10-Q 1 d247193d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

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 of principal executive offices)   (Zip Code)

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

 

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

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

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

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   þ  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

Number of shares of Common Stock outstanding at October 31, 2011: 136,330,830

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

 

 

 


Table of Contents

UnionBanCal Corporation and Subsidiaries

Table of Contents

 

PART I. FINANCIAL INFORMATION      33   

Item 1.        Financial Statements

     33   

Consolidated Statements of Income (Unaudited)

     33   

Consolidated Balance Sheets (Unaudited)

     34   

Consolidated Statements of Changes in Stockholder’s Equity (Unaudited)

     35   

Consolidated Statements of Cash Flows (Unaudited)

     36   

Note 1 – Basis of Presentation and Nature of Operations

     37   

Note 2 – Recently Issued Accounting Pronouncements That Are Not Yet Adopted

     37   

Note 3 – Business Combinations

     38   

Note 4 – Securities

     38   

Note 5 – Loans and Allowance for Loan Losses

     42   

Note 6 – Variable Interest Entities, Private Capital and Other Investments

     49   

Note 7 – Employee Pension and Other Postretirement Benefits

     50   

Note 8 – Commercial Paper and Other Short-Term Borrowings

     51   

Note 9 – Long-Term Debt

     51   

Note 10 – Fair Value Measurement and Fair Value of Financial Instruments

     52   

Note 11 – Derivative Instruments and Other Financial Instruments Used For Hedging

     56   

Note 12 – Accumulated Other Comprehensive Loss

     60   

Note 13 – Commitments, Contingencies and Guarantees

     61   

Note 14 – Business Segments

     62   

Note 15 – Subsequent Event

     66   

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

     5   

Consolidated Financial Highlights

     5   

Introduction

     7   

Executive Overview

     7   

Critical Accounting Estimates

     8   

Net Interest Income

     9   

Noninterest Income and Noninterest Expense

     11   

Income Tax Expense

     12   

Securities

     13   

Loans Held for Investment

     13   

Allowance for Credit Losses

     15   

Nonperforming Assets

     17   

Loans 90 Days or More Past Due and Still Accruing

     18   

Deposits

     19   

Quantitative and Qualitative Disclosures About Market Risk

     19   

Liquidity Risk

     22   

Capital

     24   

Business Segments

     25   

Item 3.         Quantitative and Qualitative Disclosures About Market Risk

     32   

Item 4.        Controls and Procedures

     32   
PART II. OTHER INFORMATION      67   

Item 1. Legal Proceedings

     67   

Item 1A. Risk Factors

     67   

Item 6. Exhibits

     75   

SIGNATURES

     76   

 

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Table of Contents

NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report includes forward-looking statements, which include expectations for our operations and business and our assumptions for those expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly compared to our expectations. See Part I, Item 1A. “Risk Factors,” in our 2010 Annual Report on Form 10-K, Part II, Item 1A. “Risk Factors” in this report, and the other risks described in this report and in our 2010 Annual Report on Form 10-K for factors to be considered when reading any forward-looking statements in this filing.

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

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

 

  ¡  

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

 

  ¡  

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

 

  ¡  

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

 

  ¡  

The economic outlook for the California, U.S. and global economy

 

  ¡  

The impact of changes in interest rates, our strategy to manage our interest rate risk profile and our outlook for short-term and long-term interest rates and their effect on our net interest margin

 

  ¡  

Our sensitivity to and management of market risk, including changes in interest rates, and the economic outlook within specific industries, for the U.S. in general, for particular states in the U.S. including California, Oregon, Texas and Washington, and in foreign countries (including Japan)

 

  ¡  

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

 

  ¡  

Our strategies and expectations regarding capital levels and liquidity, our funding base, core deposits, our intent and ability to implement new capital standards under the Dodd-Frank Act and the Basel Committee capital standards and the effect of the foregoing on our business

 

  ¡  

Regulatory controls and processes and their impact on our business

 

  ¡  

The costs and effects of legal actions, investigations, regulatory actions, criminal proceedings or similar matters, our anticipated litigation strategies, our assessment of the timing and ultimate outcome of legal actions, or adverse facts and developments related thereto

 

  ¡  

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

 

  ¡  

Loan portfolio composition and risk grade trends, residential loan delinquency rates compared to the industry average, portfolio credit quality, our strategy regarding troubled debt restructurings (TDRs), and our intent to sell or hold loans we originate

 

  ¡  

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

 

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Table of Contents
  ¡  

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

 

  ¡  

Tax rates and taxes, the possible effect of changes in taxable profits of the U.S. operations of Mitsubishi UFJ Financial Group, Inc. (MUFG) on our state tax obligations and of expected tax credits or benefits

 

