telephone number: (415) 765-2969
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $1 par value per share
(Title of each class)
New York Stock Exchange
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
None
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 _ No _
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes _ No _
As of June 30, 2004, the aggregate market value of voting and non-voting
common equity held by non-affiliates of the registrant was $2,387,488,196. The
aggregate market value was computed by reference to the last sales price of such
stock.
As of January 31, 2005, the number of shares outstanding of the
registrant's Common Stock was 148,441,799.
DOCUMENTS INCORPORATED BY REFERENCE
INCORPORATED DOCUMENT LOCATION IN FORM 10-K
Portions of the Proxy Statement for our April 27, Part III
2005 Annual Meeting of Stockholders
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INDEX
PAGE
PART I
ITEM 1. BUSINESS..................................................... 3
General............................................................ 3
Banking Lines of Business.......................................... 3
Employees.......................................................... 4
Competition........................................................ 4
Monetary Policy and Economic Conditions............................ 5
Supervision and Regulation......................................... 5
ITEM 2. PROPERTIES................................................... 8
ITEM 3. LEGAL PROCEEDINGS............................................ 9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......... 9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES........... 9
ITEM 6. SELECTED FINANCIAL DATA...................................... 10, F-1
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 10, F-1
10,
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.. F-32
10,
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..... F-52
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..................................... 10
ITEM 9A. CONTROLS AND PROCEDURES..................................... 11
ITEM 9B. OTHER INFORMATION........................................... 11
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 11
ITEM 11. EXECUTIVE COMPENSATION...................................... 14
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS.................. 14
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 14
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES...................... 15
PART IV
ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES..... 15
SIGNATURES............................................................. II-1
2
PART I
ITEM 1. BUSINESS
All reports that we file electronically with the Securities and Exchange
Commission (SEC), including the Annual Reports on Form 10-K, Quarterly Reports
on Form 10-Q, and current reports on Form 8-K, as well as any amendments to
those reports, are accessible at no cost on our internet website at www.uboc.com
as soon as reasonably practicable after we electronically file such reports
with, or furnish them to, the SEC. These filings are also accessible on the
SEC's website at www.sec.gov.
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
from our forecasts and expectations. See the section entitled "Factors that May
Affect Future Results" located near the end of "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
GENERAL
UnionBanCal Corporation through its banking subsidiary, Union Bank of
California, N.A., provides a wide range of financial services to consumers,
small businesses, middle-market companies and major corporations, primarily in
California, Oregon, and Washington, and nationally and internationally as well.
At December 31, 2004, The Bank of Tokyo-Mitsubishi, Ltd. (BTM), our majority
owner, which is a wholly-owned subsidiary of Mitsubishi Tokyo Financial Group,
Inc. (MTFG), owned approximately 62 percent of our outstanding common stock.
BANKING LINES OF BUSINESS
Our operations are divided into four primary segments, which are described
more fully in our Management's Discussion and Analysis of Financial Condition
and Results of Operations and in Note 25 to our Consolidated Financial
Statements included in this Annual Report on Form 10-K.
THE COMMUNITY BANKING AND INVESTMENT SERVICES GROUP. This group offers its
customers a broad spectrum of financial products under one convenient umbrella.
With a broad line of checking and savings, investment, loan and fee-based
banking products, individual and business clients can each have their specific
needs met. These products are offered in 315 full-service branches, primarily in
California, as well as in Oregon and Washington. In addition, the group offers
international and settlement services, e-banking through our website, check
cashing services at our Cash & Save(R) locations and loan and investment
products tailored to our high net worth individual customers through our offices
of The Private Bank. Institutional customers are offered employee benefit,
401(k) administration, corporate trust, securities lending and custody (global
and domestic) services. The group also includes a registered broker-dealer and a
registered investment advisor, which provide securities brokerage and investment
advisory services and manage a proprietary mutual fund family.
In recent years, we have acquired several businesses in the insurance
services field in order to facilitate our offering to our customers an extensive
array of cost-effective risk management services and insurance products,
including Armstrong/Robitaille, Inc. in 2001, John Burnham & Company in 2002 and
Tanner Insurance Brokers in 2003. In addition, we acquired the trust business
portfolio of CNA Trust Company and the corporate trust portfolio of BTM Trust
Company, both in 2004, which have expanded our institutional trust services.
In the past two years, we have augmented our retail branch network through
acquisitions of community banks, including Jackson Federal Bank in October 2004,
with $1.9 billion in assets and 14 full service branches, Business Bank of
California in January 2004 with $704 million in assets and 15 full service
branches in the Southern California Inland Empire and the San Francisco Bay
Area, and the Monterey Bay Bank in Watsonville, California in July 2003, with
$632 million in assets and eight full service branches.
3
These bank, insurance agency and trust acquisitions are consistent with our
strategies to diversify earnings and broaden our branch network. For information
regarding certain regulatory matters that may adversely affect our ability to
expand through acquisitions, see "Regulatory Matters" in Management's Discussion
and Analysis of Financial Condition and Results of Operations.
THE COMMERCIAL FINANCIAL SERVICES GROUP. This group offers a variety of
commercial financial services, including commercial loans and project financing,
real estate financing, asset-based financing, trade finance and letters of
credit, lease financing, customized cash management services and selected
capital markets products. The group's customers include middle-market companies,
large corporations, real estate companies and other more specialized industry
customers. In addition, specialized depository services are offered to title and
escrow companies, retailers, domestic financial institutions, bankruptcy
trustees and other customers with significant deposit volumes.
THE INTERNATIONAL BANKING GROUP. This group primarily provides
correspondent banking and trade finance-related products and services to
financial institutions worldwide, primarily in Asia.
THE GLOBAL MARKETS GROUP. This group is responsible for our treasury
management, which encompasses wholesale funding, liquidity management, and
interest rate risk management. In collaboration with our other business groups,
this group also offers customers a broad range of financial services products
and risk management products.
EMPLOYEES
At January 31, 2005, we had 10,447 full-time equivalent employees.
COMPETITION
Banking is a highly competitive business. We compete actively for loan,
deposit, and other financial services business in California, as well as
nationally and internationally. Our competitors include a large number of state
and national banks, thrift institutions, credit unions, finance companies 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, which are well in excess of ours. 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.
Technology and other changes increasingly allow parties to complete
financial transactions electronically, and in many cases, without banks. For
example, consumers can pay bills and transfer funds over the internet and by
telephone without banks. Many non-bank financial service providers have lower
overhead costs and are subject to fewer regulatory constraints. If consumers do
not use banks to complete their financial transactions, we could potentially
lose fee income, deposits and income generated from those deposits.
Changes in federal law have made it easier for out-of-state banks to enter
and compete in the states in which we operate. The Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the Riegle-Neal Act), among other
things, eliminated substantially all state law barriers to the acquisition of
banks by out-of-state bank holding companies. A bank holding company may acquire
banks in states other than its home state, without regard to the permissibility
of such acquisitions under state law, but subject to any state requirement that
the acquired bank has been organized and operating for a minimum period of time
(not to exceed five years), and the requirement that the acquiring bank holding
company, prior to or following the proposed acquisition, controls no more than
10 percent of the total amount of deposits of the insured depository
institutions in the United States and no more than 30 percent of such deposits
in that state (or such lesser or greater amount as may be established by state
law). The Riegle-Neal Act also permits banks to
4
acquire branches located in another state by purchasing or merging with a bank
chartered in that state or a national banking association having its
headquarters located in that state.
Banks, securities firms, and insurance companies can now combine as a
"financial holding company." Financial holding companies can offer virtually any
type of financial service, including banking, securities underwriting, insurance
(both agency and underwriting), and merchant banking. Many of our competitors
have elected to become financial holding companies. Recently, a number of
foreign banks have acquired financial holding companies in the U.S., further
increasing competition in the U.S. market. Under current regulatory
interpretations, Mitsubishi Tokyo Financial Group, Inc. (MTFG) would be required
to make a financial holding company election. We do not expect that MTFG will
make such an election in the near future.
We believe that continued emphasis on enhanced services and distribution
systems, an expanded customer base, increased productivity and strong credit
quality, together with a substantial capital base, will position us to meet the
challenges provided by this competition.
MONETARY POLICY AND ECONOMIC CONDITIONS
Our earnings and businesses are affected not only by general economic
conditions (both domestic and international), but also by the monetary policies
of various governmental regulatory authorities of the United States and foreign
governments and international agencies. In particular, our earnings and growth
may be affected by actions of the Federal Reserve Board (FRB) in connection with
its implementation of national monetary policy through its open market
operations in United States Government securities, control of the discount rate
and establishment of reserve requirements against both member and non-member
financial institutions' deposits. These actions have a significant effect on the
overall growth and distribution of loans and leases, investments and deposits,
as well as on the rates earned on securities, loans and leases or paid on
deposits. It is difficult to predict future changes in monetary policies.
SUPERVISION AND REGULATION
We, MTFG and BTM are subject to regulation under the Bank Holding Company
Act of 1956 (BHCA), as amended, which subjects us to FRB reporting and
examination requirements. Generally, the BHCA restricts our ability to invest in
non-banking entities, and we may not acquire more than 5 percent of the voting
shares of any domestic bank without the prior approval of the FRB. Our
activities are limited, with some exceptions, to banking, the business of
managing or controlling banks, and other activities, which the FRB deems to be
so closely related to banking as to be a proper incident thereto.
Union Bank of California, N.A. and most of its subsidiaries are regulated
by the Office of the Comptroller of the Currency (OCC). Our subsidiaries are
also subject to extensive regulation, supervision, and examination by various
other federal and state regulatory agencies. In addition, Union Bank of
California, N.A. and its subsidiaries are subject to certain restrictions under
the Federal Reserve Act, including restrictions on affiliate transactions. As a
holding company, the principal source of our cash has been dividends and
interest received from Union Bank of California, N.A. Dividends payable by Union
Bank of California, N.A. to us are subject to restrictions under a formula
imposed by the OCC unless express approval is given to exceed these limitations.
For more information regarding restrictions on loans and dividends by Union Bank
of California, N.A. to its affiliates and on transactions with affiliates, see
Notes 19 and 24 to our Consolidated Financial Statements included in this Annual
Report on Form 10-K.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
requires federal bank regulatory authorities to take "prompt corrective action"
in dealing with inadequately capitalized banks. FDICIA established five tiers of
capital measurement ranging from "well-capitalized" to "critically
undercapitalized." It is our policy to maintain capital ratios above the minimum
regulatory requirements for "well-capitalized" institutions for both Union Bank
of California, N.A. and us. Management believes that, at December 31, 2004,
Union Bank of California, N.A. and we met the requirements for
"well-capitalized" institutions.
5
The activities of Union Bank of California, N.A. subsidiaries, HighMark
Capital Management, Inc. and UnionBanc Investment Services LLC are subject to
the rules and regulations of the SEC as well as state securities regulators.
UnionBanc Investment Services LLC is also subject to the rules and regulations
of the National Association of Securities Dealers (NASD).
Armstrong/Robitaille, Inc., John Burnham & Company, and Tanner Insurance
Brokers, Inc. are indirect subsidiaries of Union Bank of California, N.A., and
are subject to the rules and regulations of the California Department of
Insurance, as well as insurance regulators of other states.
Deposits of Union Bank of California, N.A. are insured up to statutory
limits by the Federal Deposit Insurance Corporation (FDIC), and, accordingly,
are subjected to deposit insurance assessments to maintain the Bank Insurance
Fund (BIF) and the Savings Association Insurance Fund (SAIF) administered by the
FDIC. Union Bank of California, N.A. currently pays no insurance assessments on
these deposits under the FDIC's risk-related assessment system. Although we
believe there are no definite plans on the part of the FDIC to raise assessment
rates in 2005, we can give no assurance as to the future level of such insurance
premiums.
There are additional requirements and restrictions in the laws of the
United States and the states of California, Oregon, and Washington, as well as
other states in which Union Bank of California, N.A. and its subsidiaries may
conduct operations. These include restrictions on the levels of lending and the
nature and amount of investments, as well as activities as an underwriter of
securities, the opening and closing of branches and the acquisition of other
financial institutions. The consumer lending and finance activities of Union
Bank of California, N.A. are also subject to extensive regulation under various
Federal laws, including the Truth-in-Lending, Equal Credit Opportunity, Fair
Credit Reporting, Fair Debt Collection Practice and Electronic Funds Transfer
Acts, as well as various state laws. These statutes impose requirements on the
making, enforcement and collection of consumer loans and on the types of
disclosures that need to be made in connection with such loans. Union Bank of
California, N.A. is also subject to the Community Reinvestment Act (CRA). The
CRA generally requires the federal banking agencies to evaluate the record of a
financial institution in meeting the needs of their local communities, including
low- and moderate-income neighborhoods. In addition to substantive penalties and
corrective measures that may be required for a violation of certain fair lending
laws, the federal banking agencies may take compliance with such laws and CRA
into account when regulating and supervising other activities, and in evaluating
whether to approve applications for permission to engage in new activities or
acquisitions of other banks or companies.
The international activities of Union Bank of California, N.A. are subject
to the laws and regulations of the jurisdiction where business is being
conducted, which may change from time to time and affect Union Bank of
California, N.A.'s business opportunities and competitiveness in these
jurisdictions. Furthermore, due to BTM's controlling ownership of us, regulatory
requirements adopted or enforced by the Government of Japan may have an effect
on the activities and investments of Union Bank of California, N.A. and us in
the future.
The Gramm-Leach-Bliley (GLB) Act allows "financial holding companies"
(FHCs) to offer banking, insurance, securities and other financial products.
Among other things, the GLB Act amended section 4 of the BHCA in order to
provide a framework for the engagement in new financial activities by bank
holding companies (BHCs). BHCs such as we may elect to become an FHC if all of
their subsidiary depository institutions are well-capitalized and well-managed.
Under current FRB interpretations, a foreign bank holding company, such as MTFG,
which controls a subsidiary U.S. bank holding company, must make the election.
In addition, the foreign bank holding company must be well-capitalized and
well-managed in accordance with standards comparable to those required of U.S.
banks as determined by the FRB and must have a "satisfactory" or better CRA
rating. We do not expect that MTFG will make an FHC election in the near future.
Under the GLB Act, "financial subsidiaries" of banks may engage in some
types of activities beyond those permitted to banks themselves, provided certain
conditions are met. Union Bank of California, N.A., has no plans to seek to form
any "financial subsidiaries" in the near future.
6
The terrorist attacks in September 2001, impacted the financial services
industry and led to federal legislation that attempts to address certain issues
involving financial institutions. On October 26, 2001, President Bush signed
into law the Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 (the USA PATRIOT Act).
Part of the USA PATRIOT Act is the International Money Laundering Abatement
and Financial Anti-Terrorism Act of 2001 (IMLAFATA). Among its provisions,
IMLAFATA requires each financial institution to: (i) establish an anti-money
laundering program; (ii) establish due diligence policies, procedures and
controls with respect to its private banking accounts and correspondent banking
accounts involving foreign individuals and certain foreign banks; and (iii)
avoid establishing, maintaining, administering, or managing correspondent
accounts in the United States for, or on behalf of, a foreign bank that does not
have a physical presence in any country. In addition, IMLAFATA contains a
provision encouraging cooperation among financial institutions, regulatory
authorities and law enforcement authorities with respect to individuals,
entities and organizations engaged in, or reasonably suspected of engaging in,
terrorist acts or money laundering activities. IMLAFATA expands the
circumstances under which funds in a bank account may be forfeited and requires
covered financial institutions to respond under certain circumstances to
requests for information from federal banking agencies within 120 hours.
IMLAFATA also amends the BHCA and the Bank Merger Act to require the federal
banking agencies to consider the effectiveness of a financial institution's
anti-money laundering activities when reviewing an application under these acts.
Pursuant to IMLAFATA, the Secretary of the Treasury, in consultation with
the heads of other government agencies, has adopted and proposed special
measures applicable to banks, bank holding companies, and/or other financial
institutions. These measures include enhanced record keeping and reporting
requirements for certain financial transactions that are of primary money
laundering concern, due diligence requirements concerning the beneficial
ownership of certain types of accounts, and restrictions or prohibitions on
certain types of accounts with foreign financial institutions.
The banking industry is now subject to significantly increased regulatory
controls and processes regarding Bank Secrecy Act and anti-money laundering
matters. This may adversely affect the ability to obtain regulatory approvals
for future initiatives requiring regulatory approval, including acquisitions.
Under the USA PATRIOT Act, federal banking regulators must consider the
effectiveness of a financial institution's anti-money laundering program prior
to approving an application for a merger, acquisition or other activities
requiring regulatory approval. For information regarding certain regulatory
matters that may adversely affect our ability to expand through acquisitions,
see "Regulatory Matters" in Management's Discussion and Analysis of Financial
Condition and Results of Operations.
On July 30, 2002, in response to various high profile corporate scandals,
the United States Congress enacted the Sarbanes-Oxley Act of 2002. The
Sarbanes-Oxley Act aims to restore the credibility lost as a result of these
scandals by addressing, among other issues, corporate governance, auditing and
accounting, executive compensation, and enhanced and timely disclosure of
corporate information. The New York Stock Exchange has adopted and the SEC has
approved additional corporate governance rules. The new rules are intended to
allow stockholders to more easily and effectively monitor the performance of
companies and directors.
Among other provisions, Section 302(a) of the Sarbanes-Oxley Act requires
that our Chief Executive Officer and Chief Financial Officer certify that our
quarterly and annual reports do not contain any untrue statement or omission of
a material fact. Specific requirements of the certifications include having
these officers confirm that they are responsible for establishing, maintaining
and regularly evaluating the effectiveness of our disclosure controls and
procedures; they have made certain disclosures to our auditors and Audit
Committee about our internal controls; and they have included information in our
quarterly and annual reports about their evaluation and whether there have been
significant changes in our internal controls or in other factors that could
significantly affect internal controls subsequent to their evaluation.
7
In addition, Section 404 of the Sarbanes-Oxley Act and the SEC's rules and
regulations thereunder require our management to evaluate, with the
participation of our principal executive and principal financial officers, the
effectiveness, as of the end of each fiscal year, of our internal control over
financial reporting. Our management must then provide a report of management on
our internal control over financial reporting that contains, among other things,
a statement of their responsibility for establishing and maintaining adequate
internal control over financial reporting, and a statement identifying the
framework they used to evaluate the effectiveness of our internal control over
financial reporting.
In response to these requirements, we have established a Disclosure
Committee to monitor compliance with these new rules. Membership of the
Disclosure Committee is comprised of senior management from throughout our
organization whom we believe collectively provide an extensive understanding of
our operations. As part of our compliance with section 302 of the Sarbanes-Oxley
Act, we evaluate our internal control process quarterly and we test and assess
our internal controls over financial reporting annually, in compliance with
section 404 of the Sarbanes-Oxley Act.
The Basel Committee on Banking Supervision (BIS) proposed new international
capital standards for banking organizations in June 2004, and the proposal is
currently being evaluated by bank supervisory authorities worldwide. Basel II is
an effort to update the original international bank capital accord (Basel I),
which has been in effect since 1988. Basel II is intended to improve the
consistency of capital regulations internationally, make regulatory capital more
risk sensitive, and promote enhanced risk-management practices among large,
internationally active banking organizations. Since the accord is not yet final,
the ultimate timing for implementation and the specifics of capital assessments
for addressing operational risk are still uncertain. The U.S. banking and thrift
agencies have issued a joint release outlining a comprehensive plan to
incorporate the advanced risk and capital measurement methodologies of Basel II
into regulations and supervisory guidance for U.S. institutions. It is currently
expected that a notice of proposed rulemaking to implement Basel II will be
published in mid-2005 and a final rule will be in place in the second quarter of
2006. We are evaluating what effect the new capital requirements that may arise
out of a new BIS capital accord may have on our minimum capital requirements.
U.S. banking regulators have stated that the approximately ten largest U.S. bank
holding companies will be required to adopt the new standard, and that others
may "opt in."
UnionBanCal Corporation and Union Bank of California, N.A. cannot be
certain of the effect, if any, of the foregoing legislation and regulatory
developments on their business.
See our Consolidated Financial Statements starting on page F-52 for
specific financial information about UnionBanCal Corporation and its
subsidiaries.
FUTURE LEGISLATION
Future changes in the laws, regulations, or policies that impact Union Bank
of California, N.A., our other subsidiaries and us cannot necessarily be
predicted and may have a material effect on our business and earnings.
Legislation relating to banking and other financial services has been introduced
from time to time in Congress and is likely to be introduced in the future. If
enacted, such legislation could significantly change the competitive environment
in which we and our subsidiaries operate. We cannot predict whether these or any
other proposals will be enacted or the ultimate impact of any such legislation
on our competitive situation, financial condition or results of operations.
ITEM 2. PROPERTIES
At December 31, 2004, we operated 311 full service branches in California,
4 full service branches in Oregon and Washington, and 21 international offices.
In addition, we have another 49 limited service branches, including 6 Cash &
Save(R) facilities, and 3 Private Bank offices. We own the property occupied by
101 of the domestic offices and lease the remaining properties for periods of
five to twenty years.
8
We own two administrative facilities in San Francisco, two in Los Angeles,
and three in San Diego. Other administrative offices in San Francisco, Los
Angeles, Portland, Seattle, and New York operate under leases expiring in one to
twenty-six years.
Rental expense for branches and administrative premises is described in
Note 5 to our Consolidated Financial Statements included in this Annual Report
on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various pending and threatened legal actions that arise
in the normal course of business. We maintain reserves for losses from legal
actions that are both probable and estimable.
Grafton Partners LP v. Union Bank of California is pending in Alameda
County Superior Court (filed March 12, 2003). That suit concerns a "Ponzi"
scheme perpetrated by PinnFund, USA, located in San Diego, California. The
victims of this scheme seek $235 million from the Bank. They assert that the
Bank improperly opened and administered a deposit account, which was used by
PinnFund in furtherance of the fraud.
The Bank has numerous legal defenses to the Grafton case. Based on our
evaluation to date of this pending case, management believes that this matter
will not result in a material adverse effect on our financial position or
results of operations. In addition, we believe the disposition of all other
claims currently pending will also not have a material adverse effect on our
financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the New York Stock Exchange under the symbol
UB. As of January 31, 2005, our common stock was held by approximately 2,677
stockholders of record. At December 31, 2004, The Bank of Tokyo-Mitsubishi, Ltd.
(BTM) held approximately 62 percent of our common stock. During 2003 and 2004,
the average daily trading volume of our common stock was approximately 269,838
shares and 263,184 shares, respectively. At December 31, 2002, 2003 and 2004,
our common stock closed at $39.27 per share, $57.54 per share, and $64.48 per
share, respectively. The following table presents stock quotations for each
quarterly period for the two years ended December 31, 2003 and 2004.
2003 2004
------------------ ------------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First quarter................. $42.50 $37.77 $58.26 $50.80
Second quarter................ 43.39 39.20 57.59 49.51
Third quarter................. 50.83 42.40 59.79 56.24
Fourth quarter................ 58.45 50.35 64.78 59.10
The following table presents quarterly per share cash dividends declared
for 2003 and 2004:
2003 2004
----- -----
First quarter.......................................... $0.28 $0.31
Second quarter......................................... 0.31 0.36
Third quarter.......................................... 0.31 0.36
Fourth quarter......................................... 0.31 0.36
9
On October 27, 2004, our Board of Directors approved a quarterly common
stock dividend of $0.36 per share for the fourth quarter of 2004. Future
dividends will depend upon our earnings, financial condition, capital
requirements and other factors as our Board of Directors may deem relevant.
We offer a dividend reinvestment and stock purchase plan that allows
stockholders to reinvest dividends in our common stock at market price. BTM did
not participate in the plan during 2003 and 2004. For further information about
this plan, see Note 14 to our Consolidated Financial Statements included in this
Annual Report on Form 10-K.
Our ability to declare and pay dividends is affected by certain regulatory
restrictions. See Note 19 to our Consolidated Financial Statements included in
this Annual Report on Form 10-K.
The following table presents repurchases by us of our equity securities
during the fourth quarter 2004:
TOTAL NUMBER APPROXIMATE DOLLAR
OF SHARES PURCHASED VALUE OF SHARES THAT
TOTAL NUMBER OF AVERAGE PRICE PAID AS PART OF PUBLICLY MAY YET BE PURCHASED
PERIOD SHARES PURCHASED PER SHARE ANNOUNCED PROGRAMS UNDER THE PROGRAMS
- ------- ---------------- ------------------ ------------------ ------------------
OCTOBER 2004
(October 28-29,
2004).......... 100,000 $60.57 100,000 $177,237,734
NOVEMBER 2004
(November 1-30,
2004).......... 735,000 $62.43 735,000 $131,349,660
DECEMBER 2004
(December 1-30,
2004).......... 631,000 $63.25 631,000 $91,441,401(1)
--------- ---------
TOTAL........ 1,466,000 $62.66 1,466,000
========= =========
- ---------------------------------
(1) $91 million is remaining at December 31, 2004, under a $200 million repurchase program announced on April 28, 2004.
ITEM 6. SELECTED FINANCIAL DATA
See page F-1 of this Annual Report on Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
See pages F-1 through F-51 of this Annual Report on Form 10-K.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See pages F-32 through F-36 of this Annual Report on Form 10-K.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See pages F-52 through F-110 of this Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
10
ITEM 9A. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS. 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 December 31, 2004. 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.
INTERNAL CONTROLS OVER FINANCIAL REPORTING. Management's Report on Internal
Control Over Financial Reporting regarding the effectiveness of internal
controls over financial reporting is presented on page F-112. The Report of
Independent Registered Public Accounting Firm is presented on page F-113. During
the quarter ended December 31, 2004, there were no changes in our internal
controls over financial reporting that materially affected, or are reasonably
likely to affect, our internal controls over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to the information contained in the sections entitled
"Audit Committee," "Election of Directors" and "Section 16(a) Beneficial
Reporting Compliance" of our Proxy Statement for our April 27, 2005 Annual
Meeting of Stockholders for incorporation by reference of information concerning
directors and persons nominated to become directors of UnionBanCal Corporation
and the UnionBanCal Corporation Audit Committee.
CORPORATE GOVERNANCE
We have adopted the following:
o A Code of Ethics applicable to senior financial officers,
including our Chief Executive Officer, Chief Financial Officer
and Controller;
o Business Standards of Conduct, which is a code of ethics and
conduct applicable to all officers and employees;
o A Code of Ethics applicable to directors of UnionBanCal
Corporation and Union Bank of California, N.A.;
o Corporate Governance Guidelines to promote the effective
functioning of the activities of the UnionBanCal Corporation
Board of Directors and to promote a common set of expectations as
to how the Board, its Committees, individual directors and
management should perform their functions; and
o Charters for the Committees of the Board, including the Audit
Committee, Corporate Governance Committee and Executive
Compensation & Benefits Committee.
A copy of each of these committee charters, Codes of Ethics, Business
Standards of Conduct and Corporate Governance Guidelines is posted on our
website, or is available, without charge, upon the written request of any
stockholder directed to the Secretary of UnionBanCal Corporation, 400 California
Street, San Francisco, California 94104-1302. We intend to disclose promptly any
amendment to, or waiver from any provision of, the Code of Ethics applicable to
senior financial officers, and any waiver from any provision of the
11
Code of Ethics applicable to directors or the Business Standards of Conduct
applicable to executive officers, on our website. Our website address is
www.uboc.com.
The following information pertains to our executive officers as of December
31, 2004:
EXECUTIVE OFFICER AGE PRINCIPAL OCCUPATIONS FOR THE PAST FIVE YEARS
- ----------------------- --- -------------------------------------------------
Tetsuo Shimura......... 66 Mr. Shimura has served as Chairman of UnionBanCal
Corporation and Union Bank of California, N.A.
since October 2003. He previously served on the
Boards of Directors of UnionBanCal Corporation
and Union Bank of California, N.A. from June 1997
to July 1998. Mr. Shimura has served in the
following positions at The Bank of
Tokyo-Mitsubishi, Ltd.: Deputy President from
July 2001 to June 2003, Chief Executive, Global
Corporate Banking Business Unit from July 2000 to
July 2001 and Senior Managing Director from June
1998 to July 2001. Mr. Shimura has been a
director of UnionBanCal Corporation and Union
Bank of California, N.A. since October 2003.
Norimichi Kanari....... 58 Mr. Kanari has served as President and Chief
Executive Officer of UnionBanCal Corporation and
Union Bank of California, N.A. since July 2001.
He served as Vice Chairman of UnionBanCal
Corporation and Union Bank of California, N.A.
from July 2000 to July 2001. From May 1999 to
July 2000, he served as General Manager of the
Corporate Banking Division in the Osaka Branch of
The Bank of Tokyo-Mitsubishi, Ltd. He has served
as a director of The Bank of Tokyo-Mitsubishi,
Ltd., since June 1997 and was elected a Senior
Managing Director of The Bank of
Tokyo-Mitsubishi, Ltd. on January 1, 2005. Mr.
Kanari has been a director of UnionBanCal
Corporation and Union Bank of California, N.A.
since July 2000.
Philip B. Flynn........ 47 Mr. Flynn has served as Vice Chairman and head of
the Commercial Financial Services Group of
UnionBanCal Corporation and Union Bank of
California, N.A., since April 1, 2004. He served
as Executive Vice President and Chief Credit
Officer of UnionBanCal Corporation and Union Bank
of California, N.A., from September 2000 to April
2004, as Executive Vice President and head of
Specialized Lending from May 2000 to September
2000 and as Executive Vice President and head of
the Commercial Banking Group from June 1998 to
May 2000. Mr. Flynn has served as a director of
UnionBanCal Corporation and Union Bank of
California, N.A. since April 2004.
Richard C. Hartnack.... 59 Mr. Hartnack has served as Vice Chairman and head
of the Community Banking and Investment Services
Group of UnionBanCal Corporation and Union Bank
of California, N.A. since September 1999. Mr.
Hartnack has served as a Director of UnionBanCal
Corporation since June 1991.
12
EXECUTIVE OFFICER AGE PRINCIPAL OCCUPATIONS FOR THE PAST FIVE YEARS
- ----------------------- --- -------------------------------------------------
Takashi Morimura....... 52 Mr. Morimura was elected Vice Chairman and
Director of UnionBanCal Corporation and Union
Bank of California, N.A. effective at the close
of business on July 28, 2004. Mr. Morimura served
as General Manager, Global Corporate Banking IT
Planning Office of The Bank of Tokyo-Mitsubishi,
Ltd. from July 2000 to June 2004 and as Deputy
General Manager, Overseas Planning Division of
The Bank of Tokyo-Mitsubishi, Ltd. from September
1999 to June 2000. Mr. Morimura was elected a
Director of The Bank of Tokyo-Mitsubishi, Ltd. in
June 2002.
Linda F. Betzer........ 58 Ms. Betzer has served as Executive Vice President
and head of the Operations and Customer Services
Group of UnionBanCal Corporation and Union Bank
of California, N.A. since January 2000.
JoAnn M. Bourne........ 49 Ms. Bourne has served as Executive Vice President
since April 2000 and as head of the Commercial
Deposits and Treasury Management Group of
UnionBanCal Corporation and Union Bank of
California, N.A. since April 2003. She served as
head of the Commercial Banking Group from January
2002 to April 2003 and managed the Commercial
Deposit Services Division from June 1997 to
January 2002.
Bruce H. Cabral........ 49 Mr. Cabral has served as Executive Vice President
since March 2000 and as Chief Credit Officer of
UnionBanCal Corporation and Union Bank of
California, N.A. since April 2004. He served as
Deputy Chief Credit Officer from November 2002
until April 2004. Prior to this position, Mr.
Cabral was a Senior Credit Officer responsible
for Real Estate Lending and National Banking.
Paul E. Fearer......... 61 Mr. Fearer has served as Executive Vice President
and Director of Human Resources of UnionBanCal
Corporation and Union Bank of California, N.A.
since April 1996.
Katsuyoshi Hamahashi... 55 Mr. Hamahashi has served as head of Global
Markets Group of UnionBanCal Corporation and
Union Bank of California, N.A. since October 1998
and as Executive Vice President and Treasurer of
UnionBanCal Corporation and Union Bank of
California, N.A. since April 1996.
Ronald H. Kendrick..... 63 Mr. Kendrick has served as Executive Vice
President and head of the Community Banking Group
of UnionBanCal Corporation and Union Bank of
California, N.A. since December 2000. He served
as Executive Vice President and Southern
California Area Executive of Union Bank of
California, N.A. from March 1994 to December
2000.
David I. Matson........ 60 Mr. Matson has served as Executive Vice President
and Chief Financial Officer of UnionBanCal
Corporation and Union Bank of California, N.A.
since July 1998.
John H. McGuckin, Jr... 58 Mr. McGuckin has served as Executive Vice
President, General Counsel and Secretary of
UnionBanCal Corporation and Union Bank of
California, N.A. since September 2000. He served
as Executive Vice President and General Counsel
of UnionBanCal Corporation from January 1998 to
September 2000 and served as Executive Vice
President and General Counsel of Union Bank of
California, N.A. from April 1996 until September
2000.
13
EXECUTIVE OFFICER AGE PRINCIPAL OCCUPATIONS FOR THE PAST FIVE YEARS
- ----------------------- --- -------------------------------------------------
Magan C. Patel......... 67 Mr. Patel has served as Executive Vice President
and head of the International Banking Group of
UnionBanCal Corporation and Union Bank of
California, N.A. since April 1996.
Charles L. Pedersen.... 61 Mr. Pedersen has served as Executive Vice
President and head of the Systems Technology and
Item Processing Group of UnionBanCal Corporation
and Union Bank of California, N.A. since April
1996. Mr. Pedersen announced his retirement from
UnionBanCal Corporation and Union Bank of
California, N.A. effective December 31, 2004.
Effective January 1, 2005, Ms. Betzer is serving
as acting head of the Systems Technology Group.
The term of office of an executive officer extends until the officer
resigns, is removed, retires, or is otherwise disqualified for service. There
are no family relationships among the executive officers.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated by reference
from the text under the captions "Executive Compensation" and "Director
Compensation" in the Proxy Statement for our April 27, 2005 Annual Meeting of
Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information concerning ownership of the equity stock of UnionBanCal
Corporation by certain beneficial owners and management is incorporated by
reference from page 1 and the text under the caption "Security Ownership by
Management" in the Proxy Statement for our April 27, 2005 Annual Meeting of
Stockholders.
The following table provides information relating to our equity
compensation plans as of December 31, 2004:
NUMBER OF SECURITIES
NUMBER OF SECURITIES REMAINING AVAILABLE FOR
TO BE ISSUED WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER
UPON EXERCISE OF EXERCISE PRICE OF EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
WARRANTS, AND RIGHTS WARRANTS, AND RIGHTS REFLECTED IN COLUMN A)
(A) (B) (C)
-------------------- -------------------- -------------------------
Equity compensation approved by
stockholders.................. 9,482,336 $41.87 2,937,629
Equity compensation not approved
by stockholders............... -- -- --
--------- ------ ---------
9,482,336 $41.87 2,937,629
========= ====== =========
All equity compensation plans have been approved by our stockholders. At
December 31, 2004, there were 2,937,629 shares of common stock available for
future issuance as either stock options or restricted stock under the Stock
Plans. For additional information concerning our equity compensation plans, see
Note 15 to our Consolidated Financial Statements included in this Annual Report
on Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions with
officers, directors, and The Bank of Tokyo-Mitsubishi, Ltd. is incorporated by
reference from the text under the caption "Transactions with Management and
Others" in our Proxy Statement for our April 27, 2005 Annual Meeting of
Stockholders.
14
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Reference is made to the information contained in the section entitled,
"Ratification of Selection of Independent Registered Public Accounting Firm" of
the Proxy Statement for our April 27, 2005 Annual Meeting of Stockholders for
incorporation by reference of information concerning principal accounting fees
and services.
PART IV
ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
(A)(1) FINANCIAL STATEMENTS
Our Consolidated Financial Statements, the Management's Report on Internal
Control Over Financial Reporting, and the Report of Independent Registered
Public Accounting Firm are set forth on pages F-53 through F-114. (See index on
page F-52).
(A)(2) FINANCIAL STATEMENT SCHEDULES
All schedules to our Consolidated Financial Statements are omitted because
of the absence of the conditions under which they are required or because the
required information is included in our Consolidated Financial Statements or
accompanying notes.
(A)(3) EXHIBITS
NO. DESCRIPTION
----- ----------------------------------------------------------------------
3.1 Restated Certificate of Incorporation of the Registrant(1)
3.2 By-laws of the Registrant(1)
4.1 Trust Indenture between UnionBanCal Corporation and the First National
Bank of Chicago, as Trustee, dated February 19, 1999(2)
4.2 Trust Indenture between UnionBanCal Corporation and J.P. Morgan Trust
Company, National Association, as Trustee, dated December 8, 2003(3)
10.1 UnionBanCal Corporation Management Stock Plan. (As restated effective
June 1, 1997)*(4)
10.2 Union Bank of California Deferred Compensation Plan.(January 1, 1997,
Restatement, as amended November 21,1996)*(5)
10.3 Union Bank of California Senior Management Bonus Plan. (Effective
January 1, 2000)*(6)
10.4 Richard C. Hartnack Employment Agreement. (Effective January 1, 1998)
*(7)
10.6 Union Bank of California, N.A. Supplemental Executive Retirement Plan.
(Effective January 1, 1988) (Amended and restated as of January 1,
1997)*(4)
10.7 Union Bank Financial Services Reimbursement Program. (Effective
January 1, 1996)*(8)
10.9 1997 UnionBanCal Corporation Performance Share Plan, as amended. (As
amended, effective January 1, 2004)*(6)
10.10 Service Agreement Between Union Bank of California, N.A. and The Bank
of Tokyo-Mitsubishi, Ltd. (Effective October 1, 1997)*(4)
10.11 Year 2000 UnionBanCal Corporation Management Stock Plan. (As restated
effective January 1, 2000)*(9)
15
NO. DESCRIPTION
-- -----------
10.12 Union Bank of California, N.A. Supplemental Retirement Plan for
Policy Making Officers (Effective November 1, 1999)(10)
10.13 Philip B. Flynn Employment Agreement (Effective April 1, 2004)*(11)
10.14 David I. Matson Employment Agreement (Effective January 1, 1998)*(12)
10.15 Form of Change-of-Control Agreement, dated as of May 1, 2003, between
UnionBanCal Corporation and each of the policy-making officers of
UnionBanCal Corporation(12)
12.1 Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividend Requirements(13)
21.1 Subsidiaries of the Registrant(13)
23.1 Consent of Deloitte & Touche LLP(13)
24.1 Power of Attorney(13)
24.2 Resolution of Board of Directors(13)
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002(13)
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002(13)
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(13)
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(13)
- ------------------------------
(1) Incorporated by reference to the UnionBanCal Corporation Quarterly Report
on Form 10-Q for the quarter ended September 30, 2003.
(2) Incorporated by reference to the UnionBanCal Corporation Current Report on
Form 8-K dated February 11, 2001.
(3) Incorporated by reference to the UnionBanCal Corporation Current Report on
Form 8-K dated December 8, 2003.
(4) Incorporated by reference to the UnionBanCal Corporation Annual Report on
Form 10-K for the year ended December 31, 1997 (SEC File No. 1-15081).
(5) Incorporated by reference to the UnionBanCal Corporation Annual Report on
Form 10-K for the year ended December 31, 1996 (SEC File No. 1-15081).
(6) Incorporated by reference to the UnionBanCal Corporation Definitive Proxy
Statement on Form 14A filed on March 26, 2004.
(7) Incorporated by reference to the UnionBanCal Corporation Quarterly Report
on Form 10-Q for the quarter ended September 30, 1998 (SEC File No.
1-15081).
(8) Incorporated by reference to the UnionBanCal Corporation Current Report on
Form 8-K dated April 1, 1996 (SEC File No. 1-15081).
(9) Incorporated by reference to the UnionBanCal Corporation Quarterly Report
on Form 10-Q for the quarter ended June 30, 1999.
(10) Incorporated by reference to the UnionBanCal Corporation Quarterly Report
on Form 10-Q for the quarter ended June 30, 2000.
(11) Incorporated by reference to the UnionBanCal Corporation Quarterly Report
on Form 10-Q for the quarter ended March 31, 2004.
(12) Incorporated by reference to the UnionBanCal Corporation Quarterly Report
on Form 10-Q for the quarter ended June 30, 2003.
(13) Provided herewith.
* Management contract or compensatory plan, contract or arrangement.
16
UNIONBANCAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
SELECTED FINANCIAL DATA
AS OF AND FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER
SHARE DATA) 2000 2001 2002 2003 2004
-------------------------------- ------------ ------------ ------------ ------------ ------------
RESULTS OF OPERATIONS:
Net interest income(1)......... $ 1,587,008 $ 1,526,099 $ 1,564,556 $ 1,571,619 $ 1,648,968
(Reversal of) provision for
credit losses................ 440,000 285,000 175,000 75,000 (35,000)
Noninterest income............. 647,180 668,066 685,275 794,253 989,305
Noninterest expense............ 1,130,185 1,191,836 1,296,965 1,408,353 1,524,182
------------ ------------ ------------ ------------ ------------
Income before income taxes(1).. 664,003 717,329 777,866 882,519 1,149,091
Taxable-equivalent adjustment.. 2,568 2,057 2,587 2,553 3,745
Income tax expense............. 221,535 233,844 247,376 292,827 412,812
------------ ------------ ------------ ------------ ------------
Net income..................... $ 439,900 $ 481,428 $ 527,903 $ 587,139 $ 732,534
============ ============ ============ ============ ============
PER COMMON SHARE:
Net income (basic)............. $ 2.72 $ 3.05 $ 3.41 $ 3.94 $ 4.96
Net income (diluted)........... 2.72 3.04 3.38 3.90 4.87
Dividends(2)................... 1.00 1.00 1.09 1.21 1.39
Book value (end of period)..... 20.17 22.66 24.94 25.66 28.93
Common shares outstanding (end
of period)................... 159,234,454 156,483,511 150,702,363 145,758,156 148,359,918
Weighted average common shares
outstanding (basic).......... 161,604,648 157,844,745 154,757,817 148,917,249 147,767,238
Weighted average common shares
outstanding (diluted)........ 161,989,388 158,623,454 156,414,940 150,645,193 150,303,144
BALANCE SHEET (END OF PERIOD):
Total assets................... $ 35,162,475 $ 36,038,746 $ 40,169,773 $ 42,498,467 $ 48,098,021
Total loans.................... 26,010,398 24,994,030 26,728,083 25,944,628 30,716,956
Nonperforming assets........... 408,304 492,482 337,404 286,890 163,918
Total deposits................. 27,283,183 28,556,199 32,840,815 35,532,283 40,175,836
Medium and long-term debt...... 200,000 399,657 418,360 820,488 816,113
Junior subordinated debt....... -- -- -- 363,940 15,790
Trust preferred securities..... 350,000 363,928 365,696 -- --
Stockholders' equity........... 3,211,565 3,546,242 3,758,189 3,740,436 4,292,244
BALANCE SHEET (PERIOD AVERAGE):
Total assets................... $ 33,672,058 $ 34,619,222 $ 36,108,496 $ 40,470,483 $ 45,226,306
Total loans.................... 26,310,420 25,951,021 25,835,075 26,428,253 27,726,625
Earning assets................. 30,379,730 31,291,782 32,983,371 36,625,837 40,910,848
Total deposits................. 25,527,547 26,542,312 28,753,185 33,446,436 37,875,760
Stockholders' equity........... 3,139,844 3,467,719 3,739,530 3,831,032 4,050,202
FINANCIAL RATIOS:
Return on average assets....... 1.31% 1.39% 1.46% 1.45% 1.62%
Return on average stockholders'
equity....................... 14.01 13.88 14.12 15.33 18.09
Efficiency ratio(3)............ 50.59 54.32 57.64 59.53 57.73
Net interest margin(1)......... 5.22 4.87 4.74 4.29 4.03
Dividend payout ratio.......... 36.76 32.79 31.96 30.71 28.02
Tangible equity ratio.......... 9.01 9.62 8.93 8.20 7.94
Tier 1 risk-based capital ratio 10.24 11.47 11.18 11.31 9.71
Total risk-based capital ratio. 12.07 13.35 12.93 14.14 12.17
Leverage ratio................. 10.19 10.53 9.75 9.03 8.09
Allowances for credit losses to
total loans(4)............... 2.36 2.54 2.28 2.05 1.59
Allowances for credit losses to
nonaccrual loans(4).......... 153.48 129.00 180.94 189.53 312.53
Net loans charged off to average
total loans.................. 1.13 1.02 0.80 0.61 0.10
Nonperforming assets to total
loans, distressed loans held
for sale, and foreclosed assets 1.57 1.97 1.26 1.11 0.53
Nonperforming assets to total
assets....................... 1.16 1.37 0.84 0.68 0.34
- --------------------------
(1) Amounts are on a taxable-equivalent basis using the federal statutory tax
rate of 35 percent.
(2) Dividends per share reflect dividends declared on UnionBanCal Corporation's
common stock outstanding as of the declaration date.
(3) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income
(taxable-equivalent) and noninterest income. Foreclosed asset expense
(income) was $(0.1) million, $(0.0) million, $0.1 million, $(0.1) million,
and $1.2 million for 2000 through 2004, respectively.
(4) Includes allowance for credit losses related to off-balance sheet
commitments.
F-1
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
FROM OUR FORECASTS AND EXPECTATIONS. PLEASE REFER TO "FACTORS THAT MAY AFFECT
FUTURE RESULTS" FOR A DISCUSSION OF SOME FACTORS THAT MAY CAUSE RESULTS TO
DIFFER.
You should read the following discussion and analysis of our consolidated
financial position and results of our operations for the years ended December
31, 2002, 2003 and 2004 together with our Consolidated Financial Statements and
the Notes to Consolidated Financial Statements included in this Annual Report.
Averages, as presented in the following tables, are substantially all based upon
daily average balances.
INTRODUCTION
We are a California-based, commercial bank holding company with
consolidated assets of $48.1 billion at December 31, 2004. At December 31, 2004,
The Bank of Tokyo-Mitsubishi, Ltd. (BTM), our majority owner, owned
approximately 62 percent of our outstanding 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 results for 2004 and that
could impact future results. You should carefully read the rest of this document
for more detailed information that will complete your understanding of trends,
events and uncertainties that impact us.
We are a bank holding company that derives most of our revenues from our
commercial bank subsidiary, which provides lending, deposit taking and trust
services to customers, primarily in California. We also serve customers in the
western United States, nationally and internationally. Our ability to generate
revenue is affected by changes in economic conditions, interest rates, customer
confidence, as well as from competition and the regulatory environment.
Overall credit quality in the commercial lending area continued to improve
in 2004. Our nonaccrual loan portfolio declined significantly during 2004, from
$281 million at December 31, 2003 to $157 million at December 31, 2004.
Improvement came from positive financial results of our borrowers, principal
payoffs and loans sales. We were able to lower our exposure to inflows of
nonaccrual loans by continuing to reduce our exposures in several businesses
such as non-core syndicated loans. We reversed $35 million of our provision for
loan losses during 2004 compared with an expense of $75 million in 2003. We
expect that with our anticipated loan growth we will need to provide for credit
losses in 2005.
During 2004, commercial lending in our core industries grew. In addition,
we acquired Business Bank of California in January 2004, which provided a
significant increase to our commercial loan portfolio. Growth in commercial
lending for 2005, assuming that the economy's positive momentum continues,
should be more significant than we have experienced during the past several
years. Growth in average commercial real estate lending is expected to rise,
primarily from our acquisition of Jackson Federal Bank in October 2004.
Residential lending grew significantly in 2004 over 2003 and growth in this area
is expected to continue in 2005, although not to the same degree as we have
experienced in the past few years due to slowing refinancings as interest rates
rise.
Although our net interest margin continued to decline in 2004, during this
period of low interest rates, we maintained an attractive 403 basis points
margin. We achieved this in large part by our success in attracting core demand
deposits that provided us with a very low cost of funds coupled with our
decision to grow our fixed rate portfolios, which we began to grow in 2003. This
allowed us to maintain a neutral overall interest rate risk profile. During this
period of low interest rates, our variable rate commercial loans have had a
negative impact on our net interest margin, which has been supported by the
incremental spread on our growing adjustable rate mortgage loans that are still
in their fixed rate period, the benefit of derivative hedge positions and the
securities portfolio.
F-2
While we expect that business activity will continue to improve, increasing
our variable rate commercial loans, we do not expect the growth in these loans
to significantly increase our net interest margin until rates rise by 100 to 150
basis points. Rising interest rates beyond this level will improve our net
interest margin. However, we do not anticipate that this will occur until late
2005.
Growth in core deposits continued to be strong in 2004, providing us with a
low cost of funding, which is a competitive advantage. Average demand deposits
in 2004 were 48 percent of average total deposits compared with 46 percent in
2003, contributing to an average all-in cost of funds (interest expense divided
by total interest bearing liabilities and noninterest bearing deposits) of 0.50
percent and 0.56 percent for 2004 and 2003, respectively. We attract deposits by
offering a variety of cash management products aimed at business clients,
including web cash management, check imaging, remittance and depository services
and disbursements. We believe that our success in attracting these low cost
funds arises from the quality of service and competitive pricing that we are
able to deliver to our customers. Additional growth in deposits came from the
bank acquisitions that were made in 2003 and 2004 and the creation of a number
of de novo branches. As the economy improves, refinancings slow and as the value
of deposits increase, we expect that the growth in core deposits that we have
experienced in the recent past will slow. As our asset base grows, we may need
to look to other sources of funding to provide for that growth. Those needs may
be met through the purchase of fed funds, or the issuance of medium or long term
debt.
We sold our merchant card portfolio in June 2004 and realized a gain of $93
million. Simultaneously, we formed a long-term merchant card marketing alliance
with NOVA Information Systems (NOVA). NOVA acquired our merchant accounts and
provides processing services, customer service and support operations to our
more than 10,000 merchant locations. We market merchant services through our
branch network in California, Oregon and Washington. The sale was part of our
strategy to divest ourselves of products and services for which we lack a
competitive advantage and to invest in products and services that we believe
will provide better opportunities for increasing our noninterest income.
Excluding the gain on the sale of our merchant card portfolio, we increased
noninterest income during 2004, compared with 2003, primarily as a result of
higher service charges on deposits, trust and investment management fees,
letters of credit and international commissions and fees and insurance
commissions. Increases in volumes, as well as our acquisitions, were primarily
responsible for the increases in our noninterest income.
Noninterest expense rose during 2004, compared with 2003. Much of that
increase related to investments that we made in bank acquisitions, de novo
branches and technology. We believe that these investments will bring
opportunities for growth in our business by increasing our customer base and
expanding the services we provide.
Our effective tax rate increased to 36 percent in 2004, compared with 33
percent in 2003. The increase arose primarily from higher California state taxes
where we file franchise tax returns as a member of a unitary group that includes
Mitsubishi Tokyo Financial Group, Inc. (MTFG) and others in the group. A more
detailed discussion of our income tax expense and the impact of our inclusion in
the MTFG group is provided under "Income Tax Expense" beginning on page F-12.
We returned a significant amount of capital in the form of common stock
repurchases and dividends to our shareholders during 2004.
Our long-term strategic targets are to increase earnings per share at a
rate of 8 to 10 percent per year over the next three-year strategic horizon and
to generate a return on average equity of 15 to 17 percent. There can be no
assurance that we will meet these objectives.
CRITICAL ACCOUNTING POLICIES
GENERAL
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. The
financial information contained within our statements is, to a significant
extent,
F-3
financial information that is based on approximate measures of the financial
effects of transactions and events that have already occurred. A variety of
factors could affect the ultimate value that is obtained either when earning
income, recognizing an expense, recovering an asset or relieving a liability. In
many instances, we use a discount factor to determine the present value of
assets and liabilities. A change in the discount factor could increase or
decrease the values of those assets and liabilities and such a change would
result in either a beneficial or adverse impact to our financial results. We use
historical loss factors, adjusted for current conditions, to determine the
inherent loss that may be present in our loan and lease portfolio. Actual losses
could differ significantly from the loss factors that we use. Other estimates
that we use are employee turnover factors for pension purposes, residual values
in our leasing portfolio, fair value of our derivatives and securities, expected
useful lives of our depreciable assets and assumptions regarding our effective
income tax rates. We enter into derivative contracts to accommodate our
customers and for our own risk management purposes. The derivative contracts are
generally foreign exchange, interest rate swap and interest rate option
contracts, although we could enter into other types of derivative contracts. We
value these contracts at fair value, using either readily available, market
quoted prices or from information that can be extrapolated to approximate a
market price. We have not historically entered into derivative contracts for our
customers or for ourselves, which relate to commodity or weather-related
indices. We are subject to US GAAP that may change from one previously
acceptable method to another method. Although the economics of our transactions
would be the same, the timing of events that would impact our transactions could
change.
Our most significant estimates are approved by our Chief Executive Officer
(CEO) Forum, which is comprised of our most senior officers. At each financial
reporting period, a review of these estimates is then presented to the Audit
Committee of our Board of Directors.
All of our significant accounting policies are identified in Note 1 to our
Consolidated Financial Statements included in this Annual Report. The following
describes our most critical accounting policies and our basis for estimating the
allowance for credit losses, pension obligations and asset impairment.
ALLOWANCES FOR LOAN AND OFF-BALANCE SHEET LOSSES
The allowances for loan and off-balance sheet losses are estimates of the
losses that may be sustained in our loan and lease portfolio as well as for
certain off-balance sheet commitments such as unfunded commitments, commercial
letters of credit, and financial guarantees. The allowances are based on two
principles of accounting: (1) Statement of Financial Accounting Standards (SFAS)
No. 5, "Accounting for Contingencies," which requires that losses be accrued
when they are probable of occurring and estimable; and (2) SFAS No. 114,
"Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting
by Creditors for Impairment of a Loan--Income Recognition and Disclosures,"
which requires that losses be accrued based on the differences between the value
of collateral, present value of future cash flows or values that are observable
in the secondary market and the loan balance.
Our allowances for loan and off-balance sheet losses have four components:
the formula allowance, the specific allowance, the unallocated allowance and
off-balance sheet commitments, which is included in other liabilities. Each of
these components is determined based upon estimates that can and do change when
the actual events occur. The formula allowance uses a model based, in part, on
historical losses as an indicator of future losses and, as a result, could
differ from the losses incurred in the future. However, this history is updated
quarterly to include any data that makes the historical data more relevant.
Moreover, management adjusts the historical loss estimates for conditions that
more accurately capture probable losses inherent in the portfolio. The specific
allowance uses various techniques to arrive at an estimate of loss. Historical
loss information, discounted cash flows, fair market value of collateral and
secondary market information are all used to estimate those losses. The use of
these values is inherently subjective and our actual losses could be greater or
less than the estimates. The unallocated allowance captures losses that are
attributable to various economic events, as well as to industry or geographic
sectors whose impact on the portfolio have occurred but have yet to be
recognized in either the formula or specific allowances. Our allowance for
off-balance sheet commitments is measured in approximately the same manner as
the allowance for our loans. We have
F-4
recorded an allowance for loan losses of $407 million and we have recorded an
allowance for off-balance sheet commitments of $83 million as of December 31,
2004, based upon our assessment of the probability of loss. For further
information regarding our allowance for loan losses, see "Allowances for Credit
Losses" beginning on page F-17.
PENSION OBLIGATIONS
Our pension obligations and related assets of our retirement benefit plan
are presented in Note 8 to our Consolidated Financial Statements included in
this Annual Report. Plan assets, which consist primarily of marketable equity
and debt instruments, are valued using market quotations. Plan obligations and
the annual benefit expense are determined by independent actuaries and through
key assumptions. Key assumptions in measuring the plan obligations are the
discount rate, the rate of compensation increases, and the estimated future
return on plan assets. In determining the discount rate, we use the yield on
high-quality, fixed-income investments currently available with maturities
corresponding to the anticipated timing of the future benefit payments.
Compensation increase assumptions are based upon historical experience and
anticipated future management actions. Asset returns are based upon the
anticipated average rate of earnings expected on the invested funds of the plan.
The 2004 net periodic pension cost was $22 million, which increased over the
2003 net periodic pension cost of $13 million primarily due to a decrease in the
assumed discount rate from 6.75 percent to 6.25 percent. This drop in the
discount rate was the primary source of the 2004 pension benefit obligation
(PBO) experience increase of $128.5 million, and the additional unrecognized net
actuarial loss of $92.6 million, which resulted in $9.5 million of additional
expense. Of the total $320 million of unrecognized net actuarial loss as of
December 31, 2004, roughly $212 million will be subject to amortization over 9.7
years, producing additional expense of approximately $22 million. The $22
million is included in the 2005 net periodic pension cost. We estimate the 2005
net periodic pension cost will be approximately $33 million, assuming a 2005
contribution of $125 million. The primary reason for the increase from 2004 net
periodic pension cost is the decrease in the assumed discount rate from 6.25
percent to 5.75 percent. The 2005 estimate for net periodic pension cost was
actuarially determined using a discount rate of 5.75 percent, an expected return
on plan assets of 8.25 percent and an expected compensation increase assumption
of 4.50 percent. A 50 basis point increase in either the discount rate, expected
return on plan assets, or the rate of increase in future compensation levels
would decrease (increase) 2005 periodic pension cost by $12.3 million, $5.8
million, and ($4.1) million, respectively. A 50 basis point decrease in either
the discount rate, expected return on plan assets, or the rate of increase in
future compensation levels would increase (decrease) 2005 periodic benefit cost
by $12.7 million, $5.8 million, and ($4.1) million, respectively.
ASSET IMPAIRMENT
We make estimates and assumptions when preparing our consolidated financial
statements for which actual results will not be known for some time. This
includes the recoverability of long-lived assets employed in our business,
including those of acquired businesses, and other-than-temporary impairment in
our securities portfolio. Annually, we test goodwill from our acquisitions and
we determined that no impairment existed at year-end 2004. Quarterly, we test
our private capital investments for impairment by reviewing the investee's
business model, current and projected financial performance, liquidity and
overall economic and market conditions. In addition, we test our non-investment
grade debt securities for impairment quarterly and during 2004 we recognized
$0.75 million of other-than-temporary impairment in the collateralized loan
obligation (CLO) portfolio. Impairment testing of these securities requires the
use of a number of assumptions related to cash flows, recovery rates, default
rates, market valuations and reinvestment of cash flows during the reinvestment
period. This portfolio of securities is highly diversified, which will mitigate
the risk that downturns in any one industry segment will significantly impair
the portfolio. At December 31, 2004, the entire CLO portfolio was comprised of
127 securities with an average investment market value of $7.3 million. Our
investment grade debt securities are not tested for other-than-temporary
impairment since we have the ability and intent to hold until our cost has been
recovered.
F-5
FINANCIAL PERFORMANCE
SUMMARY OF FINANCIAL PERFORMANCE
INCREASE (DECREASE)
------------------------------------------
2003 VERSUS 2002 2004 VERSUS 2003
------------------- --------------------
DOLLARS IN THOUSANDS 2002 2003 2004 AMOUNT PERCENT AMOUNT PERCENT
- ----------------------- ---------- ---------- ---------- --------- -------- --------- --------
RESULTS OF OPERATIONS
Net interest income(1) $1,561,969 $1,569,066 $1,645,223 $ 7,097 0.5% $ 76,157 4.9%
Noninterest income
Service charges on
deposit accounts.. 275,820 311,417 342,169 35,597 12.9 30,752 9.9
Trust and investment
management fees... 143,953 136,347 153,083 (7,606) (5.3) 16,736 12.3
Insurance commissions 27,847 62,652 77,874 34,805 125.0 15,222 24.3
International
commissions and
fees.............. 61,608 67,582 73,397 5,974 9.7 5,815 8.6
Securities gains
(losses), net..... 2,502 9,309 (12,085) 6,807 nm (21,394) nm
Gain on sale of
merchant card
portfolio......... -- -- 93,000 -- nm 93,000 nm
Other noninterest
income............ 173,545 206,946 261,867 33,401 19.2 54,921 26.5
---------- ---------- ---------- --------- ---------
Total noninterest
income.............. 685,275 794,253 989,305 108,978 15.9 195,052 24.6
Total revenue......... 2,247,244 2,363,319 2,634,528 116,075 5.2 271,209 11.5
(Reversal of)
provision for loan
losses.............. 175,000 75,000 (35,000) (100,000) (57.1) (110,000) (146.7)
Noninterest expense
Salaries and
employee benefits. 731,166 808,804 877,557 77,638 10.6 68,753 8.5
Net occupancy....... 106,592 124,274 132,108 17,682 16.6 7,834 6.3
Intangible asset
amortization...... 5,485 11,366 19,471 5,881 107.2 8,105 71.3
Other noninterest
expense........... 453,722 463,909 495,046 10,187 2.2 31,137 6.7
---------- ---------- ---------- --------- ---------
Total noninterest
expense............. 1,296,965 1,408,353 1,524,182 111,388 8.6 115,829 8.2
Income before income
tax................. 775,279 879,966 1,145,346 104,687 13.5 265,380 30.2
Income tax............ 247,376 292,827 412,812 45,451 18.4 119,985 41.0
---------- ---------- ---------- --------- ---------
Net income............ $ 527,903 $ 587,139 $ 732,534 $ 59,236 11.2% $ 145,395 24.8%
========== ========== ========== ========= =========
- --------------------
(1) Net interest income does not include any adjustments for fully taxable
equivalence.
nm = not meaningful
THE PRIMARY CONTRIBUTORS TO OUR FINANCIAL PERFORMANCE FOR 2004 COMPARED TO
2003 ARE PRESENTED BELOW.
o The reversal of our provision for loan losses in 2004 reflects the
improvement in credit quality in our commercial loan portfolio.
Reductions in criticized and classified credits resulted from
pay-offs, loan grade improvements, and loan sales, which reduced our
allowances for credit losses. (See our discussion under "Allowance for
Credit Losses.")
o Our net interest income was negatively impacted by generally lower
yields on our earning assets, resulting in a lower average yield of 32
basis points on average earning assets, as well as lower hedge income
of $66 million. Net interest income was favorably influenced, however,
by higher earning asset volumes, including a higher mix of residential
mortgages and securities. Strong deposit growth, including an
attractive mix of average noninterest bearing deposits to total
deposits, also contributed favorably to our net interest income, which
included lower hedge income of $2 million. (See our discussion under
"Net Interest Income.")
F-6
o Our noninterest income was impacted by several factors:
-- Service charges on deposit accounts rose primarily from a 20
percent increase in average demand deposits (excluding title and
escrow deposits) over 2003 and higher overdraft and ATM
transaction fees;
-- Insurance commissions increased mostly from our 2003 insurance
agency acquisitions;
-- Private capital investments had net gains of $27.9 million in
2004 compared to net gains of $1.3 million in 2003 as market
valuations stabilized and private capital investments were sold;
-- International commissions and fees grew, reflecting strong growth
in the foreign remittances product from a combination of
increased pricing, product enhancement and higher market
penetration;
-- Trust and investment management fees increased from 2003 due to
the impact of our acquisition of CNA Trust's (renamed TruSource)
assets in August 2004 and higher servicing fees related to
increased assets under administration. Managed assets increased
by 7 percent and non-managed assets increased by 36 percent
year-over-year. Total assets under administration increased by 33
percent, to $204 billion, by the end of the year, partly
resulting from our acquisition of the corporate trust portfolio
of BTM Trust Company in December 2004;
-- In May 2004, we sold our merchant card portfolio, which was
acquired by NOVA Information Systems. The sale of our merchant
card portfolio reflects our ongoing effort to sharpen our
strategic focus. The long-term marketing alliance we formed with
NOVA will provide us with marketing fees in the future; and
-- A loss of $13.3 million on the sale of $1.0 billion of agency
securities in our available for sale portfolio in 2004. The sale
occurred as a result of our decision to use liquidity from
low-yielding securities to fund our expected loan growth and to
increase overall asset-sensitivity in the balance sheet.
o Contributing to our higher noninterest expense were several
factors:
-- Salaries and employee benefits increased mostly from:
o Acquisitions and new branch openings, which accounted for 48
percent of the increase in our salaries and other
compensation,
o annual merit increases; and
o increased employee benefits expense due to acquisitions and
new branch openings, which accounted for 34 percent of our
employee benefits increase, and higher pension expense;
-- Net occupancy costs increased mostly from our acquisitions and
new branch openings, partly offset by a $5.5 million write-off of
certain leasehold improvements in the prior year;
-- Intangible asset amortization increased mainly due to our 2004
acquisitions; and
-- Other noninterest expense rose in 2004 as a result of our
strategy to diversify our earnings and broaden our branch network
through acquisitions and new branch openings and our continued
development of online capabilities to complement physical
distribution through purchased software. In addition, we
experienced higher expenses for customer vendor bills paid by us
as a result of a higher earnings credit rate on deposits and
increased litigation costs.
F-7
THE PRIMARY CONTRIBUTORS TO OUR FINANCIAL PERFORMANCE FOR 2003 COMPARED TO
2002 ARE PRESENTED BELOW.
o The significant decline in our provision for loan losses in 2003
reflects the improvement in credit quality in our commercial loan
portfolio. Reductions in criticized and classified credits resulted
from pay-offs, loan grade improvements, and loan sales, which reduced
our allowance for loan losses.
o Our net interest income was negatively impacted by the lower interest
rate environment and a decline in the average balances of our
commercial loan portfolio. Net interest income was favorably
influenced, however, by higher other earning asset volumes, including
a higher mix of residential mortgages and securities. Strong deposit
growth, including an attractive mix of average noninterest bearing
deposits to total deposits, also contributed favorably to our net
interest income.
o Our noninterest income was impacted by several factors:
-- Service charges on deposit accounts rose primarily from a 22
percent increase in average demand deposits (excluding title and
escrow deposits) over 2002 and higher overdraft fees of $10.7
million associated with a new overdraft program introduced in
April 2003;
-- Insurance commissions increased mostly from our insurance agency
acquisitions in 2003;
-- Private capital investments had net gains of $1.3 million in 2003
compared to net losses of $16.5 million in 2002 as market
valuations stabilized;
-- International commissions and fees grew, reflecting strong growth
in our foreign remittances product in almost all of our markets,
from a combination of increased pricing, product enhancement and
higher market penetration;
-- Residual value writedowns on auto leases were $8.7 million lower
in 2003 reflecting a stabilization of automobile residual values
and the declining auto lease portfolio;
-- The early call of a Mexican Brady Bond produced a $9.0 million
gain in 2003; and;
-- Trust and investment management fees decreased from 2002 due to
the impact of low interest rates on money market funds and
corporate sweep balances. Trust administration fees began growing
in the second half of 2003 as trust assets started to recover
with the strengthening of the equity markets. Managed assets
increased by 3 percent and non-managed assets increased by 17
percent year-over-year. Total assets under administration
increased by 15 percent, to $154 billion, by the end of the year.
o Contributing to our higher noninterest expense were the following
factors:
-- Salaries and employee benefits increased mostly from:
o Acquisitions and new branch openings, which accounted for 48
percent of the increase in our salaries and other
compensation,
o higher performance-related incentive expense as a result of
goal achievement,
o annual merit increases; and
o increased employee benefits expense due to acquisitions and
new branch openings, which accounted for 32 percent of our
employee benefits increase, and increasing healthcare costs
for current employees and retirees;
-- Net occupancy costs increased mostly from our acquisitions and
new branch openings and a $5.5 million write-off of certain
leasehold improvements;
-- Intangible asset amortization increased mainly due to our 2003
acquisitions; and
-- Other noninterest expense rose in 2003 as a result of numerous
initiatives such as expanding our small business franchise,
improving our sales force, increasing marketing activities and
purchasing software, in part, for developing online capabilities
to complement physical distribution. In addition, we accrued $7.8
million for a pre-litigation claim, which was offset by the
decrease of $15.3 million for the 2002 correction of an
accounting error related to amortization expense for low income
housing tax credit (LIHC) investments.
F-8
NET INTEREST INCOME
The table below shows the major components of net interest income and
net interest margin for the periods presented.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------------
2002 2003 2004
--------------------------------- --------------------------------- ------------------------- -------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
(DOLLARS IN THOUSANDS) BALANCE EXPENSE(1) RATE(1) BALANCE EXPENSE(1) RATE(1) BALANCE EXPENSE(1) RATE(1)
- ----------------------- ----------- ---------- ------- ----------- ---------- ------- ----------- ---------- -------
ASSETS
Loans:(2)
Domestic............... $24,662,415 $1,488,184 6.03% $24,878,462 $1,371,717 5.51% $25,928,206 $1,362,424 5.25%
Foreign(3)............. 1,172,660 32,285 2.75 1,549,791 32,708 2.11 1,798,419 38,220 2.13
Securities--taxable...... 5,858,193 313,232 5.35 8,716,051 345,996 3.97 11,707,369 422,052 3.61
Securities--tax-exempt... 37,835 3,968 10.49 40,962 4,003 9.77 68,399 5,551 8.12
Interest bearing
deposits in banks...... 124,023 2,806 2.26 229,547 3,990 1.74 394,145 7,433 1.89
Federal funds sold and
securities purchased
under resale agreements 812,435 13,478 1.66 893,369 10,203 1.14 719,714 9,189 1.28
Trading account assets... 315,810 4,606 1.46 317,655 3,599 1.13 294,596 3,778 1.28
----------- ---------- ----------- ---------- ----------- ----------
Total earning assets. 32,983,371 1,858,559 5.63 36,625,837 1,772,216 4.84 40,910,848 1,848,647 4.52
---------- ---------- ----------
Allowance for loan
losses(5).............. (635,057) (576,871) (514,075)
Cash and due from banks.. 1,928,821 2,213,273 2,271,616
Premises and equipment,
net.................... 498,454 508,973 511,853
Other assets............. 1,332,907 1,699,271 2,046,064
----------- ----------- -----------
Total assets......... $36,108,496 $40,470,483 $45,226,306
=========== =========== ===========
LIABILITIES
Domestic deposits:
Interest bearing....... $ 8,159,892 89,952 1.10 $10,390,459 71,208 0.69 $11,740,269 74,222 0.63
Savings and consumer
time................. 3,632,748 60,758 1.67 3,977,902 42,734 1.07 4,406,610 38,382 0.87
Large time............. 2,958,162 64,428 2.18 2,364,156 37,062 1.57 2,198,078 32,877 1.50
Foreign deposits(3)...... 1,535,837 21,110 1.37 1,280,804 10,232 0.80 1,463,182 15,410 1.05
----------- ---------- ----------- ---------- ----------- ----------
Total interest
bearing deposits. 16,286,639 236,248 1.45 18,013,321 161,236 0.90 19,808,139 160,891 0.81
----------- ---------- ----------- ---------- ----------- ----------
Federal funds purchased
and securities sold
under repurchase
agreements............. 427,610 6,030 1.41 405,982 3,401 0.84 596,997 7,470 1.25
Commercial paper......... 997,543 16,645 1.67 809,930 8,508 1.05 620,053 6,899 1.11
Other borrowed funds..... 469,877 10,111 2.15 192,248 5,097 2.65 163,147 4,866 2.98
Medium and long-term debt 399,769 9,344 2.34 425,960 7,845 1.84 807,070 16,773 2.08
Preferred securities and
trust notes(4)......... 352,106 15,625 4.44 351,575 14,510 4.13 62,480 2,780 4.45
----------- ---------- ----------- ---------- ----------- ----------
Total borrowed funds... 2,646,905 57,755 2.18 2,185,695 39,361 1.80 2,249,747 38,788 1.72
----------- ---------- ----------- ---------- ----------- ----------
Total interest bearing
liabilities.......... 18,933,544 294,003 1.55 20,199,016 200,597 0.99 22,057,886 199,679 0.91
---------- ---------- ----------
Noninterest bearing
deposits............... 12,466,546 15,433,115 18,067,621
Other liabilities........ 968,876 1,007,320 1,050,597
----------- ----------- -----------
Total liabilities.. 32,368,966 36,639,451 41,176,104
STOCKHOLDERS' EQUITY
Common equity............ 3,739,530 3,831,032 4,050,202
----------- ----------- -----------
Total
stockholders'
equity........... 3,739,530 3,831,032 4,050,202
----------- ----------- -----------
Total liabilities
and
stockholders'
equity........... $36,108,496 $40,470,483 $45,226,306
=========== =========== ===========
Net interest
income/margin
(taxable-equivalent
basis)................. 1,564,556 4.74% 1,571,619 4.29% 1,648,968 4.03%
Less: taxable-equivalent
adjustment............... 2,587 2,553 3,745
---------- ---------- ----------
Net interest income...... $1,561,969 $1,569,066 $1,645,223
========== ========== ==========
- -------------------------
(1) Yields and interest income are presented on a taxable-equivalent basis
using the federal statutory tax rate of 35 percent.
(2) Average balances on loans outstanding include all nonperforming loans 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.
(3) Foreign loans and deposits are those loans and deposits originated in
foreign branches.
(4) Includes interest expense for both trust preferred securities and trust
notes.
(5) On December 31, 2004, UnionBanCal Corporation transferred the allowance
related to off-balance sheet commitments of $82.4 million from allowance
for loan losses to other liabilities. Reported averages for all periods
have not been restated.
F-9
Net interest income in 2004, on a taxable-equivalent basis, increased 5
percent from 2003. The increase was attributable to the following factors:
o The growth in average earning assets was primarily attributable to an
increase in average securities and in average loans. The increase in
average securities, which was comprised primarily of fixed rate
securities, reflected liquidity and interest rate risk management
actions. The increase in average loans was largely due to a $1.3
billion increase in average residential mortgages and a $314 million
increase in average commercial mortgages;
o Deposit growth contributed significantly to our lower cost of funds in
2004. Average noninterest bearing deposits were higher in 2004,
compared to 2003, mainly attributable to higher average business
demand deposits of $2.2 billion, including demand deposits from our
title and escrow clients which increased less than $0.1 billion, and
higher consumer demand deposit growth;
o Yields on our earning assets were impacted by a flattening yield curve
and lower reinvestment rates, resulting in a lower average yield of 32
basis points on average earning assets, which was also negatively
impacted by lower hedge income of $66.1 million;
o During 2004, our strategy was to take advantage of our higher
noninterest bearing deposit balances by reducing our balances in
higher interest rate liabilities such as large certificates of
deposit, foreign deposits, commercial paper and other borrowed funds.
In addition, we redeemed our higher rate trust preferred notes in
February 2004, which we funded with lower rate subordinated debt
(issued in December 2003). The shift to lower rate liabilities
resulted in a lower cost of funds on interest bearing liabilities of 8
basis points, which included lower hedge income of $1.7 million; and
As a result of these changes and a flattening yield curve environment, our
net interest margin decreased by 26 basis points.
In 2005, we expect that derivative hedges will provide less net interest
income than in 2004, as positions mature and, to a lesser extent, as interest
rates rise. For 2003 and 2004, we had hedge income of $160.0 million and $92.2
million, respectively.
F-10
ANALYSIS OF CHANGES IN NET INTEREST INCOME
The following table shows the changes in the components of net interest
income on a taxable-equivalent basis for 2002, 2003, and 2004. The changes in
net interest income between periods have been reflected as attributable either
to volume or to rate changes. For purposes of this table, changes that are not
solely due to volume or rate changes are allocated to rate.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------------
2003 VERSUS 2002 2004 VERSUS 2003
-------------------------------------- ------------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
CHANGE IN CHANGE IN
-------------------------------------- ------------------------------------
AVERAGE AVERAGE NET AVERAGE AVERAGE NET
(DOLLARS IN THOUSANDS) VOLUME RATE CHANGE VOLUME RATE CHANGE
- ---------------------------------------- -------- --------- --------- -------- --------- --------
CHANGES IN INTEREST INCOME(1)
Loans:
Domestic.............................. $ 13,028 $(129,495) $(116,467) $ 57,841 $ (67,134) $ (9,293)
Foreign(2)............................ 10,371 (9,948) 423 5,246 266 5,512
Securities--taxable..................... 152,895 (120,131) 32,764 118,755 (42,699) 76,056
Securities--tax-exempt.................. 328 (293) 35 2,681 (1,133) 1,548
Interest bearing deposits in banks...... 2,385 (1,201) 1,184 2,864 579 3,443
Federal funds sold and securities
purchased under resale agreements..... 1,344 (4,619) (3,275) (1,980) 966 (1,014)
Trading account assets.................. 27 (1,034) (1,007) (261) 440 179
-------- --------- --------- -------- --------- --------
Total earning assets................ 180,378 (266,721) (86,343) 185,146 (108,715) 76,431
-------- --------- --------- -------- --------- --------
CHANGES IN INTEREST EXPENSE
Domestic deposits:
Interest bearing...................... 24,536 (43,280) (18,744) 9,314 (6,300) 3,014
Savings and consumer time............. 5,764 (23,788) (18,024) 4,587 (8,939) (4,352)
Large time............................ (12,949) (14,417) (27,366) (2,607) (1,578) (4,185)
Foreign deposits(2)..................... (3,494) (7,384) (10,878) 1,459 3,719 5,178
-------- --------- --------- -------- --------- --------
Total interest bearing deposits..... 13,857 (88,869) (75,012) 12,753 (13,098) (345)
-------- --------- --------- -------- --------- --------
Federal funds purchased and securities
sold under repurchase agreements...... (305) (2,324) (2,629) 1,605 2,464 4,069
Commercial paper........................ (3,133) (5,004) (8,137) (1,994) 385 (1,609)
Other borrowed funds.................... (5,969) 955 (5,014) (771) 540 (231)
Medium and long-term debt............... 613 (2,112) (1,499) 7,012 1,916 8,928
Preferred securities and trust notes(3). (24) (1,091) (1,115) (11,940) 210 (11,730)
-------- --------- --------- -------- --------- --------
Total borrowed funds.............. (8,818) (9,576) (18,394) (6,088) 5,515 (573)
-------- --------- --------- -------- --------- --------
Total interest bearing liabilities 5,039 (98,445) (93,406) 6,665 (7,583) (918)
-------- --------- --------- -------- --------- --------
Changes in net interest income.... $175,339 $(168,276) $ 7,063 $178,481 $(101,132) $ 77,349
======== ========= ========= ======== ========= ========
- --------------------
(1) Interest income is presented on a taxable-equivalent basis using the
federal statutory tax rate of 35 percent.
(2) Foreign loans and deposits are those loans and deposits originated in
foreign branches.
(3) Includes interest expense for both trust preferred securities and trust
notes.
F-11
NONINTEREST INCOME
INCREASE (DECREASE)
------------------------------------------
YEARS ENDED DECEMBER 31,
------------------------------------------
YEARS ENDED DECEMBER 31, 2003 VERSUS 2002 2004 VERSUS 2003
--------------------------------- ----------------- ------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004 AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------ -------- -------- -------- -------- ------- ------- --------
Service charges on deposit accounts. $275,820 $311,417 $342,169 $ 35,597 13% $ 30,752 10%
Trust and investment management fees 143,953 136,347 153,083 (7,606) (5) 16,736 12
Insurance commissions............... 27,847 62,652 77,874 34,805 125 15,222 24
International commissions and fees.. 61,608 67,582 73,397 5,974 10 5,815 9
Merchant banking fees............... 32,314 30,990 39,646 (1,324) (4) 8,656 28
Card processing fees, net........... 35,318 37,520 34,147 2,202 6 (3,373) (9)
Foreign exchange gains, net......... 28,548 30,000 33,516 1,452 5 3,516 12
Brokerage commissions and fees...... 35,625 31,755 33,063 (3,870) (11) 1,308 4
Securities gains (losses), net...... 2,502 9,309 (12,085) 6,807 272 (21,394) nm
Gain on sale of merchant card
portfolio......................... -- -- 93,000 -- -- 93,000 nm
Other............................... 41,740 76,681 121,495 34,941 84 44,814 58
-------- -------- -------- -------- --------
Total noninterest income.......... $685,275 $794,253 $989,305 $108,978 16% $195,052 25%
======== ======== ======== ======== ========
- --------------------
nm = not meaningful
NONINTEREST EXPENSE
INCREASE (DECREASE)
--------------------------------------------
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
----------------------------------------- --------------------------------------------
2003 VERSUS 2002 2004 VERSUS 2003
-------------------- -------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004 AMOUNT PERCENT AMOUNT PERCENT
- ---------------------------- ---------- ---------- ---------- -------- ------- --------- -------
Salaries and other
compensation.............. $ 599,617 $ 659,589 $ 709,015 $ 59,972 10% $ 49,426 7%
Employee benefits........... 131,549 149,215 168,542 17,666 13 19,327 13
---------- ---------- ---------- -------- ---------
Salaries and employee
benefits................ 731,166 808,804 877,557 77,638 11 68,753 9
Net occupancy............... 106,592 124,274 132,108 17,682 17 7,834 6
Equipment................... 66,160 65,394 69,268 (766) (1) 3,874 6
Software.................... 42,850 47,569 54,820 4,719 11 7,251 15
Communications.............. 53,382 52,087 51,899 (1,295) (2) (188) --
Professional services....... 44,851 48,558 50,033 3,707 8 1,475 3
Advertising and public
relations................. 37,510 39,455 38,442 1,945 5 (1,013) (3)
Data processing............. 32,589 31,574 32,229 (1,015) (3) 655 2
Intangible asset amortization 5,485 11,366 19,471 5,881 107 8,105 71
Foreclosed asset expense.... 146 (84) 1,211 (230) nm 1,295 nm
Other....................... 176,234 179,356 197,144 3,122 2 17,788 10
---------- ---------- ---------- -------- ---------
Total noninterest expense. $1,296,965 $1,408,353 $1,524,182 $111,388 9% $115,829 8%
========== ========== ========== ======== =========
- --------------------
nm = not meaningful
INCOME TAX EXPENSE
YEARS ENDED DECEMBER 31,
------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ------------------------------------------ -------- -------- ----------
Income before income taxes................ $775,279 $879,966 $1,145,346
Income tax expense........................ 247,376 292,827 412,812
Effective tax rate........................ 32% 33% 36%
F-12
The increase in the effective tax rate in 2004 reflects higher California
state taxes in 2004 as compared to 2003, primarily as a result of increased
profits reported by MTFG for its most recent fiscal reporting period, as well as
estimates of MTFG's income for its fiscal year ending March 31, 2005.
The State of California requires us to file our franchise tax returns as a
member of a unitary group that includes MTFG and either all worldwide affiliates
or only U.S. affiliates. Since 1996, we have elected to file our California
franchise tax returns on a worldwide unitary basis. The inclusion of MTFG's
financial results, which in some years were net losses, has partially offset our
net profits subject to California income tax. The inclusion of MTFG's worldwide
property, payroll and sales in the calculation of the California apportionment
factor has also reduced the percentage of our income subject to California
income tax. As a result, our effective tax rate for California had been
significantly lower than the statutory rate, net of federal benefit, of 7.05
percent.
Changes in MTFG's taxable profits will impact our effective tax rate.
MTFG's taxable profits are impacted most significantly by changes in the
worldwide economy, especially in Japan, and decisions that they may make about
the timing of the recognition of credit losses. When MTFG's worldwide taxable
profits rise, our effective tax rate in California will rise. We review MTFG's
financial information on a quarterly basis in order to determine the rate at
which to recognize our California income taxes. However, all of the information
relevant to determining the effective tax rate may not be available until after
the end of the period to which the tax relates in part from the differences
between our fiscal year-end and MTFG's. The determination of the California
effective tax rate involves management judgment and estimates, and can change
during the calendar year or between calendar years, as additional information
becomes available.
UnionBanCal Corporation and its subsidiaries file consolidated federal
income tax returns. During 2004 the Internal Revenue Service (IRS) completed its
audit of our income tax returns for the years ended December 31, 2001 and 2002,
and has issued Notices of Proposed Adjustment with respect to the tax treatment
of certain leveraged leasing transactions. Management believes that its tax
reporting of these transactions was consistent with applicable tax law and
intends to defend its position. Resolution of this issue is not expected to have
a significant impact on our financial statements.
For additional information regarding income tax expense, including a
reconciliation of the effective tax rate to the statutory tax rate, see Note 10
to our Consolidated Financial Statements included in this Annual Report.
CREDIT RISK MANAGEMENT
Our principal business activity is the extension of credit in the form of
loans and credit substitutes to individuals and businesses. Our policies and
applicable laws and regulations governing the extension of credit require risk
analysis including an extensive evaluation of the purpose of the request and the
borrower's ability and willingness to repay us as scheduled. Our evaluation also
includes ongoing portfolio and credit management through portfolio
diversification, lending limit constraints, credit review and approval policies,
and extensive internal monitoring.
We manage and control credit risk through diversification of the portfolio
by type of loan, industry concentration, dollar limits on multiple loans to the
same borrower, geographic distribution and type of borrower. Geographic
diversification of loans originated through our branch network is generally
within California, Oregon and Washington, which we consider to be our principal
markets. In addition, we originate and participate in lending activities outside
these states, as well as internationally.
In analyzing our loan portfolios, we apply specific monitoring policies and
procedures that vary according to the relative risk profile and other
characteristics of the loans within the various portfolios. Our residential,
consumer and certain small commercial and commercial real estate loans and
leases are relatively homogeneous and no single loan is individually significant
in terms of its size or potential risk of loss. Therefore, we review these
portfolios by analyzing their performance as a pool of loans. In contrast, our
monitoring process for the larger commercial, financial and industrial,
construction, commercial mortgage, leases, and foreign loan portfolios includes
a periodic review of individual loans. Loans that are performing but have shown
F-13
some signs of weakness are subjected to more stringent reporting and oversight.
We review these loans to assess the ability of the borrowing entity to continue
to service all of its interest and principal obligations and as a result may
adjust the risk grade of the loan accordingly. In the event that we believe that
full collection of principal and interest is not reasonably assured, the loan is
appropriately downgraded and, if warranted, placed on nonaccrual status, even
though the loan may be current as to principal and interest payments.
We have a Credit Review and Management Committee chaired by the Chief
Credit Officer and composed of the Chief Executive Officer and other executive
officers that establishes our overall risk appetite, portfolio concentration
limits, and credit risk rating methodology. This committee is supported by the
Credit Policy Forum, composed of Group Senior Credit Officers that have
responsibility for establishing credit policy, credit underwriting criteria, and
other risk management controls. Credit Administration, under the direction of
the Chief Credit Officer and his designated Group Senior Credit Officers, is
responsible for administering the credit approval process and related policies.
Policies require an evaluation of credit requests and ongoing reviews of
existing credits in order to ensure that the purpose of the credit is
acceptable, and that the borrower is able and willing to repay as agreed.
Furthermore, policies require prompt identification and quantification of asset
quality deterioration or potential loss.
Another part of the control process is the internal credit examination
function, which reports to the Board of Directors and provides both the Board of
Directors and executive management with an independent assessment of the level
of credit risk and the effectiveness of the credit management process. The
Credit Examination Group routinely reviews the accuracy and timeliness of risk
grades assigned to individual borrowers to ensure that the business unit credit
risk identification process is functioning properly. This group also assesses
compliance with credit policies and underwriting standards at the business unit
level. Additionally, the Credit Examination Group reviews and provides
commentary on proposed changes to credit policies, practices and underwriting
guidelines. The Credit Examination Group summarizes its significant findings on
a regular basis and provides recommendations for corrective action when credit
management or control deficiencies are identified.
LOANS
The following table shows loans outstanding by loan type and as a
percentage of total loans for 2000 through 2004. Information about our loan
portfolio is also included in "Business Segments."