  ¡  

Critical accounting policies and estimates, the impact or anticipated impact of recent accounting pronouncements, guidance or changes in accounting principles and future recognition of impairments for the fair value of assets, including goodwill, financial instruments, intangible assets and other assets acquired in our April 2010 FDIC-assisted acquisitions

 

  ¡  

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

 

  ¡  

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

 

  ¡  

The impact of changes in our credit rating

 

  ¡  

Maintenance of casualty and liability insurance coverage appropriate for our operations

 

  ¡  

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

 

  ¡  

Descriptions of assumptions underlying or relating to any of the foregoing

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

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

 

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UnionBanCal Corporation and Subsidiaries

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

Consolidated Financial Highlights

 

    For the Three Months Ended     Percent
Change
    For the Nine Months Ended     Percent
Change
 
    September 30,       September 30,    

(Dollars in millions)

  2011     2010               2011                     2010            

Results of operations:

           

Net interest income

  $ 606      $ 618        (2 )%    $ 1,838      $ 1,793        3

Noninterest income

    185        218        (15     665        672        (1
 

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

    791        836        (5     2,503        2,465        2   

Noninterest expense

    603        562        7        1,796        1,671        7   
 

 

 

   

 

 

     

 

 

   

 

 

   

Pre-tax, pre-provision income

    188        274        (31     707        794        (11

(Reversal of) provision for loan losses

    (13     8        nm        (209     222        nm   
 

 

 

   

 

 

     

 

 

   

 

 

   

Income before income taxes and including noncontrolling interests

    201        266        (24     916        572        60   

Income tax expense

    33        99        (67     278        181        54   
 

 

 

   

 

 

     

 

 

   

 

 

   

Net income including noncontrolling interests

    168        167        1        638        391        63   

Deduct: Net loss from noncontrolling interests

    4        3        33        11        10        10   
 

 

 

   

 

 

     

 

 

   

 

 

   

Net income attributable to UnionBanCal Corporation (UNBC)

  $ 172      $ 170        1      $ 649      $ 401        62   
 

 

 

   

 

 

     

 

 

   

 

 

   

Balance sheet (period average):

           

Total assets

  $ 82,197      $ 82,265        -   $ 80,870      $ 84,186        (4 )% 

Total securities

    19,145        22,487        (15     20,421        23,037        (11

Total loans held for investment

    50,214        48,105        4        49,121        47,598        3   

Earning assets

    73,303        73,603        -        72,128        76,210        (5

Total deposits

    59,580        64,822        (8     59,129        66,910        (12

UNBC Stockholder’s equity

    10,708        9,913        8        10,417        9,693        7   

Performance Ratios:

           

Return on average assets (1)

    0.83     0.82       1.07     0.64  

Return on average UNBC stockholder’s equity (1)

    6.36        6.80          8.33        5.53     

Core efficiency ratio, excluding impact of privatization (2)

    70.41        61.13          67.13        61.68     

Net interest margin (1) (3)

    3.31        3.36          3.41        3.15     

Net loans charged off to average total loans held for investment (1)

    0.35        0.74          0.57        0.85     

Net loans charged off to average total loans held for investment, excluding FDIC covered assets (1)(8)

    0.36        0.77          0.58        0.87     
    As of                          
    September 30,
2011
    December 31,
2010
                         

Balance sheet (end of period):

           

Total assets

  $ 84,013      $ 79,097        6      

Total securities

    20,962        22,114        (5      

Total loans held for investment

    50,998        48,094        6         

Nonperforming assets

    870        1,142        (24      

Total deposits

    60,454        59,954        1         

Long-term debt

    7,064        5,598        26         

UNBC Stockholder’s equity

    10,900        10,125        8         

Capital ratios:

           

Tier 1 risk-based capital ratio

    13.09     12.44        

Total risk-based capital ratio

    15.41        15.01           

Leverage ratio

    10.96        10.34           

Tier 1 common capital ratio (4)

    13.09        12.42           

Tangible common equity ratio (5)

    10.10        9.67           

Credit Ratios:

           

Allowance for loan losses to total loans held for investment (6)

    1.51     2.48        

Allowance for loan losses to nonaccrual loans (6)

    105.97        123.40           

Allowance for credit losses to total loans held for investment (7)

    1.76        2.81           

Allowance for credit losses to nonaccrual loans (7)

    124.09        140.23           

Nonperforming assets to total loans held for investment and other real estate owned (OREO)

    1.70        2.37           

Nonperforming assets to total assets

    1.04        1.44           

Nonaccrual loans to total loans held for investment

    1.42        2.01           

Excluding FDIC covered assets (8):

           

Allowance for loan losses to total loans held for investment (6)

    1.51     2.50        

Allowance for loan losses to nonaccrual loans (6)

    112.28        137.32           

Allowance for credit losses to total loans held for investment (7)

    1.77        2.85           

Allowance for credit losses to nonaccrual loans (7)

    131.92        156.44           

Nonperforming assets to total loans held for investment and OREO

    1.38        1.91           

Nonperforming assets to total assets

    0.83        1.15           

Nonaccrual loans to total loans held for investment

    1.34        1.82           

 

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Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

 

(1) 

Annualized.