INCREASE (DECREASE)
DECEMBER 31, 2004 FROM:
-----------------------
DECEMBER 31, DECEMBER 31, 2003
------------------------------------------------------------------------ -----------------------
(DOLLARS IN MILLIONS) 2000 2001 2002 2003 2004 AMOUNT PERCENT
- -------------------------------- ------------ ------------ ------------ ------------ ------------ ---------- ---------
Domestic:
Commercial, financial and
industrial.................. $13,749 53% $11,476 46% $10,629 40% $ 8,818 34% $ 9,761 32% $ 943 10.7%
Construction.................. 939 4 1,060 4 1,285 5 1,101 4 1,130 4 29 2.6
Mortgage:
Residential................. 3,295 13 4,788 19 6,365 24 7,464 29 9,538 31 2,074 27.8
Commercial.................. 3,348 13 3,591 15 4,150 16 4,195 16 5,409 18 1,214 28.9
------- ------- ------- ------- ------- ----------
Total mortgage............ 6,643 26 8,379 34 10,515 40 11,659 45 14,947 49 3,288 28.2
Consumer:
Installment................... 1,656 6 1,200 5 910 3 819 3 768 2 (51) (6.2)
Revolving lines of credit..... 755 3 859 3 1,103 4 1,222 5 1,582 5 360 29.5
------- ------- ------- ------- ------- ----------
Total consumer.............. 2,411 9 2,059 8 2,013 7 2,041 8 2,350 7 309 15.1
Lease financing................. 1,134 4 979 4 813 3 664 3 609 2 (55) (8.3)
------- ------- ------- ------- ------- ----------
Total loans in domestic
offices................... 24,876 96 23,953 96 25,255 95 24,283 94 28,797 94 4,514 18.6
Loans originated in foreign
branches...................... 1,134 4 1,041 4 1,456 5 1,650 6 1,802 6 152 9.2
------- ------- ------- ------- ------- ----------
Total loans held to maturity.... $26,010 100 $24,994 100 $26,711 100 $25,933 100 $30,599 100 4,666 18.0
Total loans held for sale....... -- -- -- -- 17 -- 12 -- 118 -- 106 nm
------- ------- ------- ------- ------- ----------
Total loans................. $26,010 100% $24,994 100% $26,728 100% $25,945 100% $30,717 100% $ 4,772 18.4%
======= ======= ======= ======= ======= ==========
- --------------------
nm = not meaningful
F-14
COMMERCIAL, FINANCIAL AND INDUSTRIAL LOANS
Commercial, financial and industrial loans represent one of the largest
categories in the loan portfolio. These loans are extended principally to
corporations, middle-market businesses, and small businesses, with no industry
concentration exceeding 10 percent of total loans. This portfolio has a high
degree of geographic diversification based upon our customers' revenue bases,
which we believe lowers our vulnerability to changes in the economic outlook of
any particular region of the U.S.
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. Presently, we are
active in, among other sectors, the oil and gas, communications, media,
entertainment, retailing, power and utilities and financial services industries.
The commercial, financial and industrial loan portfolio increased from
December 31, 2003 mainly from increased loan demand primarily in the California
middle market and specialty segments, which reflected the improving economy in
those markets.
CONSTRUCTION AND COMMERCIAL MORTGAGE LOANS
We engage in non-residential real estate lending that includes commercial
mortgage loans and construction loans secured by deeds of trust. Construction
loans are made primarily to commercial property developers and to residential
builders.
The construction loan portfolio increase from December 31, 2003 was
primarily attributable to growth in the demand for new single family homes,
partially offset by slowing growth in capital assets and employment and higher
office vacancy rates in our markets, which were factors that impacted the level
of development and construction projects we financed.
The commercial mortgage loan portfolio consists of loans on commercial and
industrial projects primarily in California. The increase in commercial
mortgages from December 31, 2003 was primarily due to our acquisitions of
Business Bank of California in the first quarter of 2004 and Jackson Federal
Bank in the fourth quarter of 2004, offset by substantial commercial mortgage
refinancings with other lenders.
RESIDENTIAL MORTGAGE LOANS
We originate residential mortgage loans, secured by one-to-four family
residential properties, through our multiple channel network (including
branches, mortgage brokers, and loan-by-phone) throughout California, Oregon and
Washington, and we periodically purchase loans in our market area.
The residential mortgages increase from December 31, 2003 was influenced by
a high refinance market primarily attributable to an active refinance market
driven by low interest rates throughout the period. While we hold most of the
loans we originate, we sell most of our 30-year, fixed rate, non-Community
Reinvestment Act (CRA) residential mortgage loans.
CONSUMER LOANS
We originate consumer loans, such as auto loans and home equity loans and
lines, through our branch network. Consumer loans increased from December 31,
2003 mainly due to an increase in home equity loans as a result of our
competitive pricing, advertising and promotion, which was partially offset by
pay-offs related to the run-off of the automobile dealer lending business that
we exited in the third quarter of 2000. The indirect automobile dealer lending
portfolio at December 31, 2004 was $16.3 million.
F-15
LEASE FINANCING
We primarily 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. The lease financing
decrease from December 31, 2003 was attributable to the run-off of our
discontinued auto leasing activity. At December 31, 2004, our auto lease
portfolio had declined to $22.6 million and will fully mature by mid-year 2006.
Included in our lease portfolio are leveraged leases of $577 million, which are
net of non-recourse debt of approximately $1.3 billion. We utilize a number of
special purpose entities for our leveraged leases. These entities serve legal
and tax purposes and 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.
LOANS ORIGINATED IN FOREIGN BRANCHES
Our loans originated in foreign branches consist primarily of short-term
extensions of credit to financial institutions located primarily in Asia and
energy related lending in Canada.
The increase in loans originated in foreign branches from December 31,
2003, was primarily related to the expansion of our energy-related lending in
Canada and higher yen-denominated trade finance borrowings by Korean banks.
CROSS-BORDER OUTSTANDINGS
Our cross-border outstandings reflect certain additional economic and
political risks that are not reflected in domestic outstandings. These risks
include those arising from exchange rate fluctuations and restrictions on the
transfer of funds. The following table sets forth our cross-border outstandings
as of December 31, 2002, 2003 and 2004, for any country where such outstandings
exceeded 1 percent of total assets. The cross-border outstandings were compiled
based upon category and domicile of ultimate risk and are comprised of balances
with banks, trading account assets, securities available for sale, securities
purchased under resale agreements, loans, accrued interest receivable,
acceptances outstanding and investments with foreign entities. For any country
shown in the table below, we do not have significant local currency outstandings
that are not hedged or are not funded by local currency borrowings.
PUBLIC CORPORATIONS
FINANCIAL SECTOR AND OTHER TOTAL
(DOLLARS IN MILLIONS) INSTITUTIONS ENTITIES BORROWERS OUTSTANDINGS
- -------------------------------- ------------ -------- ------------ ------------
December 31, 2002
Korea......................... $599 $-- $75 $674
December 31, 2003
Korea......................... $630 $-- $28 $658
December 31, 2004
Korea......................... $615 $-- $3 $618
PROVISION FOR LOAN LOSSES
We recorded a reversal of provision for loan losses of $35 million in 2004,
compared with a $75 million provision for loan losses in 2003. Provisions for
loan losses are charged to income to bring our allowance for loan losses to a
level deemed appropriate by management based on the factors discussed under
"Allowances for Credit Losses" below. Provisions for off-balance sheet
commitments are recognized in noninterest expense.
F-16
ALLOWANCES FOR CREDIT LOSSES
POLICY AND METHODOLOGY
We maintain allowances for credit losses to absorb losses inherent in the
loan portfolio as well as for leases and off-balance sheet commitments. The
allowances are based on our regular, quarterly assessments of the probable
estimated losses inherent in the loan portfolio and unused commitments to
provide financing. Our methodology for measuring the appropriate level of the
allowances relies on several key elements, which include the formula allowance,
specific allowances for identified problem credit exposures, and the unallocated
allowance.
The formula allowance is calculated by applying loss factors to outstanding
loans and certain unused commitments, in each case based on the internal risk
grade of such loans, leases and commitments. Changes in risk grades affect the
amount of the formula allowance. Loss factors are based on our historical loss
experience and may be adjusted for significant factors that, in management's
judgment, affect the collectibility of the portfolio as of the evaluation date.
Loss factors are developed in the following ways:
o loss factors for individually graded credits are derived from a
migration model that tracks historical losses over a period, which we
believe captures the inherent losses in our loan portfolio; and
o pooled loan loss factors (not individually graded loans) are based on
expected net charge-offs. Pooled loans are loans that are homogeneous
in nature, such as consumer installment, home equity, residential
mortgage loans and certain small commercial and commercial real estate
loans.
We believe that an economic cycle is a period in which both upturns and
downturns in the economy have been reflected. We calculate loss factors over a
time interval that spans what we believe constitutes a complete and
representative economic cycle.
Loan loss factors, which are used in determining our formula allowance, are
adjusted quarterly primarily based upon the level of historical net charge-offs
and losses expected by management in the near term. Prior to the quarter ended
June 30, 2004, our loan loss factors for non-criticized graded credits captured
estimated losses that were expected to occur in the next twelve months.
Beginning with the quarter ended June 30, 2004, we have refined our methodology
to estimate our expected losses based on a loss confirmation period. The loss
confirmation period is the estimated average period of time between a material
adverse event affecting the credit-worthiness of a borrower and the subsequent
recognition of a loss. Based upon our evaluation process, we believe that, for
our risk-graded loans, on average, losses are sustained approximately 10
quarters after an adverse event in the creditor's financial condition has taken
place. Similarly, for pool-managed credits, the loss confirmation period varies
by product, but ranges between one and two years.
Furthermore, based on management's judgment, our methodology permits
adjustments to any loss factor used in the computation of the formula allowance
for significant factors, which affect the collectibility of the portfolio as of
the evaluation date, but are not reflected in the loss factors. By assessing the
probable estimated losses inherent in the loan portfolio on a quarterly basis,
we are able to adjust specific and inherent loss estimates based upon the most
recent information that has become available. This includes changing the number
of periods that are included in the calculation of the loss factors and
adjusting qualitative factors to be representative of the economic cycle that we
expect will impact the portfolio.
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to a credit or a
portfolio segment that management believes indicate the probability that a loss
has been incurred. This amount may be determined either by a method prescribed
by SFAS No. 114, or methods that include a range of probable outcomes based upon
certain qualitative factors.
The unallocated allowance is based on management's evaluation of conditions
that are not directly reflected in the determination of the formula and specific
allowances. Certain losses that had previously been considered in the
determination of the unallocated allowance have been incorporated into our
formula allowance through the change made to recognize losses based on a loss
confirmation period, thereby
F-17
eliminating the need to reflect them in our unallocated allowance. The
evaluation of the inherent loss with respect to these conditions is subject to a
higher degree of uncertainty because they may not be identified with specific
problem credits or portfolio segments. The conditions evaluated in connection
with the unallocated allowance include the following, which existed at the
balance sheet date:
o general economic and business conditions affecting our key lending
areas;
o credit quality trends (including trends in nonperforming loans
expected to result from existing conditions);
o collateral values;
o loan volumes and concentrations;
o seasoning of the loan portfolio;
o specific industry conditions within portfolio segments;
o recent loss experience in particular segments of the portfolio;
o duration of the current economic cycle;
o bank regulatory examination results; and
o findings of our internal credit examiners.
Executive management reviews these conditions quarterly in discussion
with our senior credit officers. To the extent that any of these conditions is
evidenced by a specifically identifiable problem credit or portfolio segment as
of the evaluation date, management's estimate of the effect of such conditions
may be reflected as a specific allowance, applicable to such credit or portfolio
segment. Where any of these conditions is not evidenced by a specifically
identifiable problem credit or portfolio segment as of the evaluation date,
management's evaluation of the probable loss related to such condition is
reflected in the unallocated allowance.
The allowances for credit losses are based upon estimates of probable
losses inherent in the loan portfolio and certain off-balance sheet commitments.
The actual losses can vary from the estimated amounts. Our methodology includes
several features that are intended to reduce the differences between estimated
and actual losses. The loss migration model that is used to establish the loan
loss factors for individually graded loans is designed to be self-correcting by
taking into account our loss experience over prescribed periods. In addition, by
basing the loan loss factors over a period reflective of an economic cycle,
recent loss data that may not be reflective of prospective losses going forward
will not have an undue influence on the calculated loss factors.
F-18
The following table reflects the allowance for loan losses allocated to
each respective loan category at period end and as a percentage of the total
period end balance of that loan category, as set forth in the "Loans" table on
page F-14. For periods prior to 2004, the allowance for loan losses included the
allowance for off-balance sheet commitments. At year-end 2004, the allowance for
off-balance sheet commitments totaled $83 million.
DECEMBER 31,
----------------------------------------------------------
2000 2001 2002
---------------- ---------------- ---------------
(DOLLARS IN THOUSANDS)
- -------------------------
Domestic:
Commercial, financial,
and industrial........ $452,400 3.29% $399,900 3.48% $314,873 2.96%
Construction............ 10,200 1.09 12,300 1.16 24,900 1.94
Mortgage:
Residential........... 1,000 0.03 1,400 0.03 1,900 0.03
Commercial............ 19,100 0.57 21,100 0.59 28,519 0.69
-------- -------- --------
Total mortgage...... 20,100 0.30 22,500 0.27 30,419 0.29
Consumer:
Installment........... 10,500 0.63 9,700 0.81 6,400 0.70
Revolving lines of
credit.............. 8,000 1.06 4,800 0.56 6,100 0.55
-------- -------- --------
Total consumer...... 18,500 0.77 14,500 0.70 12,500 0.62
Lease financing......... 7,900 0.70 12,000 1.23 30,690 3.77
-------- -------- --------
Total domestic
allowance......... 509,100 2.05 461,200 1.93 413,382 1.64
Foreign allowance......... 3,400 0.30 1,800 0.17 1,400 0.10
Unallocated............... 101,402 171,509 194,408
-------- -------- --------
Total allowance
for loan losses $613,902 2.36% $634,509 2.54% $609,190 2.28%
======== ======== ========
INCREASE (DECREASE)
YEARS ENDED DECEMBER 31,
------------------------
DECEMBER 31, 2004 VERSUS 2003
-------------------------------------- ------------------------
2003 2004 AMOUNT PERCENT
---------------- ---------------- ----------- ---------
(DOLLARS IN THOUSANDS)
- --------------------------
Domestic:
Commercial, financial,
and industrial........ $276,366 3.13% $187,577 1.92% $ (88,789) (32)%
Construction............ 16,400 1.49 14,843 1.31 (1,557) (9)
Mortgage:
Residential........... 2,200 0.03 2,900 0.03 700 32
Commercial............ 24,756 0.59 83,414 1.54 58,658 237
-------- -------- -----------
Total mortgage...... 26,956 0.23 86,314 0.58 59,358 220
Consumer:
Installment........... 3,000 0.37 2,400 0.31 (600) (20)
Revolving lines of
credit.............. 5,300 0.43 2,400 0.15 (2,900) (55)
-------- -------- -----------
Total consumer...... 8,300 0.41 4,800 0.20 (3,500) (42)
Lease financing......... 29,800 4.49 27,634 4.54 (2,166) (7)
-------- -------- -----------
Total domestic
allowance......... 357,822 1.47 321,168 1.12 (36,654) (10)
Foreign allowance......... 2,200 0.13 3,300 0.18 1,100 50
Unallocated............... 172,948 82,688 (90,260) (52)
-------- -------- -----------
Total allowance
for loan losses.. $532,970 2.05% $407,156 1.33% $ (125,814) (24)%
======== ======== ===========
F-19
COMPARISON OF THE TOTAL ALLOWANCES AND RELATED PROVISIONS FOR CREDIT LOSSES
At December 31, 2004, 2003, and 2002, our total allowances for credit
losses were 313 percent, 190 percent, and 181 percent of total nonaccrual loans,
respectively. In addition, the allowances incorporate the results of measuring
impaired loans as provided in SFAS No. 114 and SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan--Income Recognition and Disclosures." These
accounting standards prescribe the measurement methods, income recognition and
disclosures related to impaired loans. At December 31, 2004, total impaired
loans were $102 million and the associated impairment allowance was $32 million,
compared with total impaired loans of $230 million and an associated impairment
allowance of $55 million at December 31, 2003, and total impaired loans of $300
million and an associated impairment allowance of $88 million at December 31,
2002.
At December 31, 2003 and 2002, the total allowance for credit losses
included allowances for off-balance sheet commitments of $85.8 million and $75.4
million, respectively. At December 31, 2004, the allowance of $82.4 million was
transferred to other liabilities. However, funded loans and off-balance sheet
commitments are considered together when determining the adequacy of the
allowances for credit losses as a whole.
During 2004, 2003, and 2002 there were no material changes in estimation
methods or assumptions that affected our methodology for assessing the
appropriateness of the formula and specific allowances for credit losses, except
for the following refinements:
o In 2002, we changed our method for calculating impairment on loans by
basing the expected cash flows on those which had the highest
probability of outcome. In 2003, we adjusted our loss factors for
refinements in the recovery rates on previously charged off loans and
the period used to measure an economic cycle.
o In 2004, we refined our loss factors for commercial real estate and
construction lending in order to more accurately capture probable loss
inherent in the portfolio, we adjusted the period used to calculate
the cumulative loss rates on criticized loans from 12 to 24 quarters
to better estimate losses over the life of the loans. We revised our
method of estimating our expected losses based on a loss confirmation
period. The loss confirmation period is the estimated average period
of time between a material adverse event affecting the
credit-worthiness of a borrower and the subsequent recognition of a
loss. Based upon our evaluation process, we believe that, for our
risk-graded loans, on average, losses are sustained approximately 10
quarters after an adverse event in the creditor's financial condition
has taken place. Similarly, for pool-managed credits, the loss
confirmation period varies by product, but ranges between one and two
years.
o During 2002, 2003, and 2004, changes in estimates and assumptions
regarding the effects of economic and business conditions on borrowers
and other factors also affected the assessment of the unallocated
allowance.
As a result of management's assessment of factors, including improvements
in the quality of our loan portfolio, the continued improvement in the U.S.
economy, improving conditions in the communications/media, power, and other
sectors in domestic markets in which we operate, and growth and changes in the
composition of the loan portfolio, offset by the adverse impact of increasing
fuel costs across the whole economy, we recorded a reversal of provision for
loan losses of $35 million in 2004. The refinements we made in the manner in
which we segment our allowances for credit losses, as previously described, had
no impact on the overall level of the allowances.
F-20
The following table sets forth the components of the allowances for credit
losses.
INCREASE (DECREASE)
DECEMBER 31, 2004 FROM:
------------------------
DECEMBER 31, DECEMBER 31, 2003
-------------------- ------------------------
(DOLLARS IN MILLIONS) 2002 2003 2004 AMOUNT PERCENT
- --------------------- ---- ---- ---- --------- ---------
Allocated allowance:
Formula............................ $294 $280 $361 $ 81 29%
Specific........................... 121 80 46 (34) (43)
---- ---- ---- ---------
Total allocated allowance.......... 415 360 407 47
Unallocated allowance................ 194 173 83 (90) (52)
---- ---- ---- ---------
Total allowances for credit losses... $609 $533 $490 $ (43) (8)%
==== ==== ==== =========
CHANGES IN THE FORMULA AND SPECIFIC ALLOWANCES
The increase in the formula allowance as of December 31, 2004, compared to
December 31, 2003, was due primarily to the impact of the introduction in the
second quarter of 2004 of the loss confirmation period into the determination of
our loan loss factors, which was approximately $125 million, the modifications
to the commercial real estate and construction loss factors, which was
approximately $18 million, the expansion of the period used to calculate
cumulative loss rates on criticized credits, which was $9 million, and growth in
our commercial loan portfolio, offset by significant improvements in the credit
quality of our loan portfolio. Since a portion of the impact for the use of the
loss confirmation period had already been considered in our attributions in the
unallocated allowance, a reallocation between the formula and unallocated
portions of the allowance was made.
The specific allowance decreased at December 31, 2004, compared to December
31, 2003. The decrease was primarily reflective of decreases in impaired loans
and the renegotiation of terms for certain aircraft leases that are now reported
as operating leases. At December 31, 2003, the specific allowance decreased from
December 31, 2002 primarily as a result of the decreased levels of nonaccrual
loans and lower estimated loss content in nonaccrual loans.
At December 31, 2004, the total allocated allowance included $83 million
related to off-balance sheet exposures such as unfunded commitments and letters
of credit.
At December 31, 2004, the allocated portion of the allowances for credit
losses included $126 million related to special mention and classified credits,
compared to $240 million at December 31, 2003, and $304 million at December 31,
2002. The yearly declines resulted primarily from improving credit quality.
Special mention and classified credits are those that are internally risk graded
as "special mention," "substandard" or "doubtful." Special mention credits are
potentially weak, as the borrower has begun to exhibit deteriorating trends,
which, if not corrected, could jeopardize repayment of the loan and result in
further downgrade. Substandard credits have well-defined weaknesses, which, if
not corrected, could jeopardize the full satisfaction of the debt. A credit
classified as "doubtful" has critical weaknesses that make full collection
improbable.
F-21
CHANGES IN THE UNALLOCATED ALLOWANCE
The following table identifies the components of the unallocated allowance
and the range of inherent loss.
DECEMBER 31, 2002 DECEMBER 31, 2003 DECEMBER 31, 2004
---------------------------- ---------------------------- ----------------------------
(DOLLARS IN MILLIONS)
CONCENTRATION COMMITMENTS(1) LOW HIGH COMMITMENTS(1) LOW HIGH COMMITMENTS(1) LOW HIGH
- -------------------------- -------------- --- ---- -------------- --- ---- -------------- --- ----
Fuel Prices............... $ -- $-- $ -- $ -- $-- $ -- $38,472 $10 $34
Leasing................... 662 8 16 596 5 11 615 15 26
Real Estate............... 6,186 16 32 6,432 16 32 7,663 10 22
Foreign................... 620 9 19 1,134 11 20 181 5 10
Power Companies/Utilities. 3,805 25 50 3,208 13 27 3,611 3 6
Retail.................... 1,668 8 16 1,557 6 12 1,807 1 3
Communications/Media...... 1,907 18 40 1,629 10 30 -- -- --
California................ -- -- -- 9,106 6 12 -- -- --
Other..................... 12,458 13 27 15,659 19 36 1,793 3 5
--- ---- --- ---- --- ----
Total Attributed.......... $97 $200 $86 $180 $47 $106
=== ==== === ==== === ====
- --------------------
(1) Includes loans outstanding and unused commitments.
At December 31, 2004, the unallocated allowance decreased compared to
December 31, 2003. The reasons for the decrease, and for which an unallocated
allowance is warranted, are detailed below.
In our assessment as of December 31, 2004, management focused, in
particular, on the factors and conditions set out below. There can be no
assurance that the adverse impact of any of these conditions on us will not be
in excess of the ranges set forth.
Although in certain instances the downgrading of a loan resulting from the
effects of the conditions described below has been reflected in the formula
allowance, management believes that the impact of these events on the
collectibility of the applicable loans may not have been reflected in the level
of nonperforming loans or in the internal risk grading process with respect to
such loans. In addition, our formula allowance does not take into consideration
sector-specific changes in the severity of losses that are expected to arise
from current economic conditions compared with our historical losses.
Accordingly, our evaluation of the probable losses related to the impact of
these factors was reflected in the unallocated allowance. The evaluations of the
inherent losses with respect to these factors are subject to higher degrees of
uncertainty because they are not identified with specific problem credits.
As previously mentioned, we refined our formula allowance to include
certain losses based upon a loss confirmation period, which has eliminated the
need to consider those losses in the attributions of our unallocated allowance.
In evaluating the results of this methodology change, we considered the effect
of underlying conditions on expected future credit migration for each of our
lending segments. In several cases, we concluded that this experience is not
likely to be more severe than the long-run average embedded in the loss factors
that drive the formula allowance calculation. In these cases, we determined that
our attribution, previously established for the technology and consumer sectors,
was no longer required.
Similarly, in certain cases, we believe that credit migration is likely to
be somewhat more severe than the long-run average, but a greater share of the
inherent probable loss associated with this credit migration is now captured in
the allocated allowance as a result of the previously mentioned refinement in
methodology. In these cases, we have reduced certain unallocated allowance
attributions. The following describes the specific conditions we considered.
o With respect to fuel prices, we considered the sustained high prices
of oil and petroleum products, and the impact across virtually all
sectors of the economy.
o With respect to leasing, we considered the worsening situation for
some electric service providers, combined with continued weakness in
the airline industry.
F-22
o With respect to commercial real estate, we considered slightly
improving vacancy rates and stagnant rent growth being experienced
nationally, with specific weakness in Northern California.
o With respect to cross-border exposures in certain foreign countries,
we considered the improving economic performances in many countries of
our key international markets, as well as better financial results of
our customers, and reduced the attribution range from December 31,
2003. This attribution range also provided for certain weaknesses in
the banking sector of some of our markets and the possible effects the
December 26, 2004 tsunami may have on certain Southeast Asian markets.
o With respect to power companies/utilities, we considered the effects
of lower excess capacity and evidence that a slow recovery is
beginning in this industry.
At December 31, 2003, the unallocated allowance decreased compared to
December 31, 2002 primarily from improving economic indicators in general and
identifiable improving conditions in several specific sectors. In our assessment
as of December 31, 2003, management focused, in particular, on the factors and
conditions set out below.
Although in certain instances the downgrading of a loan resulting from
these effects was reflected in the formula allowance, management believes that
in most instances the impact of these events on the collectibility of the
applicable loans may not have been reflected in the level of nonperforming loans
or in the internal risk grading process with respect to such loans. Accordingly,
our evaluation of the probable losses related to these factors was reflected in
the unallocated allowance. The evaluations of the inherent losses with respect
to these factors were subject to higher degrees of uncertainty because they were
not identified with specific problem credits.
o With respect to the real estate sector, management considered the
continued weakness in many markets, with the national office vacancy
rate continuing to rise and average rents falling, as well as the
specific weakness in Northern California resulting from overdependence
on the technology sector.
o With respect to the communications/media industry, management
considered improving advertising revenues contrasted against
subscriber erosion for cable companies resulting from satellite TV
competition and the increasingly intense competition between, as well
as within, Telecom modes.
o With respect to power companies/utilities, management considered the
excess capacity and flat demand in the power generation market,
exacerbated by excessive debt levels and limited repayment or
refinancing opportunities.
o With respect to cross-border loans and acceptances to certain Latin
America and Asia/Pacific Rim countries, management considered
continuing structural imbalances, even as the strong US growth has
lifted its trading partners in the region.
o With respect to the retail sector, management considered the improved
holiday season sales, compared to those experienced in 2002, against a
backdrop of higher household debt at a time of considerable employment
and income uncertainty.
o With respect to the State of California, management considered
underlying uncertainties, including the major shortfall in the state's
budgetary position and the various fiscal and other cost-related
factors that combine to make California a more expensive state in
which to conduct business.
o With respect to leasing, management considered some cyclical recovery
in airline traffic demand, contrasted against increased market share
and fleet growth from discount carriers.
o With respect to the technology industry, management considered
improved spending as a result of tax law changes and pressure to
sustain the productivity gains, and associated cost savings, witnessed
during 2003, while remaining aware of the competitive pricing market
that will rein in revenue gains.
F-23
In our assessment as of December 31, 2002, management focused, in
particular, on the following factors:
o With respect to power companies/utilities, management considered the
adverse effects of declining wholesale power prices, continued
accounting concerns, and uncertainties regarding the course of
deregulation on borrowers in the power industry.
o With respect to the communications/media industry, management
considered the continued adverse effects of changes in the economic,
regulatory and technology environments.
o With respect to the real estate sector, management considered the
general weakening in commercial real estate markets reflecting weak
demand, as well as the specific deterioration in Northern California.
o With respect to cross-border loans and acceptances to certain Asia/
Pacific Rim countries, management considered the weak economic
conditions in that region and the reduced strength of Japanese
corporate parent companies.
o With respect to leasing, management considered the growing problems of
the airline industry including weakness in financial performance and
in collateral values.
o With respect to the retail sector, management considered the adverse
effects of the weak economy and the expected fallout from poor
Christmas sales results.
o With respect to the technology industry, management considered the
adverse effects of continuing excess capacity and cyclical weak demand
for personal computers and other products.
Accordingly, our evaluation of the probable losses related to the impact of
these factors was reflected in the unallocated allowance. The evaluations of the
inherent losses with respect to these factors were subject to higher degrees of
uncertainty because they were not identified with specific problem credits.
F-24
CHANGE IN THE TOTAL ALLOWANCES FOR CREDIT LOSSES
The following table sets forth a reconciliation of changes in our
allowances for credit losses.
INCREASE (DECREASE)
DECEMBER 31, 2004 FROM:
-----------------------
YEARS ENDED DECEMBER 31, DECEMBER 31, 2003
------------------------------------------------------- -----------------------
(DOLLARS IN THOUSANDS) 2000 2001 2002 2003 2004 AMOUNT PERCENT
- --------------------------- -------- -------- -------- -------- -------- --------- -------
Balance, beginning of
period................... $470,378 $613,902 $634,509 $609,190 $532,970 $ (76,220) (13)%
Loans charged off:
Commercial, financial
and industrial......... 302,152 300,521 212,675 159,611 73,086 (86,525) (54)
Construction............. -- 567 -- -- 765 765 nm
Mortgage................. 174 5,113 1,591 7,286 43 (7,243) (99)
Consumer................. 11,760 12,667 11,220 9,657 6,397 (3,260) (34)
Lease financing.......... 2,925 3,601 19,856 33,032 2,361 (30,671) (93)
Foreign(1)............... 5,352 -- -- 2,140 -- (2,140) (100)
-------- -------- -------- -------- -------- ---------
Total loans charged off 322,363 322,469 245,342 211,726 82,652 (129,074) (61)
RECOVERIES OF LOANS
PREVIOUSLY CHARGED OFF:
Commercial, financial
and industrial......... 16,440 48,321 34,075 45,822 50,593 4,771 10
Construction............. -- -- 40 -- 118 118 nm
Mortgage................. 2,394 32 405 150 1,702 1,552 1,035
Consumer................. 6,882 4,289 4,436 3,673 1,971 (1,702) (46)
Lease financing.......... 581 754 590 446 1,374 928 208
Foreign(1)............... -- 4,974 -- -- -- -- nm
-------- -------- -------- -------- -------- ---------
Total recoveries of
loans previously
charged off.......... 26,297 58,370 39,546 50,091 55,758 5,667 11
-------- -------- -------- -------- -------- ---------
Net loans charged off 296,066 264,099 205,796 161,635 26,894 (134,741) (83)
(Reversal of) provision
for credit losses........ 440,000 285,000 175,000 75,000 (35,000) (110,000) (147)
Foreign translation
adjustment and other net
additions
(deductions)(2)(3)....... (410) (294) 5,477 10,415 (63,920) (74,335) (714)
-------- -------- -------- -------- -------- ---------
Ending balance of
allowance for loan
losses(3)................ $613,902 $634,509 $609,190 $532,970 $407,156 $(125,814) (24)
Allowance for off-balance
sheet commitment
losses(3)................ -- -- -- -- 82,375 82,375 nm
-------- -------- -------- -------- -------- ---------
Allowances for credit
losses................... $613,902 $634,509 $609,190 $532,970 $489,531 $ (43,439) (8)
======== ======== ======== ======== ======== =========
Allowances for credit
losses to total loans.... 2.36% 2.54% 2.28% 2.05% 1.59%
(Reversal of) provision
for credit losses to net
loans charged off........ 148.62 107.91 85.04 46.40 (130.14)
Net loans charged off to
average total loans...... 1.13 1.02 0.80 0.61 0.10
- --------------------
(1) Foreign loans are those loans originated in foreign branches.
(2) Includes $5.7 million related to the Business Bancorp acquisition and $12.6
million related to the Jackson Federal Bank acquisition, both acquired in
2004. Also includes $10.3 million related to the Monterey Bay Bank
acquisition in 2003, $2.8 million for the Valencia Bank & Trust
acquisition, and $2.4 million for the First Western Bank acquisition, both
acquired in 2002.
(3) On December 31, 2004, UnionBanCal Corporation transferred the allowance
related to off-balance sheet commitments of $82.4 million from allowance
for loan losses to other liabilities. Prior periods have not been restated.
nm - not meaningful
Totalloans charged off in 2004, 2003 and 2002, decreased compared to their
prior years, primarily attributable to improvements in loan quality. Lease
charge-offs in 2002 and 2003 related primarily to several
F-25
commercial aircraft leases. Charge-offs reflect the realization of losses in the
portfolio that were recognized previously through provisions for credit losses.
Loan recoveries in 2004 and 2003 increased compared to their prior years,
while loan recoveries in 2002 decreased from 2001. Such fluctuations in loan
recoveries from year-to-year are due to variability in timing of recoveries and
tend to trail the periods in which charge-offs are recorded.
Our annual net charge-offs, averaged for the past five years were $171
million, $196 million, and $191 million at December 31, 2002, 2003, and 2004,
respectively. These net charge-offs represent 3.6 years, 2.7 years and 2.6 years
of losses based on the level of the allowance for credit losses at December 31,
2002, 2003 and 2004, respectively. Historical net charge-offs are not
necessarily indicative of the amount of net charge-offs that we will realize in
the future.
NONPERFORMING ASSETS
Nonperforming assets consist of nonaccrual loans, distressed loans held for
sale, and foreclosed assets. 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 this Annual
Report.
Distressed loans held for sale are loans, which would otherwise be included
in nonaccrual loans, but that have been identified for accelerated disposition.
Disposition of these assets is contemplated within a short period of time, not
to exceed one year.
Foreclosed assets include property where we acquired title through
foreclosure or "deed in lieu" of foreclosure.
F-26
The following table sets forth an analysis of nonperforming assets.
INCREASE (DECREASE)
DECEMBER 31, 2004 FROM:
-----------------------
DECEMBER 31, DECEMBER 31, 2003
------------------------------------------------------- -----------------------
(DOLLARS IN THOUSANDS) 2000 2001 2002 2003 2004 AMOUNT PERCENT
- -------------------------- -------- -------- -------- -------- -------- --------- -------
Commercial, financial and
industrial.............. $385,263 $471,509 $276,415 $190,404 $72,600 $(117,804) (61.9)%
Construction.............. 3,967 -- -- -- 2,622 2,622 nm
Mortgage--Commercial...... 10,769 17,430 23,980 38,354 26,520 (11,834) (30.9)
Lease financing........... -- 2,946 36,294 51,603 54,894 3,291 6.4
Loans originated in
foreign branches........ -- -- -- 840 -- (840) (100.0)
-------- -------- -------- -------- -------- ---------
Total nonaccrual loans.. 399,999 491,885 336,689 281,201 156,636 (124,565) (44.3)
Foreclosed assets......... 1,181 597 715 5,689 7,282 1,593 28.0
Distressed loans held for
sale.................... 7,124 -- -- -- -- -- --
-------- -------- -------- -------- -------- ---------
Total nonperforming
assets................ $408,304 $492,482 $337,404 $286,890 $163,918 $(122,972) (42.9)
======== ======== ======== ======== ======== =========
Allowances for credit
losses(1)............... $613,902 $634,509 $609,190 $532,970 $489,531 $ (43,439) (8.2)%
======== ======== ======== ======== ======== =========
Nonaccrual loans to total
loans................... 1.54% 1.97% 1.26% 1.08% 0.51%
Allowances for credit
losses to nonaccrual
loans................... 153.48 129.00 180.94 189.53 312.53
Nonperforming assets to
total loans, distressed
loans held for sale, and
foreclosed assets....... 1.57 1.97 1.26 1.11 0.53
Nonperforming assets to
total assets............ 1.16 1.37 0.84 0.68 0.34
- --------------------
(1) Includes allowance for losses related to off-balance sheet commitments.
nm = not meaningful
As of December 31, 2004, our nonperforming assets included approximately
$54.9 million in aircraft leases and $35.1 million in acquired syndicated loans.
The decrease in nonaccrual loans was primarily due to pay-downs, charge-offs,
and loan sales, coupled with significantly reduced inflows. During 2004, we sold
approximately $43 million of nonperforming loans compared to approximately $139
million in 2003, which reduced our credit exposures. Losses from these sales
were reflected in our charge-offs.
F-27
The following table sets forth an analysis of loans contractually past due
90 days or more as to interest or principal and still accruing, but not included
in nonaccrual loans above.
INCREASE (DECREASE)
DECEMBER 31, 2004 FROM:
-----------------------
DECEMBER 31, DECEMBER 31, 2003
-------------------------------------------------------- -----------------------
(DOLLARS IN THOUSANDS) 2000 2001 2002 2003 2004 AMOUNT PERCENT
- ------------------------------------- -------- -------- -------- -------- --------- -------- ---------
Commercial, financial and industrial. $ 1,713 $ 26,571 $ 1,705 $ 893 $ 1,315 $ 422 47.3%
Construction......................... -- -- 679 -- -- -- --
Mortgage:
Residential........................ 2,699 4,854 3,211 1,878 1,385 (493) (26.3)
Commercial......................... -- 2,356 506 -- -- -- --
-------- -------- -------- -------- --------- --------
Total mortgage................... 2,699 7,210 3,717 1,878 1,385 (493) (26.3)
Consumer and other................... 2,921 2,579 2,072 1,123 1,157 34 3.0
-------- -------- -------- -------- --------- --------
Total loans 90 days or more past
due and still accruing........... $ 7,333 $ 36,360 $ 8,173 $ 3,894 $ 3,857 $ (37) (1.0)%
======== ======== ======== ======== ========= ========
At December 31, 2001, we had a $17.5 million credit to a customer that was
reclassified to nonaccrual loans in 2002.
INTEREST FOREGONE
If interest that was due on the book balances of all nonaccrual and
restructured loans (including loans that were, but are no longer on nonaccrual)
had been accrued under their original terms, $37.0 million and $31.6 million of
interest would have been recorded in 2004 and 2003, respectively.
After designation as a nonaccrual loan, we recognized interest income on a
cash basis of $25.8 million and $6.5 million for loans that were on nonaccrual
status at December 31, 2004 and December 31, 2003, respectively.
SECURITIES
Management of the securities portfolio involves the maximization of return
while maintaining prudent levels of quality, market risk, and liquidity. At
December 31, 2004, approximately 98 percent of total securities were investment
grade. The amortized cost, gross unrealized gains, gross unrealized losses, and
fair values of securities are detailed in Note 2 to our Consolidated Financial
Statements included in this Annual Report.
ANALYSIS OF SECURITIES AVAILABLE FOR SALE
The following table shows the remaining contractual maturities and expected
yields of the securities available for sale based upon amortized cost at
December 31, 2004. The fair value of our securities available for sale portfolio
at December 31, 2004 was $11.1 billion.
Included in our securities available for sale portfolios at December 31,
2003 and 2004 were securities used for Asset and Liability Management (ALM)
purposes of $10.4 billion and $10.2 billion, respectively. These securities had
an expected weighted average maturity of 2.9 years and 2.8 years, respectively.
F-28
SECURITIES AVAILABLE FOR SALE
MATURITY
---------------------------------------------------------------------------------
OVER ONE YEAR OVER FIVE YEARS
ONE YEAR THROUGH THROUGH OVER TOTAL
OR LESS FIVE YEARS TEN YEARS TEN YEARS AMORTIZED COST
------------------- ------------------- ------------------- ------------------- --------------------
(DOLLARS IN THOUSANDS) AMOUNT YIELD(3) AMOUNT YIELD(3) AMOUNT YIELD(3) AMOUNT YIELD(3) AMOUNT YIELD(3)
- ---------------------- ---------- -------- ---------- -------- ---------- -------- ---------- -------- ----------- --------
U.S. Treasury........ $ 1,998 1.32% $ 50,419 3.99% $ -- --% $ -- --% $ 52,417 3.89%
Other U.S. government 1,187,764 2.85 2,721,318 2.92 -- -- -- -- 3,909,082 2.90
Mortgage-backed
securities(1)(2)... 2,109 4.74 75,523 3.69 1,391,540 3.73 4,556,298 4.13 6,025,470 4.03
State and municipal(3) 4,923 3.33 11,220 7.59 17,826 9.55 35,593 6.21 69,562 7.08
Asset-backed and debt
securities......... -- -- 49,418 2.88 219,336 4.63 854,750 3.45 1,123,504 3.66
Equity securities(4). -- -- -- -- -- -- -- -- 9,153 --
Foreign securities... 5,909 0.03 1,123 4.98 -- -- -- -- 7,032 0.82
---------- ---------- ---------- ---------- -----------
Total securities
available for sale $1,202,703 2.84% $2,909,021 2.98% $1,628,702 3.91% $5,446,641 4.04% $11,196,220 3.61%
========== ========== ========== ========== ===========
- --------------------
(1) The remaining contractual maturities of mortgage-backed securities were
allocated assuming no prepayments. The contractual maturity of these
securities is not a reliable indicator of their expected life because
borrowers have the right to repay their obligations at any time.
(2) See discussion of expected duration in "Qualitative and Quantative
Disclosures About Market Risk."
(3) Yields on tax-exempt municipal securities are presented on a
taxable-equivalent basis using the current federal statutory rate of 35
percent.
(4) Equity securities do not have a stated maturity and are included in the
total column only.
LOAN MATURITIES
The following table presents our loans by contractual maturity except for
loans held for sale, which are presented based on the period when the sale is
expected to take place.
DECEMBER 31, 2004
------------------------------------------------
OVER
ONE YEAR
ONE YEAR THROUGH OVER
(DOLLARS IN THOUSANDS) OR LESS FIVE YEARS FIVE YEARS TOTAL
- ---------------------------------------------- ---------- ---------- ---------- -----------
Domestic:
Commercial, financial and industrial........ $3,118,369 $5,307,891 $ 1,334,836 $ 9,761,096
Construction................................ 438,501 683,325 8,244 1,130,070
Mortgage:
Residential............................... 1,620 399,319 9,137,211 9,538,150
Commercial................................ 340,484 1,692,114 3,376,431 5,409,029
---------- ---------- ----------- -----------
Total mortgage.......................... 342,104 2,091,433 12,513,642 14,947,179
Consumer:
Installment............................... 11,641 126,968 629,158 767,767
Revolving lines of credit................. 1,404,684 176,799 383 1,581,866
---------- ---------- ----------- -----------
Total consumer.......................... 1,416,325 303,767 629,541 2,349,633
Lease financing............................. 23,382 35,005 550,703 609,090
---------- ---------- ----------- -----------
Total loans in domestic offices......... 5,338,681 8,421,421 15,036,966 28,797,068
Loans originated in foreign branches.......... 1,787,965 10,414 3,609 1,801,988
---------- ---------- ----------- -----------
Total loans held to maturity............ $7,126,646 $8,431,835 $15,040,575 30,599,056
Total loans held for sale............... 117,900 -- -- 117,900
---------- ---------- ----------- -----------
Total loans............................. $7,244,546 $8,431,835 $15,040,575 30,716,956
========== ========== ===========
Allowance for loan losses............. 407,156
-----------
Loans, net.............................. $30,309,800
===========
Total fixed rate loans due after one year..... $12,506,100
Total variable rate loans due after one year.. 10,966,310
-----------
Total loans due after one year.......... $23,472,410
===========
F-29
CERTIFICATES OF DEPOSIT OF $100,000 AND OVER
The following table presents domestic certificates of deposit of $100,000
and over by maturity.
DECEMBER 31,
(DOLLARS IN THOUSANDS) 2004
- ------------------------------------------------- ------------
Three months or less............................. $ 1,199,699
Over three months through six months............. 466,566
Over six months through twelve months............ 293,784
Over twelve months............................... 272,364
------------
Total domestic certificates of deposit
of $100,000 and over......................... $ 2,232,413
============
We offer certificates of deposit of $100,000 and over at market rates of
interest. Many of these certificates are issued to customers, both public and
private, who have done business with us for an extended period. Based on our
historical experience, we expect that as these deposits come due, the majority
will continue to be renewed at market rates of interest.
Most of our deposits in foreign branches are certificates of deposit of
$100,000 and over and mature in less than one year.
BORROWED FUNDS
The following table presents information on our borrowed funds.
DECEMBER 31,
------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ----------------------------------------------------------------------------- ---------- ---------- ----------
Federal funds purchased and securities sold under repurchase agreements with
weighted average interest rates of 0.88%, 0.68% and 1.90% at December 31,
2002, 2003 and 2004, respectively.......................................... $ 334,379 $ 280,968 $ 587,249
Commercial paper, with weighted average interest rates of 1.21%, 0.83% and
1.69% at December 31, 2002, 2003 and 2004, respectively.................... 1,038,982 542,270 824,887
Other borrowed funds, with weighted average interest rates of 2.25%, 1.49%
and 4.25% at December 31, 2002 2003 and 2004, respectively................. 267,047 212,088 172,549
---------- ---------- ----------
Total borrowed funds....................................................... $1,640,408 $1,035,326 $1,584,685
========== ========== ==========
Federal funds purchased and securities sold under repurchase agreements:
Maximum outstanding at any month end....................................... $ 428,808 $ 421,373 $ 739,386
Average balance during the year............................................ 427,610 405,982 596,997
Weighted average interest rate during the year............................. 1.41% 0.84% 1.25%
Commercial paper:
Maximum outstanding at any month end....................................... $1,107,578 $1,078,981 $855,334
Average balance during the year............................................ 997,543 809,930 620,053
Weighted average interest rate during the year............................. 1.67% 1.05% 1.11%
Other borrowed funds:
Maximum outstanding at any month end....................................... $ 942,627 $ 322,308 $ 212,371
Average balance during the year............................................ 469,877 192,248 163,147
Weighted average interest rate during the year............................. 2.15% 2.65% 2.98%
F-30
CAPITAL ADEQUACY, DIVIDENDS AND SHARE REPURCHASES
CAPITAL ADEQUACY AND CAPITAL MANAGEMENT
We strive to maintain strong capital levels, to use capital effectively,
and to return excess capital to our shareholders.
We have traditionally maintained capital levels well in excess of those
levels required by bank regulators and above industry averages. Strong capital
improves our ability to absorb unanticipated losses and positions us to be an
opportunistic acquirer. Our commitment to strong capital also contributes to
higher ratings by bank regulatory agencies and credit rating agencies.
We strive to use our capital effectively, with our first priority to
support the long-term growth and strategic positioning of the company. Capital
is used to fund loan growth and other balance sheet growth, to reinvest in our
core businesses, and to fund strategic acquisitions. Capital is also employed to
pay a competitive dividend to our shareholders and to periodically increase the
dividend. When we possess capital in excess of core business and dividend
requirements, we often employ some of that excess capital to repurchase common
stock.
Our primary source of capital is net income. In addition, we generate
capital from common stock issued in connection with acquisitions, from common
stock issued in connection with employee stock option exercises and restricted
stock grants, and from the net proceeds of asset sales and business
divestitures.
We monitor a variety of regulatory and US GAAP capital measures to maintain
capital levels consistent with our goals. We are subject to minimum capital
requirements at both the bank and holding company levels, as defined by our bank
regulators. We have historically maintained capital levels well above the
minimum thresholds and, where applicable, comfortably in excess of the
thresholds established to identify "well-capitalized" institutions.
In addition, we monitor a variety of US GAAP capital measures and hybrid
capital measures. These measures include the tangible equity ratio and various
capital metrics favored by the major credit rating agencies. We analyze these
ratios relative to our current financial position, our projected financial
position, and peer banks. Our strategic target for the tangible equity ratio is
7 percent to 8 percent.
DIVIDENDS
We strive to pay our shareholders a competitive dividend, while maintaining
a conservative payout ratio. We review our dividend rate quarterly in
conjunction with a quarterly review of capital. We have elected to increase the
dividend rate several times in recent years, reflecting our strong capital
levels and expectations of solid capital generation going forward.
SHARE REPURCHASES
In recent years, we have elected to return a significant amount of excess
capital to our stockholders in the form of share repurchases. Our share
repurchase activity has reflected our confidence in our ability to maintain
healthy rates of new capital generation, as well as a surplus of capital beyond
our core business and dividend requirements. In recent years, share repurchases
have been executed at prices that have considerably enhanced our earnings per
share and return on equity. In addition, the repurchase of shares has resulted
in lower dividend expenditures due to fewer shares outstanding.
As compared to dividends, share repurchases are highly flexible, allowing
management to return excess capital in times of surplus, or to eliminate
repurchases altogether if superior strategic opportunities to deploy excess
capital exist. In addition, many of our largest shareholders favor higher
repurchase levels over higher dividend rates when we cannot reinvest excess
capital in our core businesses at attractive rates of return.
F-31
The following table summarizes our risk-based capital, risk-weighted
assets, and risk-based capital ratios.
DECEMBER 31,
-------------------------------------------------------------------
MINIMUM
EGULATORY
(DOLLARS IN THOUSANDS) 2000 2001 2002 2003 2004 REQUIREMENT
- -------------------------- ----------- ----------- ----------- ----------- ----------- -----------
CAPITAL COMPONENTS
Tier 1 capital............ $ 3,471,289 $ 3,661,231 $ 3,667,237 $ 3,747,884 $ 3,817,698
Tier 2 capital............ 620,102 598,812 573,858 936,189 968,294
----------- ----------- ----------- ----------- -----------
Total risk-based capital $ 4,091,391 $ 4,260,043 $ 4,241,095 $ 4,684,073 $ 4,785,992
=========== =========== =========== =========== ===========
Risk-weighted assets...... $33,900,404 $31,906,438 $32,811,441 $33,133,407 $39,324,859
=========== =========== =========== =========== ===========
Quarterly average assets.. $34,075,813 $34,760,203 $37,595,002 $41,506,828 $47,168,683
=========== =========== =========== =========== ===========
CAPITAL RATIOS
Total risk-based capital.. 12.07% 13.35% 12.93% 14.14% 12.17% 8.0%
Tier 1 risk-based capital. 10.24 11.47 11.18 11.31 9.71 4.0
Leverage ratio(1)......... 10.19 10.53 9.75 9.03 8.09 4.0
- --------------------
(1) Tier 1 capital divided by quarterly average assets (excluding certain
intangible assets).
We and Union Bank of California, N.A. (the Bank) are subject to various
regulations of the federal banking agencies, including minimum capital
requirements. We both are required to maintain minimum ratios of Total and Tier
1 capital to risk-weighted assets and of Tier 1 capital to quarterly average
assets (the leverage ratio).
Included in Tier 1 capital at year-end 2003 was $350 million in Trust
Preferred Securities, which we redeemed on February 19, 2004, resulting in a
decrease in our Tier 1 capital ratio at December 31, 2004, compared with
December 31, 2003. In December 2003, we issued $400 million of long-term
subordinated debt, which is included in Tier 2 capital as of December 31, 2003
and 2004 (further discussion of our subordinated debt can be found in Note 12 to
our Consolidated Financial Statements included in this Annual Report on Form
10-K).
In addition to the changes to our capital structure mentioned in the above
paragraph, the decrease in our capital ratios compared with December 31, 2003,
was also attributable to higher risk-weighted assets. Our leverage ratio
decrease was primarily attributable to a $6 billion, or 14 percent, increase in
quarterly average assets, which was substantially the result of increases in our
securities and residential mortgage portfolios.
As of December 31, 2004, the most recent notification from the Office of
the Comptroller of the Currency (OCC) categorized the Bank as
"well-capitalized." This means that the 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.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk exists primarily in interest rate risk in our
non-trading balance sheet and to a much lesser degree in price risk in our
trading portfolio for our customer-focused trading and sales activities. The
objective of market risk management is to mitigate an undue adverse impact on
earnings and capital arising from changes in interest rates and other market
variables. This risk management objective supports our broad objective of
preserving shareholder value, which encompasses earnings growth over time and
capital stability.
The Board of Directors, through its Finance and Capital Committee, approves
our Asset-Liability Management (ALM) Policy, which governs the management of
market risk and liquidity. In the administration of market risk management, the
Chief Executive Officer Forum (CEO Forum) provides broad and strategic guidance
and, as appropriate, specific direction to the Asset & Liability Management
Committee (ALCO) whose voting members are comprised of senior executives. ALCO
is responsible for ongoing management of interest rate and price risks as well
as liquidity risk, including formulation of risk management strategies, in
accordance
F-32
with the CEO Forum's directives. The Treasurer is primarily responsible for the
implementation of risk management strategies approved by ALCO and for operating
management of market risk through the funding, investment, derivatives hedging,
and trading activities of the Global Markets Group (GMG).
The Market Risk Monitoring (MRM) unit is responsible for the measurement
and monitoring of market risk, including ensuring that ALCO, our senior
management and the Board are kept fully informed as to our market risk profile
and compliance with applicable limits, guidelines and policies. MRM functions
independently of all operating and management units and reports directly to the
ALCO Chairman.
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.
INTEREST RATE RISK MANAGEMENT (OTHER THAN TRADING)
ALCO monitors interest rate risk monthly through a variety of modeling
techniques that are used to quantify the sensitivity of Net Interest Income
(NII) and of Economic Value of Equity (EVE) to changes in interest rates. As
directed by ALCO, and in consideration of the importance of our demand deposit
accounts as a funding source, NII is adjusted in the policy risk measure to
incorporate the effect of certain noninterest income and expense items related
to these deposits that are nevertheless sensitive to changes in interest rates.
NII, so adjusted, is termed Economic NII. In managing interest rate risk, ALCO
monitors NII sensitivity on both an adjusted ("Economic") and an unadjusted
basis over various time horizons and in response to a variety of interest rate
changes.
Our NII policy measure involves a simulation of "Earnings-at-Risk" (EaR) in
which we estimate the impact that gradual, ramped-on parallel shifts in the
yield curve would have on earnings over a 12-month horizon, given our projected
balance sheet profile. We measure and monitor our interest rate risk profile
using two calculations of EaR: unadjusted NII-at-Risk, and Economic NII-at-Risk,
the latter adjusted for the non-interest items described above. Under the policy
limits, the negative change in simulated Economic NII in either the up or down
200 basis point shock scenarios may not, except on a temporary basis, exceed 4
percent of Economic NII as measured in the base case or no change scenario.
Our EaR simulations use a 12-month projected balance sheet in order to
model the impact of interest rate changes. Assumptions are made to model the
future behavior of deposit rates and loan spreads based on statistical analysis,
management's outlook, and historical experience. The prepayment risks related to
residential loans and mortgage-backed securities are measured using industry
estimates of prepayment speeds. The sensitivity of the simulation results to the
underlying assumptions is tested as a regular part of the risk measurement
process by running simulations with different assumptions. This includes
alternate scenarios for volume growth for key balance sheet items.
At December 31, 2004, Economic NII showed very modest asset-sensitivity to
parallel rate shifts. A +200 basis point parallel shift would raise 12-month
Economic NII by 0.60 percent, while a similar downward shift would reduce it by
1.39 percent. We caution that continued enhancements to our interest rate risk
modeling may make prior-year comparisons of Economic NII less meaningful. Of
particular note during 2004 were our change from a constant to a projected
balance sheet, and various enhancements to our modeling of the non-interest,
DDA-related items contained in Economic NII. Prior year simulation was not
restated for the 2004 model enhancements.
F-33
ECONOMIC NII
DECEMBER 31, DECEMBER 31,
(DOLLARS IN MILLIONS) 2003 2004
- ---------------------- ------------ ------------
+200 basis points........................... $ 17.2 $ 10.9
as a percentage of base case NII............ 1.20% 0.60%
- -200 basis points........................... $(19.8) $(25.0)
as a percentage of base case NII............ 1.38% 1.39%
Because the non-interest items included in Economic NII are innately
liability-sensitive, our Economic NII measure is considerably less
asset-sensitive than our unadjusted NII. Unadjusted NII-at-Risk at December 31,
2004 was positive 2.46 percent of base case under a +200 basis point parallel
shift and negative 3.72 percent under a similar downward shift. In comparison,
Economic NII-at-Risk, which we believe provides the most meaningful indication
of our EaR profile, is very close to neutral with respect to parallel rate
shifts, as seen in the above table. The 1.39 percent decrease in Economic NII
under a down 200 basis point rate shift at December 31, 2004 is well within our
4 percent policy limit.
While parallel rate shifts would currently have very little earnings
impact, our balance sheet shows more sensitivity to non-parallel yield curve
shifts. We are slightly liability-sensitive to short-term rate changes (with
long-term rates held constant) but asset-sensitive to long-term rate changes.
This translates into reduced Economic NII in the event of a flattening of the
yield curve, particularly a flattening at lower average rates.
In addition to EaR, we measure the sensitivity of EVE to interest rate
shocks. EVE-at-Risk is reviewed and monitored for its compliance with ALCO
limits. Consistent with the projected increase in asset-sensitivity of earnings
over time, our EVE-at-Risk shows modest asset-sensitivity as well. Our
relatively stable base of long-duration non-maturity deposits represents
increased value to us when rates rise. That increase more than offsets the
value-reducing impact of higher rates on our asset portfolio, whose average
duration is somewhat shorter.
We believe that, together, our NII and EVE simulations provide management
with a reasonably comprehensive view of the sensitivity of our operating results
and value profile to changes in interest rates, at least over the measurement
horizon. However, as with any financial model, the underlying assumptions are
inherently uncertain and subject to refinement as modeling techniques and theory
improve and historical data becomes more readily accessible. Consequently, our
simulation models cannot predict with certainty how rising or falling interest
rates might impact net interest income. Actual and simulated results will differ
to the extent there are differences between actual and assumed interest rate
changes, balance sheet volumes, and management strategies, among other factors.
ALM ACTIVITIES
In general, our unhedged, core balance sheet is asset sensitive, meaning
that our loans generally re-price more quickly than our core deposits. In
managing the interest sensitivity of our balance sheet, we use the ALM
investment portfolio and derivatives positions as the primary tools. During
2004, our ALM investments and derivatives activities sought to maintain the
Economic NII risk profile of our total balance sheet close to neutral while
keeping a relatively short duration for the investment portfolio. The continued
run-off of the securities portfolio in 2005 is expected to help support loan
growth, which together with the continued maturation of our existing derivative
hedges, will have the effect of modestly increasing asset-sensitivity during the
course of 2005.
ALM INVESTMENTS
At December 31, 2003 and December 31, 2004, our securities available for
sale portfolio included $10.4 billion and $10.2 billion, respectively, of
securities for ALM purposes. During 2004, as we sought to
F-34
maintain its overall neutral Economic NII risk profile, the estimated effective
duration of the ALM portfolio was managed within a range of 2.0 to 2.8. The
estimated ALM portfolio effective duration was 2.3 at December 31, 2004, as
compared to 2.5 at December 31, 2003. Effective duration is a measure of price
sensitivity of a bond portfolio to immediate parallel shifts in interest rates.
An effective duration of 2.3 suggests an expected price change of approximately
minus 2.3 percent for an immediate one percent change in interest rates.
During the fourth quarter of 2004, we reduced the overall size of the
securities portfolio from the prior quarter's levels, through a combination of
reduced reinvestments of maturing securities and sales of securities, resulting
in lower average balances as compared to the third quarter of 2004. We also
increased our allocations to investments in floating rate securities. These
actions reflected management's decision to reduce the level and effects of the
fixed-rate ALM portfolio and to allow our core asset-sensitivity to begin to
emerge.
ALM DERIVATIVES
We also orchestrated a shift in our ALM derivatives strategy during 2004
and reduced the net level of fixed-rate receive hedges (swaps, floors,
floor-collars) by $1.2 billion. This net run-off of fixed-rate positions was
complemented by a net increase of $1.6 billion in asset-sensitive caps and
cap-corridor holdings. Collectively these helped to reduce the overall
fixed-rate receive effects of the total ALM derivative hedge portfolio. For a
further discussion of derivative instruments and our hedging strategies, see
Note 18 to our Consolidated Financial Statements included in this Annual Report
on Form 10-K.
TRADING ACTIVITIES
We enter into trading account activities primarily as a financial
intermediary for customers and, to a minor extent, for our own account. By
acting as a financial intermediary, we are able to provide our customers with
access to a wide range of products from the securities, foreign exchange, and
derivatives markets. In acting for our own account, we may take positions in
certain securities and foreign exchange instruments, subject to various limits
in amount, tenor and other respects, with the objective of generating trading
profits.
The risks associated with these positions are very conservatively managed.
We utilize a combination of position limits and stop-loss limits, applied at an
aggregated level and to various sub-components within. MRM prepares daily
reports for broad distribution on positions, profit and loss, and mark-to-market
valuations. Summary versions of these reports go to senior management on a daily
or weekly basis and to ALCO monthly. Positions are controlled and reported both
in notional and Value-at-Risk (VaR) terms. Our calculation of VaR estimates how
high the loss in fair value might be, at a 97.5 percent confidence level, due to
an adverse shift in market prices over a period of five business days. VaR at
the trading activity level is managed within limits well below the maximum limit
established by Board policy for total trading positions at 0.5 percent of
stockholders' equity. The VaR model incorporates assumptions on key parameters,
including holding period and historical volatility.
The following table sets forth the average, high and low VaR for our
trading activities for the years ended December 31, 2003 and December 31, 2004.
DECEMBER 31, 2003 DECEMBER 31, 2004
--------------------- ---------------------
AVERAGE HIGH LOW AVERAGE HIGH LOW
(DOLLARS IN THOUSANDS) VAR VAR VAR VAR VAR VAR
- ------------------------------- ------- ---- --- ------- ---- ---
Foreign exchange............... $143 $428 $57 $131 $377 $49
Securities..................... 206 463 97 289 585 86
Consistent with our business strategy of focusing on the sale of capital
markets products to customers, we manage our trading risk exposures at
conservative levels. Our foreign exchange business continues to derive the bulk
of its revenue from customer-related transactions. We take inter-bank trading
positions only on a limited basis and we do not take any large or long-term
strategic positions in the market for our own portfolio.
F-35
Similarly, we continue to generate the vast majority of our securities trading
income from customer-related transactions. The Securities Trading and
Institutional Sales department serves the fixed-income needs of our
institutional clients and acts as the fixed-income wholesaler for our
broker/dealer subsidiary, UnionBanc Investment Services LLC.
Our interest rate derivative contracts included, as of December 31, 2004,
$4.4 billion notional amount of derivative contracts entered into as an
accommodation for customers. We act as an intermediary and match these
contracts, at a credit spread, to contracts with major dealers, thus
neutralizing the related market risk.
We also engage in energy derivatives contracts, in order to meet the
hedging needs of our existing energy industry customers, primarily those that
are oil and gas producers. The first transactions were booked in December 2004
for which a total of $45 million in notional amount of derivatives contracts was
outstanding as of year-end. As is the case for our customer interest rate
derivatives business, all transactions are fully matched to remove market risk,
with income produced for us from the credit spread earned.
LIQUIDITY RISK
Liquidity risk represents the potential for loss as a result of limitations
on our ability to adjust our future cash flows to meet the needs of depositors
and borrowers and to fund operations on a timely and cost-effective basis. The
ALM Policy approved by the Finance and Capital Committee of the Board requires
regular reviews of our liquidity by ALCO. ALCO conducts monthly ongoing reviews
of our liquidity situation as well as regular updates to our CEO Forum who
approve our Liquidity Contingency Plan. Liquidity is managed through this ALCO
coordination process on an entity-wide basis, encompassing all major business
units. The operating management of liquidity is implemented through the funding
and investment functions of the Global Markets Group. Our liquidity management
draws upon the strengths of our extensive retail and commercial core deposit
franchise, coupled with the ability to obtain funds for various terms in a
variety of domestic and international money markets. Our securities portfolio
represents a significant source of additional liquidity.
Core deposits provide us with a sizable source of relatively stable and
low-cost funds. Our average core deposits, which include demand deposits, money
market demand accounts, and savings and consumer time deposits, combined with
average common stockholders' equity, funded 85 percent of average total assets
of $45.2 billion in 2004. Most of the remaining funding was provided by
short-term borrowings in the form of negotiable certificates of deposit, large
time deposits, foreign deposits, federal funds purchased, securities sold under
repurchase agreements, commercial paper, and other borrowings. In the fourth
quarter of 2003, we issued $400 million in long-term subordinated debt. In
February 2004, we used a portion of the net proceeds (approximately $350
million) from the sale of these securities to redeem our outstanding Trust Notes
with the remainder of the net proceeds from this offering used for general
corporate purposes.
The securities portfolio provides additional enhancement to our liquidity
position, which may be created through either securities sales or repurchase
agreements. At December 31, 2004, we could have sold or transferred under
repurchase agreements approximately $7.9 billion of our available for sale
securities, although no portion of this balance was encumbered at December 31,
2004. Liquidity may also be provided by the sale or maturity of other assets
such as interest-bearing deposits in banks, federal funds sold, and trading
account securities. The aggregate balance of these assets averaged $1.4 billion
in 2004. Additional liquidity may be provided through loan maturities and sales.
OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS AND
COMMITMENTS
Off-balance sheet arrangements are any contractual arrangement to which an
unconsolidated entity is a party, under which we have: (1) any obligation under
a guarantee contract; (2) a retained or contingent interest in assets
transferred to an unconsolidated entity or similar arrangement that serves as
credit, liquidity or market risk support to that entity for such assets; (3) any
obligation under certain derivative instruments; or (4) any obligation under a
material variable interest held by us in an unconsolidated entity that provides
F-36
financing, liquidity, market risk or credit risk support to us, or engages in
leasing, hedging or research and development services with us.
Our most significant off-balance sheet arrangements are limited to
obligations under guarantee contracts such as financial and performance standby
letters of credit for our credit customers, commercial letters of credit,
unfunded commitments to lend, commitments to sell mortgage loans and commitments
to fund investments in various CRA investments and venture capital investments.
To a lesser extent, we enter into contractual guarantees of agented sales of
LIHC tax credit investments that require us to perform under those guarantees if
there are breaches of performance of the underlying income-producing properties.
As part of our leasing activities, we may be lessor to special purpose entities
to which we provide financing for large equipment leasing projects.
It is our belief that none of these arrangements expose us to any greater
risk of loss than is already reflected on our balance sheet. We do not have any
off-balance sheet arrangements in which we have any retained or contingent
interest (as we do not transfer or sell our assets to entities in which we have
a continuing involvement), any exposure to derivative instruments that are
indexed to our stock nor any variable interests in any unconsolidated entity to
which we may be a party, except for those leasing arrangements described
previously.
The following table presents, as of December 31, 2004, our significant and
determinable contractual obligations by payment date, except for obligations
under the Company's pension and postretirement plans, which are included in Note
8 to our Consolidated Financial Statements included in this Annual Report on
Form 10-K. The payment amounts represent those amounts contractually due to the
recipient and do not include any unamortized premiums or discounts, hedge basis
adjustment or other similar carrying value adjustments. For further information
on contractual obligations and commitments, see Note 23 to our Consolidated
Financial Statements included in this Annual Report on Form 10-K.
DECEMBER 31, 2004
----------------------------------------------------------------
LESS THAN ONE THROUGH FOUR TO AFTER FIVE
(DOLLARS IN THOUSANDS) ONE YEAR THREE YEARS FIVE YEARS YEARS TOTAL
- ---------------------------------------- -------- ----------- ---------- ---------- ----------
Time deposits........................... $4,596,764 $ 581,197 $ 167,409 $ 11,202 $5,356,572
Medium and long-term debt............... -- 400,000 -- 400,000 800,000
Junior subordinated debt payable to
subsidiary grantor trust.............. -- -- -- 13,000 13,000
Other long-term liabilities
Operating leases (premises)........... 54,745 88,013 64,459 78,179 285,396
Purchase obligations.................. 21,794 12,011 1,326 -- 35,131
---------- ---------- ---------- ---------- ----------
Total debt and operating leases......... $4,673,303 $ 1,081,221 $ 233,194 $ 502,381 $6,490,099
========== =========== ========== ========== ==========
Purchase obligations include any legally binding contractual obligations
that require us to spend more than $1,000,000 annually under the contract.
Payments are shown through the date of contract termination. Purchase
obligations in the table above include purchases of hardware, software licenses
and printing.
The following table presents our significant commitments to fund as of
December 31, 2004:
DECEMBER 31,
--------------------------
(DOLLARS IN THOUSANDS) 2003 2004
- ------------------------------------------------ ----------- -----------
Commitments to extend credit.................... $13,475,513 $16,500,152
Standby letters of credit....................... 2,748,612 2,993,502
Commercial letters of credit.................... 195,915 250,405
Commitments to fund principal investments....... 56,005 69,490
F-37
BUSINESS SEGMENTS
We segregate our operations into four primary business units for the
purpose of management reporting, as shown in the table that follows. The results
show the financial performance of our major business units.
The risk-adjusted return on capital (RAROC) methodology used seeks to
attribute economic capital to business units consistent with the level of risk
they assume. These risks are primarily credit risk, market risk and operational
risk. Credit risk is the potential loss in economic value due to the likelihood
that the obligor will not perform as agreed. Market risk is the potential loss
in fair value due to changes in interest rates, currency rates and equity
prices. Operational risk is the potential loss due to all other factors, such as
failures in internal control, system failures, or external events. RAROC is one
of several measures that is used to measure business unit compensation.
The following table reflects the condensed income statements, selected
average balance sheet items, and selected financial ratios, including changes
from the prior year, for each of our primary business units. The information
presented does not necessarily represent the business units' financial condition
and results of operations as if they were independent entities. Also, the tables
have been expanded to include performance center earnings. A performance center
is a special unit whose income generating activities, unlike typical profit
centers, are based on other business segment units' customer base. The revenues
generated and expenses incurred for those transactions entered into to
accommodate our customers are allocated to other business segments where the
customer relationships reside. A performance center's purpose is to foster
cross-selling with a total profitability view of the products and services it
manages. For example, the Global Markets Trading and Sales unit, within the
Global Markets Group, is a performance center that manages the foreign exchange,
derivatives, and fixed income securities activities within the Global Markets
organization. Unlike financial accounting, there is no authoritative body of
guidance for management accounting equivalent to US GAAP. Consequently, reported
results are not necessarily comparable with those presented by other companies.
The RAROC measurement methodology recognizes credit expense for expected
losses arising from credit risk and attributes economic capital related to
unexpected losses arising from credit, market and operational risks. As a result
of the methodology used by the RAROC model to calculate expected losses,
differences between the provision for credit losses and credit expense in any
one period could be significant. However, over an economic cycle, the cumulative
provision for credit losses and credit expense for expected losses should be
substantially the same. Business unit results are based on an internal
management reporting system used by management to measure the performance of the
units and UnionBanCal Corporation as a whole. Our management reporting system
identifies balance sheet and income statement items for each business unit based
on internal management accounting policies. Net interest income is determined
using our internal funds transfer pricing system, which assigns a cost of funds
to assets or a credit for funds to liabilities and capital, based on their type,
maturity or repricing characteristics. Noninterest income and expense directly
or indirectly attributable to a business unit are assigned to that business. The
business units are assigned the costs of products and services directly
attributable to their business activity through standard unit cost accounting
based on volume of usage. All other corporate expenses (overhead) are allocated
to the business units based on a predetermined percentage of usage.
F-38
We have restated certain business units' results for the prior periods to
reflect certain transfer pricing changes and any reorganization changes that may
have occurred. Information about our segments is also presented in Note 25 of
this Annual Report.
COMMUNITY BANKING
AND INVESTMENT INTERNATIONAL
SERVICES GROUP COMMERCIAL BANKING GROUP
YEARS ENDED 2004 VS. 2003 FINANCIAL 2004 VS. 2003 YEARS ENDED 2004 VS. 2003
DECEMBER 31, INCREASE(DECREASE) SERVICES GROUP INCREASE(DECREASE) DECEMBER 31, INCREASE(DECREASE)
------------------- ----------------- ----------------- ---------------- ----------------- -----------------
2003 2004 AMOUNT PERCENT 2003 2004 AMOUNT PERCENT 2003 2004 AMOUNT PERCENT
--------- --------- -------- ------- ------- --------- -------- -------- -------- ------- ------- -------
RESULTS OF
OPERATIONS
AFTER
PERFORMANCE
CENTER
EARNINGS
(DOLLARS IN
THOUSANDS):
Net
interest
income.... $ 680,834 $ 784,429 $103,595 15% $727,255 $ 800,121 $ 72,866 10% $ 33,932 $35,398 $1,466 4%
Noninterest
income.... 433,784 502,363 68,579 16 253,596 290,647 37,051 15 80,903 78,732 (2,171) (3)
--------- --------- -------- -------- --------- -------- -------- ------- -------
Total
revenue... 1,114,618 1,286,792 172,174 15 980,851 1,090,768 109,917 11 114,835 114,130 (705) (1)
Noninterest
expense... 818,424 947,875 129,451 16 411,598 431,941 20,343 5 61,514 67,112 5,598 9
Credit
expense... 31,718 33,126 1,408 4 159,026 107,313 (51,713) (33) 2,104 2,284 180 9
--------- --------- -------- -------- --------- -------- -------- ------- -------
Income
before
income
tax
expense... 264,476 305,791 41,315 16 410,227 551,514 141,287 34 51,217 44,734 (6,483) (13)
Income tax
expense... 101,162 116,965 15,803 16 131,290 183,672 52,382 40 19,591 17,111 (2,480) (13)
--------- --------- -------- -------- --------- -------- -------- ------- -------
Net income
(loss).... $ 163,314 $ 188,826 $ 25,512 16 $278,937 $ 367,842 $ 88,905 32 $ 31,626 $27,623 $(4,003) (13)
========= ========= ======== ======== ========= ======== ======== ======= =======
PERFORMANCE
CENTER
EARNINGS
(DOLLARS IN
THOUSANDS):
Net
interest
income.... $ 753 $ 553 $ (200) (27) $ (576)$ (269) $ 307 53 $ 33 $ 106 $ 73 221
Noninterest
income.... (38,045) (25,963) 12,082 32 61,835 52,194 (9,641) (16) 1,260 1,146 (114) (9)
Noninterest
expense... (34,114) (22,382) 11,732 34 35,788 25,941 (9,847) (28) 436 143 (293) (67)
Net income
(loss).... (2,035) (1,943) 92 5 15,885 16,290 405 3 529 684 155 29
Total loans
(dollars
in
millions). 25 25 -- nm (43) (46) (3) (7) -- -- -- na
AVERAGE
BALANCES
(DOLLARS IN
MILLIONS):
Total
loans(1).. $ 11,462 $ 12,814 $ 1,352 12 $ 12,853 $ 12,738 $ (115) (1) $ 1,537 $ 1,715 $ 178 12
Total assets 12,489 14,093 1,604 13 14,847 15,220 373 3 1,967 2,123 156 8
Total
deposits(1) 16,902 19,410 2,508 15 12,715 14,300 1,585 12 1,551 1,961 410 26
FINANCIAL
RATIOS:
Risk
adjusted
return on
capital... 24% 27% 17% 24% 51% 45%
Return on
average
assets.... 1.31 1.34 1.88 2.42 1.61 1.30
Efficiency
ratio(2).. 73.43 73.66 41.96 39.60 53.57 58.80
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
YEARS ENDED 2004 VS. 2003 YEARS ENDED 2004 VS. 2003 YEARS ENDED 2004 VS. 2003
DECEMBER 31, INCREASE(DECREASE) DECEMBER 31, INCREASE(DECREASE) DECEMBER 31, INCREASE(DECREASE)
------------------- ----------------- ----------------- ----------------- -------------------- ----------------
2003 2004 AMOUNT PERCENT 2003 2004 AMOUNT PERCENT 2003 2004 AMOUNT PERCENT
--------- --------- -------- ------- ------- --------- -------- ------- --------- ---------- ------- -------
RESULTS OF
OPERATIONS
AFTER
PERFORMANCE
CENTER
EARNINGS
(DOLLARS IN
THOUSANDS):
Net
interest
income.... $70,757 $(89,432)$(160,189) (226)% $56,288 $114,707 $58,419 104% $1,569,066 $1,645,223 $ 76,157 5%
Noninterest
income.... 7,674 (7,465) (15,139) (197) 18,296 125,028 106,732 583 794,253 989,305 195,052 25
--------- --------- -------- -------- --------- -------- ---------- ---------- --------
Total
revenue... 78,431 (96,897) (175,328) (224) 74,584 239,735 165,151 221 2,363,319 2,634,528 271,209 11
Noninterest
expense... 16,261 21,224 4,963 31 100,556 56,030 (44,526) (44) 1,408,353 1,524,182 115,829 8
Credit
expense
(income).. 200 335 135 68 (118,048) (178,058) (60,010) (51) 75,000 (35,000)(110,000) (147)
--------- --------- -------- -------- --------- -------- ---------- ---------- --------
Income
(loss) before
income tax
expense
(benefit). 61,970 (118,456) (180,426) (291) 92,076 361,763 269,687 293 879,966 1,145,346 265,380 30
Income tax
expense
(benefit). 23,703 (45,310) (69,013) (291) 17,081 140,374 123,293 722 292,827 412,812 119,985 41
--------- --------- -------- -------- --------- -------- ---------- ---------- --------
Net income
(loss).... $38,267 $(73,146)$(111,413) (291) $74,995 $221,389 $146,394 195 $ 587,139 $732,534 $145,395 25
========= ========= ======== ======== ========= ======== ========== ========== ========
PERFORMANCE
CENTER
EARNINGS
(DOLLARS IN
THOUSANDS):
Net
interest
income.... $(621) $(862) $(241) (39) $411 $472 $61 15 $-- $-- $--
Noninterest
income.... (38,671) (41,069) (2,398) (6) 13,621 13,692 71 1 -- -- --
Noninterest
expense... (7,684) (7,676) 8 (0) 5,574 3,974 (1,600) (29) -- -- --
Net income
(loss).... (19,518) (21,152) (1,634) (8) 5,139 6,121 982 19 -- -- --
Total loans
(dollars
in
millions). -- -- -- na 18 21 3 17 -- -- --
AVERAGE
BALANCES
(DOLLARS IN
MILLIONS):
Total
loans(1).. $270 $203 $(67) (25) $306 $257 $(49) (16) $26,428 $27,727 $1,299 5
Total assets 10,089 12,625 2,536 25 1,077 1,165 88 8 40,470 45,226 4,756 12
Total
deposits(1) 1,006 864 (142) (14) 1,272 1,341 69 5 33,446 37,876 4,430 13
FINANCIAL
RATIOS:
Risk
adjusted
return on
capital... 4% (9)% na na na na
Return on
average
assets.... 0.38 (0.58) na na 1.45% 1.62%
Efficiency
ratio(2).. 20.73 nm na na 59.53 57.73
- --------------------
(1) Represents loans and deposits for each business segment after allocation
between the segments of loans and deposits originated in one segment but
managed by another segment.
(2) The efficiency ratio is noninterest expense, excluding foreclosed asset
expense (income), as a percentage of net interest income and noninterest
income. Foreclosed asset expense (income) was ($0.1) million in 2003 and
$1.2 million in 2004.
na = not applicable
nm = not meaningful
F-39
COMMUNITY BANKING AND INVESTMENT SERVICES GROUP
The Community Banking and Investment Services Group provides financial
products including a set of credit, deposit, trust, risk management, and
insurance products delivered through branches, relationship managers, private
bankers, trust administrators, and insurance agents to individuals and small
businesses.
During 2004 net interest income increased in loans, leases and customer
deposits. This growth in net interest income reflects the group's continued
focus on growing the consumer asset portfolio and attracting retail and small
business deposits.
The group's strategy is to grow assets through an expanded small business
sales force, increased emphasis on real estate secured and Small Business
Administration (SBA) guaranteed loans to small business, and a stronger network
of residential real estate brokers. Increasing demand for home equity loans and
more effective cross-selling tactics have led to an overall growth in consumer
loans, despite run-off of discontinued auto dealer and auto lease lines of
business. In addition, the group expects a larger branch network, created from
new branches and acquired branches, to improve growth prospects when combined
with more robust efforts in the telephone and internet channels.
Total core deposit growth demonstrates the group's continued success in
attracting mass retail, affluent consumers and small business deposits through
marketing activities, relationship management, increased and improved sales
resources, new locations, and new products. Among the more successful marketing
activities was the introduction of the "Power Bank" network, first in Fresno,
California in late 2003 and more recently in the Central Coast region of
California. These branches offer an expanded set of service options, extended
hours and have been remodeled to improve the customer experience with facility
enhancements. We do not, however, intend to expand the "Power Bank" to
additional markets in 2005 until we better understand the return on our
significant investment in facilities and improved service, before we commit to
larger, and therefore, more expensive markets. Sales activities have improved
with the introduction of a new enterprise wide cross sale initiative and
continued training on our "extreme sales" methodology. The focus on cross sell
has been particularly effective in our affluent market where a key strategy of
The Private Bank is to expand its business by leveraging existing Bank client
relationships. These activities, in the aggregate, have resulted in an increase
of 16 percent in core deposits.
The largest portion of the increase in noninterest income was due to an
increase in deposit fees. This increase is a reflection of increased volume as
well as re-pricing initiatives undertaken to offset the increase in the number
of competitors offering free checking. Trust fees increased in part from the
acquisition of CNA Trust (renamed TruSource), completed in August of 2004, which
added outsourcing capability for direct distributors of retirement products, and
strengthened capacity to support smaller plans. Insurance agency commissions
increased in 2004 in part due to the acquisitions of the Knight Insurance Agency
and Tanner Insurance Agency during 2003. Offsetting these increases is the loss
of revenue from the merchant credit card portfolio, which was sold in 2004, and
lower brokerage fees due to decreases in premiums for certain insurance products
even though the number of clients served increased during 2004.
The Community Banking and Investment Services Group is comprised of five
major divisions: Community Banking, Wealth Management, Institutional Services
and Asset Management, Consumer Asset Management, and Insurance Services.
COMMUNITY BANKING serves its customers through 311 full-service branches in
California, 4 full-service branches in Oregon and Washington, and a network of
572 proprietary ATMs. Customers may also access our services 24 hours a day by
telephone or through our website at www.uboc.com. In addition, the division
offers automated teller and point-of-sale merchant services.
F-40
This division is organized by service delivery method, by markets and by
geography. We serve our customers in the following ways:
o through community banking branches, which serve consumers and
businesses with checking and deposit services, as well as various
types of consumer financing;
o through on-line access to our internet banking services, which augment
our physical delivery channels by providing an array of customer
transaction, bill payment and loan payment services;
o through branches and business banking centers, which serve businesses
with annual sales up to $5 million; and
o through in-store branches, which also serve consumers and businesses.
o WEALTH MANAGEMENT provides comprehensive private banking services to
our affluent clientele. The Private Bank focuses primarily on
delivering financial services to high net worth individuals with
sophisticated financial needs as well as to professional service
firms. Specific products and services include trust and estate
services, investment account management services, and deposit and
credit products. A key strategy of The Private Bank is to expand its
business by leveraging existing Bank client relationships. Through 14
existing locations, The Private Bank relationship managers offer all
of our available products and services.
INSTITUTIONAL SERVICES AND ASSET MANAGEMENT provides investment management
and administration services for a broad range of individuals and institutions.
o HighMark Capital Management, Inc., a registered investment advisor,
provides investment advisory services to institutional clients and our
proprietary mutual funds, the affiliated HighMark Funds. It also
provides advisory services to Union Bank of California, N.A. trust and
agency clients, including corporations, pension funds and individuals.
HighMark Capital Management, Inc. also provides mutual fund support
services. HighMark Capital Management, Inc.'s strategy is to increase
assets under management by broadening its client base and helping to
expand the distribution of shares of its mutual fund clients.
o Institutional Services provides custody, corporate trust, and
retirement plan services. Custody Services provides both domestic and
international safekeeping/settlement services in addition to
securities lending. Corporate Trust acts as trustee for corporate and
municipal debt issues. Retirement Services provides a full range of
defined benefit and defined contribution administrative services,
including trustee services, administration, investment management, and
401(k) valuation services. The client base of Institutional Services
includes financial institutions, corporations, government agencies,
unions, insurance companies, mutual funds, investment managers, and
non-profit organizations. Institutional Services' strategy is to
continue to leverage and expand its position in our target markets.
The acquisition of CNA Trust Company (renamed TruSource) expanded our
retirement processing capability by providing outsourcing capability
for direct distributors of retirement products, and strengthened
capacity to support smaller plans. The acquisition of the corporate
trust portfolio of BTM Trust Company enhanced our capability in the
areas of municipal and project finance trustee and agent services.
CONSUMER ASSET MANAGEMENT provides the centralized underwriting,
processing, servicing, collection and administration for consumer assets
including residential loans.
INSURANCE SERVICES provides a range of risk management services and
insurance products to business and retail customers. The group, which includes
our 2001 acquisition of Armstrong/Robitaille, Inc., our 2002 acquisition of John
Burnham & Company, and our 2003 acquisitions of Tanner Insurance Brokers, Inc.
and Knight Insurance Agency, offers its risk management and insurance products
through offices in California and Oregon.
F-41
Through alliances with other financial institutions, the Community Banking
and Investment Services Group offers additional products and services, such as
credit cards, merchant bank cards, leasing, and asset-based and leveraged
financing.
The group competes with larger banks by attempting to provide service
quality superior to that of its major competitors. The group's primary means of
competing with community banks include its branch network and its technology to
deliver banking services. The group also offers convenient banking hours to
consumers through our drive-through banking locations and selected branches that
are open seven days a week.
The group competes with a number of commercial banks, internet banks,
savings associations and credit unions, as well as more specialized financial
service providers such as investment brokerage companies, consumer finance
companies, and residential real estate lenders.
COMMERCIAL FINANCIAL SERVICES GROUP
The Commercial Financial Services Group offers financing and cash
management services to middle market and large corporate businesses primarily
headquartered in the western United States. The group has continued to focus on
specific geographic markets and industry segments such as energy, entertainment,
and real estate. Relationship managers provide credit services, including
commercial loans, accounts receivable and inventory financing, project
financing, lease financing, trade financing, and real estate financing. In
addition to credit services, the group offers its customers access to cash
management services delivered through deposit managers with experience in cash
management solutions for businesses and government entities.
In 2004 the increase in net income was due to significant growth in
deposits and strong noninterest income. In 2004, net interest income increased
from higher demand deposits and a higher margin on assets resulting in a $73
million improvement over the prior year. Deposit growth comes primarily from
sales successes in middle market, corporate and real estate industries. In
addition to new sales, pricing strategies to retain volume helped to offset the
disintermediation associated with a rising interest rate environment. Our
title/escrow deposits, while creating volatility over the course of the year,
were not a significant source of growth in 2004.
Despite an increase in the ending balances of loans and leases, full year
2004 average loans were slightly behind the average for 2003. This is primarily
due to the group's strategy to improve credit quality through a focus on markets
where we have proven expertise, and the continued divestiture of
non-relationship syndicated credits during 2003. The margin on assets improved
through a combination of higher spreads on commercial loans through improved
pricing and the fourth quarter acquisition of Jackson Federal Bank's commercial
mortgage portfolio, higher loan fees from credit run-off, higher investment
spread and a lower cost of funds on non-earning assets.
The increase in noninterest income was mainly attributable to gains from
our private capital investments of $28 million, strong syndication results,
higher deposit-related service fee revenue associated with higher volume. These
increases helped to offset the loss of revenue from the sale of the merchant
credit card portfolio. The increase in noninterest expense during 2004 was
primarily attributable to higher expenses to support increased product sales and
deposit volumes. Credit expense decreased as a result of improving credit
quality.
The group's initiatives during 2005 will continue to include expanding
wholesale deposit activities and increasing domestic trade financing. Loan
strategies include originating, underwriting and syndicating loans in core
competency markets, such as the California middle-market, corporate banking,
commercial real estate, energy, entertainment, equipment leasing and commercial
finance. The group is particularly strong in processing services, including
services such as check processing and cash vault services.
F-42
The Commercial Financial Services Group is comprised of the following
business units:
o the Commercial Banking Division, which serves California middle-market
and large corporate companies with commercial lending, trade
financing, and asset-based loans;
o the Corporate Deposit and Treasury Management Division, which provides
deposit and cash management expertise to middle-market and large
corporate clients, government agencies and specialized industries;
o the Real Estate Industries Division, which provides real estate
lending products such as construction loans, commercial mortgages and
bridge financing;
o the Energy Capital Services Division, which provides corporate
financing and project financing to oil and gas companies, as well as
power and utility companies, nationwide; and
o the Corporate Capital Markets Division, which provides financing to
middle-market and large corporate clients in their defined industries
and geographic markets, together with limited merchant and investment
banking related products and services.
The group's main strategy is to target industries and companies for which
the group can reasonably expect to be one of a customer's primary banks.
Consistent with its strategy, the group attempts to serve a large part of its
targeted customers' credit and depository needs. The group competes with other
banks primarily on the basis of the quality of its relationship managers, the
delivery of quality customer service, and its reputation as a "business bank".
The group also competes with a variety of other financial services companies.
Competitors include other major California banks, as well as regional, national
and international banks. In addition, the group competes with investment banks,
commercial finance companies, leasing companies, and insurance companies.
INTERNATIONAL BANKING GROUP
The International Banking Group primarily focuses on providing
correspondent banking and trade finance related products and services to
international financial institutions worldwide. This focus includes products and
services such as letters of credit, international payments, collections and
providing short-term financing. The majority of the revenue generated by the
International Banking Group is from financial institutions domiciled outside the
U.S.