 

(2) 

The core efficiency ratio, excluding impact of privatization, a non-GAAP financial measure, is net noninterest expense (noninterest expense excluding privatization-related expenses and fair value amortization/accretion, foreclosed asset expense, (reversal of) provision for losses on off-balance sheet commitments, low income housing credit investment amortization expense, expenses of the consolidated Variable Interest Entities (VIEs), merger costs related to the acquisitions of certain assets and assumption of certain liabilities of Frontier Bank (Frontier) and Tamalpais Bank (Tamalpais) and asset impairment charge) as a percentage of total revenue (net interest income (taxable-equivalent basis) and noninterest income). Management discloses the core efficiency ratio as a measure of the efficiency of our operations, focusing on those costs most relevant to our core activities. Refer to “Noninterest Expense” in this Form 10-Q for further information.

 

(3) 

Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.

 

(4) 

The Tier 1 common capital ratio is the ratio of Tier 1 capital, less qualifying trust preferred securities, to risk-weighted assets. All of the trust preferred securities were paid off during the first quarter of 2011. The Tier 1 common capital ratio, a non-GAAP financial measure, has been included to facilitate the understanding of the Company’s capital structure and for use in assessing and comparing the quality and composition of UNBC’s capital structure to other financial institutions. Refer to “Capital” in this Form 10-Q for further information.

 

(5) 

The tangible common equity ratio, a non-GAAP financial measure, is calculated as tangible common equity divided by tangible assets. The methodology for determining tangible common equity may differ among companies. The tangible common equity ratio has been included to facilitate the understanding of the Company’s capital structure and for use in assessing and comparing the quality and composition of UNBC’s capital structure to other financial institutions. Refer to “Capital” in this Form 10-Q for further information.

 

(6) 

The allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans held for investment or total nonaccrual loans, as appropriate.

 

(7) 

The allowance for credit losses ratios are calculated using the sum of the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans held for investment or total nonaccrual loans, as appropriate.

 

(8) 

These ratios exclude the impact of the FDIC covered loans, the related allowance for loan losses and FDIC covered OREO, which are covered under loss share agreements between Union Bank, N.A. and the Federal Deposit Insurance Corporation. Such agreements are related to the April 2010 acquisitions of certain assets and assumption of certain liabilities of Frontier Bank and Tamalpais Bank. Management believes the exclusion of FDIC covered loans and FDIC covered OREO in certain asset quality ratios that include nonperforming loans, nonperforming assets, total loans held for investment and the allowance for loan losses or credit losses in the numerator or denominator provides a better perspective into underlying asset quality trends.

nm = not meaningful

 

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UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Please refer to our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2010 (2010 Form 10-K) along with the following discussion and analysis of our consolidated financial condition and results of operations for the period ended September 30, 2011 in this Form 10-Q. Averages, as presented in the following tables, are substantially all based upon daily average balances.

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

Introduction

We are a California-based financial holding company and commercial bank holding company whose major subsidiary, Union Bank, N.A. (the Bank), is a commercial bank. We provide a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, primarily in California, Oregon, Washington, Texas and New York, as well as nationally and internationally. We had consolidated assets of $84.0 billion at September 30, 2011.

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

Executive Overview

We are providing you with an overview of what we believe are the most significant factors and developments that impacted our third quarter 2011 results and that could impact our future results. Further detailed information can be found elsewhere in this Form 10-Q. In addition, we ask that you carefully read this entire document and any other reports that we refer to in this Form 10-Q for more detailed information that will assist your understanding of trends, events and uncertainties that impact us.

Our sources of revenue are net interest income and noninterest income (collectively “total revenue”). Net interest income is generated predominantly from interest received from loans, investment securities and other interest-earning assets, less interest paid on deposits and borrowings. The primary sources of noninterest income are revenues from service charges on deposit accounts, trust and investment management fees, and trading account activities. Changes in interest rates, credit quality, economic trends and the capital markets are primary factors that impact our revenue sources. A summary of our key financial results are presented below:

Performance Highlights

In the third quarter of 2011, net income was $172 million, up slightly from $170 million in the third quarter of 2010. While total revenue was lower and noninterest expense was higher, credit quality improved and our effective tax rate was lower in the third quarter 2011. Net income increased for the nine months ended September 30, 2011, to $649 million compared to $401 million for the nine months ended September 30, 2010, primarily due to a reversal of provision for loan losses of $209 million in 2011 compared to a provision for loan losses of $222 million for the same period in 2010, reflecting improved credit quality.