The International Banking Group's business revolves around providing
correspondent banking services and short-term financing, mostly to banks. The
increase in net interest income was primarily attributable to an increase in
demand deposit balances due to growth in almost all of our markets. Taiwan,
Russia, Eastern Europe, Japan, the Peoples Republic of China and Latin America
contributed the largest incremental growth. This growth was slightly offset by
narrowing loan spreads as a result of improving economies in Korea, India, and
Brazil. Adjusting for a $9 million gain on an early call of a Mexican Brady Bond
in 2003, growth in noninterest income was primarily attributable to growth in
international payments and trade transactions as a result of better market
penetration, product enhancements and increased pricing coinciding with economic
growth in our markets. The increase in noninterest expense was primarily due to
an increase of $1.9 million for personnel and professional consulting expenses
related to anti-money laundering laws and compliance matters. In August 2004, we
decided to exit from Russia and other former Eastern Bloc countries and allow
their transactions to run-off and close accounts by December 2004. We made this
decision after weighing the costs of meeting the extensive compliance rules and
regulations surrounding transactions from or to those countries.
The group has a long history of providing correspondent banking and
trade-related products and services to international financial institutions. We
believe the group continues to achieve strong customer loyalty in the
correspondent banking markets, but there are certain trends in these markets
that could materially adversely affect our international correspondent banking
business. These trends include heightened regulatory burdens
F-43
related to the Bank Secrecy Act and other anti-money laundering laws and
regulations, as well as consolidation of banks in key international markets and
increased technological investments and competition from major banks that are
active in international correspondent banking. The International Banking Group,
headquartered in San Francisco, also maintains offices in Asia, Latin America
and Eastern Europe, and an international banking subsidiary in New York.
GLOBAL MARKETS GROUP
The Global Markets Group operates to support all of the Bank's business
groups and serve the Company as a whole. This group is responsible for our
treasury management, which encompasses wholesale funding, liquidity management,
and interest rate risk management including the ALM securities portfolio
management and derivatives hedging activities. These treasury management
activities are carried out to counter-balance the residual risk positions of the
Company's core balance sheet and to manage those risks conservatively within
prudent guidelines. For more discussion on these risk management activities, see
"Quantitative and Qualitative Disclosures about Market Risk" on page F-32.
Associated with this function, the results of the treasury unit within this
group includes the funds transfer pricing results for the Company, which
allocates to the other business segments their cost of funds on all asset
categories and credit for funds on all liability categories. Another important
function of the Global Markets Group is the offering of a broad range of market
products and risk management products in its UBOC Markets unit. The products
include foreign exchange and interest rate derivatives. In the fourth quarter
2004, this unit began offering certain energy commodity derivative hedge
products on a limited scale, to serve our energy sector client base. The UBOC
Markets unit includes the Bank's brokerage subsidiary UnionBanc Investment
Services LLC, whose profitability flows into Community Banking and Investment
Services Group. The income of UBOC Markets attributable to business with our
clients is allocated, through performance centers, to the business units.
During 2004, the net loss was $73 million compared to a net income of $38
million in 2003. Total revenue for 2004 declined by $175 million, compared to
the prior year, including the loss of $13 million on the sale of $1 billion of
available for sale securities. See discussion of the sale in "Quantitative and
Qualitative Discussion of Market Risk" beginning on page F-32. Net interest
income declined by $160 million in 2004 primarily attributable to a higher
transfer pricing residual in 2004 compared to 2003 resulting from the continuing
growth in core deposits, which are priced on longer-term liability rates,
compared to our portfolio of relatively short-term loans and securities, which
are credited at shorter-term lending and investment rates. Noninterest income
decreased $15 million compared to the prior year as a result of the sale of
available for sale securities mentioned above. Noninterest expense increased $5
million or 31 percent, compared to the prior year as we incurred costs for
technology improvements and added staff.
OTHER
"Other" includes the following items:
o corporate activities that are not directly attributable to one of the
four major business units. Included in this category are certain other
nonrecurring items such as the results of operations of certain parent
company non-bank subsidiaries and the elimination of the fully
taxable-equivalent basis amount;
o the adjustment between the credit expense under RAROC and the
provision for credit losses under US GAAP and earnings associated with
unallocated equity capital;
o the adjustment between the tax expense calculated under RAROC using a
tax rate of 38.25 percent and the Company's effective tax rates;
o the Pacific Rim Corporate Group, with assets of $236 million at
December 31, 2004, which offers a range of credit, deposit, and
investment management products and services to companies in the US,
which are affiliated with companies headquartered in Japan; and
o the residual costs of support groups.
F-44
The 2004 financial results were impacted by the following factors:
o Credit expense (income) of ($178.1) million was due to the difference
between the $35.0 million reversal of provision for credit losses
calculated under our US GAAP methodology and the $143.1 million in
expected losses for the reportable business segments, which utilizes
the RAROC methodology;
o Net interest income is the result of differences between the credit
for equity for the reportable segments under RAROC and the net
interest income earned by UnionBanCal Corporation, and a credit for
deposits in the Pacific Rim Corporate Group;
o Noninterest income included a $93.0 million gain on the sale of our
merchant card portfolio in the second quarter of 2004; and
o Noninterest expense declined partially from the increased level of
corporate overhead allocation and lower litigation expenses.
The 2003 financial results were impacted by the following factors:
o Credit expense (income) of ($118.0) million was due to the difference
between the $75.0 million in provision for loan losses calculated
under our US GAAP methodology and the $193.0 million in expected
losses for the reportable business segments, which utilizes the RAROC
methodology;
o Net interest income is the result of differences between the credit
for equity for the reportable segments under RAROC and the net
interest income earned by UnionBanCal Corporation, and a credit for
deposits in the Pacific Rim Corporate Group.
REGULATORY MATTERS
Union Bank of California International has entered into a written agreement
with the Federal Reserve Bank of New York relating to Union Bank of California
International's Bank Secrecy Act controls and processes. Union Bank of
California International is wholly owned by Union Bank of California, N.A.,
which is wholly owned by UnionBanCal Corporation. Union Bank of California
International is headquartered in New York City and, as an Edge Act subsidiary,
is limited to engaging in international banking activities. Union Bank of
California International is implementing a plan to strengthen its Bank Secrecy
Act controls and processes. UnionBanCal Corporation filed a Form 8-K on October
19, 2004 containing Union Bank of California International's agreement with the
Federal Reserve Bank of New York.
On February 28, 2005, Union Bank of California, N.A., a wholly-owned
subsidiary of UnionBanCal Corporation, was advised by the Office of the
Comptroller of the Currency, its principal regulator, that it expects to provide
Union Bank of California, N.A. with a memorandum of understanding which will
require Union Bank of California, N.A. to strengthen its Bank Secrecy Act and
anti-money laundering controls and processes. We do not expect the memorandum of
understanding to be accompanied by any fines or penalties.
Management is committed to resolving the issues raised by the regulators
and already has begun to take action.
These regulatory matters may adversely affect UnionBanCal Corporation's and
Union Bank of California, N.A.'s ability to obtain regulatory approvals for
future initiatives requiring regulatory approval, including acquisitions.
However, neither this effect, Union Bank of California, N.A.'s expected
memorandum of understanding with the Office of the Comptroller of the Currency,
Union Bank of California International's agreement with the Federal Reserve Bank
of New York, nor the financial impact of enhanced Bank Secrecy Act and
anti-money laundering controls and processes, are expected to have a material
adverse impact on the financial condition or results of operations of Union Bank
of California, N.A. or UnionBanCal Corporation.
F-45
FACTORS THAT MAY AFFECT FUTURE RESULTS
This document includes forward-looking information, which is subject to the
"safe harbor" created by section 27A of the Securities Act of 1933, as amended,
and section 21E of the Securities Exchange Act of 1934, as amended. We may make
forward-looking statements in our Securities and Exchange Commission (SEC)
filings, press releases, news articles, conference calls with analysts and
stockholders 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," "estimate,"
"potential," "project," or words of similar meaning, or future or conditional
verbs such as "will," "would," "should," "could," or "may." These
forward-looking statements are intended to provide investors with additional
information with which they may assess our future potential. All of these
forward-looking statements are based on assumptions about an uncertain future
and are based on information available to us 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
discussing our expectations about:
o Competition
o Pending legal actions
o Credit quality and provision for credit losses
o Commercial, commercial real estate, and residential lending activity
o Core deposits and other funding sources
o Earnings growth
o Return on equity
o Net interest income including income from derivative hedges
o The effect of Mitsubishi Tokyo Financial Group, Inc.'s taxable profits
on our California effective tax rate
o The unallocated portion of our allowance for credit losses
o Our sensitivity to changes in interest rates
o The asset sensitivity of our balance sheet
o Increased regulatory controls and processes regarding Bank Secrecy Act
and anti-money laundering matters
o Future legislative and regulatory developments
There are numerous risks and uncertainties that could and will cause actual
results to differ materially from those discussed in our forward-looking
statements. Many of these factors are beyond our ability to control or predict
and could have a material adverse effect on our stock price, financial
condition, and results of operations or prospects. Such risks and uncertainties
include, but are not limited to those listed in "Industry Factors" and Company
Factors."
Readers of this document should not rely solely on forward-looking
information 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. There are also
other factors that we have not described in this report and our other reports
that could cause our results to differ from our expectations.
F-46
INDUSTRY FACTORS
FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR BUSINESS
Significant increases in market interest rates, or the perception that an
increase may occur, could adversely affect both our ability to originate new
loans and our ability to grow. Conversely, decreases in interest rates could
result in an acceleration of loan prepayments. An increase in market interest
rates could also adversely affect the ability of our floating-rate borrowers to
meet their higher payment obligations. If this occurred, it could cause an
increase in nonperforming assets and charge-offs, which could adversely affect
our business.
FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR MARGIN SPREAD
Changes in market interest rates, including changes in the relationship
between short-term and long-term market interest rates or between different
interest rate indices, can impact our margin spread, that is, the difference
between the interest rates we charge on interest earning assets, such as loans,
and the interest rates we pay on interest bearing liabilities, such as deposits
or other borrowings. The impact could result in a decrease in our interest
income relative to interest expense.
THE CONTINUING WAR ON TERRORISM COULD ADVERSELY AFFECT U.S. AND GLOBAL
ECONOMIC CONDITIONS
Acts or threats of terrorism and actions taken by the U.S. or other
governments as a result of such acts or threats may result in a disruption of
U.S. and global economic and financial conditions and could adversely affect
business and economic and financial conditions in the U.S. and globally
generally and in our principal markets.
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. 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.
ADVERSE EFFECTS OF, OR CHANGES IN, BANKING OR OTHER LAWS AND REGULATIONS OR
GOVERNMENTAL FISCAL OR MONETARY POLICIES COULD ADVERSELY AFFECT US
We are subject to significant federal and state regulation and supervision,
which is primarily for the benefit and protection of our customers and not for
the benefit of investors. In the past, our business has been materially affected
by these regulations. This will likely continue in the future. Laws, regulations
or policies, including accounting standards and interpretations currently
affecting us and our subsidiaries may change at any time. Regulatory authorities
may also change their interpretation of these statutes and regulations.
Therefore, our business may be adversely affected by future changes in laws,
regulations, policies or interpretations or regulatory approaches to compliance
and enforcement, including requirements concerning enterprise-wide risk
management. Additionally, our international activities may be subject to the
laws and regulations of the jurisdiction where business is being conducted.
International laws, regulations and policies affecting us and our subsidiaries
may change at any time and affect our business opportunities and competitiveness
in these jurisdictions. Due to The Bank of Tokyo-Mitsubishi, Ltd.'s controlling
ownership of us, laws, regulations and policies adopted or enforced by the
Government of Japan and the FRB may adversely affect our activities and
investments and those of our subsidiaries in the future.
F-47
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 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 (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.
The Check Clearing for the 21st Century Act (Check 21) was signed into law
on October 28, 2003, and became effective on October 28, 2004. Check 21 is
designed to foster innovation in the payments system and to enhance its
efficiency by reducing some of the legal impediments to check truncation (that
is, the banking process by which cancelled original checks are not returned to
the customer with the customer's regular bank statement). The law facilitates
check truncation by creating a new negotiable instrument called a substitute
check, which would permit banks to truncate original checks, to process check
information electronically, and to deliver substitute checks to banks that want
to continue receiving paper checks. A substitute check will be the legal
equivalent of the original check and will include all the information contained
on the original check. The law does not require banks to accept checks in
electronic form nor does it require banks to use the new authority granted by
Check 21 to create substitute checks. The final regulations regarding Check 21
were published in July 2004. In order to manage and control the changes which
may be necessitated by Check 21, we have established a "Check 21 Initiative
Project Management Structure," composed of representatives from many of our
operating and support units. The objective of this initiative is to allow us to
prioritize and allocate our resources and mitigate risk to our ongoing
operations. It is not possible at this time to predict the long-term financial
impact of Check 21, on our business.
Refer to "Supervision and Regulation" and "Regulatory Matters" for
discussion of other laws and regulations, including the Bank Secrecy Act and
other anti-money laundering laws and regulations that may have a material effect
on our business, prospects, results of operations and financial condition.
CHANGES IN ACCOUNTING STANDARDS COULD MATERIALLY IMPACT OUR FINANCIAL
STATEMENTS
From time to time the Financial Accounting Standards Board, the SEC and
bank regulators change the financial accounting and reporting standards that
govern the preparation of our financial statements. These changes can be very
difficult to predict and can materially impact how we record and report our
financial condition and results of operations. In some cases, we could be
required to apply a new or revised standard retroactively, resulting in our
restating prior period financial statements.
THERE ARE AN INCREASING NUMBER OF NON-BANK COMPETITORS PROVIDING FINANCIAL
SERVICES
Technology and other changes increasingly allow parties to complete
financial transactions electronically, and in many cases, without banks. For
example, consumers can pay bills and transfer funds over the internet and by
telephone without banks. Many non-bank financial service providers have lower
overhead costs and are subject to fewer regulatory constraints. If consumers do
not use banks to complete their financial transactions, we could potentially
lose fee income, deposits and income generated from those deposits.
F-48
COMPANY FACTORS
ADVERSE CALIFORNIA ECONOMIC CONDITIONS COULD ADVERSELY AFFECT OUR BUSINESS
A substantial majority of our assets, deposits and fee income are generated
in California. As a result, poor economic conditions in California may cause us
to incur losses associated with higher default rates and decreased collateral
values in our loan portfolio. Economic conditions in California are subject to
various uncertainties at this time, including the pace and scope of the recovery
in the technology sector, the California state government's continuing budgetary
and fiscal difficulties. If economic conditions in California decline, we expect
that our level of problem assets could increase and our prospects for growth
could be impaired. The State of California continues to face fiscal challenges,
the long-term impact of which on the State's economy cannot be predicted with
any certainty.
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 and increasing portion of our total loan portfolio is related to
residential real estate, especially in California. Accordingly, a downturn in
the real estate and housing industries in California could have an adverse
effect on our operations and the quality of our real estate loan portfolio.
Increases in residential mortgage loan interest rates could also have an adverse
effect on our operations by depressing new mortgage loan originations. We
provide financing to businesses in a number of other industries that may be
particularly vulnerable to industry-specific economic factors, including the
commercial real estate industry, the communications / media industry, the retail
industry, the airline industry, the power industry and the technology industry.
Recent increases in fuel prices have adversely affected businesses in several of
these industries. 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.
WE ARE NOT ABLE TO OFFER ALL OF THE FINANCIAL SERVICES AND PRODUCTS OF A
FINANCIAL HOLDING COMPANY
Banks, securities firms, and insurance companies can now combine as a
"financial holding company." Financial holding companies can offer virtually any
type of financial service, including banking, securities underwriting, insurance
(both agency and underwriting), and merchant banking. Many of our competitors
have elected to become financial holding companies. Recently, a number of
foreign banks have acquired financial holding companies in the U.S., further
increasing competition in the U.S. market. Under current regulatory
interpretations, Mitsubishi Tokyo Financial Group, Inc. would be required to
make a financial holding company election. We do not expect that Mitsubishi
Tokyo Financial Group, Inc. will make such an election in the near future.
OUR STOCKHOLDER VOTES ARE CONTROLLED BY THE BANK OF TOKYO-MITSUBISHI, LTD.;
OUR INTERESTS AND THOSE OF OUR MINORITY STOCKHOLDERS MAY NOT BE THE SAME AS
THOSE OF THE BANK OF TOKYO-MITSUBISHI, LTD.
The Bank of Tokyo-Mitsubishi, Ltd., a wholly owned subsidiary of Mitsubishi
Tokyo Financial Group, Inc., owns a majority of the outstanding shares of our
common stock. As a result, The Bank of Tokyo-Mitsubishi, Ltd. can elect all of
our directors and can control the vote on all matters, including: approval of
mergers or other business combinations; a sale of all or substantially all of
our assets; issuance of any additional common stock or other equity securities;
incurrence of debt other than in the ordinary course of business; the selection
and tenure of our Chief Executive Officer; payment of dividends with respect to
our common stock or other equity securities; and other matters that might be
favorable to The Bank of Tokyo-Mitsubishi, Ltd. A majority of our directors are
independent of The Bank of Tokyo-Mitsubishi, Ltd. and are not officers or
employees of UnionBanCal Corporation or any of our affiliates, including The
Bank of Tokyo-Mitsubishi, Ltd. However, because of The Bank of Tokyo-Mitsubishi,
Ltd.'s control over the election of our directors, we could designate ourselves
as a "controlled company" under the New York Stock Exchange Rules and could
change the composition of our Board of Directors so that the Board would not
have a majority of
F-49
independent directors. The Bank of Tokyo-Mitsubishi, Ltd.'s ability to prevent
an unsolicited bid for us or any other change in control could also have an
adverse effect on the market price for our common stock.
POSSIBLE FUTURE SALES OF OUR SHARES BY THE BANK OF TOKYO-MITSUBISHI,LTD.
COULD ADVERSELY AFFECT THE MARKET FOR OUR STOCK
The Bank of Tokyo-Mitsubishi, Ltd. may sell shares of our common stock in
compliance with the federal securities laws. By virtue of The Bank of
Tokyo-Mitsubishi, Ltd.'s current control of us, The Bank of Tokyo-Mitsubishi,
Ltd. could sell large amounts of shares of our common stock by causing us to
file a registration statement that would allow it to sell shares more easily. In
addition, The Bank of Tokyo-Mitsubishi, Ltd. could sell shares of our common
stock without registration under certain circumstances, such as in a "private
placement." Although we can make no prediction as to the effect, if any, that
such sales would have on the market price of our common stock, sales of
substantial amounts of our common stock, or the perception that such sales could
occur, could adversely affect the market price of our common stock. If The Bank
of Tokyo-Mitsubishi, Ltd. sells or transfers shares of our common stock as a
block, another person or entity could become our controlling stockholder.
THE BANK OF TOKYO-MITSUBISHI, LTD.'S AND MITSUBISHI TOKYO FINANCIAL GROUP,
INC.'S FINANCIAL CONDITION COULD ADVERSELY AFFECT OUR OPERATIONS
We fund our operations independently of The Bank of Tokyo-Mitsubishi, Ltd.
and Mitsubishi Tokyo Financial Group, Inc. and believe our business is not
necessarily closely related to the business or outlook of The Bank of
Tokyo-Mitsubishi, Ltd. or Mitsubishi Tokyo Financial Group, Inc. However, The
Bank of Tokyo-Mitsubishi, Ltd.'s and Mitsubishi Tokyo Financial Group, Inc.'s
credit ratings may affect our credit ratings. The Bank of Tokyo-Mitsubishi, Ltd.
and Mitsubishi Tokyo Financial Group, Inc. are also subject to regulatory
oversight and review by Japanese and U.S. regulatory authorities. Our business
operations and expansion plans could be negatively affected by regulatory
concerns related to the Japanese financial system, The Bank of Tokyo-Mitsubishi,
Ltd. or Mitsubishi Tokyo Financial Group, Inc., and other developments
concerning The Bank of Tokyo-Mitsubishi, Ltd. or Mitsubishi Tokyo Financial
Group, Inc., including the proposed merger with UFJ Holdings, Inc., which may
result in capital constraints as well as additional Japanese and U.S. regulatory
constraints.
POTENTIAL CONFLICTS OF INTEREST WITH THE BANK OF TOKYO-MITSUBISHI, LTD.
COULD ADVERSELY AFFECT US
The Bank of Tokyo-Mitsubishi, Ltd.'s view of possible new businesses,
strategies, acquisitions, divestitures or other initiatives may differ from
ours. This may delay or hinder us from pursuing such initiatives.
Also, as part of The Bank of Tokyo-Mitsubishi, Ltd.'s normal risk
management processes, The Bank of Tokyo-Mitsubishi, Ltd. manages global credit
and other types of exposures and concentrations on an aggregate basis, including
exposures and concentrations at UnionBanCal Corporation. Therefore, at certain
levels or in certain circumstances, our ability to approve certain credits or
other banking transactions and categories of customers is subject to the
concurrence of The Bank of Tokyo-Mitsubishi, Ltd. We may wish to extend credit
or furnish other banking services to the same customers as The Bank of
Tokyo-Mitsubishi, Ltd. Our ability to do so may be limited for various reasons,
including The Bank of Tokyo-Mitsubishi, Ltd.'s aggregate exposure and marketing
policies.
Certain directors' and officers' ownership interests in The Bank of
Tokyo-Mitsubishi, Ltd.'s common stock or service as a director or officer or
other employee of both us and The Bank of Tokyo-Mitsubishi, Ltd. could create or
appear to create potential conflicts of interest, especially since both of us
compete in U.S. banking markets.
F-50
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS COULD LIMIT AMOUNTS
PAYABLE TO US
As a holding company, a substantial portion of our cash flow typically
comes from dividends our bank and nonbank subsidiaries pay to us. Various
statutory provisions restrict the amount of dividends our subsidiaries can pay
to us without regulatory approval. In addition, if any of our subsidiaries were
to liquidate, that subsidiary's creditors will be entitled to receive
distributions from the assets of that subsidiary to satisfy their claims against
it before we, as a holder of an equity interest in the subsidiary, will be
entitled to receive any of the assets of the subsidiary.
OUR ABILITY TO MAKE ACQUISITIONS IS SUBJECT TO REGULATORY CONSTRAINTS AND
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR DIVESTITURES OR
RESTRUCTURINGS MAY ADVERSELY AFFECT US
Our ability to obtain regulatory approval of acquisitions is subject to
constraints related to the Bank Secrecy Act, as described above in "Supervision
and Regulation" and "Regulatory Matters." Subject to our ability to successfully
address these regulatory concerns, we may seek to acquire or invest in financial
and non-financial companies that complement our business. There can be no
assurance that we will be successful in completing any such acquisition or
investment as this will depend on the availability of prospective target
opportunities at valuation levels we find attractive and the competition for
such opportunities from other parties. In addition, we continue to evaluate the
performance of all of our businesses and business lines and may sell a business
or business line. Any acquisitions, divestitures or restructurings may result in
the issuance of potentially dilutive equity securities, significant write-offs,
including those related to goodwill and other intangible assets, and/or the
incurrence of debt, any of which could have a material adverse effect on our
business, results of operations and financial condition. Acquisitions,
divestitures or restructurings could involve numerous additional risks including
difficulties in obtaining any required regulatory approvals and in the
assimilation or separation of operations, services, products and personnel, the
diversion of management's attention from other business concerns, higher than
expected deposit attrition (run-off), divestitures required by regulatory
authorities, the disruption of our business, and the potential loss of key
employees. There can be no assurance that we will be successful in addressing
these or any other significant risks encountered.
PRIVACY RESTRICTIONS COULD ADVERSELY AFFECT OUR BUSINESS
Our business model relies, in part, upon cross-marketing the services
offered by us and our subsidiaries to our customers. Laws that restrict our
ability to share information about customers within our corporate organization
could adversely affect our business, results of operations and financial
condition.
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. While
we have selected these third party vendors carefully, we do not control their
actions. Any problems caused by these third parties, including 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 and otherwise to conduct our business. Replacing these
third party vendors could also entail significant delay and expense.
SIGNIFICANT LEGAL ACTIONS COULD SUBJECT US TO SUBSTANTIAL UNINSURED
LIABILITIES
We are from time to time subject to claims related to our operations. These
claims and legal actions, including supervisory actions by our regulators, could
involve large monetary claims and significant defense costs. To protect
ourselves from the cost of these claims, we maintain insurance coverage in
amounts and with deductibles that we believe are appropriate for our operations.
However, our insurance coverage may not cover all claims against us or continue
to be available to us at a reasonable cost. As a result, we may be exposed to
substantial uninsured liabilities, which could adversely affect our business,
prospects, results of operations and financial condition.
F-51
UNIONBANCAL CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Consolidated Statements of Income for the Years Ended December 31,
2002, 2003, and 2004.................................................. F-53
Consolidated Balance Sheets as of December 31, 2003 and 2004........... F-54
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended December 31, 2002, 2003, and 2004......................... F-55
Consolidated Statements of Cash Flows for the Years Ended December 31,
2002, 2003, and 2004.................................................. F-56
Notes to Consolidated Financial Statements............................. F-57
Report of Independent Registered Public Accounting Firm................ F-111
F-52
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
-----------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2003 2004
- ----------------------------------------------------------- ---------- ---------- ----------
INTEREST INCOME
Loans...................................................... $1,519,335 $1,403,293 $1,399,176
Securities................................................. 315,956 348,718 425,612
Interest bearing deposits in banks......................... 2,806 3,990 7,433
Federal funds sold and securities purchased under
resale agreements........................................ 13,478 10,203 9,189
Trading account assets..................................... 4,397 3,459 3,492
---------- ---------- ----------
Total interest income.................................... 1,855,972 1,769,663 1,844,902
---------- ---------- ----------
INTEREST EXPENSE
Domestic deposits.......................................... 215,138 151,004 145,481
Foreign deposits........................................... 21,110 10,232 15,410
Federal funds purchased and securities sold under
repurchase agreements.................................... 6,030 3,401 7,470
Commercial paper........................................... 16,645 8,508 6,899
Medium and long-term debt.................................. 9,344 7,845 16,773
Preferred securities and trust notes....................... 15,625 14,510 2,780
Other borrowed funds....................................... 10,111 5,097 4,866
---------- ---------- ----------
Total interest expense................................... 294,003 200,597 199,679
---------- ---------- ----------
NET INTEREST INCOME........................................ 1,561,969 1,569,066 1,645,223
(Reversal of) provision for loan losses.................... 175,000 75,000 (35,000)
---------- ---------- ----------
Net interest income after provision for loan losses...... 1,386,969 1,494,066 1,680,223
---------- ---------- ----------
NONINTEREST INCOME
Service charges on deposit accounts........................ 275,820 311,417 342,169
Trust and investment management fees....................... 143,953 136,347 153,083
Insurance commissions...................................... 27,847 62,652 77,874
International commissions and fees......................... 61,608 67,582 73,397
Merchant banking fees...................................... 32,314 30,990 39,646
Card processing fees, net.................................. 35,318 37,520 34,147
Foreign exchange gains, net................................ 28,548 30,000 33,516
Brokerage commissions and fees............................. 35,625 31,755 33,063
Securities gains (losses), net............................. 2,502 9,309 (12,085)
Other...................................................... 41,740 76,681 214,495
---------- ---------- ----------
Total noninterest income................................. 685,275 794,253 989,305
---------- ---------- ----------
NONINTEREST EXPENSE
Salaries and employee benefits............................. 731,166 808,804 877,557
Net occupancy.............................................. 106,592 124,274 132,108
Equipment.................................................. 66,160 65,394 69,268
Software................................................... 42,850 47,569 54,820
Communications............................................. 53,382 52,087 51,899
Professional services...................................... 44,851 48,558 50,033
Foreclosed asset expense (income).......................... 146 (84) 1,211
Other...................................................... 251,818 261,751 287,286
---------- ---------- ----------
Total noninterest expense................................ 1,296,965 1,408,353 1,524,182
---------- ---------- ----------
Income before income taxes................................. 775,279 879,966 1,145,346
Income tax expense......................................... 247,376 292,827 412,812
---------- ---------- ----------
NET INCOME................................................. $ 527,903 $ 587,139 $ 732,534
========== ========== ==========
NET INCOME PER COMMON SHARE--BASIC $ 3.41 $ 3.94 $ 4.96
========== ========== ==========
NET INCOME PER COMMON SHARE--DILUTED $ 3.38 $ 3.90 $ 4.87
========== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--BASIC 154,758 148,917 147,767
========== ========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING--DILUTED 156,415 150,645 150,303
========== ========== ==========
See accompanying notes to consolidated financial statements.
F-53
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------------
(DOLLARS IN THOUSANDS) 2003 2004
- ----------------------------------------------------------- ----------- -----------
ASSETS
Cash and due from banks.................................... $ 2,494,127 $ 2,111,185
Interest bearing deposits in banks......................... 235,158 491,905
Federal funds sold and securities purchased
under resale agreements.................................. 769,720 944,950
----------- -----------
Total cash and cash equivalents.......................... 3,499,005 3,548,040
Trading account assets..................................... 252,929 236,331
Securities available for sale:
Securities pledged as collateral........................... 106,560 144,240
Held in portfolio.......................................... 10,660,332 11,000,754
Loans (net of allowance for loan losses: 2003,
$532,970; 2004, $407,156)(1)............................. 25,411,658 30,309,800
Due from customers on acceptances.......................... 71,078 55,914
Premises and equipment, net................................ 509,734 530,431
Intangible assets.......................................... 49,592 61,737
Goodwill................................................... 226,556 450,961
Other assets............................................... 1,711,023 1,759,813
----------- -----------
Total assets............................................. $42,498,467 $48,098,021
=========== ===========
LIABILITIES
Domestic deposits:
Noninterest bearing........................................ $16,668,773 $19,205,596
Interest bearing........................................... 17,146,858 19,480,868
Foreign deposits:
Noninterest bearing........................................ 619,249 435,999
Interest bearing........................................... 1,097,403 1,053,373
----------- -----------
Total deposits........................................... 35,532,283 40,175,836
Federal funds purchased and securities sold
under repurchase agreements.............................. 280,968 587,249
Commercial paper........................................... 542,270 824,887
Other borrowed funds....................................... 212,088 172,549
Acceptances outstanding.................................... 71,078 55,914
Other liabilities(1)....................................... 934,916 1,157,439
Medium and long-term debt.................................. 820,488 816,113
Junior subordinated debt payable to subsidiary
grantor trust............................................ 363,940 15,790
----------- -----------
Total liabilities........................................ 38,758,031 43,805,777
----------- -----------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock:
Authorized 5,000,000 shares, no shares issued or
outstanding at December 31, 2003 or 2004.................. -- --
Common stock, par value $1 per share in 2003
and in 2004:
Authorized 300,000,000 shares, issued 146,000,156
shares in 2003 and 152,191,818 shares in 2004.......... 146,000 152,192
Additional paid-in capital................................. 555,156 881,928
Treasury stock -- 242,000 shares in 2003 and
3,831,900 shares in 2004................................. (12,846) (223,361)
Retained earnings.......................................... 2,999,884 3,526,312
Accumulated other comprehensive income (loss).............. 52,242 (44,827)
----------- -----------
Total stockholders' equity............................... 3,740,436 4,292,244
----------- -----------
Total liabilities and stockholders' equity............... $42,498,467 $48,098,021
=========== ===========
- --------------------
(1) On December 31, 2004, UnionBanCal Corporation transferred the allowance
relating to off-balance sheet commitments of $82.4 million from allowance
for loan losses to other liabilities. Prior periods have not been restated.
See accompanying notes to consolidated financial statements.
F-54
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
ACCUMULATED TOTAL
ADDITIONAL OTHER STOCK-
NUMBER COMMON PAID-IN TREASURY RETAINED COMPREHENSIVE HOLDERS'
(IN THOUSANDS, EXCEPT SHARES) OF SHARES STOCK CAPITAL STOCK EARNINGS INCOME EQUITY
- ----------------------------- --------- ----- ------- ----- -------- ------ ------
BALANCE DECEMBER 31, 2001.... 156,483,511 $1,181,925 $ -- $ -- $2,231,384 $ 132,933 $3,546,242
---------- -------- --------- ---------- --------- ----------
Comprehensive income
Net income--2002............. 527,903 527,903
Other comprehensive income,
net of tax:
Net change in unrealized
gains on cash flow
hedges..................... 41,528 41,528
Net change in unrealized
gains on securities
available for sale....... 64,179 64,179
Foreign currency
translation adjustment... 1,556 1,556
Minimum pension liability
adjustment............... (102) (102)
----------
Total comprehensive income... 635,064
Dividend reinvestment plan... 19,881 99 99
Deferred
compensation--restricted
stock awards............... 5,541 255 (59) 196
Stock options exercised...... 2,187,170 75,311 75,311
Stock issued in acquisitions. 1,221,577 54,830 54,830
Common stock repurchased(1).. (9,215,317) (385,960) (385,960)
Dividends declared on common
stock, $1.09 per share(2).. (167,593) (167,593)
---------- -------- --------- ---------- --------- ----------
Net change................... (255,465) -- -- 360,251 107,161 211,947
------------ ---------- -------- --------- ---------- --------- ----------
BALANCE DECEMBER 31, 2002.... 150,702,363 $926,460 $ -- $ -- $2,591,635 $ 240,094 $3,758,189
---------- -------- --------- ---------- --------- ----------
Comprehensive income
Net income-2003.............. 587,139 587,139
Other comprehensive income,
net of tax:
Net change in unrealized
losses on cash flow
hedges................... (60,582) (60,582)
Net change in unrealized
losses on securities
available for sale....... (124,915) (124,915)
Foreign currency
translation adjustment... 356 356
Minimum pension liability
adjustment............... (2,711) (2,711)
----------
Total comprehensive income. 399,287
Reincorporation(3)........... (520,876) 520,876 --
Dividend reinvestment plan... 5,731 34 22 56
Deferred
compensation--restricted
stock awards............... 6,000 282 (46) 236
Stock options exercised...... 1,912,323 36,686 34,258 70,944
Stock issued in acquisitions. 1,149,106 48,254 48,254
Common stock repurchased(1).. (7,775,367) (344,840) (12,846) (357,686)
Dividends declared on common
stock, $1.21 per share(2).. (178,844) (178,844)
---------- -------- --------- ---------- --------- ----------
Net change................... (780,460) 555,156 (12,846) 408,249 (187,852) (17,753)
------------ ---------- -------- --------- ---------- --------- ----------
BALANCE DECEMBER 31, 2003.... 146,000,156 $ 146,000 $555,156 $ (12,846) $2,999,884 $ 52,242 $3,740,436
---------- -------- --------- ---------- --------- ----------
Comprehensive income
Net income-2004.............. 732,534 732,534
Other comprehensive income,
net of tax:
Net change in unrealized
gains on cash flow
hedges..................... (42,357) (42,357)
Net change in unrealized
losses on securities
available for sale....... (54,231) (54,231)
Foreign currency
translation adjustment... 2,423 2,423
Minimum pension liability
adjustment............... (2,904) (2,904)
----------
Total comprehensive income... 635,465
Dividend reinvestment plan... 308 1 16 17
Deferred
compensation--restricted
stock awards............... 16,000 16 968 (583) 401
Stock options exercised...... 1,918,011 1,918 78,391 80,309
Stock issued in acquisitions. 4,257,343 4,257 247,571 251,828
Common stock repurchased(1) (174) (210,515) (210,689)
Dividends declared on common
stock, $1.39
per share(2)................. (205,523) (205,523)
---------- -------- --------- ---------- --------- ----------
Net change................... 6,192 326,772 (210,515) 526,428 (97,069) 551,808
------------ ---------- -------- --------- ---------- --------- ----------
BALANCE DECEMBER 31, 2004.... 152,191,818 $ 152,192 $881,928 $(223,361) $3,526,312 $ (44,827) $4,292,244
============ ========== ======== ========= ========== ========= ==========
- --------------------
(1) Common stock repurchased includes commission costs. All repurchases
subsequent to September 29, 2003, are reflected in Treasury Stock.
(2) Dividends are based on UnionBanCal Corporation's shares outstanding as of
the declaration date.
(3) On September 30, 2003, UnionBanCal Corporation changed its state of
incorporation from California to Delaware, establishing a par value of $1
per share of common stock.
See accompanying notes to consolidated financial statements.
F-55
UNIONBANCAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
---------------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ------------------------------------------------------------------------ ----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................................. $ 527,903 $ 587,139 $ 732,534
Adjustments to reconcile net income to net cash
provided by operating activities:
(Reversal of) provision for loan losses............................... 175,000 75,000 (35,000)
Depreciation, amortization and accretion.............................. 87,040 119,035 134,901
Provision for deferred income taxes................................... 38,448 52,916 77,327
Loss (gain) on sales of securities available for sale, net............ (2,502) (9,309) 12,085
Net increase in prepaid expenses...................................... (167,188) (85,240) (89,599)
Net increase (decrease) in accrued expenses........................... 144,329 (93,983) (9,504)
Net (increase) decrease in trading account assets..................... (46,324) 23,092 16,598
Net increase (decrease) in other liabilities.......................... (138,662) (94,109) 55,238
Net increase in other assets, net of acquisitions..................... (114,382) (150,021) (131,929)
Loans originated for resale........................................... (754,474) (306,510) (1,046,833)
Net proceeds from sale of loans originated for resale................. 712,777 336,794 931,324
Other, net............................................................ (1,275) 24,831 111,193
----------- ----------- -----------
Total adjustments................................................... (67,213) (107,504) 25,801
----------- ----------- -----------
Net cash provided by operating activities............................... 460,690 479,635 758,335
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale.................... 176,731 312,489 1,046,055
Proceeds from matured and called securities available for sale.......... 1,472,573 3,368,796 3,754,714
Purchases of securities available for sale, net of acquisitions......... (3,116,001) (7,363,168) (4,890,741)
Net purchases of premises and equipment................................. (87,521) (96,005) (109,840)
Net decrease (increase) in loans, net of acquisitions................... (1,623,261) 1,132,237 (3,025,176)
Net cash received (used) in acquisitions................................ 86,590 (60,920) (101,359)
Other, net.............................................................. 29,548 1,053 671
----------- ----------- -----------
Net cash used in investing activities................................... (3,061,341) (2,705,518) (3,325,676)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits, net of acquisitions........................... 3,852,835 2,224,742 2,809,803
Net increase (decrease) in federal funds purchased and
securities sold under repurchase agreements, net of acquisitions...... (84,435) (53,411) 220,681
Net increase (decrease) in commercial paper and other
borrowed funds........................................................ (225,031) (551,671) 243,078
Proceeds from issuance of debt.......................................... -- 398,548 --
Redemption of junior subordinated debt.................................. -- -- (360,825)
Common stock repurchased................................................ (385,960) (357,686) (210,689)
Payments of cash dividends.............................................. (164,440) (175,795) (197,198)
Stock options exercised................................................. 75,311 70,944 80,309
Other, net.............................................................. 1,655 412 2,440
----------- ----------- -----------
Net cash provided by financing activities............................... 3,069,935 1,556,083 2,587,599
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents.................... 469,284 (669,800) 20,258
Cash and cash equivalents at beginning of year.......................... 3,664,954 4,152,122 3,499,005
Effect of exchange rate changes on cash and cash equivalents............ 17,884 16,683 28,777
----------- ----------- -----------
Cash and cash equivalents at end of year................................ $ 4,152,122 $ 3,499,005 $ 3,548,040
=========== =========== ===========
CASH PAID DURING THE YEAR FOR:
Interest................................................................ $ 312,188 $ 201,690 $ 188,822
Income taxes............................................................ 166,875 238,515 310,789
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisitions:
Fair value of assets acquired....................................... $ 571,065 $ 721,749 $ 2,577,765
Purchase price:
Cash.............................................................. (52,524) (83,597) (201,522)
Stock issued...................................................... (54,830) (48,254) (251,828)
----------- ----------- -----------
Fair value of liabilities assumed................................... $ 463,711 $ 589,898 $ 2,124,415
=========== =========== ===========
Loans transferred to foreclosed assets (OREO) and/or distressed loans
held for sale......................................................... $ 826 $ 6,381 $ 5,506
See accompanying notes to consolidated financial statements.
F-56
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
INTRODUCTION
UnionBanCal Corporation is a commercial bank holding company and has, as
its major subsidiary, a banking subsidiary, Union Bank of California, N.A. (the
Bank). 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, and
Washington, and also nationally and internationally.
The Bank of Tokyo-Mitsubishi, Ltd. (BTM), which is a wholly-owned
subsidiary of Mitsubishi Tokyo Financial Group, Inc. (MTFG), owned approximately
62 percent of the Company's outstanding common stock at December 31, 2004.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America (US GAAP) and
general practice within the banking industry. Those policies that materially
affect the determination of financial position, results of operations, and cash
flows are summarized below.
The Consolidated Financial Statements include the accounts of the Company,
and all material intercompany transactions and balances have been eliminated.
The preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. Certain amounts for prior periods have been reclassified to conform
with current financial statement presentation.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks, interest bearing deposits in banks, and federal funds
sold and securities purchased under resale agreements, substantially all of
which have original maturities less than 90 days.
RESALE AND REPURCHASE AGREEMENTS
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.
TRADING ACCOUNT ASSETS
Trading account assets consist of securities and loans that management
acquires with the intent to hold for short periods of time in order to take
advantage of anticipated changes in market values. Substantially all of these
assets are securities with a high degree of liquidity and readily determinable
market value. Interest
F-57
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
earned, paid, or accrued on trading account assets is included in interest
income using a method that produces a level yield. Realized gains and losses
from the sale or close-out of trading account positions and unrealized market
value adjustments are recognized in noninterest income.
Included in trading account assets are the unrealized gains related to a
variety of interest rate derivative contracts, primarily swaps and options,
energy derivative contracts and foreign exchange contracts, entered into either
for trading purposes, based on management's intent at inception, or as an
accommodation to customers.
Derivatives held or issued for trading or customer accommodation are
carried at fair value, with realized and unrealized changes in fair values on
contracts included in noninterest income in the period in which the changes
occur. Unrealized gains and losses are reported gross and included in trading
account assets and other liabilities, respectively. Cash flows are reported net
as operating activities. The reserve for credit exposures and administrative
costs related to derivative and foreign exchange contracts is presented as an
offset to trading account assets. Changes in the reserves for those contracts
offset trading gains and losses in noninterest income.
SECURITIES AVAILABLE FOR SALE
The Company's securities portfolio consists of debt and equity securities
that are classified as securities available for sale.
Debt securities and equity securities with readily determinable market
values that are not classified as trading account assets are classified as
securities available for sale and carried at fair value, with the unrealized
gains or losses reported net of taxes as a component of accumulated other
comprehensive income (loss) in stockholders' equity until realized.
Interest income on debt securities includes the amortization of premiums
and the accretion of discounts using a method that produces a level yield and is
included in interest income on securities. Dividend income on equity securities
is included in noninterest income.
The Company recognizes other-than-temporary impairment on its securities
available for sale portfolio cost when it is likely that it will not recover its
principal. A security is subject to quarterly impairment testing when its fair
value is lower than its carrying value. The Company excludes from quarterly
impairment testing debt securities that are backed by the full faith and credit
of the U.S. government or where the likelihood of default is remote and
purchased at a premium below 10 percent of par. Typical securities in the
portfolio that are subject to other-than-temporary impairment are collateralized
loan obligations (CLOs), commercial mortgage conduits and equity securities. In
calculating the level of other-than-temporary impairment, the Company considers
expected cash flows utilizing a number of assumptions such as recovery rates,
default rates and reinvestment rates, business models, current and projected
financial performance, and overall economic market conditions.
Realized gains and losses on the sale of and other-than-temporary
impairment charges on available for sale securities are included in noninterest
income as securities gains (losses), net. The specific identification method is
used to calculate realized gains or losses.
Securities available for sale that are pledged under an agreement to
repurchase and which may be sold or repledged under that agreement have been
separately identified as pledged as collateral.
F-58
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
LOANS HELD FOR INVESTMENT AND LOANS HELD FOR SALE
Loans are reported at the principal amounts outstanding, net of unamortized
nonrefundable loan fees and related direct loan origination costs. Deferred net
fees and costs related to loans held for investment are recognized in interest
income generally over the contracted loan term using a method that generally
produces a level yield on the unpaid loan balance. Nonrefundable fees and direct
loan origination costs related to loans held for sale are deferred and
recognized as a component of the gain or loss on sale. Interest income is
accrued principally on a simple interest basis. Loans held for sale are carried
at the lower of cost or market on an individual basis for commercial loans and
an aggregate basis for residential mortgage loans. Changes in value are
recognized in other noninterest income.
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.
Interest accruals are continued for certain small business loans that are
processed centrally, consumer loans, and one-to-four family residential mortgage
loans. These loans are charged off or written down to their net realizable value
based on delinquency time frames that range from 120 to 270 days, depending on
the type of credit that has been extended. Interest accruals are also continued
for loans that are both well-secured and in the process of collection. For this
purpose, loans are considered well-secured if they are collateralized by
property having a net realizable value in excess of the amount of principal and
accrued interest outstanding or are guaranteed by a financially responsible and
willing party. Loans are considered "in the process of collection" if collection
is proceeding in due course either through legal action or other actions that
are reasonably expected to result in the prompt repayment of the debt or in its
restoration to current status.
When a loan is placed on nonaccrual, all previously accrued but uncollected
interest is reversed against current period operating results. All subsequent
payments received are first applied to unpaid principal and then to uncollected
interest. Interest income is accrued at such time as the loan is brought fully
current as to both principal and interest, and, in management's judgment, such a
loan is considered to be fully collectible. However, Company policy also allows
management to continue the recognition of interest income on certain loans
designated as nonaccrual. This portion of the nonaccrual portfolio is referred
to as "Cash Basis Nonaccrual" loans. This policy only applies to loans that are
well-secured and in management's judgment are considered to be fully
collectible. Although the accrual of interest is suspended, any payments
received may be applied to the loan according to its contractual terms and
interest income recognized when cash is received.
Loans are considered impaired when, based on current information, it is
probable that the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement, including interest payments.
Impaired loans are carried at the lower of the recorded investment in the loan,
the estimated present value of total expected future cash flows, discounted at
the loan's effective rate, or the fair value of the collateral, if the loan is
collateral dependent. Additionally, some impaired loans with commitments of less
than $2.5 million are aggregated for the purpose of measuring impairment using
historical loss factors as a means of measurement. Excluded from the impairment
analysis are large groups of smaller balance homogeneous loans such as consumer
and residential mortgage loans.
The Company offers primarily two types of leases to customers: 1) direct
financing leases where the assets leased are acquired without additional
financing from other sources, and 2) leveraged leases where a substantial
portion of the financing is provided by debt with no recourse to the Company.
Direct financing
F-59
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
leases are carried net of unearned income, unamortized nonrefundable fees and
related direct costs associated with the origination or purchase of leases.
Leveraged leases are carried net of nonrecourse debt.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for loan losses to absorb losses
inherent in the loan portfolio. The allowance is based on ongoing, quarterly
assessments of the probable estimated losses inherent in the loan portfolio. The
allowance is increased by the provision for loan losses, which is charged
against current period operating results and decreased by the amount of
charge-offs, net of recoveries. The Company's methodology for assessing the
appropriateness of the allowance consists of several key elements, which include
the formula allowance, the specific allowance and the unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding
loans. Loss factors are based on the Company's historical loss experience and
may be adjusted for significant factors that, in management's judgement, affect
the collectibility of the portfolio as of the evaluation date. The Company
derives the loss factors for most commercial loans from a loss migration model
and, for pooled loans, by using expected net charge-offs. Pooled loans are
homogeneous in nature and include consumer and residential mortgage loans, and
certain small commercial and commercial real estate loans. Estimated losses are
based on a loss confirmation period, which is the estimated average period of
time between a material adverse event affecting the credit worthiness of a
borrower, and the subsequent recognition of a loss.
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to a credit that
management believes indicate the probability that a loss has been incurred in
excess of the amount determined by the application of the formula allowance.
The unallocated allowance is composed of attribution factors, which are
based upon management's evaluation of various conditions that are not directly
measured in the determination of the formula and specific allowances. The
conditions evaluated in connection with the unallocated allowance may include
existing general economic and business conditions affecting the key lending
areas of the Company, credit quality trends, collateral values, loan volumes and
concentrations, seasoning of the loan portfolio, specific industry conditions
within portfolio segments, recent loss experience in particular segments of the
portfolio, duration of the current business cycle, bank regulatory examination
results and findings of the Company's internal credit examiners.
The allowance also incorporates the results of measuring impaired loans as
provided in Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting
by Creditors for Impairment of a Loan--Income Recognition and Disclosures."
These accounting standards prescribe the measurement methods, income recognition
and disclosures related to impaired loans. A loan is considered impaired when
management determines that it is probable that the Company will be unable to
collect all amounts due according to the original contractual terms of the loan
agreement. Impairment is measured by the difference between the recorded
investment in the loan (including accrued interest, net deferred loan fees or
costs and unamortized premium or discount) and the estimated present value of
total expected future cash flows, discounted at the loan's effective rate, or
the fair value of the collateral, if the loan is collateral dependent.
Additionally, some impaired loans with commitments of less than $2.5 million are
aggregated for the purpose of measuring impairment using historical loss factors
as a means of measurement. In addition, the impairment allowance may include
amounts related to certain qualitative
F-60
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
factors that have yet to manifest themselves in the other measurements.
Impairment is recognized as a component of the existing allowance for loan
losses.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation
and amortization. Depreciation and amortization are calculated using the
straight-line method over the estimated useful life of each asset. Lives of
premises range from ten to forty years; lives of furniture, fixtures and
equipment range from three to eight years. Leasehold improvements are amortized
over the term of the respective lease or ten years, whichever is shorter.
Long-lived assets that are held or that are to be disposed of and certain
intangibles are evaluated periodically for impairment when events or changes in
circumstances indicate that the carrying amount may not be recoverable. The
impairment is calculated as the difference between the expected undiscounted
future cash flows of a long-lived asset, if lower, and its carrying value. In
the event of an impairment, the Company recognizes a loss for the difference
between the carrying amount and the estimated value of the asset as measured
using a quoted market price or, in the absence of a quoted market price, a
discounted cash flow analysis. The impairment loss is reflected in noninterest
expense.
OTHER ASSETS
Intangible assets that have infinite lives, such as goodwill, are tested
for impairment at least annually.
Intangible assets that have finite lives are amortized either using the
straight-line method or a method that patterns the manner in which the economic
benefit is consumed. Intangible assets are typically amortized over their
estimated period of benefit ranging from six to fifteen years, although some
intangible assets may have useful lives which extend to 30 years. The Company
periodically evaluates the recoverability of intangible assets and takes into
account events or circumstances that warrant revised estimates of useful lives
or that indicate that impairment exists.
Other real estate owned (OREO) represents the collateral acquired through
foreclosure in full or partial satisfaction of the related loan. OREO is
recorded at the lower of the loan's unpaid principal balance or its fair value
as established by a current appraisal, adjusted for disposition costs. Any
write-down at the date of transfer is charged to the allowance for loan losses.
OREO values, recorded in other assets, are reviewed on an ongoing basis and any
decline in value is recognized as foreclosed asset expense in the current
period. The net operating results from these assets are included in the current
period in noninterest expense as foreclosed asset expense (income).
Distressed loans held for sale are included in other assets in the
consolidated financial statements and represent loans that the Company has
identified as available for accelerated disposition. These are loans that would
otherwise be included in nonaccrual loans. Distressed loans are recorded at the
lower of the loans' unpaid principal balance or their fair value. Any write-down
at the date of transfer is charged to the allowance for loan losses. Distressed
loans, recorded in other assets, are reviewed on a quarterly basis and any
decline in value is recognized in other noninterest income during the period in
which the decline occurs. At December 31, 2004 and 2003, other assets included
no distressed loans held for sale.
F-61
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
PRIVATE CAPITAL INVESTMENTS
Private capital investments include direct investments in private companies
and indirect investments in private equity funds. These investments are
initially valued at cost and tested for other-than-temporary impairment on a
quarterly basis if the carrying value exceeds fair value. Fair value is
estimated based on a company's business model, current and projected financial
performance, liquidity and overall economic and market conditions. Any
other-than-temporary impairment is recognized as securities gains (losses), net.
DERIVATIVE INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING
The Company enters into a variety of derivative contracts as a means of
reducing the Company's interest rate and foreign exchange exposures. At
inception, these contracts, i.e., hedging instruments, are evaluated in order to
determine if the hedging instrument will be highly effective in achieving
offsetting changes in the hedge instrument and hedged item attributable to the
risk being hedged. Any ineffectiveness, which arises during the hedging
relationship, is recognized in noninterest expense in the period in which it
arises. All qualifying hedge instruments are valued at fair value and included
in other assets or other liabilities. For fair value hedges of interest bearing
assets or liabilities, the change in the fair value of the hedged item and the
hedging instrument, to the extent effective, is recognized in net interest
income. For all other fair value hedges, the changes in the fair value of the
hedged item and changes in fair value of the derivative are recognized in
noninterest income. For cash flow hedges, the unrealized changes in fair value
to the extent effective are recognized in other comprehensive income. Amounts
realized on cash flow hedges related to variable rate loans are recognized in
net interest income in the period when the cash flow from the hedged item is
realized. The fair value of cash flow hedges related to forecasted transactions
is recognized in noninterest expense in the period when the forecasted
transaction occurs.
FOREIGN CURRENCY TRANSLATION
Assets, liabilities and results of operations for foreign branches are
recorded based on the functional currency of each branch. Since the functional
currency of the branches is the local currency, the net assets are remeasured
into U.S. dollars using a combination of current and historical exchange rates.
The resulting gains or losses are included in stockholders' equity, as a
component of accumulated other comprehensive income (loss), on a net of tax
basis.
INCOME TAXES
The Company files consolidated federal and combined state income tax
returns. Amounts provided for income tax expense are based on income reported
for financial statement purposes and do not necessarily represent amounts
currently payable under tax laws. Deferred taxes, which arise principally from
temporary differences between the period in which certain income and expenses
are recognized for financial accounting purposes and the period in which they
affect taxable income, are included in the amounts provided for income taxes.
Under this method, the computation of the net deferred tax liability or asset
gives current recognition to changes in the tax laws.
NET INCOME PER COMMON SHARE
Basic earnings per share (EPS) is computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
EPS incorporates the dilutive effect of common stock
F-62
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
equivalents outstanding on an average basis during the period. Stock options are
a common stock equivalent. See discussion under "Stock-Based Compensation,"
which follows below and Note 15 of these consolidated financial statements.
ALLOWANCE FOR OFF-BALANCE SHEET COMMITMENTS
The Company maintains an allowance for off-balance sheet commitments to
absorb losses inherent in those commitments upon funding. The commitments
include unfunded loans, standby letters of credit and commercial lines of credit
that are not for sale. The Company's methodology for assessing the
appropriateness of this allowance is the same as that used for the allowance for
loan losses. See accounting policy "ALLOWANCE FOR LOAN LOSSES." The allowance
for off-balance sheet commitments is classified as other liabilities as of
December 31, 2004 and the change in this allowance is recognized in noninterest
expense. Prior periods have not been restated for the reclassification to other
liabilities.
STOCK-BASED COMPENSATION
As allowed under the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended, the Company has chosen to continue to
recognize compensation expense using the intrinsic value-based method of valuing
stock options prescribed in Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees" and related Interpretations. Under
the intrinsic value-based method, compensation cost is measured as the amount by
which the quoted market price of the Company's stock at the date of grant
exceeds the stock option exercise price.
At December 31, 2004, the Company had two stock-based employee compensation
plans, which are described more fully in Note 15 of these consolidated financial
statements. Only restricted stock awards have been reflected in compensation
expense, while all options granted under those plans had an exercise price equal
to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation. For the purpose of this
disclosure, the Company has recognized compensation expense for graded vesting
on a straight-line basis and without regard for forfeitures.
YEAR ENDED DECEMBER 31,
----------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ---------------------------------------------------------------------- -------- -------- --------
As reported net income................................................ $527,903 $587,139 $732,534
Stock-based employee compensation expense (determined
under fair value based method for all awards,
net of taxes)....................................................... (21,827) (24,052) (25,129)
-------- -------- --------
Pro forma net income, after stock-based employee
compensation expense................................................ $506,076 $563,087 $707,405
======== ======== ========
Net income per common share--basic
As reported $3.41 $3.94 $4.96
Pro forma $3.27 $3.78 $4.79
Net income per common share--diluted
As reported $3.38 $3.90 $4.87
Pro forma $3.24 $3.74 $4.71
F-63
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
Compensation cost associated with the Company's unvested restricted stock
issued under the management stock plan is measured based on the market price of
the stock at the grant date and is expensed over the vesting period.
Compensation expense related to restricted stock awards for the years ended
December 31, 2002, 2003, and 2004 was not significant.
Compensation cost associated with the Company's Performance Share Plan,
described more fully in Note 15 of these consolidated financial statements, is
accounted for in accordance with APB No. 25.
EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
The Company provides a variety of benefit and incentive compensation plans
for eligible employees and retirees. Provisions for the costs of these employee
benefit and incentive plans and postretirement benefit plans are accrued and
charged to expense when the benefit is earned.
SEGMENT REPORTING
Business unit results are based on an internal management reporting system
used by management to measure the performance of the units and the Company as a
whole. The management reporting system identifies balance sheet and income
statement items to each business unit based on internal management accounting
policies. Net interest income is determined using the Company's internal funds
transfer pricing system, which assigns a cost of funds to assets or a credit for
funds to liabilities and capital based on their type, maturity or repricing
characteristics. Noninterest income and expense directly or indirectly
attributable to a business unit are assigned to that business. Economic capital
is attributed to each business unit using a Risk Adjusted Return on Capital
(RAROC) methodology, which seeks to allocate capital to each business unit
consistent with the level of risk they assume. These risks are primarily credit
risk, market risk and operational risk. Credit risk is the potential loss in
economic value due to the likelihood that the obligor will not perform as
agreed. Market risk is the potential loss in fair value due to changes in
interest rates, currency rates and volatilities. Operational risk is the
potential loss due to failures in internal controls, system failures, or
external events.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
GRANTOR TRUST (TRUST PREFERRED SECURITIES) AND JUNIOR SUBORDINATED DEBT
PAYABLE TO SUBSIDIARY GRANTOR TRUST (TRUST NOTES)
Trust preferred securities and trust notes (as of October 1, 2003) are
accounted for as liabilities on the balance sheet. Dividends (or distributions)
on trust preferred securities and interest on trust notes are treated as
interest expense on an accrual basis.
Additional information on the trust preferred securities and trust notes
can be found in Note 13 of these consolidated financial statements.
TREASURY STOCK
In 2003, the Company reincorporated in the State of Delaware and adopted
the treasury stock method of accounting for repurchases of common stock. The
cost of common stock repurchased is shown separately in the statement of changes
in stockholders' equity and shares repurchased are deducted from shares
outstanding until retired. Gains and losses resulting from shares reissued are
based on the average cost of
F-64
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
shares repurchased. Gains and losses, up to the amount of gains previously
recognized, are included in additional paid in capital. Losses in excess of the
gains previously recognized reduce retained earnings.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities."
This Statement replaces the accounting and reporting provisions of Emerging
Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." It requires that costs associated
with an exit or disposal activity be recognized when a liability is incurred
rather than at the date an entity commits to an exit plan. This Statement was
effective on January 1, 2003 and did not have a material impact on the Company's
financial position or results of operations.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS No. 149 was effective for contracts entered into
or modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. The provisions of the Statement, with certain exceptions, are
required to be applied prospectively. The adoption of this Statement did not
have a material impact on the Company's financial position or results of
operations.
ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." The
Statement establishes standards for how the Company should classify and measure
certain financial instruments with characteristics of both liabilities and
equity. This Statement was effective for financial instruments entered into or
modified after May 31, 2003, and to other instruments effective at the beginning
of the first interim period beginning after June 15, 2003. Adoption of this
Statement did not have a material impact on the Company's financial position or
results of operations.
ACCOUNTING FOR EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER
POSTRETIREMENT BENEFITS
In December 2003, the FASB issued SFAS No. 132R, a revision of SFAS No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits,
an amendment of FASB Statements No. 87, 88, and 106." The Statement expands the
disclosure requirements of SFAS No. 132 to include information describing types
of plan assets, investment strategy, measurement date(s), plan obligations, cash
flows, and components of net periodic benefit costs of defined pension plans and
other defined benefit postretirement plans. The Statement was effective for
financial statements with fiscal years ending after December 15, 2003, with
additional disclosure of expected benefits to be paid in each of the next five
years and in the aggregate for the five years thereafter required for fiscal
years ending after June 15, 2004. The disclosures required under SFAS No. 132R
are contained in Note 8 of these consolidated financial statements.
F-65
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
ACCOUNTING FOR SHARE-BASED PAYMENTS
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment". This Statement requires that compensation costs related to share-based
payment transactions be recognized in the financial statements. Measurement of
the cost of employee service will be based on the grant-date fair value of the
equity or liability instruments issued. That cost will be recognized over the
period during which an employee is required to provide service in exchange for
the award. Additionally, liability awards will be remeasured each reporting
period. Statement 123R replaces SFAS No. 123, "Accounting for Stock-Based
Compensation" and supercedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees". This Statement is effective for interim periods beginning after June
15, 2005 and requires adoption using a modified prospective application or a
modified retrospective application. The Company has not yet concluded on the
method of adoption allowed by the Statement and is currently evaluating the
impact of this accounting guidance on its financial condition and results of
operations. Disclosure required under SFAS No. 123 is shown in Note 1 of these
consolidated financial statements.
ACCOUNTING FOR GUARANTORS AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." The Interpretation elaborates on
the existing disclosure requirements for most guarantees and requires that
guarantors recognize a liability for the fair value of certain guarantees at
inception. The disclosure requirements of this Interpretation were effective for
financial statements ending after December 15, 2002. The initial recognition and
measurement provisions of this Interpretation were applied on a prospective
basis to guarantees issued or modified after December 31, 2002. The adoption of
this Interpretation did not have a material impact on the Company's financial
position or results of operations.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities". FIN 46 provides guidance on how
to identify a variable interest entity (VIE), and when the assets, liabilities,
noncontrolling interests and result of operations of a VIE need to be included
in a company's consolidated financial statements. A VIE exists when either the
total equity investment at risk is not sufficient to permit the entity to
finance its activities by itself, or the equity investors lack a controlling
financial interest or they have voting rights that are not proportionate to
their economic interest. A company that holds variable interests in an entity
will need to consolidate that entity if the company's interest in the VIE is
such that the company will absorb a majority of the VIE's expected losses and/or
receive a majority of the VIE's expected residual returns, if they occur. FIN 46
also requires additional disclosures by primary beneficiaries and other
significant variable interest holders.
In December 2003, the FASB issued FIN 46R, a revision of FIN 46. FIN 46R
clarifies that only the holder of a variable interest can ever be a VIE's
primary beneficiary. FIN 46R delays the effective date of FIN 46 for all
entities created subsequent to January 31, 2003 and non-SPE's (special-purpose
entities) created prior to February 1, 2003 to reporting periods ending after
March 15, 2004. Entities created prior to February 1, 2004 and defined as SPE's
must apply either the provisions of FIN 46 or early adopt the provisions of FIN
46R by the first reporting period ending after December 15, 2003. The adoption
of FIN 46R on January 1, 2004 did not have a material impact on the Company's
financial position or results of operations.
F-66
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
(CONTINUED)
THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO
CERTAIN INVESTMENTS
In March 2004, the EITF reached consensus on certain incremental issues
related to Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments." EITF Issue No. 03-1 establishes a
three-step model to determine whether an investment is other-than-temporarily
impaired and requires disclosures about unrealized losses that have not been
recognized as other-than-temporary impairment and the aggregate carrying amount
and fair value evaluation of cost method investments. EITF Issue No. 03-1 is
effective for interim periods beginning after June 15, 2004, however certain
guidance contained in the EITF has been delayed by FASB Staff Position (FSP)
EITF Issue 03-1-1, "The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments." The Company adopted the disclosure
provisions of EITF Issue No. 03-1 for investments carried at cost at December
31, 2004. At adoption, there was no impact on the Company's financial position
or statement of operations.
ACCOUNTING FOR CERTAIN LOANS ACQUIRED IN A TRANSFER
In December 2003, under clearance of the FASB, the Accounting Standards
Executive Committee (AcSEC) of the AICPA issued Statement of Position (SOP)
03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer."
This SOP establishes accounting standards for discounts on purchased loans when
the discount is attributable to credit quality. The SOP requires that the loan
discount, rather than contractual amounts, establishes the investor's estimate
of undiscounted expected future principal and interest cash flows as a benchmark
for yield and impairment measurements. The SOP prohibits the carryover or
creation of a valuation allowance in the initial accounting for these loans.
This SOP is effective for loans acquired in years beginning after December 15,
2004. Since this SOP applies only to transfers after 2004, this Statement will
have no impact on the Company's financial position or results of operations at
adoption.
PRESCRIPTION DRUG BENEFITS
In May 2004, the FASB issued FSP No. 106-2, "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003". The FSP provides guidance on the accounting for the
effects of the Medicare prescription drug benefit and the federal subsidy to
sponsors of retiree healthcare benefit plans that offer prescription drug
coverage to retirees that is actuarially equivalent to the Medicare benefit. In
accordance with the FSP, sponsoring companies must recognize the subsidy in the
measurement of their plan's accumulated postretirement benefit obligation (APBO)
and net postretirement benefit cost. The Company adopted the Staff Position on
July 1, 2004. The impact of adoption and disclosure required under FSP 106-2 are
contained in Note 8 of these consolidated financial statements.
F-67
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 2--SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses, and
fair values of securities are presented below.
SECURITIES AVAILABLE FOR SALE
DECEMBER 31,
-------------------------------------------------------------------------------------------------------------
2002 2003 2004
---------- ------------------------------------------------ ------------------------------------------------
GROSS GROSS GROSS GROSS
(DOLLARS IN FAIR AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
THOUSANDS) VALUE COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
- ------------------- ---------- ----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
U.S. Treasury...... $ 344,389 $ 270,692 $ 5,663 $ -- $ 276,355 $ 52,417 $ 970 $ 12 $ 53,375
Other U.S.
government....... 2,687,306 4,904,611 64,533 29,060 4,940,084 3,909,082 9,700 43,103 3,875,679
Mortgage-backed
securities....... 4,018,537 5,149,449 46,407 40,317 5,155,539 6,025,470 28,532 50,576 6,003,426
State and municipal 49,091 40,560 5,617 -- 46,177 69,562 4,825 260 74,127
Asset-backed and
debt securities.. 150,516 355,099 3,938 21,751 337,286 1,123,504 6,778 8,398 1,121,884
Equity securities.. 11,020 1,949 1,425 15 3,359 9,153 719 349 9,523
Foreign securities. 6,462 8,036 56 -- 8,092 7,032 -- 52 6,980
---------- ----------- ---------- ---------- ----------- ----------- ---------- ---------- ----------
Total securities
available for
sale........... $7,267,321 $10,730,396 $ 127,639 $ 91,143 $10,766,892 $11,196,220 $ 51,524 $ 102,750 $11,144,994
========== =========== ========== ========== =========== =========== ========== ========== ===========
For the years ending December 31, 2002, 2003 and 2004, interest income
included $2.7 million, $2.7 million and $3.6 million, respectively, from
non-taxable securities and dividend income of $0.6 million, $1.2 million and
$3.9 million, respectively, from equity securities.
The amortized cost and fair 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)
---------------------------
DECEMBER 31, 2004
---------------------------
AMORTIZED FAIR
(DOLLARS IN THOUSANDS) COST VALUE
- -------------------------------------------------- ---------- ----------
Due in one year or less........................... $1,202,703 $1,201,511
Due after one year through five years............. 2,909,021 2,878,512
Due after five years through ten years............ 1,628,702 1,623,015
Due after ten years............................... 5,446,641 5,432,433
Equity securities(2).............................. 9,153 9,523
----------- -----------
Total securities................................ $11,196,220 $11,144,994
=========== ===========
- --------------------
(1) The remaining contractual maturities of 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.
F-68
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 2--SECURITIES (CONTINUED)
In 2002, proceeds from sales of securities available for sale were $177
million with gross realized gains of $4 million and $1 million of gross realized
losses. In 2003, proceeds from sales of securities available for sale were $312
million with gross realized gains of $16 million and gross realized losses of $7
million. In 2004, proceeds from sales of securities available for sale were
$1.046 billion with gross realized gains of $2 million and gross realized losses
of $14 million.
ANALYSIS OF UNREALIZED LOSSES ON SECURITIES AVAILABLE FOR SALE
At December 31, 2004, the Company's securities available for sale shown
below were in a continuous unrealized loss position for the periods less than 12
months and 12 months or more.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
------------------------------ ------------------------------ ------------------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
(DOLLARS IN THOUSANDS) VALUE LOSSES COUNT VALUE LOSSES COUNT VALUE LOSSES COUNT
- -------------------------- ---------- ---------- ----- ---------- ---------- ----- ---------- ---------- -----
U.S. Treasury............. $ 1,987 $ 12 2 $ -- $ -- -- $ 1,987 $ 12 2
Other U.S. government..... 1,959,190 14,405 51 1,056,437 28,698 26 3,015,627 43,103 77
Mortgage-backed securities 1,738,317 13,038 132 1,988,371 37,538 69 3,726,688 50,576 201
State and municipal....... 22,619 260 72 -- -- -- 22,619 260 72
Asset-backed and debt
securities.............. 116,125 1,054 9 106,026 7,344 28 222,151 8,398 37
Equity securities......... 1,028 349 2 -- -- -- 1,028 349 2
Foreign securities........ 5,825 52 1 -- -- -- 5,825 52 1
---------- ---------- ----- ---------- ---------- ----- ---------- ---------- -----
Total securities available
for sale................ $3,845,091 $ 29,170 269 $3,150,834 $ 73,580 123 $6,995,925 $ 102,750 392
========== ========== ===== ========== ========== ===== ========== ========== =====
The Company's securities are primarily investments in debt securities,
which the Company has the ability and intent to hold until recovery of the
carrying value. The following describes the nature of the investments, the
causes of impairment, the severity and duration of the impairment, if
applicable, and a discussion regarding how the Company has determined that the
unrealized loss is not other-than-temporary.
U.S. TREASURY SECURITIES
U.S. Treasury securities are securities backed by the full faith and credit
of the United States government and therefore have no risk of default. These
securities are issued at a stated interest rate and mature within six months.
All of the unrealized losses on U.S. Treasury securities resulted from rising
interest rates subsequent to purchase. Unrealized losses will decline as
interest rates fall below the purchased yield and as the securities approach
maturity. Since the Company has the ability and intent to hold the U.S. Treasury
securities until recovery of the carrying value, which could be maturity, the
unrealized loss is considered temporary.
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. These securities were
issued with a stated interest rate and mature in less than four years. All of
the unrealized losses on other U.S. Government securities resulted from rising
interest rates subsequent to purchase. Unrealized losses will decline as
interest rates fall below the purchased yield and as the securities
F-69
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 2--SECURITIES (CONTINUED)
approach maturity. Since the Company has the ability and intent to hold the
other U.S. Government securities until recovery of the carrying value, which
could be maturity, the unrealized loss is considered temporary.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are primarily securities guaranteed by a GSE
such as Fannie Mae or Freddie Mac. These securities are collateralized by
residential mortgage loans and may be prepaid at par prior to maturity. All of
the unrealized losses on the mortgage-backed securities resulted from rising
interest rates subsequent to purchase. Because the likelihood of credit loss is
remote, the securities are excluded from the periodic evaluation of
other-than-temporary impairment. The securities are subject to the provisions of
SFAS No. 91, "Accounting for Non-refundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases" and any
purchased premiums in excess of the par amount are evaluated for recoverability
on a quarterly basis and the result of that evaluation is recorded in interest
income. Unrealized losses, beyond the purchased premium, will decline as
interest rates fall below the purchased yield and as the securities approach
contractual or expected maturity. Since the Company has the ability and intent
to hold the mortgage-backed securities until recovery of the par amount, which
could be maturity, the unrealized loss is considered temporary.
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 maturities ranging from
7 to 15 years. All of the unrealized losses on the state and municipal
securities resulted from rising interest rates subsequent to purchase, which
occurred with the acquisition of Business Bank of California on January 16,
2004. Unrealized losses will decline as interest rates fall below the purchased
yield and as the securities approach maturity. Since the Company has the ability
and intent to hold the state and municipal securities until recovery of the
carrying value, which could be maturity, the unrealized loss is considered
temporary.
ASSET-BACKED AND DEBT SECURITIES
Asset-backed and debt securities are primarily collateralized loan
obligations that are highly illiquid and for which fair values are difficult to
obtain. Unrealized losses arise from rising interest rates, widening credit
spreads, credit quality of the underlying collateral, 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 on those securities below investment grade. Any security
with a change in credit rating is also subject to cash flow analysis to
determine whether or not an other-than-temporary impairment exists. During 2004,
the Company recognized $0.75 million of other-than-temporary impairment. Since
the Company is able and intends to hold these securities until recovery of the
carrying value, the unrealized loss is considered temporary as of December 31,
2004.
EQUITY SECURITIES
Equity securities consist of securities traded on a national exchange as
part of the venture capital investment portfolio. The unrealized losses of the
two securities in our portfolio have resulted from recent declines in share
price due to lower earnings results. The Company has no reason to believe that a
full recovery
F-70
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 2--SECURITIES (CONTINUED)
of the carrying value will not occur prior to the disposition of the securities.
The Company has the intent and ability to hold these equity securities until
recovery of the carrying value.
COLLATERAL
The Company reports securities pledged as collateral in secured borrowings
and other arrangements when the secured party can sell or repledge the
securities. These securities have been separately identified. If the secured
party cannot resell or repledge the securities of the Company, those securities
are not separately identified. As of December 31, 2003 and 2004, the Company had
no pledged collateral to secured parties who are not permitted to resell or
repledge those securities.
As of December 31, 2003 and 2004, the Company had not accepted any
collateral that it is permitted by contract to sell or repledge.
NOTE 3--LOANS AND ALLOWANCE FOR LOAN LOSSES
A summary of loans, net of unearned interest and fees of $35 million and
$33 million, at December 31, 2003 and 2004, respectively, is as follows:
DECEMBER 31,
--------------------------
(DOLLARS IN THOUSANDS) 2003 2004
- ----------------------------------------------------- ----------- -----------
Domestic:
Commercial, financial and industrial(1)............ $ 8,817,679 9,761,096
Construction....................................... 1,101,166 1,130,070
Mortgage:
Residential...................................... 7,463,538 9,538,150
Commercial....................................... 4,195,178 5,409,029
----------- -----------
Total mortgage................................. 11,658,716 14,947,179
Consumer:
Installment...................................... 818,746 767,767
Revolving lines of credit........................ 1,222,220 1,581,866
----------- -----------
Total consumer................................. 2,040,966 2,349,633
Lease financing.................................... 663,632 609,090
----------- -----------
Total loans in domestic offices................ 24,282,159 28,797,068
Loans originated in foreign branches................. 1,650,204 1,801,988
----------- -----------
Total loans held to maturity................... 25,932,363 30,599,056
Total loans held for sale...................... 12,265 117,900
----------- -----------
Total loans.................................. 25,944,628 30,716,956
Allowance for loan losses.................... 532,970 407,156
----------- -----------
Loans, net(2)................................ $25,411,658 $30,309,800
=========== ===========
- --------------------
(1) Included in commercial, financial and industrial loans at December 31, 2003
and 2004 were overdrafts from various deposit accounts of $53.0 million and
$77.8 million, respectively.
(2) On December 31, 2004, UnionBanCal Corporation transferred the allowance
relating to off-balance sheet commitments of $82.4 million from allowance
for loan losses to other liabilities. Prior periods have not been restated.
F-71
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
Changes in the allowance for loan losses were as follows:
YEARS ENDED DECEMBER 31,
------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ---------------------- -------- -------- --------
Balance, beginning of year................................................... $634,509 $609,190 $532,970
Loans charged off............................................................ (245,342) (211,726) (82,652)
Recoveries of loans previously charged off................................... 39,546 50,091 55,758
-------- -------- --------
Total net loans charged off................................................ (205,796) (161,635) (26,894)
(Recovery of) provision for credit losses.................................... 175,000 75,000 (35,000)
Foreign translation adjustment and other net additions (deductions)(1)(2).... 5,477 10,415 (63,920)
-------- -------- --------
Ending balance of allowance for loan losses.................................. $609,190 $532,970 $407,156
Allowance for off-balance sheet commitment losses(2)......................... -- -- 82,375
-------- -------- --------
Allowances for credit losses balance, end of year............................ $609,190 $532,970 $489,531
======== ======== ========
- --------------------
(1) Includes $5.7 million related to the Business Bank of California
acquisition and $12.6 million related to the Jackson Federal Bank
acquisition, both acquired in 2004. Also includes $10.3 million related to
the Monterey Bay Bank acquisition in 2003, $2.8 million for the Valencia
Bank & Trust acquisition, and $2.4 million for the First Western Bank
acquisition both acquired in 2002.
(2) On December 31, 2004, UnionBanCal Corporation transferred the allowance
relating to off-balance sheet commitments of $82.4 million from allowance
for loan losses to other liabilities. Prior periods have not been restated.
Nonaccrual loans totaled $281 million and $157 million at December 31, 2003
and 2004, respectively. There were no renegotiated loans at December 31, 2003
and 2004.
LOAN IMPAIRMENT
Impaired loans of the Company include commercial, financial and industrial,
construction and commercial mortgage loans designated as nonaccrual. When the
value of an impaired loan is less than the recorded investment in the loan, a
portion of the Company's allowance for loan losses is allocated as an impairment
allowance.
The Company's policy for recognition of interest income, charge-offs of
loans, and application of payments on impaired loans is the same as the policy
applied to nonaccrual loans.
F-72
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following table sets forth information about the Company's impaired
loans.
DECEMBER 31,
----------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ---------------------------------------------------------- -------- -------- --------
Impaired loans with an allowance.......................... $270,399 $218,456 $ 95,078
Impaired loans without an allowance(1).................... 29,996 11,141 6,664
-------- -------- --------
Total impaired loans(2)............................... $300,395 $229,597 $101,742
======== ======== ========
Allowance for impaired loans.............................. $ 88,404 $ 55,021 $ 32,282
Average balance of impaired loans during the year......... $363,409 $295,474 $143,776
Interest income recognized during the year on
nonaccrual loans at December 31......................... $ 10,842 $ 6,544 $ 25,750
- --------------------
(1) These loans do not require an allowance for credit losses under SFAS No.
114 since the fair values of the impaired loans equal or exceed the
recorded investments in the loans.
(2) This amount was evaluated for impairment using three measurement methods as
follows: $264 million, $178 million, and $55 million was evaluated using
the present value of the expected future cash flows at December 31, 2002,
2003 and 2004, respectively; $22 million, $38 million, and $9 million was
evaluated using the fair value of the collateral at December 31, 2002, 2003
and 2004, respectively; and $15 million, $13 million, and $38 million was
evaluated using historical loss factors at December 31, 2002, 2003 and
2004, respectively.
RELATED PARTY LOANS
In some cases, the Company makes loans to related parties including its
directors, executive officers, and their affiliated companies. At December 31,
2003, related party loans outstanding to individuals who served as directors or
executive officers at anytime during the year totaled $37 million, as compared
to $42 million at December 31, 2004. In the opinion of management, these related
party loans were made on substantially the same terms, including interest rates
and collateral requirements, as those terms prevailing in the market at the date
these loans were made. During 2003 and 2004, there were no loans to related
parties that were charged off. Additionally, at December 31, 2003 and 2004,
there were no loans to related parties that were nonperforming.
NOTE 4--GOODWILL AND OTHER INTANGIBLE ASSETS
Upon adoption of SFAS No. 142 on January 1, 2002, the amortization of
existing goodwill ceased and the carrying amount of goodwill was allocated to
the applicable reporting units. The allocation was based on the sources of
previously recognized goodwill and the reporting units to which the related
acquired net assets were assigned. Management's expectations of which reporting
units had benefited from the synergies of acquired businesses were considered in
the allocation process. Annual impairment testing for 2003 and 2004 resulted in
no impairment of goodwill.
F-73
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
Goodwill as of December 31, 2002, 2003 and 2004, as well as the changes in
the carrying amount of goodwill and intangible assets with finite lives for
2004, are as follows:
IDENTIFIABLE INTANGIBLE ASSETS
------------------------------
CORE DEPOSIT RIGHTS-TO- TOTAL IDENTIFIABLE
(DOLLARS IN THOUSANDS) GOODWILL INTANGIBLES EXPIRATION OTHER INTANGIBLE ASSETS
- ------------------------------------------- -------- ------------ ---------- ------ ------------------
Balance, December 31, 2002................. $150,542 $18,694 $19,824 $-- $38,518
Amounts recorded during the year......... 76,014 9,523 12,918 -- 22,441
Amortization expense..................... -- (6,100) (5,267) -- (11,367)
-------- ------- ------- ------ -------
Balance, December 31, 2003................. $226,556 $22,117 $27,475 $-- $49,592
======== ======= ======= ====== =======
Amounts recorded during the year......... 224,405 29,516 -- 2,100 31,616
Amortization expense..................... -- (14,272) (4,942) (257) (19,471)
-------- ------- ------- ------ -------
Balance, December 31, 2004................. $450,961 $37,361 $22,533 $1,843 $61,737
======== ======= ======= ====== =======
Estimated amortization expense for the
years ending:
2005 $15,096 $4,311 $504 $19,911
2006 9,571 3,672 389 13,632
2007 5,471 3,113 299 8,883
2008 3,245 2,622 231 6,098
2009 1,764 2,188 178 4,130
thereafter 2,214 6,627 242 9,083
------- ------- ------ -------
Total amortization expense after 2004...... $37,361 $22,533 $1,843 $61,737
======= ======= ====== =======
On April 1, 2003, the Company completed its acquisition of Tanner Insurance
Brokers, Inc., and recorded approximately $31 million of goodwill and $9 million
of rights-to-expiration. The rights-to-expiration is being amortized on an
accelerated basis over its estimated useful economic life of 30 years.
On July 1, 2003, the Company completed its acquisition of Monterey Bay
Bank, and recorded approximately $32 million of goodwill and $8 million of core
deposit intangible. The core deposit intangible is being amortized on an
accelerated basis over an estimated life of 8 years.
On December 1, 2003, the Company completed its acquisition of Knight
Insurance Agency, and recorded approximately $8 million of goodwill and $3
million of rights-to-expiration. The rights-to-expiration is being amortized on
an accelerated basis over its estimated useful economic life of 10 years.
On January 16, 2004, the Company completed its acquisition of Business Bank
of California, and recorded approximately $86 million of goodwill and $16
million of core deposit intangible. The core deposit intangible is being
amortized on an accelerated basis over an estimated life of 6 years.
On August 1, 2004, the Company completed its acquisition of the business
portfolio of CNA Trust Company (CNAT), and recorded approximately $3 million of
goodwill, $7 million of core deposit intangible and $2 million in other
intangible assets. The identifiable intangibles are being amortized on an
accelerated basis over their estimated life of 7 years.
F-74
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
On October 28, 2004, the Company completed its acquisition of Jackson
Federal Bank, and recorded approximately $139 million of goodwill and $6 million
of core deposit intangible. The core deposit intangible is being amortized on an
accelerated basis over an estimated life of 7 years.
NOTE 5--PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation
and amortization. As of December 31, 2003 and 2004, the amounts were as follows:
DECEMBER 31,
--------------------------------------------------------------------------------------------
2003 2004
------------------------------------------- --------------------------------------------
ACCUMULATED ACCUMULATED
(DOLLARS IN DEPRECIATION AND NET BOOK DEPRECIATION AND NET BOOK
THOUSANDS) COST AMORTIZATION VALUE COST AMORTIZATION VALUE
- ---------------------- ---------- ---------------- -------- ---------- ---------------- --------
Land.................. $ 69,923 $ -- $ 69,923 $ 66,082 $ -- $ 66,082
Premises.............. 394,704 180,912 213,792 432,192 195,389 236,803
Leasehold improvements 160,431 94,423 66,008 175,148 111,368 63,780
Furniture, fixtures
and equipment....... 581,864 421,853 160,011 616,322 452,556 163,766
---------- -------- -------- ---------- -------- --------
Total............. $1,206,922 $697,188 $509,734 $1,289,744 $759,313 $530,431
========== ======== ======== ========== ======== ========
Rental and depreciation and amortization expenses were as follows:
YEARS ENDED DECEMBER 31,
------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ----------------------------------------------------------- ------- ------- -------
Rental expense of premises................................. $53,595 $53,878 $59,405
Less: rental income........................................ 18,505 18,505 15,208
------- ------- -------
Net rental expense....................................... $35,090 $35,373 $44,197
======= ======= =======
Other net rental income, primarily for equipment........... $(1,576) $(1,423) $ (145)
======= ======= =======
Depreciation and amortization of premises and equipment.... $77,426 $90,937 $89,143
======= ======= =======
Future minimum lease payments are as follows:
(DOLLARS IN THOUSANDS) DECEMBER 31, 2004
- -------------------------------------------------------- -----------------
Years ending December 31,
2005.................................................. $ 54,745
2006.................................................. 48,915
2007.................................................. 39,098
2008.................................................. 34,209
2009.................................................. 30,250
Later years........................................... 78,179
--------
Total minimum operating lease payments.................. $285,396
========
Minimum rental income due in the future under
noncancellable subleases.............................. $ 45,101
========
A majority of the leases provide for the payment of taxes, maintenance,
insurance, and certain other expenses applicable to the leased premises. Many of
the leases contain extension provisions and escalation clauses.
F-75
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 6--OTHER ASSETS--INVESTMENTS CARRIED AT COST
The Company invests in private capital funds either directly in the
privately held companies or indirectly through private equity funds. These
investments are carried at cost. The investments' fair value is estimated
quarterly based on a company's business model, current and projected financial
performance, liquidity and overall economic and market conditions. 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
forecasted recovery is beyond a reasonable period of time, an
other-than-temporary impairment is recorded. At December 31, 2003, private
capital investments were carried at cost of $83.6 million. At December 31, 2004,
private capital investments were carried at cost of $97.0 million and there were
no investments in private capital equity securities or funds in excess of fair
value.
NOTE 7--DEPOSITS
At December 31, 2004, the Company had $760 million in domestic interest
bearing time deposits with a remaining term of greater than one year, of which
$272 million exceeded $100,000. Maturity information for all domestic interest
bearing time deposits with a remaining term of greater than one year is
summarized below.
(DOLLARS IN THOUSANDS) DECEMBER 31, 2004
- ---------------------------------------------------------- -----------------
Due after one year through two years...................... $331,434
Due after two years through three years................... 249,763
Due after three years through four years.................. 88,352
Due after four years through five years................... 79,058
Due after five years...................................... 11,201
--------
Total................................................... $759,808
========
All of the foreign interest bearing time deposits exceeding $100,000 mature
in less than one year.
NOTE 8--EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
RETIREMENT PLAN
The Company maintains the Union Bank of California, N.A. Retirement Plan
(the Pension Plan), which is a domestic noncontributory defined benefit pension
plan covering substantially all of the employees of the Company. The Pension
Plan provides retirement benefits based on years of credited service and the
final average compensation amount, as defined in the Pension Plan. Employees
become eligible for this plan after one year of service and become fully vested
after five years of service. The Company's funding policy is to make
contributions between the minimum required and the maximum deductible amount as
allowed by the Internal Revenue Code. Contributions are intended to provide not
only for benefits attributed to services to date, but also for those expected to
be earned in the future. The Company also separately maintains foreign pension
plans with a value of approximately $4 million. These plans are accounted for
separately and are not included in the pension benefits table below.
F-76
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 8--EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
(CONTINUED)
OTHER POSTRETIREMENT BENEFITS
GENERAL
The Company maintains the Union Bank of California Employee Health Benefit
Plan (the Health Plan), which in part provides certain healthcare benefits for
its retired employees and life insurance benefits for those employees who
retired prior to January 1, 2001. The healthcare cost is shared between the
Company and the retiree. The life insurance plan is noncontributory. The
accounting for the Health Plan anticipates future cost-sharing changes that are
consistent with the Company's intent to maintain a level of cost-sharing at
approximately 25 to 50 percent, depending on age and service with the Company.
Assets set aside to cover such obligations are primarily invested in mutual
funds and insurance contracts.