Our net interest income declined $12 million, or 2 percent, to $606 million in the third quarter of 2011 compared to the third quarter of 2010. The decrease was substantially due to a 5 basis point decline in the net interest margin, which was primarily due to lower yields on loans, a decrease in our average balances in securities along with an increase in lower yielding interest bearing deposits in banks, and a higher proportion of long-term debt within our mix of interest bearing liabilities, partially offset by a higher average balance of noninterest bearing funding sources. As a result of our targeted rate reductions, our average interest bearing deposits decreased by 17 percent to $40.9 billion compared to the third quarter of 2010.

In the third quarter of 2011, economic indicators reflected increased economic uncertainty and weak economic growth for the U.S. economy. In response, the Federal Reserve announced in September 2011 that it would adopt a more accommodative monetary policy that would provide additional stimulus to the economic recovery. Those actions are expected to result in a period of persistently low short-term and long-term interest rates, which would place downward pressure on our net interest margin.

In the third quarter of 2011, our noninterest income decreased $33 million, or 15 percent, from the third quarter of 2010 to $185 million, primarily due to a decrease in accretion on the indemnification asset associated with FDIC covered loans. Our noninterest expense increased $41 million, or 7 percent, to $603 million compared to the same period last year, primarily due to higher salaries and employee benefits expense. The increase was partially offset by lower regulatory assessment expense, which resulted from a change in the FDIC’s methodology for deposit insurance from a deposit-based model to an asset-based model.

Credit Quality

The provision for credit losses was a benefit of $13 million in the third quarter of 2011 compared to no provision for credit losses in the third quarter of 2010. The decrease in the provision for credit losses was primarily due to improved credit quality of the loan

 

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UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

portfolio reflected by the lower level of criticized and nonaccrual loans during the third quarter of 2011 compared to the third quarter of 2010. Our ratio of nonaccrual loans to total loans held for investment, excluding FDIC covered loans, decreased from 2.50 percent at September 30, 2010 to 1.34 percent at September 30, 2011. The allowance for credit losses as a percent of total loans, excluding FDIC covered loans, was 1.77 percent at September 30, 2011, compared with 3.12 percent at September 30, 2010. See further discussion under “Allowance for Credit Losses.”

Capital Ratios

We continued to build capital during the nine months ended September 30, 2011. Our Tier 1 risk-based capital ratio increased to 13.09 percent from 12.44 percent, the total risk-based capital ratio increased to 15.41 percent from 15.01 percent and our tangible common equity ratio increased to 10.10 percent from 9.67 percent, at September 30, 2011 from December 31, 2010, respectively. Effective October 1, 2011, BTMU transferred its trust company, The Bank of Tokyo-Mitsubishi UFJ Trust Company, to us. This transaction had the effect of increasing our assets by over $900 million and increasing our Tier 1 common capital by over $700 million.

Critical Accounting Estimates

UnionBanCal Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) and the general practices of the banking industry, which include management estimates and judgments. The financial information contained within our statements is, to a significant extent, 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. For example, we use discount factors and other assumptions to determine the fair value of certain assets and liabilities. A change in the discount factor or another important assumption could significantly increase or decrease the values of those assets and liabilities and result in either a beneficial or an adverse impact to our financial results. We use historical loss factors, adjusted for current conditions, to estimate the inherent credit loss present in our loan and lease portfolio. Actual losses could differ significantly from the loss factors that we use. Other significant estimates that we use include the fair values of our acquired loans (see Note 5 in this Form 10-Q), FDIC indemnification asset, and certain derivatives and securities (see Notes 10 and 11 in this Form 10-Q), assumptions used in measuring our pension obligations, and assumptions regarding our effective tax rates.

For each financial reporting period, our most significant estimates are presented to and discussed with the Audit & Finance Committee of our Board of Directors.

Understanding our accounting policies is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly, both our Critical Accounting Estimates and our significant accounting policies are discussed in detail in our 2010 Form 10-K. There have been no material changes to these critical accounting estimates during the nine months ended September 30, 2011.

 

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UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Financial Performance

Net Interest Income

The following table shows the major components of net interest income and net interest margin.

 

    For the Three Months Ended    Increase (Decrease) in  
    September 30, 2011    September 30, 2010       
    Average
Balance
         Interest
Income/
Expense(1)
         Average
Yield/
Rate(1)(2)
         Average
Balance
         Interest
Income/
Expense(1)
         Average
Yield/
Rate(1)(2)
         Average
Balance
  Interest
Income/
Expense (1)
 

(Dollars in millions)

                                Amount          Percent         Amount         Percent  

Assets

                                            

Loans held for investment:(3)

                                            

Commercial and industrial

  $ 16,947         $     160           3.76      $     14,628         $     176           4.78      $     2,319           16     $     (16       (9 )% 

Commercial mortgage

    7,838           82           4.22           8,006           85           4.23           (168        (2       (3       (4

Construction

    992           12           5.04           1,946           16           3.12           (954        (49       (4       (25

Lease financing

    697           8           4.28           639           6           3.77           58           9          2          33   

Residential mortgage

    18,818           221           4.70           17,196           226           5.26           1,622           9          (5       (2

Home equity and other consumer loans

    3,751           40           4.25           3,900           43           4.43           (149        (4       (3       (7
 

 

 

      

 

 

           

 

 

      

 

 

           

 

 

          

 

 

     

Total loans, excluding FDIC covered loans

    49,043           523           4.26           46,315           552           4.75           2,728           6          (29       (5

FDIC covered loans

    1,171           55           18.60           1,790           32           7.17           (619        (35       23          72   
 

 

 

      

 

 

           

 

 

      

 

 

           

 

 

          

 

 

     

Total loans held for investment

    50,214           578           4.60           48,105           584           4.84           2,109           4          (6       (1

Securities

    19,145           123           2.56           22,487           132           2.36           (3,342        (15       (9       (7

Interest bearing deposits in banks

    3,610           3           0.25           2,407           1           0.25           1,203           50          2          200   

Federal funds sold and securities purchased under resale agreements

    61           -           0.03           390           1           0.15           (329        (84       (1       (100

Trading account assets

    166           -           0.68           214           -           1.10           (48        (22       -          -   

Other earning assets

    107           -           0.54           -           -           -           107           nm          -          -   
 

 

 

      

 

 

           

 

 

      

 

 

           

 

 

          

 

 

     

Total earning assets

    73,303           704           3.83           73,603           718           3.89           (300        (0       (14       -   
      

 

 

                

 

 

                    

 

 

     

Allowance for loan losses

    (785                  (1,375                  590           43           

Cash and due from banks

    1,254                     1,184                     70           -           

Premises and equipment, net

    676                     672                     4           1           

Other assets

    7,749                     8,181                     (432        -           
 

 

 

                

 

 

                

 

 

              

Total assets

  $ 82,197                   $ 82,265                   $ (68        (0 )%         
 

 

 

                

 

 

                

 

 

              

Liabilities

                                            

Interest bearing deposits:

                                            

Transaction and money market accounts

  $ 23,836         $ 14           0.23         $ 32,722         $ 34           0.40         $ (8,886        (27     $ (20       (59

Savings

    5,476           3           0.21           4,414           3           0.28           1,062           24          -          -   

Time

    11,634           36           1.28           12,254           33           1.07           (620        (5       3          9   
 

 

 

      

 

 

           

 

 

      

 

 

           

 

 

          

 

 

     

Total interest bearing deposits

    40,946           53           0.53           49,390           70           0.56           (8,444        (17       (17       (24
 

 

 

      

 

 

           

 

 

      

 

 

           

 

 

          

 

 

     

Commercial paper and other short-term borrowings (4)

    2,371           2           0.20           1,026           1           0.35           1,345           131          1          100   

Long-term debt

    7,066           41           2.31           4,528           27           2.40           2,538           56          14          52   
 

 

 

      

 

 

           

 

 

      

 

 

           

 

 

          

 

 

     

Total borrowed funds

    9,437           43           1.78           5,554           28           2.02           3,883           70          15          54   
 

 

 

      

 

 

           

 

 

      

 

 

           

 

 

          

 

 

     

Total interest bearing liabilities

    50,383           96           0.76           54,944           98           0.71           (4,561        (8       (2       (2
      

 

 

                

 

 

                    

 

 

     

Noninterest bearing deposits

    18,634                     15,432                     3,202           21           

Other liabilities

    2,203                     1,698                     505           30           
 

 

 

                

 

 

                

 

 

              

Total liabilities

    71,220                     72,074                     (854        (1        

Equity

                                            

UNBC Stockholder’s equity

    10,708                     9,913                     795           8           

Noncontrolling interests

    269                     278                     (9        (3        
 

 

 

                

 

 

                

 

 

              

Total equity

    10,977                     10,191                     786           8           
 

 

 

                

 

 

                

 

 

              

Total liabilities and equity

  $     82,197                   $ 82,265                   $ (68        (0 )%         
 

 

 

                

 

 

                

 

 

              

Net interest income/spread (taxable-equivalent basis)

         608           3.07             620           3.18                 (12       (2 )% 

Impact of noninterest bearing deposits

              0.20                     0.16                     

Impact of other noninterest bearing sources

              0.04                     0.02                     

Net interest margin

              3.31                     3.36                     

Less: taxable-equivalent adjustment

         2                     2                         -          -   
      

 

 

                

 

 

                    

 

 

     

Net interest income

       $ 606                   $ 618                       $ (12       (2 )% 
      

 

 

                

 

 

                    

 

 

     

 

(1) 

Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.