PRESCRIPTION DRUG BENEFITS
In 2004, the Company recorded a $6.1 million reduction in employee benefit
expense associated with the remeasurement of our postretirement benefits as a
result of the Medicare Prescription Drug, Improvement and Modernization Act of
2003 ("The Act"). The reduction is attributable to a federal subsidy provided by
The Act to employers that sponsor retiree health care plans with drug benefits
that are equivalent to those offered under Medicare Part D. The effect of the
subsidy on the measurement of net periodic postretirement benefit cost for the
year ended December 31, 2004 includes a $3.1 million actuarial experience gain,
a $1.1 million reduction in service cost, and a $1.9 million reduction in
interest cost on the accumulated postretirement benefit obligation (APBO). The
effect of the subsidy related to benefits attributed to past service in
measuring the Company's January 1, 2004 APBO was a reduction of $30.8 million
related to benefits attributed to past service. This is reflected in the 2004
actuarial gain of $35.9 million in the benefit obligations for other benefits
noted below.
The following table sets forth the fair value of the assets in the
Company's defined benefit pension plan and its other postretirement benefit plan
as of December 31, 2002, 2003 and 2004.
PENSION BENEFITS OTHER BENEFITS
------------------------------------ ---------------------------------
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
------------------------------------ ---------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004 2002 2003 2004
- -------------------------------------------- -------- -------- ---------- ------- -------- --------
CHANGE IN PLAN ASSETS
Fair value of plan assets, beginning of year $596,470 $660,140 $ 904,878 $52,489 $ 81,536 $106,245
Actual return on plan assets................ (54,847) 168,416 104,649 (10,850) 17,842 10,872
Employer contribution....................... 140,000 100,000 100,000 48,820 16,627 15,286
Plan participants' contributions............ -- -- -- 1,615 1,968 2,444
Benefits paid............................... (21,483) (23,678) (26,704) (10,538) (11,728) (12,247)
-------- -------- ---------- ------- -------- --------
Fair value of plan assets, end of year...... $660,140 $904,878 $1,082,823 $81,536 $106,245 $122,600
======== ======== ========== ======= ======== ========
F-77
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 8--EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
(CONTINUED)
The Company's actual period-end asset allocation for the Pension Plan
and Health Plan, by asset category, was as follows:
PENSION PLAN HEALTH PLAN
------------------- -------------------
DECEMBER 31, DECEMBER 31,
------------------- -------------------
ASSET CATEGORY 2002 2003 2004 2002 2003 2004
- ------------------------------------------------ ---- ---- ---- ---- ---- ----
Domestic equity securities...................... 39% 48% 50% 56% 30% 31%
International equity securities................. 12 21 22 0 13 14
Fixed income debt securities.................... 35 29 28 11 25 28
Insurance contracts............................. 0 0 0 33 30 26
Cash and cash equivalents....................... 14 2 0 0 2 1
--- --- --- --- --- ---
Total........................................... 100% 100% 100% 100% 100% 100%
=== === === === === ===
The investment objective for the Company's Pension Plan and Health Plan is
to maximize total return within reasonable and prudent levels of risk. The
Plan's asset allocation strategy is the principal determinant in achieving
expected investment returns on the Plans' assets. The asset allocation strategy
favors equities, with a target allocation of 70 percent equity securities and 30
percent debt securities. Additionally, the Health Plan holds investments in an
insurance contract with Hartford Life that is separate from the target
allocation. Actual asset allocations may fluctuate within acceptable ranges due
to market value variability. If market fluctuations cause an asset class to fall
outside of its strategic asset allocation range, the portfolio will be
rebalanced as appropriate. The Company's policy is to fully invest plan assets;
however, on December 31, 2002 the Company made a $75 million cash contribution
to the Pension Plan, which was invested in money market assets until invested
for a longer term. A core equity position of domestic large cap and small cap
stocks will be maintained, in conjunction with a diversified portfolio of
international equities and fixed income securities. Plan asset performance is
compared against established indices and peer groups to evaluate whether the
risk associated with the portfolio is appropriate for the level of return.
The Company, aided by an independent advisor, periodically reconsiders the
appropriate strategic asset allocation and the expected long-term rate of return
for plan assets. The independent advisor evaluates the investment return
volatility of different asset classes and compares the liability structure of
the Company's plan to those of other companies, while considering the Company's
funding policy to maintain a funded status sufficient to meet participants'
benefit obligations and reducing long-term funding requirements and pension
costs. Based on this information, the Company updates its asset allocation
strategy and target investment allocation percentages for the assets of the
plan, as well as adopting an expected long-term rate of return.
F-78
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 8--EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
(CONTINUED)
The following table sets forth the benefit obligation activity and funded
status for each of the Company's plans as follows:
PENSION BENEFITS OTHER BENEFITS
------------------------------------- ----------------------------------
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
------------------------------------- ----------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004 2002 2003 2004
- ------------------------------------------ -------- -------- ---------- -------- -------- --------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of year..... $595,736 $726,099 $819,552 $123,720 $157,957 $182,408
Service cost.............................. 25,810 32,867 37,659 5,262 5,180 5,643
Interest cost............................. 43,316 47,500 52,240 9,546 10,562 9,438
Plan participants' contributions.......... -- -- -- 1,615 1,968 2,444
Amendments(1)............................. -- -- -- (8,544) -- (4,109)
Actuarial loss (gain)..................... 82,720 36,765 128,553 36,896 18,469 (35,952)
Benefits paid............................. (21,483) (23,679) (26,704) (10,538) (11,728) (12,247)
-------- -------- ---------- -------- -------- --------
Benefit obligation, end of year........... 726,099 819,552 1,011,300 157,957 182,408 147,625
======== ======== ========== ======== ======== ========
Funded status............................. (65,959) 85,325 71,523 (76,422) (76,163) (25,025)
Unrecognized transition amount............ -- -- -- 25,486 22,937 16,279
Unrecognized net actuarial loss........... 290,750 227,741 320,340 77,120 78,099 36,290
Unrecognized prior service cost........... 4,524 3,457 2,390 (1,345) (1,249) (1,153)
-------- -------- --------- -------- -------- --------
Prepaid benefit cost...................... $229,315 $316,523 $394,253 $24,839 $23,624 $26,391
======== ======== ========= ======== ======== ========
- --------------------
(1) In 2002, the Company changed its postretirement medical benefit plan to
increase the required contributions as a percentage of total cost paid by
some future retirees. In 2004, the Company made changes to the plan design
for employer contribution subsidies resulting in a reduction of future
obligations.
The Company expects to make cash contributions of $125 million to the
Pension Plan and $17 million to the Health Plan for pension and postretirement
benefits, respectively, in 2005.
ESTIMATED FUTURE BENEFIT PAYMENTS AND SUBSIDIES
The following pension and postretirement benefit payments, which reflect
expected future service, as appropriate, are expected to be paid over the next
10 years and Medicare Part D Subsidies are expected to be received over the next
10 years.
PENSION POSTRETIREMENT MEDICAL PART D
(DOLLARS IN THOUSANDS) BENEFITS BENEFITS SUBSIDIES
- ---------------------- -------- -------- ---------
2005.............................. $30,429 $9,989 $--
2006.............................. 33,174 10,030 833
2007.............................. 36,259 10,567 890
2008.............................. 39,639 11,076 937
2009.............................. 43,723 11,508 983
Years 2010-2014................... 291,729 65,206 5,667
F-79
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 8--EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
(CONTINUED)
The following tables summarize the assumptions used in computing the
present value of the projected benefit obligations and the net periodic cost.
PENSION BENEFITS OTHER BENEFITS
-------------------- --------------------
YEARS ENDED YEARS ENDED
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
2002 2003 2004 2002 2003 2004
---- ---- ---- ---- ---- ----
Discount rate in determining expense.................. 7.25% 6.75% 6.25% 7.25% 6.75% 6.25%
Discount rate in determining benefit obligations
at year end........................................... 6.75 6.25 5.75 6.75 6.25 5.75
Rate of increase in future compensation levels
for determining expense............................. 5.00 5.00 4.50 -- -- --
Rate of increase in future compensation levels for
determining benefit obligations at year end......... 5.00 4.50 4.50 -- -- --
Expected return on plan assets........................ 8.25 8.25 8.25 8.00 8.00 8.25
PENSION BENEFITS OTHER BENEFITS
----------------------------------- ------------------------------
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
----------------------------------- ------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004 2002 2003 2004
- --------------------------------------------- ------- ------- ------- ------- ------ ------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost................................. $25,810 $32,867 $37,659 $5,262 $5,180 $5,643
Interest cost................................ 43,316 47,500 52,240 9,546 10,562 9,438
Expected return on plan assets............... (60,613) (72,811) (83,130) (6,591) (6,746) (9,012)
Amortization of prior service cost........... 1,067 1,067 1,067 (96) (96) (96)
Amortization of transition amount............ -- -- -- 3,403 2,549 2,549
Recognized net actuarial loss................ -- 4,169 14,434 2,299 6,394 3,996
------ ------- ------- ------- ------- -------
Net periodic benefit cost.................. 9,580 12,792 22,270 13,823 17,843 12,518
Gain due to curtailment...................... -- -- -- -- -- --
------ ------- ------- ------- ------- -------
Total net periodic benefit cost............ $9,580 $12,792 $22,270 $13,823 $17,843 $12,518
====== ======= ======= ======= ======= =======
The Company's assumed weighted-average healthcare cost trend rates are as
follows:
YEAR ENDED DECEMBER 31,
-----------------------
2002 2003 2004
---- ---- ----
Health care cost trend rate assumed for next year......... 8.95% 8.07% 7.25%
Rate to which cost trend rate is assumed to
decline (the ultimate trend rate)....................... 5.00% 5.00% 5.00%
Year the rate reaches the ultimate trend rate............. 2008 2008 2008
F-80
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 8--EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
(CONTINUED)
The healthcare cost trend rate assumptions have a significant effect on the
amounts reported for the Health Plan. A one-percentage-point change in assumed
healthcare cost trend rates would have the following effects.
1-PERCENTAGE- 1-PERCENTAGE-
(DOLLARS IN THOUSANDS) POINT INCREASE POINT DECREASE
- ---------------------- -------------- --------------
Effect on total of service and interest cost components... $2,106 $(1,741)
Effect on postretirement benefit obligation............... 15,736 (13,368)
EXECUTIVE SUPPLEMENTAL BENEFIT PLANS
The Company has several Executive Supplemental Benefit Plans (ESBP), which
provide eligible employees with supplemental retirement benefits. The plans are
unfunded. The accrued liability for ESBPs included in other liabilities in the
Consolidated Balance Sheets was $37 million at December 31, 2003 and $43 million
at December 31, 2004. The Company's expense relating to the ESBPs for the
periods ending December 31, 2002, 2003, and 2004, was $3.0 million, $0.3
million, and $4.1 million, respectively. These plans had intangible assets of
$1.7 million, $2.1 million and $1.6 million as of December 31, 2002, 2003, and
2004, respectively. Due to an additional minimum liability, these plans also had
accumulated other comprehensive income before taxes of $1.7 million, $6.1
million, and $10.8 million as of December 31, 2002, 2003, and 2004,
respectively.
SECTION 401(K) SAVINGS PLANS
The Company has a defined contribution plan authorized under Section 401(k)
of the Internal Revenue Code. All benefits-eligible employees are eligible to
participate in the plan. Employees may contribute up to 25 percent of their
pre-tax covered compensation or up to 10 percent of their after-tax covered
compensation through salary deductions to a combined maximum of 25 percent. The
Company contributes 50 percent of every pre-tax dollar an employee contributes
up to the first 6 percent of the employee's pre-tax covered compensation.
Employees are fully vested in the employer's contributions immediately. In
addition, the Company may make a discretionary annual profit-sharing
contribution up to 2.5 percent of an employee's pay. This profit-sharing
contribution is for all eligible employees, regardless of whether an employee is
participating in the 401(k) plan, and depends on the Company's annual financial
performance. All employer contributions are tax deductible by the Company. The
Company's combined matching contribution expense was $17 million, $19 million,
and $22 million for the years ended December 31, 2002, 2003 and 2004,
respectively.
F-81
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 9--OTHER NONINTEREST INCOME AND NONINTEREST EXPENSE
The details of other noninterest income and noninterest expense are as
follows:
OTHER NONINTEREST INCOME
YEARS ENDED DECEMBER 31,
-------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ------------------------------------------------------ ------- ------- --------
Gain on merchant card portfolio....................... $ -- $ -- $ 93,000
Private capital and other investment income........... (14,004) 3,697 30,807
Gains (losses) on nonmortgage loans, net.............. (3,526) 3,556 2,188
Other................................................. 59,270 69,428 88,500
------- ------- --------
Total other noninterest income...................... $41,740 $76,681 $214,495
======= ======= ========
OTHER NONINTEREST EXPENSE
YEARS ENDED DECEMBER 31,
----------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ------------------------------------------------------ -------- -------- --------
Advertising and public relations...................... $ 37,510 $ 39,455 $ 38,442
Data processing....................................... 32,589 31,574 32,229
Intangible asset amortization......................... 5,485 11,366 19,471
Other................................................. 176,234 179,356 197,144
-------- -------- --------
Total other noninterest expense..................... $251,818 $261,751 $287,286
======== ======== ========
NOTE 10--INCOME TAXES
The components of income tax expense were as follows:
YEARS ENDED DECEMBER 31,
----------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- -------------------------------------------- -------- -------- --------
Taxes currently payable:
Federal................................... $173,310 $225,813 $291,946
State..................................... 31,622 13,017 41,785
Foreign................................... 3,996 1,081 1,754
-------- -------- --------
Total currently payable................... 208,928 239,911 335,485
-------- -------- --------
Taxes deferred:
Federal................................... 58,586 38,569 54,902
State..................................... (20,807) 14,369 22,584
Foreign................................... 669 (22) (159)
-------- -------- --------
Total deferred............................ 38,448 52,916 77,327
-------- -------- --------
Total income tax expense.................. $247,376 $292,827 $412,812
======== ======== ========
F-82
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 10 - INCOME TAXES (CONTINUED)
The components of the net deferred tax balances of the Company were as
follows:
DECEMBER 31,
-------------------
(DOLLARS IN THOUSANDS) 2003 2004
- ----------------------------------------------------------------- -------- --------
Deferred tax assets:
Allowance for loan and off-balance sheet losses................ $217,759 $196,503
Accrued income and expense..................................... 57,552 81,753
Unrealized net loss on securities available for sale........... -- 19,634
Tax credit carryforwards....................................... 10,577 --
Other.......................................................... 12,806 283
-------- --------
Total deferred tax assets...................................... 298,694 298,173
Deferred tax liabilities:
Leasing........................................................ 459,997 467,027
Unrealized net gain on securities available for sale........... 13,961 --
Pension liabilities............................................ 119,121 151,757
Unrealized net gains on cash flow hedges....................... 27,122 885
-------- --------
Total deferred tax liabilities................................. 620,201 619,669
-------- --------
Net deferred tax liability....................................... $321,507 $321,496
======== ========
It is management's opinion that no valuation allowance is necessary because
the tax benefits from the Company's deferred tax assets are expected to be
utilized in future tax returns.
The following table is an analysis of the effective tax rate:
YEARS ENDED DECEMBER 31,
------------------------
2002 2003 2004
---- ---- ----
Federal income tax rate...................................... 35% 35% 35%
Net tax effects of:
State income taxes, net of federal income tax benefit...... 1 2 4
Tax credits................................................ (4) (3) (3)
Other...................................................... -- (1) --
-- -- --
Effective tax rate......................................... 32% 33% 36%
== == ==
The Company has filed its 2002 and 2003, and intends to file its 2004,
California franchise tax returns on the worldwide unitary basis, incorporating
the financial results of BTM and its worldwide affiliates. In 2004, the Company
recognized a $7.8 million state income tax expense primarily to reflect the
difference between the estimate of California state tax expense for 2003 and the
actual tax reported in the 2003 California franchise tax return.
In 2003, the Company recognized a $2.7 million reduction of income taxes
paid in 1998, 1999, and 2000, resulting from the settlement of several tax
issues with the Internal Revenue Service.
F-83
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 10 - INCOME TAXES (CONTINUED)
During 2002, the Company recognized a tax credit adjustment of $9.8 million
related to the correction of an accounting error for certain low-income housing
credit (LIHC) investments and a $3.3 million net reduction in income tax expense
resulting from a change in California state tax law concerning loan loss
reserves.
NOTE 11--BORROWED FUNDS
The following is a summary of the major categories of borrowed funds:
DECEMBER 31,
-------------------------
(DOLLARS IN THOUSANDS) 2003 2004
- ----------------------------------------------------------------- ---------- ----------
Federal funds purchased and securities sold under
repurchase agreements with weighted average
interest rates of 0.68% and 1.90% at December 31,
2003 and 2004, respectively.................................... $ 280,968 $ 587,249
Commercial paper, with weighted average interest rates
of 0.83% and 1.69% at December 31, 2003 and 2004,
respectively................................................... 542,270 824,887
Other borrowed funds, with weighted average interest
rates of 1.49% and 4.25% at December 31, 2003 and
2004, respectively............................................. 212,088 172,549
---------- ----------
Total borrowed funds........................................... $1,035,326 $1,584,685
========== ==========
Federal funds purchased and securities sold under
repurchase agreements:
Maximum outstanding at any month end........................... $ 421,373 $ 739,386
Average balance during the year................................ 405,982 596,997
Weighted average interest rate during the year................. 0.84% 1.25%
Commercial paper:
Maximum outstanding at any month end........................... $1,078,981 $855,334
Average balance during the year................................ 809,930 620,053
Weighted average interest rate during the year................. 1.05% 1.11%
Other borrowed funds:
Maximum outstanding at any month end........................... $ 322,308 $ 212,371
Average balance during the year................................ 192,248 163,147
Weighted average interest rate during the year................. 2.65% 2.98%
Included in other borrowed funds in 2003 and 2004 are assumed mortgage
notes related to the purchase of the Company's administrative facility at
Monterey Park, California. At December 31, 2004, the notes consisted of 14 zero
coupon notes with varying maturity dates through 2011. Maturities of these notes
for the next five years are as follows: $5.3 million in 2005, $5.0 million in
2006, $4.9 million in 2007, $5.6 million in 2008, $6.2 million in 2009, and
$12.6 million thereafter.
F-84
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 12--MEDIUM AND LONG-TERM DEBT
The following is a summary of the Company's medium-term senior debt and
long-term subordinated debt.
DECEMBER 31,
---------------------
(DOLLARS IN THOUSANDS) 2003 2004
- ----------------------------------------------------------------- -------- --------
Medium-Term debt, fixed rate 5.75% senior notes
due December 2006.............................................. $214,565 $207,160
Long-Term subordinated debt:
Floating rate notes due June 2007. These notes
bear interest at 0.325% above 3-month London
Interbank Offered Rate (LIBOR) and are payable to BTM........ 199,826 199,876
Fixed rate 5.25% notes due December 2013....................... 406,097 409,077
-------- --------
Total medium and long-term debt.............................. $820,488 $816,113
======== ========
MEDIUM-TERM DEBT
At December 31, 2004, the par value of the medium-term notes was $200
million. The weighted average interest rate on the medium-term notes, including
the impact of the deferred issuance costs, was 5.90 percent at December 31,
2004. The notes do not qualify as Tier 2 risk-based capital under the Federal
Reserve guidelines for assessing regulatory capital and are not redeemable prior
to the stated maturity. The notes are senior obligations and are ranked equally
with all existing or future unsecured senior debt.
The Company has converted its 5.75 percent fixed rate on these notes to a
floating rate of interest utilizing a $200 million notional interest rate swap,
which qualified as a fair value hedge at December 31, 2004. This transaction
meets the qualifications for utilizing the shortcut method for measuring
effectiveness under SFAS No. 133. The market value adjustment to the medium-term
debt was an unrealized loss of $7.2 million, and the fair value of the hedge was
an unrealized gain of $7.2 million. For the year ending December 31, 2004, the
weighted average interest rate, including the impact of the hedge and deferred
issuance costs was 2.10 percent.
LONG-TERM DEBT
On December 8, 2003, the Company issued $400 million of long-term
subordinated debt. For the year ending December 31, 2004, the weighted average
interest rate of the long-term subordinated debt, including the impact of the
deferred issuance costs was 5.40 percent. The notes are junior obligations to
the Company's existing and future outstanding senior indebtedness and ranked
equally with the existing long-term subordinated debt with a par value of $200
million.
The Company has converted its 5.25 percent fixed rate on these notes to a
floating rate of interest utilizing a $400 million notional interest rate swap,
which qualified as a fair value hedge at December 31, 2004. This transaction
meets the qualifications for utilizing the shortcut method for measuring
effectiveness under SFAS No. 133. The market value adjustment to the medium-term
debt was an unrealized loss of $10.4 million, and the fair value of the hedge
was an unrealized gain of $10.4 million. For the year ending December 31, 2004,
the weighted average interest rate, including the impact of the hedge and
deferred issuance costs was 2.25 percent.
The floating rate and fixed rate subordinated debt qualify as Tier 2
risk-based capital under the Federal Reserve guidelines for assessing regulatory
capital. For the total risk-based capital ratio, the amount of notes
F-85
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 12 - MEDIUM AND LONG-TERM DEBT (CONTINUED)
that qualify as capital is reduced as the notes approach maturity. For the year
ending December 31, 2003 and 2004, $520 million and $480 million of the notes,
respectively, qualified as risk-based capital.
In June 1997, the Company issued $200 million of floating-rate subordinated
debt due in June 2007. These notes bear interest at 0.325 percent above 3-month
LIBOR and are payable to the holder of the note, BTM. As of December 31, 2004,
the weighted average interest rate of the floating rate notes was 1.81 percent.
Provisions of the senior and subordinated notes restrict the Company's
ability to engage in mergers, consolidations, and transfers of substantially all
assets.
NOTE 13--UNIONBANCAL CORPORATION--JUNIOR SUBORDINATED DEBT PAYABLE TO SUBSIDIARY
GRANTOR TRUST
In February 1999, UnionBanCal Finance Trust I issued $350 million preferred
securities to the public and $10,824,750 common securities to the Company. The
proceeds of such issuances were invested by UnionBanCal Finance Trust I in
$360,824,750 aggregate principal amount of the Company's 7 3/8 percent debt
securities due May 15, 2029 (the Trust Notes). The Trust Notes represented the
sole asset of UnionBanCal Finance Trust I. The Trust Notes had a maturity date
of May 15, 2029, bore interest at the rate of 7 3/8 percent, payable quarterly,
and were redeemable by the Company beginning on or after February 19, 2004, at
100 percent of the principal amount thereof, plus any accrued and unpaid
interest to the redemption date.
Holders of the preferred securities and common securities were entitled to
cumulative cash distributions at an annual rate of 7 3/8 percent of the
liquidation amount of $25 per security. The preferred securities were subject to
mandatory redemption upon repayment of the Trust Notes and were callable by the
Company at 100 percent of the liquidation amount beginning on or after February
19, 2004. The Trust existed for the sole purpose of issuing the preferred
securities and investing the proceeds in the Trust Notes issued by the Company.
On February 19, 2004, the Company redeemed all $360.8 million of its
outstanding 7 3/8 percent Trust Notes, which were held by UnionBanCal Finance
Trust I. The proceeds were applied by UnionBanCal Finance Trust I to
simultaneously redeem all $350 million of its 7 3/8 percent preferred securities
at a price of $25 per share.
On March 23, 2000, Business Capital Trust I issued $10 million preferred
securities to the public and $0.3 million common securities to the Company. The
proceeds of such issuances were invested by Business Capital Trust I in $10.3
million aggregate principal amount of the Company's 10.875 percent debt
securities due March 8, 2030 (the Trust Notes). The Trust Notes represent the
sole asset of Business Capital Trust I. The Trust Notes mature on March 8, 2030,
bear interest at the rate of 10.875 percent, payable semi-annually, and are
redeemable by the Company at a premium (with premium declining each year)
beginning on or after March 8, 2010 through March 7, 2020 plus any accrued and
unpaid interest to the redemption date. On or after March 8, 2020, the Trust
Notes are redeemable by the Company at 100 percent of the principal amount.
Holders of the preferred and common securities are entitled to cumulative
cash distributions at an annual rate of 10.875 percent of the liquidation amount
of $1,000 per capital security. The preferred securities are subject to
mandatory redemption upon repayment of the Trust Notes and are callable at a
premium (with premium declining each year) at 105.438 percent of the liquidation
amount beginning on or after March 8, 2010 through March 7, 2020 plus any
accrued and unpaid interest to the redemption date. On or after
F-86
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 13 - UNIONBANCAL CORPORATION - JUNIOR SUBORDINATED DEBT PAYABLE TO
SUBSIDIARY GRANTOR TRUST (CONTINUED)
March 8, 2020, the preferred securities are redeemable at 100 percent of the
principal. Business Capital Trust I exists for the sole purpose of issuing the
preferred securities and investing the proceeds in the Trust Notes issued by the
Company.
On September 7, 2000, MCB Statutory Trust I completed an offering of 10.6
percent preferred securities of $3.0 million to the public and $0.1 million
common securities to the Company. The proceeds of such issuance were invested by
MCB Statutory Trust I in $3.1 million aggregate principal amount of the
Company's 10.6 percent debt securities due September 7, 2030 (the Trust Notes).
The Trust Notes represent the sole assets of MCB Statutory Trust I. The Trust
Notes mature on September 7, 2030, bear interest at the rate of 10.6 percent,
payable semi-annually and are redeemable by the Company at a premium (with
premium declining each year) beginning on or after September 7, 2010 through
September 6, 2020 plus any accrued and unpaid interest to the redemption date.
On or after September 7, 2020, the Trust Notes are redeemable by the Company at
100 percent of the principal amount.
Holders of the preferred securities and common securities are entitled to
cumulative cash distributions at an annual rate of 10.6 percent of the
liquidation amount of $1,000 per capital security. The preferred securities are
subject to mandatory redemption upon repayment of the Trust Notes and are
callable at a premium (with premium declining each year) at 105.3 percent of the
liquidation amount beginning on or after September 7, 2010 through September 6,
2020 plus any accrued and unpaid interest to the redemption date. On or after
September 7, 2020, the preferred securities are redeemable at 100 percent of the
principal amount. MCB Statutory Trust I exists for the sole purpose of issuing
the preferred securities and investing the proceeds in the Trust Notes issued by
the Company.
On January 16, 2004, the Company completed the acquisition of Business
Bancorp, which included Business Capital Trust I and MCB Statutory Trust I. In
accordance with SFAS No. 141 the Trust Notes were recorded at their fair value
at the date of acquisition. Accordingly, the Company has recorded the Trust
Notes at $16.2 million.
The weighted average interest rate for all Trust Notes were 4.13 percent
and 4.45 percent for the years ended December 31, 2003 and 2004, respectively.
NOTE 14--DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
The Company has a dividend reinvestment and stock purchase plan for
stockholders. Participating stockholders have the option of purchasing
additional shares at the full market price with cash payments of $25 to $3,000
per quarter. The Company obtains shares required for reinvestment primarily
through open market purchases. During 2002, 2003 and 2004, 367,713, 190,847 and
100,596 shares, respectively, were required for dividend reinvestment purposes,
of which 19,881, 5,731 and 308 shares were considered new issuances during 2002,
2003 and 2004, respectively. BTM did not participate in the plan in 2002, 2003
or 2004.
NOTE 15--MANAGEMENT STOCK PLANS
The Company has two management stock plans. The Year 2000 UnionBanCal
Corporation Stock Plan, effective January 1, 2000 (the 2000 Stock Plan), and the
UnionBanCal Corporation Management Stock Plan, restated effective June 1, 1997
(the 1997 Stock Plan), have 16.0 million and 6.6 million shares, respectively,
F-87
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 15 - MANAGEMENT STOCK PLANS (CONTINUED)
of the Company's common stock authorized to be awarded to key employees and
outside directors of the Company at the discretion of the Executive Compensation
and Benefits Committee of the Board of Directors (the Committee). Employees on
rotational assignment from BTM are not eligible for stock awards.
The Committee determines the term of each stock option grant, up to a
maximum of ten years from the date of grant. The exercise price of the options
issued under the Stock Plans shall not be less than the fair market value on the
date the option is granted. Unvested restricted stock issued under the Stock
Plans is shown as a reduction to retained earnings. The value of the restricted
shares at the date of grant is amortized to compensation expense over its
vesting period. All cancelled or forfeited options and restricted stock become
available for future grants.
In 2002, 2003 and 2004, the Company granted options to non-employee
directors and various key employees, including policy-making officers under the
2000 Stock Plan. Under both Stock Plans, options granted to employees vest
pro-rata on each anniversary of the grant date and become fully exercisable
three years from the grant date, provided that the employee has completed the
specified continuous service requirement. The options vest earlier if the
employee dies, is permanently disabled, or retires under certain grant, age, and
service conditions. Options granted to non-employee directors are fully vested
on the grant date and exercisable 33 1/3 percent on each anniversary under the
1997 Stock Plan, and fully vested and exercisable on the grant date under the
2000 Stock Plan. The following is a summary of stock option transactions under
the Stock Plans.
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
2002 2003 2004
----------------------------- ---------------------------- -----------------------------
NUMBER OF WEIGHTED-AVERAGE NUMBER OF WEIGHTED-AVERAGE NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ -------------- ------ -------------- ------ --------------
Options outstanding, beginning of
year.......................... 7,939,271 $29.79 8,515,469 $34.71 9,008,011 $37.12
Granted..................... 2,911,652 43.49 2,517,023 40.32 2,478,931 52.84
Exercised................... (2,187,170) 28.57 (1,912,323) 30.52 (1,917,818) 33.68
Forfeited................... (148,284) 34.05 (112,158) 38.96 (86,788) 42.87
---------- ---------- ----------
Options outstanding, end of year 8,515,469 $34.71 9,008,011 $37.12 9,482,336 $41.87
========== ========== ==========
Options exercisable, end of year 3,031,478 $31.08 3,845,520 $33.99 4,733,003 $36.49
========== ========== ==========
The weighted-average fair value of options granted was $16.67 during 2002,
$12.92 during 2003 and $16.55 during 2004.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants made in 2002, 2003 and 2004; risk-free interest
rates of 4.9 percent in 2002, 2.9 percent in 2003, and 2.8 percent in 2004;
expected volatility of 46 percent in 2002, 43 percent in 2003, and 40 percent in
2004; expected lives of 5 years for 2002, 2003 and 2004; and expected dividend
yields of 2.3 percent in 2002, 2.8 percent in 2003, and 2.4 percent in 2004.
F-88
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 15 - MANAGEMENT STOCK PLANS (CONTINUED)
The following table summarizes information about stock options outstanding.
OPTIONS EXERCISABLE AT
OPTIONS OUTSTANDING AT DECEMBER 31, 2004 DECEMBER 31, 2004
------------------------------------------------------- -------------------------------------
WEIGHTED-AVERAGE
REMAINING WEIGHTED- WEIGHTED-
RANGE OF NUMBER CONTRACTUAL LIFE AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING IN YEARS EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------- ----------- -------- -------------- ----------- --------------
$18.53-27.56 71,455 4.2 $22.94 71,455 $22.94
28.44-42.40 4,535,236 6.5 35.16 3,079,232 32.94
42.69-59.74 4,875,645 8.1 48.39 1,582,316 44.00
--------- ---------
9,482,336 4,733,003
========= =========
In 2002, 2003, and 2004, the Company also granted 6,000, 6,000, and 16,000
shares of restricted stock with weighted average grant date fair values of
$45.00, $46.95 and $61.50, respectively, to key officers, including
policy-making officers, under the 2000 Stock Plan. The awards of restricted
stock vest pro-rata on each anniversary of the grant date and become fully
vested four years from the grant date for awards in 2002 and 2003 and three
years from the grant date for awards in 2004, provided that the employee has
completed the specified continuous service requirement. They vest earlier if the
employee dies, is permanently and totally disabled, or retires under certain
grant, age, and service conditions. Restricted stockholders have the right to
vote their restricted shares and receive dividends.
At December 31, 2002, 2003 and 2004, 1,764,414, 5,347,715 and 2,937,629
shares, respectively, were available for future grants as either stock options
or restricted stock under the 2000 Stock Plan. The remaining shares under the
1997 Stock Plan are not available for future grants.
Effective January 1, 1997, the Company established a Performance Share
Plan. Eligible participants may earn performance share awards to be redeemed in
cash three years after the date of grant. Performance shares are linked to
stockholder value in two ways: (1) the market price of the Company's common
stock; and (2) return on equity, a performance measure closely linked to value
creation. Eligible participants generally receive grants of performance shares
annually. The plan was amended in 2004 increasing the total number of shares
that can be granted under the plan to 2.6 million shares. There were 384,183,
340,683 and 2,252,183 performance shares remaining for future awards as of
December 31, 2002, 2003 and 2004, respectively. The Company granted 61,500
shares in 2002, 43,500 shares in 2003, and 88,500 shares in 2004. No performance
shares were forfeited in 2002, 2003 or 2004. The value of a performance share is
equal to the market price of the Company's common stock. All cancelled or
forfeited performance shares become available for future grants. Expenses
related to these shares were $3.3 million in 2002, $6.6 million in 2003, and
$4.8 million in 2004.
NOTE 16--CONCENTRATIONS OF CREDIT RISK
Concentrations of credit risk exist when changes in economic, industry or
geographic factors similarly affect groups of counterparties whose aggregate
credit exposure is material in relation to the Company's total credit exposure.
Although the Company's portfolio of financial instruments is broadly diversified
along industry, product and geographic lines, material transactions are
completed with other financial institutions, particularly in the securities
portfolio and deposit accounts.
F-89
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 16 - CONCENTRATIONS OF CREDIT RISK (CONTINUED)
In connection with the Company's efforts to maintain a diversified
portfolio, the Company limits its exposure to any one country or individual
credit and monitors this exposure on a continuous basis. At December 31, 2004,
the Company's most significant concentration of credit risk was with the U. S.
Government and its agencies. The Company's exposure, which primarily results
from investment securities positions in instruments issued by the U.S.
Government and its agencies, was $10.4 billion and $9.9 billion at December 31,
2003 and 2004.
NOTE 17--FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. All of the fair values presented
below are as of their respective period-ends and have been made under this
definition of fair value unless otherwise disclosed.
It is management's belief that the fair values presented below are
reasonable based on the valuation techniques and data available to the Company
as of December 31, 2003 and 2004, as more fully described below. It should be
noted that the operations of the Company are managed on a going concern basis
and not on a liquidation basis. As a result, the ultimate value realized for the
financial instruments presented could be substantially different when actually
recognized over time through the normal course of operations. Additionally, a
substantial portion of an institution's inherent value is its capitalization and
franchise value. Neither of these components has been given consideration in the
presentation of fair values that follow.
F-90
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 17--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The table below presents the carrying value and fair value of the specified
assets, liabilities, and off-balance sheet instruments held by the Company.
DECEMBER 31,
-----------------------------------------------------------
2003 2004
-------------------------- --------------------------
CARRYING FAIR CARRYING FAIR
(DOLLARS IN THOUSANDS) VALUE VALUE VALUE VALUE
- ------------------------------------------------- ----------- ---------- ---------- ----------
ASSETS
Cash and cash equivalents...................... $3,499,005 $3,499,005 $3,548,040 $3,548,040
Trading account assets......................... 252,929 252,929 236,331 236,331
Securities available for sale:
Securities pledged as collateral............. 106,560 106,560 144,240 144,240
Held in portfolio............................ 10,660,332 10,660,332 11,000,754 11,000,754
Loans, net of allowance for loan losses(1)..... 24,777,826 24,742,090 29,728,344 29,477,602
LIABILITIES
DEPOSITS:
Noninterest bearing.......................... 17,288,022 17,288,022 19,641,595 19,641,595
Interest bearing............................. 18,244,261 18,272,083 20,534,241 20,548,041
---------- ---------- ---------- ----------
Total deposits............................. 35,532,283 35,560,105 40,175,836 40,189,636
Borrowed funds................................. 1,035,326 1,037,871 1,584,685 1,587,700
Medium and long-term debt...................... 820,488 821,617 816,113 814,370
Junior subordinated debt payable to
subsidiary grantor trust..................... 363,940 355,180 15,790 15,350
OFF-BALANCE SHEET INSTRUMENTS
Commitments to extend credit................... 52,327 52,327 60,119 60,119
Standby letters of credit...................... 6,108 6,108 5,743 5,743
- --------------------
(1) Excludes lease financing, net of allowance.
The following methods and assumptions were used to estimate fair value of
each class of financial instruments for which it is practicable to estimate that
value.
CASH AND CASH EQUIVALENTS: The carrying value of cash and cash equivalents
is considered a reasonable estimate of fair value.
TRADING ACCOUNT ASSETS: Trading account assets are short term in nature and
valued at market based on quoted market prices or dealer quotes. If a quoted
market price is not available, the recorded amounts are estimated using quoted
market prices for similar securities. Thus, carrying value is considered a
reasonable estimate of fair value for these financial instruments.
SECURITIES: The fair value of securities is based on quoted market prices
or dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities. Securities
available for sale are carried at their aggregate fair value.
F-91
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 17--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
LOANS: The fair value for performing fixed and non-reference rate loans was
estimated by discounting the future cash flows using the current rates at which
similar loans would be made to borrowers with similar credit ratings and for
similar remaining maturities and, where available, discount rates were based on
current market rates.
Loans that are on nonaccrual status were not included in the loan valuation
methods discussed previously. The fair value of these assets was estimated
assuming these loans were sold at their carrying value less their impairment
allowance.
The fair value of performing mortgage loans was based on quoted market
prices for loans with similar credit and interest rate risk characteristics.
The fair value of credit lines is assumed to approximate their carrying
value.
NONINTEREST BEARING DEPOSITS: The fair value of noninterest bearing
deposits is the amount payable on demand at the reporting date. The fair value
of the core deposit intangible has not been estimated.
INTEREST BEARING DEPOSITS: The fair value of savings accounts and certain
money market accounts is the amount payable on demand at the reporting date. The
fair value of fixed maturity certificates of deposit was estimated using rates
currently being offered on certificates with similar maturities.
BORROWED FUNDS: The carrying values of federal funds purchased and
securities sold under repurchase agreements and other short-term borrowed funds
are assumed to approximate their fair value due to their limited duration
characteristics. The fair value for commercial paper and term federal funds
purchased was estimated using market quotes.
MEDIUM AND LONG-TERM DEBT: The fair value of the fixed-rate senior and
subordinated notes were estimated using market quotes. The carrying value for
variable-rate subordinated capital notes is assumed to approximate fair market
value.
TRUST NOTES: The fair value of fixed-rate trust notes were based upon
either market quotes for those traded securities or market quotes of similar
securities, if not traded. This amount differs from the fair value of those
securities under hedge accounting since a hypothetical value based on the
present value of cash flows has been used for that purpose.
OFF-BALANCE SHEET INSTRUMENTS: The carrying value of off-balance sheet
instruments represents the unamortized fee income assessed based on the credit
quality and other covenants imposed on the borrower. Since the amount assessed
represents the market rate that would be charged for similar agreements,
management believes that the fair value approximates the carrying value of these
instruments.
NOTE 18--DERIVATIVE INSTRUMENTS
The Company is a party to certain derivative and other financial
instruments that are used for trading activities of the Company, to meet the
needs of customers, and to change the impact on the Company's operating results
due to market fluctuations in currency or interest rates.
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 agreements in order to reduce its exposure to
credit risk. Master netting
F-92
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 18 - DERIVATIVE INSTRUMENTS (CONTINUED)
agreements mitigate credit risk by permitting the offset of amounts due from and
to individual counterparties in the event of default. Market risk is the
possibility that future changes in market conditions may make the financial
instrument less valuable.
TRADING ACTIVITIES IN DERIVATIVE INSTRUMENTS
Derivative instruments used for trading purposes are carried at fair value.
The following table reflects the Company's positions relating to trading
activities in derivative instruments. Trading activities include both activities
for the Company's own account and as an accommodation for customers. At December
31, 2003 and 2004, the majority of the Company's derivative transactions for
customers were essentially offset by contracts with other counterparties.
The following is a summary of derivative instruments held or written for
trading purposes and customer accommodations.
DECEMBER 31,
---------------------------------------------------------------------------------------
2003 2004
----------------------------------------- -----------------------------------------
UNREALIZED UNREALIZED ESTIMATED UNREALIZED UNREALIZED ESTIMATED
(DOLLARS IN THOUSANDS) GAINS LOSSES FAIR VALUE GAINS LOSSES FAIR VALUE
- ------------------------------- -------- ------ ---------- ----- ------ ----------
HELD OR WRITTEN FOR TRADING
PURPOSES AND CUSTOMER
ACCOMMODATIONS
Foreign exchange forward
contracts:
Commitments to purchase...... $48,675 $(404) $48,271 $44,355 $(1,235) $43,120
Commitments to sell.......... 401 (48,762) (48,361) 1,329 (49,240) (47,911)
Foreign exchange OTC options:
Options purchased............ -- (72) (72) 742 -- 742
Options written.............. 72 -- 72 -- (742) (742)
Cross currency swaps:
Commitments to pay........... 483 -- 483 -- (2,933) (2,933)
Commitments to receive....... -- (474) (474) 2,933 -- 2,933
Energy contracts:
Option contracts............. -- -- -- -- -- --
Swap contracts............... -- -- -- 212 (116) 96
Interest rate contracts:
Caps purchased............... 4,027 -- 4,027 3,990 -- 3,990
Floors purchased............. 222 -- 222 146 -- 146
Caps written................. -- (4,027) (4,027) -- (3,990) (3,990)
Floors written............... -- (222) (222) -- (146) (146)
Swap contracts:
Pay variable/receive fixed. 103,681 (1,573) 102,108 60,363 (12,602) 47,761
Pay fixed/receive variable. 3,517 (95,039) (91,522) 16,006 (51,747) (35,741)
-------- --------
161,078 130,076
Effect of master netting
agreements................... (3,339) (1,888)
-------- --------
Total credit exposure.......... $157,739 $128,188
======== ========
F-93
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 18--DERIVATIVE INSTRUMENTS (CONTINUED)
DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS USED FOR HEDGING
Derivative positions are integral components of the Company's designated
asset and liability management activities. The Company uses interest rate
derivatives to manage the sensitivity of the Company's net interest income to
changes in interest rates. These instruments are used to manage interest rate
risk relating to specified groups of assets and liabilities, primarily
LIBOR-based commercial loans, certificates of deposit, medium-term notes and
subordinated debt. The following describes the significant hedging strategies of
the Company.
CASH FLOW HEDGES
HEDGING STRATEGIES FOR VARIABLE RATE LOANS AND CERTIFICATES OF DEPOSIT
The Company engages in several types of cash flow hedging strategies for
which the hedged transactions are forecasted future loan interest payments, and
the hedged risk is the variability in those payments due to changes in the
designated benchmark rate, e.g., U.S. dollar LIBOR. In these strategies, the
hedging instruments are matched with groups of variable rate loans such that the
tenor of the variable rate loans and that of the hedging instrument are
identical. Cash flow hedging strategies include the utilization of purchased
floor, cap, corridor options and interest rate swaps. At December 31, 2004, the
weighted average remaining life of the currently active (excluding any forward
positions) cash flow hedges was approximately 1.3 years.
The Company uses purchased interest rate floors to hedge the variable cash
flows associated with 1-month LIBOR or 3-month LIBOR indexed loans. Payments
received under the floor contract offset the decline in loan interest income
caused by the relevant LIBOR index falling below the floor's strike rate.
The Company uses interest rate floor corridors to hedge the variable cash
flows associated with 1-month LIBOR or 3-month LIBOR indexed loans. Net payments
to be received under the floor corridor contracts offset the decline in loan
interest income caused by the relevant LIBOR index falling below the corridor's
upper strike rate, but only to the extent the index falls to the lower strike
rate. The corridor will not provide protection from declines in the relevant
LIBOR index to the extent it falls below the corridor's lower strike rate.
The Company uses interest rate collars to hedge the variable cash flows
associated with 1-month LIBOR or 3-month LIBOR indexed loans. Net payments to be
received under the collar contract offset the decline in loan interest income
caused by the relevant LIBOR index falling below the collar's floor strike rate
while net payments to be paid will reduce the increase in loan interest income
caused by the LIBOR index rising above the collar's cap strike rate.
The Company uses interest rate swaps to hedge the variable cash flows
associated with 1-month LIBOR or 3-month LIBOR indexed loans. Payments to be
received (or paid) under the swap contract will offset the fluctuations in loan
interest income caused by changes in the relevant LIBOR index. As such, these
instruments hedge all fluctuations in the loans' interest income caused by
changes in the relevant LIBOR index.