(2) 

Annualized.

(3) 

Average balances on loans outstanding include all nonperforming loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield.

(4) 

Includes interest bearing trading liabilities.

 

9


Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

     For the Nine Months Ended    Increase (Decrease) in  
     September 30, 2011    September 30, 2010       
     Average
Balance
        Interest
Income/
Expense(1)
        Average
Yield/
Rate(1)(2)
         Average
Balance
         Interest
Income/
Expense(1)
         Average
Yield/
Rate(1)(2)
         Average
Balance
   Interest
Income/
Expense (1)
 

(Dollars in millions)

                               Amount          Percent          Amount         Percent  

Assets

                                            

Loans held for investment:(3)

                                            

Commercial and industrial

   $     16,035        $     476          3.97      $     14,722         $     506           4.59      $ 1,313           9      $ (30       (6 )% 

Commercial mortgage

     7,780          251          4.31           8,139           257           4.21           (359        (4        (6       (2

Construction

     1,148          35          4.11           2,132           48           2.99           (984        (46        (13       (27

Lease financing

     748          24          4.20           643           18           3.82           105           16           6          33   

Residential mortgage

     18,316          662          4.82           16,990           680           5.34           1,326           8           (18       (3

Home equity and other consumer loans

     3,785          120          4.26           3,912           129           4.42           (127        (3        (9       (7
  

 

 

     

 

 

          

 

 

      

 

 

           

 

 

           

 

 

     

Total loans, excluding FDIC covered loans

     47,812          1,568          4.38           46,538           1,638           4.70           1,274           3           (70       (4

FDIC covered loans

     1,309          138          14.03           1,060           58           7.31           249           23           80          138   
  

 

 

     

 

 

          

 

 

      

 

 

           

 

 

           

 

 

     

Total loans held for investment

     49,121          1,706          4.64           47,598           1,696           4.76           1,523           3           10          1   

Securities

     20,421          405          2.64           23,037           411           2.38           (2,616        (11        (6       (1

Interest bearing deposits in banks

     2,300          5          0.25           4,959           9           0.25           (2,659        (54        (4       (44

Federal funds sold and securities purchased under resale agreements

     76          -          0.11           414           1           0.13           (338        (82        (1       (100

Trading account assets

     151          1          0.84           202           2           1.37           (51        (25        (1       (50

Other earning assets

     59          -          1.03           -           -           -           59           nm           -          -   
  

 

 

     

 

 

          

 

 

      

 

 

           

 

 

           

 

 

     

Total earning assets

     72,128          2,117          3.92           76,210           2,119           3.71           (4,082        (5        (2       -   
      

 

 

               

 

 

                     

 

 

     

Allowance for loan losses

     (985                (1,414                  429           30            

Cash and due from banks

     1,236                   1,197                     39           3            

Premises and equipment, net

     693                   673                     20           3            

Other assets

     7,798                   7,520                     278           4            
  

 

 

              

 

 

                

 

 

               

Total assets

   $ 80,870                 $ 84,186                   $ (3,316        (4 )%          
  

 

 

              

 

 

                

 

 

               

Liabilities

                                            

Interest bearing deposits:

                                            

Transaction and money market accounts

   $ 24,325        $ 43          0.24         $ 36,704         $ 145           0.53         $     (12,379        (34      $     (102       (70

Savings

     5,042          9          0.25           4,237           13           0.40           805           19           (4       (31

Time

     11,847          107          1.21           11,090           76           0.92           757           7           31          41   
  

 

 

     

 

 

          

 

 

      

 

 

           

 

 

           

 

 

     

Total interest bearing deposits

     41,214          159          0.52           52,031           234           0.60           (10,817        (21        (75       (32
  

 

 

     

 

 

          

 

 

      

 

 

           

 

 

           

 

 

     

Commercial paper and other short-term borrowings (4)

     2,640          5          0.23           1,304           4           0.40           1,336           102           1          25   

Long-term debt

     6,443          108          2.24           4,611           81           2.36           1,832           40           27          33   
  

 

 

     

 

 

          

 

 

      

 

 

           

 

 

           

 

 

     

Total borrowed funds

     9,083          113          1.65           5,915           85           1.93           3,168           54           28          33   
  

 

 

     

 

 

          

 

 

      

 

 

           

 

 

           

 

 

     

Total interest bearing liabilities

     50,297          272          0.72           57,946           319           0.74           (7,649        (13        (47       (15
      

 

 

               

 

 

                     

 

 

     

Noninterest bearing deposits

     17,915                   14,879                     3,036           20            

Other liabilities

     1,971                   1,449                     522           36            
  

 

 

              

 

 

                

 

 

               

Total liabilities

     70,183                   74,274                     (4,091        (6         

Equity

                                            

UNBC Stockholder’s equity

     10,417                   9,693                     724           7            

Noncontrolling interests

     270                   219                     51           23            
  

 

 

              

 

 

                

 

 

               

Total equity

     10,687                   9,912                     775           8            
  

 

 

              

 

 

                

 

 

               

Total liabilities and equity

   $ 80,870                 $ 84,186                   $ (3,316        (4 )%          
  

 

 

              

 

 

                

 

 

               

Net interest income/spread
(taxable-equivalent basis)

         1,845          3.20             1,800           2.97                  45          3

Impact of noninterest bearing deposits

             0.19                     0.15                      

Impact of other noninterest bearing sources

             0.02                     0.03                      

Net interest margin

             3.41                     3.15                      

Less: taxable-equivalent adjustment

         7                    7                          -          -   
      

 

 

               

 

 

                     

 

 

     

Net interest income

       $ 1,838                  $ 1,793                        $ 45          3
      

 

 

               

 

 

                     

 

 

     

 

(1) 

Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.

(2) 

Annualized.

(3) 

Average balances on loans outstanding include all nonperforming loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield.

(4) 

Includes interest bearing trading liabilities.

Net interest income for the third quarter of 2011 decreased $12 million, or 2 percent, compared to the third quarter of 2010. The decrease was substantially due to a 5 basis point decline in the net interest margin, which was primarily due to lower yields on loans, a decrease in our average balances in securities along with an increase in lower yielding interest bearing deposits in banks, and a higher proportion of long-term debt within our mix of interest bearing liabilities, partially offset by a higher average balance of noninterest bearing funding sources. Average noninterest bearing deposits funded 25 percent of average total earning assets for the three months

 

10


Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

ended September 30, 2011 compared to 21 percent for the three months ended September 30, 2010. Average total loans, excluding FDIC covered loans, increased $2.7 billion, or 6 percent, reflecting growth in commercial and industrial loans and residential mortgage loans.

Net interest income for the nine months ended September 30, 2011 increased $45 million, or 3 percent, compared to the nine months ended September 30, 2010. The increase was due to growth in the net interest margin, which increased to 3.41 percent for the nine months ended September 30, 2011, compared with 3.15 percent for the nine months ended September 30, 2010. The growth in the net interest margin was primarily due to higher yields on securities and a shift in balances from interest bearing deposits in banks into loans. Average noninterest bearing deposits funded 25 percent of average total earning assets for the nine months ended September 30, 2011 compared to 20 percent for the nine months ended September 30, 2010.

Noninterest Income and Noninterest Expense

The following tables detail our noninterest income and noninterest expense for the three and nine months ended September 30, 2011 and 2010.

Noninterest Income

 

        For the Three Months Ended         For the Nine Months Ended  
        September 30,
2011
        September 30,
2010
        Increase (Decrease)         September 30,
2011
        September 30,
2010
        Increase (Decrease)  

(Dollars in millions)

                      Amount             Percent                         Amount             Percent  

Service charges on deposit accounts

    $ 57        $ 62        $ (5       (8 )%      $ 170        $ 192        $         (22       (11 )% 

Trust and investment management fees

      33          33          -          -          101          99          2          2   

Trading account activities

      27          32          (5       (16       88          78          10          13   

Merchant banking fees

      27          19          8          42          75          55          20          36   

Securities gains, net

      1          11          (10       (91       58          72          (14       (19

Brokerage commissions and fees

      12          11          1          9          37          30          7          23   

Standby letters of credit fees

      11          8          3          38          34          26          8          31   

Card processing fees, net

      11          10          1          10          33          31          2          6   

Other

      6          32          (26       (81       69          89          (20       (22
   

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Total noninterest income

    $             185        $         218        $         (33       (15 )%      $         665        $         672        $ (7       (1 )% 
   

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     
Noninterest Expense                                                                  
        For the Three Months Ended         For the Nine Months Ended  
        September 30,
2011
        September 30,
2010
        Increase (Decrease)         September 30,
2011
        September 30,
2010
        Increase (Decrease)  

(Dollars in millions)

                  Amount         Percent                     Amount         Percent  

Salaries and other compensation

    $ 282        $ 251        $ 31          12     $ 825        $ 745        $ 80          11

Employee benefits

      66          42          24          57          213          147          66          45   
   

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Salaries and employee benefits

      348          293          55          19          1,038          892          146          16   

Net occupancy and equipment

      64          65          (1       (2       196          188          8          4   

Professional and outside services

      55          54          1          2          154          143          11          8   

Intangible asset amortization

      25          31          (6       (19       74          93          (19       (20

Regulatory assessments

      14          30          (16       (53       54          90          (36       (40

Software

      16          18          (2       (11       48          49          (1       (2

Low income housing credit investment amortization

      16          13          3          23          47          41          6          15   