The Company uses purchased interest rate caps to hedge the variable
interest cash flows associated with the forecasted issuance and rollover of
short-term, fixed rate, negotiable certificates of deposit (CDs). In these
hedging relationships, the Company hedges the LIBOR component of the CD rates,
which is either 3-month LIBOR or 6-month LIBOR, based on the CDs' original term
to maturity, which reflects their repricing frequency.
F-94
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 18--DERIVATIVE INSTRUMENTS (CONTINUED)
Net payments to be received under the cap contract offset the increase in
interest expense caused by the relevant LIBOR index rising above the cap's
strike rate.
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, negotiable CDs. In these hedging relationships, the Company hedges the
LIBOR component of the CD rates, either 1-month LIBOR, 3-month LIBOR, or 6-month
LIBOR, based on the original term to maturity of the CDs, which reflects their
repricing frequency. Net payments to be received under the cap corridor contract
offset the increase in deposit interest expense caused by the relevant LIBOR
index rising above the corridor's lower strike rate, but only to the extent the
index rises to 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 hedge are matched with an equal principal amount of loans or CDs,
the index and repricing frequencies of the hedge matches those of the loans or
CDs, and the period in which the designated hedged cash flows occurs is equal to
the term of the hedge. As such, most of the ineffectiveness in the hedging
relationship results from the mismatch between the timing of reset dates on the
hedge versus those of the loans or CDs. In 2004, the Company recognized a net
loss of $1.8 million due to ineffectiveness, which is recognized in noninterest
expense, compared to a net gain of $0.9 million in 2003.
For cash flow hedges, based upon amounts included in accumulated other
comprehensive income at December 31, 2004, the Company expects to realize
approximately $19.3 million in net interest income during 2005. This amount
could differ from amounts actually realized due to changes in interest rates and
the addition of other hedges subsequent to December 31, 2004.
FAIR VALUE HEDGES
HEDGING STRATEGY FOR "MARKETPATH" CERTIFICATES OF DEPOSIT
The Company engages in a hedging strategy in which interest bearing CDs
issued to customers, which are tied to the changes in the Standard and Poor's
500 index, are exchanged for a fixed rate of interest. The Company accounts for
the embedded derivative in the CDs at fair value. A total return swap that
encompasses the value of a series of options that had individually hedged each
CD is valued at fair value and any ineffectiveness resulting from the hedge and
the hedged item are recognized in noninterest expense.
HEDGING STRATEGY FOR UNIONBANCAL CORPORATION--JUNIOR SUBORDINATED DEBT
PAYABLE TO SUBSIDIARY GRANTOR TRUST (TRUST NOTES)
On February 19, 2004, the Company terminated its fair value hedge and
called its Trust Notes. Prior to this date, the Company engaged in an interest
rate hedging strategy in which an interest rate swap was associated with a
specific interest bearing liability, UnionBanCal Corporation's Trust Notes, in
order to convert the liability from a fixed rate to a floating rate instrument.
This strategy mitigated the changes in fair value of the hedged liability caused
by changes in the designated benchmark interest rate, U.S. dollar LIBOR.
The fair value hedging transaction was structured at inception so that the
notional amount of the swap matched an associated principal amount of the Trust
Notes. The interest payment dates, the expiration date, and the embedded call
option of the swap matched those of the Trust Notes. The ineffectiveness on the
fair
F-95
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 18--DERIVATIVE INSTRUMENTS (CONTINUED)
value hedges in 2004 was a net gain of $1.6 million, realized upon the
termination of the swap on February 19, 2004, compared to a net gain of less
than $0.1 million in 2003.
HEDGING STRATEGY FOR MEDIUM-TERM NOTES
The Company engages in an interest rate hedging strategy in which an
interest rate swap is associated with a specified interest bearing liability,
UnionBanCal Corporation's five-year, medium-term debt issuance, in order to
convert the liability from a fixed rate to a floating rate instrument. This
strategy mitigates the changes in fair value of the hedged liability caused by
changes in the designated benchmark interest rate, U.S. dollar LIBOR.
The fair value hedging transaction for the medium-term notes was structured
at inception to mirror all of the provisions of the medium-term notes, which
allows the Company to assume that no ineffectiveness exists.
HEDGING STRATEGY FOR SUBORDINATED DEBT
The Company engages in an interest rate hedging strategy in which an
interest rate swap is associated with a specified interest bearing liability,
UnionBanCal Corporation's ten-year, subordinated debt issuance, in order to
convert the liability from a fixed rate to a floating rate instrument. This
strategy mitigates the changes in fair value of the hedged liability caused by
changes in the designated benchmark interest rate, U.S. dollar LIBOR.
The fair value hedging transaction for the subordinated debt was structured
at inception to mirror all of the provisions of the subordinated debt, which
allows the Company to assume that no ineffectiveness exists.
OTHER
The Company uses To-Be-Announced (TBA) contracts to fix the price and yield
of anticipated purchases or sales of mortgage-backed securities that will be
delivered at an agreed upon date. This strategy hedges the risk of variability
in the cash flows to be paid or received upon settlement of the TBA contract.
F-96
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 18--DERIVATIVE INSTRUMENTS (CONTINUED)
The following table reflects summary information on the Company's
derivative contracts used to hedge or modify the Company's risk as of December
31, 2003 and 2004.
DECEMBER 31, 2003 DECEMBER 31, 2004
-------------------------------------------- --------------------------------------------
ESTIMATED
UNAMORTIZED UNREALIZED UNREALIZED ESTIMATED UNAMORTIZED UNREALIZED UNREALIZED FAIR
(DOLLARS IN THOUSANDS) PREMIUMS GAINS LOSSES FAIR VALUE PREMIUMS GAINS LOSSES VALUE
- --------------------------------- ----------- ---------- ---------- ---------- ----------- ---------- ---------- ---------
HELD FOR ASSET AND LIABILITY
MANAGEMENT PURPOSES
Fair Value Hedges and Hedged
Items:
Swap Contract Indexed to
S&P 500:
Pay fixed/receive variable $-- $-- $-- $-- $-- $-- $(446) $1,650
MarketPath certificates of
deposit..................... -- -- -- -- -- 446 -- 446
Interest rate swap contracts:
Pay variable/receive fixed -- 1,538 -- 1,538 -- -- -- --
Trust notes................... -- -- (3,115) (3,115) -- -- -- --
Medium-term debt interest rate
swap........................ -- 14,605 -- 14,605 -- 7,186 -- 7,186
Medium-term note.............. -- -- (14,605) (14,605) -- -- (7,186) (7,186)
Subordinated debt interest rate
swap........................ -- 7,540 -- 7,540 -- 10,374 -- 10,374
Subordinated debt............. -- -- (7,540) (7,540) -- -- (10,374) (10,374)
Cash Flow Hedges:
Interest rate option contracts:
Caps purchased.............. 2,436 -- (1,867) 569 6,717 4,380 -- 11,097
Caps written................ -- -- (195) (195) -- -- (2,182) (2,182)
Floors purchased............ 2,624 6,770 -- 9,394 3,321 -- (1,755) 1,566
Interest rate swap contracts:
Pay variable/receive fixed.. -- 68,958 -- 68,958 -- 15,212 (13,280) 1,932
-------- -------
99,411 37,598
Effect of master netting
agreements.................... (55,362) (14,437)
-------- -------
Total credit exposure........... $ 44,049 $23,161
======== =======
NOTE 19--RESTRICTIONS ON CASH AND DUE FROM BANKS, SECURITIES, LOANS AND
DIVIDENDS
Federal Reserve Board regulations require the Bank to maintain reserve
balances based on the types and amounts of deposits received. Average reserve
balances were approximately $202 million and $148 million for the years ended
December 31, 2003 and 2004, respectively.
As of December 31, 2003 and 2004, securities carried at $2.6 billion and
$2.8 billion and loans of $9.6 billion and $10.7 billion, respectively, were
pledged as collateral for borrowings, to secure public and trust department
deposits, and for repurchase agreements as required by contract or law.
The Federal Reserve Act restricts the amount and the terms of both credit
and non-credit transactions between a bank and its non-bank affiliates. Such
transactions may not exceed 10 percent of the bank's capital and surplus (which
for this purpose represents Tier 1 and Tier 2 capital, as calculated under the
risk-based
F-97
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 19--RESTRICTIONS ON CASH AND DUE FROM BANKS, SECURITIES, LOANS AND
DIVIDENDS (CONTINUED)
capital guidelines, plus the balance of the allowance for loan losses excluded
from Tier 2 capital) with any single non-bank affiliate and 20 percent of the
bank's capital and surplus with all its non-bank affiliates. Transactions that
are extensions of credit may require collateral to be held to provide added
security to the bank. See Note 20 of these consolidated financial statements
for further discussion of risk-based capital. At December 31, 2004, $51.6
million remained outstanding on ten Bankers Commercial Corporation notes payable
to the Bank. The respective notes were fully collateralized with equipment
leases pledged by Bankers Commercial Corporation.
The declaration of a dividend by the Bank to the Company is subject to the
approval of the Office of the Comptroller of the Currency (OCC) if the total of
all dividends declared in the current calendar year plus the preceding two years
exceeds the Bank's total net income in the current calendar year plus the
preceding two years. The payment of dividends is also limited by minimum capital
requirements imposed on national banks by the OCC.
NOTE 20--REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Company's Consolidated Financial Statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of the Company's and Bank's
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The capital amounts and the Bank's prompt
corrective action classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors. Prompt
corrective action provisions are not applicable to bank holding companies such
as the Company.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as
defined) to quarterly average assets (as defined). Management believes, as of
December 31, 2003 and 2004, that the Company and the Bank met all capital
adequacy requirements to which they are subject.
On December 8, 2003, the Company issued $400 million of subordinated notes,
which qualify as Tier 2 capital. See Note 12 of these consolidated financial
statements for a complete description of these notes.
As of December 31, 2003 and 2004, the most recent notification from the OCC
categorized the Bank as "well-capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "well-capitalized," the Bank must
maintain a minimum total risk-based capital ratio of 10 percent, a Tier 1
risk-based capital ratio of 6 percent, and a Tier 1 leverage ratio of 5 percent.
There are no conditions or events since that notification that management
believes have changed the Bank's category.
On February 19, 2004, the Company redeemed $350 million of trust preferred
securities, which qualified as Tier 1 capital. See Note 13 of these consolidated
financial statements for a complete description of these securities.
F-98
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 20--REGULATORY CAPITAL REQUIREMENTS (CONTINUED)
The Company's and the Bank's capital amounts and ratios are presented in
the following tables:
FOR CAPITAL
ACTUAL ADEQUACY PURPOSES
------------------- ------------------------
(DOLLARS IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO
- ----------------------------------- ---------- ----- ---------- -----
CAPITAL RATIOS FOR THE COMPANY:
As of December 31, 2003:
Total capital (to risk-
weighted assets)............. $4,684,073 14.14% > $2,650,673 > 8.0%
- -
Tier 1 capital (to risk-
weighted assets)............. 3,747,884 11.31 > 1,325,336 > 4.0
- -
Tier 1 capital (to quarterly
average assets)(1)........... 3,747,884 9.03 > 1,660,273 > 4.0
- -
As of December 31, 2004:
Total capital (to risk-weighted
assets)...................... $4,785,992 12.17% > $3,145,989 > 8.0%
- -
Tier 1 capital (to risk-
weighted assets)............. 3,817,698 9.71 > 1,572,994 > 4.0
- -
Tier 1 capital (to quarterly
average assets)(1)........... 3,817,698 8.09 > 1,886,747 > 4.0
- -
- --------------------
(1) Excludes certain intangible assets.
TO BE WELL-CAPITALIZED
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------- ------------------------ -----------------------
(DOLLARS IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ---------------------------- ---------- ----- ----------- ----- ---------- -----
CAPITAL RATIOS FOR THE BANK:
As of December 31, 2003:
Total capital (to
risk-weighted assets)...... $3,863,138 11.88% > $2,602,081 > 8.0% > $ 3,252,602 > 10.0%
- - - -
Tier 1 capital (to
risk-weighted assets)...... 3,395,519 10.44 > 1,301,041 > 4.0 > 1,951,561 > 6.0
- - - -
Tier 1 capital (to quarterly
average assets)(1)......... 3,395,519 8.30 > 1,636,861 > 4.0 > 2,046,076 > 5.0
- - - -
As of December 31, 2004:
Total capital (to
risk-weighted assets)...... $4,091,494 10.57% > $3,096,935 > 8.0% > $ 3,871,168 > 10.0%
- - - -
Tier 1 capital (to
risk-weighted assets)...... 3,597,738 9.29 > 1,548,467 > 4.0 > 2,322,701 > 6.0
- - - -
Tier 1 capital (to quarterly
average assets)(1)......... 3,597,738 7.72 > 1,863,550 > 4.0 > 2,329,438 > 5.0
- - - -
- --------------------
(1) Excludes certain intangible assets.
F-99
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 21--EARNINGS PER SHARE
Basic EPS is computed by dividing net income by the weighted average number
of common shares outstanding during the period. For all periods presented, there
were no dividends on preferred stock. Diluted EPS is computed based on the
weighted average number of common shares outstanding adjusted for common stock
equivalents, which include stock options. The following table presents a
reconciliation of basic and diluted EPS for the years ended December 31, 2002,
2003 and 2004:
DECEMBER 31,
-----------------------------------------------------------------------
2002 2003 2004
-------------------- -------------------- ---------------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) BASIC DILUTED BASIC DILUTED BASIC DILUTED
- ---------------------------------------------- ----- ------- ----- ------- ----- -------
Net income.................................... $527,903 $527,903 $587,139 $587,139 $732,534 $732,534
Weighted average common shares outstanding.... 154,758 154,758 148,917 148,917 147,767 147,767
Additional shares due to:
Assumed conversion of dilutive stock options -- 1,657 -- 1,728 -- 2,536
-------- -------- -------- -------- -------- --------
Adjusted weighted average common shares
outstanding................................. 154,758 156,415 148,917 150,645 147,767 150,303
======== ======== ======== ======== ======== ========
Net income per share.......................... $ 3.41 $ 3.38 $ 3.94 $ 3.90 $ 4.96 $ 4.87
======== ======== ======== ======== ======== ========
Options to purchase 2,869,052 shares of common stock with the range from
$43.25 to $48.51 per share were outstanding but not included in the computation
of diluted EPS in 2002. Options to purchase 170,721 shares of common stock with
the range from $47.14 to $57.15 per share were outstanding but not included in
the computation of diluted EPS in 2003. Options to purchase 42,000 shares of
common stock with the range from $57.50 to $59.74 per share were outstanding but
not included in the computation of diluted EPS in 2004. These options to
purchase shares were not included in the computation of diluted EPS in each of
the years 2002, 2003, and 2004 because they were anti-dilutive.
F-100
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 22--OTHER COMPREHENSIVE INCOME
The following table presents the components of other comprehensive income
and the related tax effect allocated to each component:
BEFORE
TAX TAX NET OF
(DOLLARS IN THOUSANDS) AMOUNT EFFECT TAX
- ----------------------------------------------------------------------------- ---------- -------- ---------
2002:
Cash flow hedge activities:
Unrealized net gains on hedges arising during the year..................... $ 183,517 $(70,195) $ 113,322
Less: reclassification adjustment for net gains on hedges included in net
income................................................................... (116,266) 44,472 (71,794)
-------- -------- ---------
Net change in unrealized gains on hedges..................................... 67,251 (25,723) 41,528
-------- -------- ---------
Securities available for sale:
Unrealized holding gains arising during the year on securities available for
sale..................................................................... 106,436 (40,712) 65,724
Less: reclassification adjustment for net gains on securities available for
sale included in net income.............................................. (2,502) 957 (1,545)
-------- -------- ---------
Net change in unrealized gains on securities available for sale.............. 103,934 (39,755) 64,179
-------- -------- ---------
Foreign currency translation adjustments..................................... 2,520 (964) 1,556
-------- -------- ---------
Minimum pension liability adjustment......................................... (165) 63 (102)
-------- -------- ---------
Net change in accumulated other comprehensive income (loss).................. $ 173,540 $(66,379) $ 107,161
======== ======== =========
2003:
Cash flow hedge activities:
Unrealized net gains on hedges arising during the year..................... $ 41,982 $(16,058) $ 25,924
Less: reclassification adjustment for net gains on hedges included in net
income................................................................... (140,091) 53,585 (86,506)
-------- -------- ---------
Net change in unrealized losses on hedges.................................... (98,109) 37,527 (60,582)
-------- -------- ---------
Securities available for sale:
Unrealized holding losses arising during the year on securities available
for sale................................................................. (192,983) 73,816 (119,167)
Less: reclassification adjustment for net gains on securities available for
sale included in net income.............................................. (9,309) 3,561 (5,748)
-------- -------- ---------
Net change in unrealized losses on securities available for sale............. (202,292) 77,377 (124,915)
-------- -------- ---------
Foreign currency translation adjustments..................................... 577 (221) 356
-------- -------- ---------
Minimum pension liability adjustment......................................... (4,390) 1,679 (2,711)
-------- -------- ---------
Net change in accumulated other comprehensive income (loss).................. $(304,214) $116,362 $(187,852)
========= ======== =========
2004:
Cash flow hedge activities:
Unrealized net gains on hedges arising during the year..................... $3,103 $(1,187) $1,916
Less: reclassification adjustment for net gains on hedges included in net
income................................................................... (71,697) 27,424 (44,273)
-------- -------- ---------
Net change in unrealized losses on hedges.................................... (68,594) 26,237 (42,357)
-------- -------- ---------
Securities available for sale:
Unrealized holding losses arising during the year on securities available
for sale................................................................. (99,908) 38,215 (61,693)
Less: reclassification adjustment for net losses on securities available for
sale included in net income.............................................. 12,085 (4,623) 7,462
-------- -------- ---------
Net change in unrealized losses on securities available for sale............. (87,823) 33,592 (54,231)
-------- -------- ---------
Foreign currency translation adjustments..................................... 3,924 (1,501) 2,423
-------- -------- ---------
Minimum pension liability adjustment......................................... (4,703) 1,799 (2,904)
-------- -------- ---------
Net change in accumulated other comprehensive income (loss).................. $(157,196) $ 60,127 $ (97,069)
========= ======== =========
F-101
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 22--OTHER COMPREHENSIVE INCOME (CONTINUED)
The following table presents accumulated other comprehensive income
(loss) balances:
NET NET
UNREALIZED UNREALIZED
GAINS GAINS
(LOSSES) (LOSSES) FOREIGN MINIMUM ACCUMULATED
ON CASH ON SECURITES CURRENCY PENSION OTHER
FLOW AVAILABLE TRANSLATION LIABILITY COMPREHENSIVE
(DOLLARS IN THOUSANDS) HEDGES FOR SALE ADJUSTMENT ADJUSTMENT INCOME (LOSS)
- ---------------------------------------- -------- -------- ---------- ---------- -------------
BALANCE, DECEMBER 31, 2001.............. $ 62,840 $ 83,271 $(12,205) $ (973) $132,933
Change during the year.................. 41,528 64,179 1,556 (102) 107,161
-------- -------- -------- ------- --------
BALANCE, DECEMBER 31, 2002.............. $104,368 $147,450 $(10,649) $(1,075) $240,094
Change during the year.................. (60,582) (124,915) 356 (2,711) (187,852)
-------- -------- -------- ------- --------
BALANCE, DECEMBER 31, 2003.............. $ 43,786 $ 22,535 $(10,293) $(3,786) $ 52,242
Change during the year.................. (42,357) (54,231) 2,423 (2,904) (97,069)
-------- -------- -------- ------- --------
BALANCE, DECEMBER 31, 2004.............. $ 1,429 $(31,696) $ (7,870) $(6,690) $(44,827)
======== ======== ======== ======= ========
NOTE 23--COMMITMENTS, CONTINGENCIES AND GUARANTEES
The following table summarizes the Company's significant commitments:
DECEMBER 31,
--------------------------
(DOLLARS IN THOUSANDS) 2003 2004
- ---------------------------------------------------- ----------- ------------
Commitments to extend credit........................ $13,475,513 $16,500,152
Standby letters of credit........................... 2,748,612 2,993,502
Commercial letters of credit........................ 195,915 250,405
Commitments to fund principal investments........... 56,005 69,490
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. The majority of these types of commitments have
terms of one year or less. At December 31, 2004, the carrying value of the
Company's standby and commercial letters of credit, which is included in other
liabilities on the consolidated balance sheet, totaled $5.7 million.
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.
F-102
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 23 - COMMITMENTS, CONTINGENCIES AND GUARANTEES (CONTINUED)
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 has contingent consideration agreements that guarantee
additional payments to acquired insurance agencies' stockholders based on the
agencies' future performance in excess of established revenue and/or earnings
before interest, taxes, depreciation and amortization (EBITDA) thresholds. If
the insurance agencies' future performance exceeds these thresholds during a
three-year period, the Company will be liable to make payments to former
stockholders. As of December 31, 2004, the Company has a maximum exposure of
$7.2 million for these agreements, which expire December 2006.
The Company is fund manager for limited liability corporations issuing
low-income housing investments. Low-income housing investments provide tax
benefits to investors in the form of tax deductions from operating losses and
tax credits. To facilitate the sale of these investments, the Company guarantees
the timely completion of projects and delivery of tax benefits throughout the
investment term. Guarantees may include a minimum rate of return, the
availability of tax credits, and operating deficit thresholds over a ten-year
average period. Additionally, the Company receives project completion and tax
credit guarantees from the limited liability corporations issuing the
investments that reduce the Company's ultimate exposure to loss. As of December
31, 2004, the Company's maximum exposure to loss under these guarantees is
limited to a return of investor's capital and minimum investment yield, or
$141.4 million. The Company maintains a reserve of $5.9 million for these
guarantees.
The Company has rental commitments under long-term operating lease
agreements. For detail of these commitments see Note 5 of these consolidated
financial statements.
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 collateralized, primarily by
cash. The amount of securities lent with indemnification was $1.2 billion and
$2.0 billion at December 31, 2003 and 2004, respectively. The market value of
the associated collateral was $1.3 billion and $2.0 billion at December 31, 2003
and 2004, respectively.
The Company is subject to various pending and threatened legal actions that
arise in the normal course of business. The Company maintains reserves for
losses from legal actions that are both probable and estimable. In the opinion
of management, the disposition of claims currently pending will not have a
material adverse effect on the Company's financial position or results of
operations.
NOTE 24--TRANSACTIONS WITH AFFILIATES
The Company had, and expects to have in the future, banking transactions
and other transactions in the ordinary course of business with BTM and with its
affiliates. During 2002, 2003 and 2004, such transactions
F-103
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 24 - TRANSACTIONS WITH AFFILIATES (CONTINUED)
included, but were not limited to, participation, servicing and remarketing of
loans and leases, purchase and sale of acceptances, interest rate derivatives
and foreign exchange transactions, funds transfers, custodianships, electronic
data processing, investment advice and management, customer referrals, facility
leases, and trust services. In the opinion of management, such transactions were
made at rates, terms, and conditions prevailing in the market and do not involve
more than the normal risk of collectibility or present other unfavorable
features. In addition, some compensation for services rendered to the Company is
paid to the expatriate officers from BTM, and reimbursed by the Company to BTM
under a service agreement. On December 10, 2004, the Company purchased corporate
trust assets of BTM Trust Company for $1.8 million.
The Company has guarantees that obligate it to perform if its affiliates
are unable to discharge their obligations. These obligations include guarantees
of commercial paper obligations and leveraged lease transactions. The guarantee
issued by the Bank for an affiliate's commercial paper program is done in order
to facilitate their sale. As of December 31, 2004, the Bank had a maximum
exposure to loss under the commercial paper program guarantee of $825.3 million.
The Bank's guarantee has an average term of less than one year and is fully
collateralized by a pledged deposit. 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 has no material obligation to be satisfied. As of December 31, 2004, the
Company had no exposure to loss for these agreements.
NOTE 25--BUSINESS SEGMENTS
The Company is organized based on the products and services that it offers
and operates in four principal areas:
o The Community Banking and Investment Services Group offers a range of
banking services, primarily to individuals and small businesses,
delivered generally through a tri-state network of branches and ATM's.
These services include commercial loans, mortgages, home equity lines
of credit, consumer loans, deposit services and cash management as
well as fiduciary, private banking, investment and asset management
services for individuals and institutions, and risk management and
insurance products for businesses and individuals. At December 31,
2003 and 2004, this Group had $226.6 million and $327.8 million,
respectively, of goodwill assigned to its businesses.
o The Commercial Financial Services Group provides credit and cash
management services to large corporate and middle-market companies.
Services include commercial and project loans, real estate financing,
asset-based financing, trade finance and letters of credit, lease
financing, customized cash management services and selected capital
markets products. At December 31, 2003, this Group had no goodwill
assigned to its businesses compared to $123.2 million of goodwill
assigned to its businesses at December 31, 2004.
o The International Banking Group primarily provides correspondent
banking and trade-finance products and services to financial
institutions. The group's revenue predominately relates to foreign
customers.
o The Global Markets Group manages the Company's wholesale funding
needs, securities portfolio, and interest rate and liquidity risks.
The group also offers a broad range of risk management and trading
products to institutional and business clients of the Company through
the businesses described above.
The information, set forth in the table on the following page, reflects
selected income statement and balance sheet items by business unit. The
information presented does not necessarily represent the business
F-104
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 25--BUSINESS SEGMENTS (CONTINUED)
units' financial condition and results of operations were they independent
entities. Unlike financial accounting, there is no authoritative body of
guidance for management accounting equivalent to US GAAP. Consequently, reported
results are not necessarily comparable with those presented by other companies.
Included in the table within total assets are the amounts of goodwill for each
reporting unit as of December 31, 2003 and 2004.
The information in this table is derived from the internal management
reporting system used by management to measure the performance of the business
segments and the Company overall. The management reporting system assigns
balance sheet and income statement items to each business segment based on
internal management accounting policies. Net interest income is determined by
the Company's internal funds transfer pricing system, which assigns a cost of
funds or a credit for funds to assets or liabilities based on their type,
maturity or repricing characteristics. Noninterest income and expense directly
attributable to a business segment are assigned to that business. Certain
indirect costs, such as operations and technology expense, are allocated to the
segments based on studies of billable unit costs for product or data processing.
Other indirect costs, such as corporate overhead, are allocated to the business
segments based on a predetermined percentage of usage. Under the Company's
risk-adjusted return on capital (RAROC) methodology, credit expense is charged
to business segments based upon expected losses arising from credit risk. In
addition, the attribution of economic capital is related to unexpected losses
arising from credit, market and operational risks.
"Other" is comprised of certain parent company non-bank subsidiaries, the
elimination of the fully taxable-equivalent basis amount, the amount of the
provision for loan losses over/(under) the RAROC expected loss for the period,
the earnings associated with the unallocated equity capital and allowances for
credit losses, and the residual costs of support groups. In addition, it
includes the Pacific Rim Corporate Group, which offers financial products to
Japanese-owned subsidiaries located in the US. On an individual basis, none of
the items in "Other" are significant to the Company's business.
F-105
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 25--BUSINESS SEGMENTS (CONTINUED)
The business units' results for the prior periods have been restated to
reflect changes in the transfer pricing methodology and any reorganization
changes that may have occurred.
COMMUNITY BANKING COMMERCIAL FINANCIAL INTERNATIONAL
AND INVESTMENT SERVICES GROUP SERVICES GROUP BANKING GROUP
----------------------------- -------------- -------------
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
RESULTS OF OPERATIONS ------------------------ ------------------------ ------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004 2002 2003 2004 2002 2003 2004
- ----------------------- ---- ---- ---- ---- ---- ---- ---- ---- ----
Net interest income....... $ 682,431 $ 680,834 $ 784,429 $731,042 $727,255 $ 800,121 $ 35,113 $ 33,932 $ 35,398
Noninterest income........ 379,023 433,784 502,363 207,852 253,596 290,647 68,049 80,903 78,732
---------- ---------- ---------- -------- -------- ---------- -------- -------- --------
Total revenue............. 1,061,454 1,114,618 1,286,792 938,894 980,851 1,090,768 103,162 114,835 114,130
Noninterest expense....... 721,032 818,424 947,875 382,736 411,598 431,941 63,173 61,514 67,112
Credit expense............ 33,628 31,718 33,126 190,401 159,026 107,313 1,904 2,104 2,284
---------- ---------- ---------- -------- -------- ---------- -------- -------- --------
Income before income tax
expense................. 306,794 264,476 305,791 365,757 410,227 551,514 38,085 51,217 44,734
Income tax expense........ 117,349 101,162 116,965 120,733 131,290 183,672 14,567 19,591 17,111
---------- ---------- ---------- -------- -------- ---------- -------- -------- --------
Net income (loss)......... $ 189,445 $ 163,314 $ 188,826 $245,024 $278,937 $ 367,842 $ 23,518 $ 31,626 $ 27,623
========== ========== ========== ======== ======== ========== ======== ======== ========
Total assets (dollars in
millions)............... $ 11,973 $ 12,955 $ 15,553 $ 15,919 $ 14,368 $ 17,669 $ 1,985 $ 2,069 $ 2,060
========== ========== ========== ======== ======== ========== ======== ======== ========
GLOBAL UNIONBANCAL
MARKETS GROUP OTHER CORPORATION
------------- ----- -----------
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
RESULTS OF OPERATIONS ------------------------ ------------------------ ------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004 2002 2003 2004 2002 2003 2004
- ------------------------ ---- ---- ---- ---- ---- ---- ---- ---- ----
Net interest income....... $ 39,802 $ 70,757 $ (89,432) $ 73,581 $ 56,288 $ 114,707 $1,561,969 $1,569,066 $1,645,223
Noninterest income........ 10,104 7,674 (7,465) 20,247 18,296 125,028 685,275 794,253 989,305
---------- ---------- ---------- -------- -------- ---------- -------- -------- --------
Total revenue............. 49,906 78,431 (96,897) 93,828 74,584 239,735 2,247,244 2,363,319 2,634,528
Noninterest expense....... 16,000 16,261 21,224 114,024 100,556 56,030 1,296,965 1,408,353 1,524,182
Credit expense (income)... 200 200 335 (51,133) (118,048) (178,058) 175,000 75,000 (35,000)
---------- ---------- ---------- -------- -------- ---------- -------- -------- --------
Income (loss) before
income tax expense
(benefit)............... 33,706 61,970 (118,456) 30,937 92,076 361,763 775,279 879,966 1,145,346
Income tax expense
(benefit).................. 12,893 23,703 (45,310) (18,166) 17,081 140,374 247,376 292,827 412,812
---------- ---------- ---------- -------- -------- ---------- -------- -------- --------
Net income (loss)......... $ 20,813 $ 38,267 $ (73,146) $ 49,103 $ 74,995 $ 221,389 $527,903 $587,139 $732,534
========== ========== ========== ======== ======== ========== ======== ======== ========
Total assets (dollars in
millions)............... $ 9,086 $ 11,704 $ 11,909 $ 1,207 $ 1,402 $ 907 $ 40,170 $ 42,498 $ 48,098
========== ========== ========== ======== ======== ========== ======== ======== ========
F-106
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 26--CONDENSED UNIONBANCAL CORPORATION UNCONSOLIDATED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
DECEMBER 31,
-------------------------
(DOLLARS IN THOUSANDS) 2003 2004
- ------------------------------------------------------- ---------- ----------
ASSETS
Cash and cash equivalents............................ $ 764,534 $ 271,267
Investment in and advances to subsidiaries........... 4,167,034 4,896,497
Loans................................................ 833 --
Other assets......................................... 44,273 22,733
---------- ----------
Total assets....................................... $4,976,674 $5,190,497
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities.................................... $ 51,810 $ 66,350
Medium and long-term debt............................ 820,488 816,113
Junior subordinated debt payable to subsidiary
grantor trust...................................... 363,940 15,790
---------- ----------
Total liabilities.................................. 1,236,238 898,253
Stockholders' equity................................. 3,740,436 4,292,244
---------- ----------
Total liabilities and stockholders' equity......... $4,976,674 $5,190,497
========== ==========
F-107
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 26--CONDENSED UNIONBANCAL CORPORATION UNCONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
----------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ------------------------------------------------------------------------------------- -------- -------- --------
INCOME:
Dividends from bank subsidiary..................................................... $486,300 $497,600 $216,500
Dividends from nonbank subsidiaries................................................ 24,399 25,017 --
Interest income on advances to subsidiaries
and deposits in bank............................................................. 11,909 8,108 9,037
Other income....................................................................... 188 223 1,145
-------- -------- --------
Total income..................................................................... 522,796 530,948 226,682
-------- -------- --------
EXPENSE:
Interest expense................................................................... 27,443 23,392 20,148
Other expense, net................................................................. 620 5,188 (84)
-------- -------- --------
Total expense.................................................................... 28,063 28,580 20,064
-------- -------- --------
Income before income taxes and equity in undistributed
net income of subsidiaries....................................................... 494,733 502,368 206,618
(Provision for) recovery of prior loan losses...................................... (1) 14 7
Income tax benefit................................................................. (6,108) (7,740) (2,883)
-------- -------- --------
Income before equity in undistributed net income of subsidiaries................... 500,840 510,122 209,508
Equity in undistributed net income (loss) of subsidiaries:
Bank subsidiary.................................................................. 61,164 104,552 485,247
Nonbank subsidiaries............................................................. (34,101) (27,535) 37,779
-------- -------- --------
NET INCOME........................................................................... $527,903 $587,139 $732,534
======== ======== ========
F-108
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 26--CONDENSED UNIONBANCAL CORPORATION UNCONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
---------------------------------------
(DOLLARS IN THOUSANDS) 2002 2003 2004
- ----------------------- -------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................... $527,903 $587,139 $ 732,534
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed net income of subsidiaries.......... (27,063) (77,017) (523,026)
(Provision for) recovery of prior loan losses............... 1 (14) (7)
Other, net.................................................. 11,412 (4,969) 27,847
-------- -------- ---------
Net cash provided by operating activities................... 512,253 505,139 237,348
-------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances to subsidiaries...................................... (23,733) (64,950) (71,910)
Repayment of advances to subsidiaries......................... 29,460 12,155 29,698
-------- -------- ---------
Net cash (used in) provided by investing activities........... 5,727 (52,795) (42,212)
-------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in short term borrowings......................... (579) (98,507) --
Proceeds from issuance of medium-term debt.................... -- 398,548 --
Repayment of junior subordinated debt......................... -- -- (360,825)
Payments of cash dividends.................................... (164,440) (175,795) (197,198)
Repurchase of common stock.................................... (385,960) (357,686) (210,689)
Stock options exercised....................................... 75,311 70,944 80,309
Other,net..................................................... -- (3,139) --
-------- -------- ---------
Net cash used in financing activities......................... (475,668) (165,635) (688,403)
-------- -------- ---------
Net increase (decrease) in cash and due from banks.............. 42,312 286,709 (493,267)
Cash and cash equivalents at beginning of year.................. 435,513 477,825 764,534
-------- -------- ---------
Cash and cash equivalents at end of year........................ $477,825 $764,534 $ 271,267
======== ======== =========
CASH PAID DURING THE YEAR FOR:
Interest...................................................... $ 27,665 $ 22,132 $ 23,244
Income taxes.................................................. 5,901 32,047 130,985
F-109
UNIONBANCAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002, 2003, AND 2004 (CONTINUED)
NOTE 27--SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Unaudited quarterly results are summarized as follows:
2003 QUARTERS ENDED
-------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- ------------------------------------------------ -------- ------- ------------ -----------
Interest income................................. $446,404 $439,023 $447,494 $436,742
Interest expense................................ 55,624 53,246 46,405 45,322
-------- -------- -------- --------
Net interest income............................. 390,780 385,777 401,089 391,420
Provision for loan losses....................... 30,000 25,000 20,000 --
Noninterest income.............................. 185,771 203,171 201,470 203,841
Noninterest expense............................. 342,600 351,004 348,861 365,888
-------- -------- -------- --------
Income before income taxes...................... 203,951 212,944 233,698 229,373
Income tax expense.............................. 68,434 68,186 78,653 77,554
-------- -------- -------- --------
Net income...................................... $135,517 $144,758 $155,045 $151,819
======== ======== ======== ========
Net income per common share--basic.............. $0.90 $0.96 $1.04 $1.04
======== ======== ======== ========
Net income per common share--diluted............ $0.89 $0.96 $1.02 $1.02
======== ======== ======== ========
Dividends per share(1).......................... $0.28 $0.31 $0.31 $0.31
======== ======== ======== ========
2004 QUARTERS ENDED
------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- ------------------------------------------------ -------- ------- ------------ -----------
Interest income................................. $444,599 $441,346 $462,259 $496,698
Interest expense................................ 44,178 41,488 50,169 63,844
-------- -------- -------- --------
Net interest income............................. 400,421 399,858 412,090 432,854
(Reversal of) provision for loan losses......... (5,000) (10,000) (10,000) (10,000)
Noninterest income.............................. 211,205 331,010 215,954 231,136
Noninterest expense............................. 373,106 376,402 372,391 402,283
-------- -------- -------- --------
Income before income taxes...................... 243,520 364,466 265,653 271,707
Income tax expense.............................. 86,033 133,369 102,215 91,195
-------- -------- -------- --------
Net income...................................... $157,487 $231,097 $163,438 $180,512
======== ======== ======== ========
Net income per common share--basic.............. $1.07 $1.56 $1.11 $1.22
======== ======== ======== ========
Net income per common share--diluted............ $1.05 $1.54 $1.09 $1.19
======== ======== ======== ========
Dividends per share(1).......................... $0.31 $0.36 $0.36 $0.36
======== ======== ======== ========
- --------------------
(1) Dividends per share reflect dividends declared on the Company's common
stock outstanding as of the declaration date.
NOTE 28--SUBSEQUENT EVENTS
On February 23, 2005, the Company purchased $200 million of its common
stock from its majority owner, The Bank of Tokyo-Mitsubishi, Ltd., which is a
wholly-owned subsidiary of Mitsubishi Tokyo Financial Group, Inc. We repurchased
3,475,843 shares of common stock at a price of $57.54.
F-110
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of UnionBanCal Corporation:
We have audited the accompanying consolidated balance sheets of UnionBanCal
Corporation and subsidiaries (the "Company") as of December 31, 2003 and 2004,
and the related consolidated statements of income, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2004.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of UnionBanCal Corporation and
subsidiaries as of December 31, 2003 and 2004, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of the
Company's internal control over financial reporting as of December 31, 2004,
based on the criteria established in INTERNAL CONTROL--INTEGRATED FRAMEWORK
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated March 8, 2005 expressed an unqualified opinion on
management's assessment of the effectiveness of the Company's internal control
over financial reporting and an unqualified opinion on the effectiveness of the
Company's internal control over financial reporting.
/s/ DELOITTE & Touche LLP
Deloitte & Touche LLP
San Francisco, California
March 8, 2005
F-111
UNIONBANCAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of UnionBanCal Corporation is responsible for the
preparation, integrity and fair presentation of its published financial
statements and all other information presented in these consolidated financial
statements. The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America (US GAAP) and, as such, include amounts based on informed judgments and
estimates made by management.
Management is also responsible for ensuring compliance with the federal
laws and regulations relating to safety and soundness.
We maintain a system of internal accounting controls to provide reasonable
assurance that assets are safeguarded and transactions are executed in
accordance with management's authorization and recorded properly to permit the
preparation of consolidated financial statements in accordance with US GAAP.
Management recognizes that even a highly effective internal control system has
inherent risks, including the possibility of human error and the circumvention
or overriding of controls, and that the effectiveness of an internal control
system can change with circumstances. Management has assessed the effectiveness
of the Company's internal control over financial reporting as of December 31,
2004. In making this assessment, management used the criteria set out by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
INTERNAL CONTROL--INTEGRATED FRAMEWORK. Based on our assessment, we believe
that, as of December 31, 2004, the Company's internal control system over
financial reporting is effective based on those criteria.
The Audit Committee of the Board of Directors is comprised entirely of
directors who are independent of our management. It includes an audit committee
technical expert and members with banking or related financial management
expertise and who are not large customers of Union Bank of California, N.A. The
Audit Committee has access to outside counsel. The Audit Committee is
responsible for selecting the independent auditors subject to ratification by
the stockholders. It meets periodically with management, the independent
auditors, and the internal auditors to provide a reasonable basis for concluding
that the Audit Committee is carrying out its responsibilities. The Audit
Committee is also responsible for performing an oversight role by reviewing and
monitoring our financial, accounting, and auditing procedures in addition to
reviewing our financial reports. The independent auditors and internal auditors
have full and free access to the Audit Committee, with or without the presence
of management, to discuss the adequacy of internal controls for financial
reporting and any other matters which they believe should be brought to the
attention of the Audit Committee.
The Company's assessment of the effectiveness of internal control over
financial reporting and the Company's consolidated financial statements have
been audited by Deloitte & Touche LLP, Independent Registered Public Accounting
Firm, which was given unrestricted access to all financial records and related
data, including minutes of all meetings of stockholders, the Board of Directors
and committees of the Board. Management believes that all representations made
to the independent auditors during their audit were valid and appropriate.
/s/ NORIMICHI KANARI
-------------------------------------
Norimichi Kanari
PRESIDENT AND CHIEF EXECUTIVE OFFICER
/s/ TAKASHI MORIMURA
-------------------------------------
Takashi Morimura
VICE CHAIRMAN OF THE BOARD
/s/ DAVID I. MATSON
-------------------------------------
David I. Matson
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
/s/ DAVID A. ANDERSON
-------------------------------------
David A. Anderson
SENIOR VICE PRESIDENT AND CONTROLLER
F-112
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of UnionBanCal Corporation:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that
UnionBanCal Corporation and subsidiaries (the "Company") maintained effective
internal control over financial reporting as of December 31, 2004, based on
criteria established in INTERNAL CONTROL--INTEGRATED FRAMEWORK issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Because
management's assessment and our audit were conducted to meet the reporting
requirements of Section 112 of the Federal Deposit Insurance Corporation
Improvement Act (FDICIA), management's assessment and our audit of the Company's
internal control over financial reporting included controls over the preparation
of the schedules equivalent to the basic financial statements in accordance with
the instructions for the Consolidated Financial Statements for Bank Holding
Companies (Form FR Y-9C). The Company's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinions.
A company's internal control over financial reporting is a process designed
by, or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained
effective internal control over financial reporting as of December 31, 2004, is
fairly stated, in all material respects, based on the criteria established in
INTERNAL CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the criteria established in INTERNAL
F-113
CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated financial
statements as of and for the year ended December 31, 2004 of the Company and our
report dated March 8, 2005 expressed an unqualified opinion on those financial
statements.
/s/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP
San Francisco, California
March 8, 2005
F-114
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, UnionBanCal Corporation has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
UNIONBANCAL CORPORATION (Registrant)
By: /S/ NORIMICHI KANARI
--------------------------------------
Norimichi Kanari
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
By: /S/ DAVID I. MATSON
--------------------------------------
David I. Matson
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
By: /S/ DAVID A. ANDERSON
--------------------------------------
David A. Anderson
SENIOR VICE PRESIDENT AND CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
Date: March 8, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of UnionBanCal
Corporation and in the capacities and on the date indicated below.
SIGNATURE TITLE
--------- -----
* Director
- ----------------------------------
Aida M. Alvarez
* Director
- ----------------------------------
David R. Andrews
* Director
- ----------------------------------
L. Dale Crandall
* Director
- ----------------------------------
Richard D. Farman
* Director
- ----------------------------------
Stanley F. Farrar
* Director
- ----------------------------------
Philip B. Flynn
II-1
* Director
- ----------------------------------
Michael J. Gillfillan
* Director
- ----------------------------------
Richard C. Hartnack
Director
- ----------------------------------
Ronald L. Havner, Jr.
* Director
- ----------------------------------
Norimichi Kanari
* Director
- ----------------------------------
Mary S. Metz
* Director
- ----------------------------------
Shigemitsu Miki
* Director
- ----------------------------------
Takahiro Moriguchi
* Director
- ----------------------------------
Takashi Morimura
* Director
- ----------------------------------
J. Fernando Niebla
* Director
- ----------------------------------
Tetsuo Shimura
*By: /s/ JOHN H. MCGUCKIN, JR.
------------------------------
John H. McGuckin, Jr.
ATTORNEY-IN-FACT
Dated: March 8, 2005
II-2