Advertising and public relations

      9          12          (3       (25       33          34          (1       (3

Communications

      10          11          (1       (9       31          30          1          3   

Data Processing

      9          10          (1       (10       29          26          3          12   

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

      -          (8       8          100          (31       (12       (19       158   

Other

      37          33          4          12          123          97          26          27   
   

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Total noninterest expense

    $ 603        $ 562        $ 41          7     $ 1,796        $ 1,671        $ 125          7
   

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Noninterest income decreased to $185 million in the third quarter 2011 from $218 million in the third quarter 2010. This decrease was mainly due to other noninterest income decreasing by $26 million, substantially due to a decrease in indemnification asset accretion, driven by better than expected FDIC covered loan performance. Securities gains, net decreased primarily due to a $14 million gain on the sale of U.S. Government sponsored agency securities in 2010. These were partially offset by an increase in merchant banking fees, which increased primarily due to a $6 million increase in fees from syndicated loan activity.

 

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Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Noninterest income decreased to $665 million in the nine months ended September 30, 2011 from $672 million in the nine months ended September 30, 2010. This decrease was mainly due to service charges on deposit accounts decreasing primarily due to lower overdraft volumes resulting from changes in customer behavior and the impact of changes to fee-related regulations. Other noninterest income decreased $20 million, primarily due to a $37 million decrease in indemnification asset accretion, driven by better than expected FDIC covered loan performance, partially offset by a $15 million gain on the sale of MasterCard shares in the first quarter of 2011. These decreases were partially offset by an increase in merchant banking fees primarily due to a $15 million increase in fees from syndicated loan activity.

Our card processing fees are substantially composed of debit card interchange fees. We expect our debit card interchange fees to decline beginning October 1, 2011 due to the Dodd-Frank Act and the recently enacted Federal Reserve final rule, which sets a cap on interchange fees at a rate below the third quarter 2011 levels. Management believes that the impact of these developments on our interchange fee income will not be material relative to our total revenue.

Noninterest expense increased to $603 million in the third quarter 2011 from $562 million in the third quarter 2010. This increase was primarily due to an increase in salaries and employee benefits, which resulted from an increase in incentive compensation accruals, and higher costs related to employee benefit plans. This increase was partially offset by a decrease in regulatory assessments mainly due to a change in the FDIC’s methodology from a deposit-based to an asset-based model.

Noninterest expense increased to $1.8 billion in the nine months ended September 30, 2011 from $1.7 billion in the nine months ended September 30, 2010. This increase was primarily due to an increase in salaries and employee benefits, which was largely driven by the growth in the number of employees, and higher costs related to employee benefit plans. Other expenses also increased due to additional reserves for certain contingencies. This increase was partially offset by a decrease in regulatory assessments mainly due to a change in the FDIC’s methodology from a deposit-based to an asset-based model, as well as an increase in the reversal of the provision for losses on off-balance sheet commitments of $19 million, primarily due to improved credit quality.

The core efficiency ratio, excluding the privatization transaction, is a non-GAAP financial measure that is used by management to measure the efficiency of our operations, focusing on those costs management believes to be most relevant to our core activities. The following table shows the calculation of this ratio for the three and nine months ended September 30, 2011 and 2010.

 

    For the Three Months Ended         For the Nine Months Ended  

(Dollars in millions)

  September 30,
2011
        September 30,
2010
        September 30,
2011
        September 30,
2010
 

Noninterest Expense

  $ 603        $ 562        $ 1,796        $ 1,671   

Less: Foreclosed asset expense

    4          6          8          7   

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

    -          (8       (31       (12

Less: Low income housing credit investment amortization expense

    15          13          47          41   

Less: Expenses of the consolidated VIEs

    6          6          18          17   

Less: Merger costs related to acquisitions

    -          11          23          24   
 

 

 

     

 

 

     

 

 

     

 

 

 

Net noninterest expense before privatization adjustments

  $ 578        $ 534        $ 1,731        $ 1,594   

Net adjustments related to privatization transaction

    26          33          77          104   
 

 

 

     

 

 

     

 

 

     

 

 

 

Net noninterest expense, excluding privatization transaction (a)

  $ 552        $ 501        $ 1,654        $ 1,490   
 

 

 

     

 

 

     

 

 

     

 

 

 

Total Revenue

  $ 791        $ 836        $ 2,503        $ 2,465   

Add: Net interest income taxable-equivalent adjustment

    2          2          7          7   
 

 

 

     

 

 

     

 

 

     

 

 

 

Total revenue, including taxable-equivalent adjustment

    793          838          2,510          2,472   

Less: Accretion related to privatization-related fair value adjustments

    10          18          47          56   
 

 

 

     

 

 

     

 

 

     

 

 

 

Total revenue, excluding impact of privatization transaction (b)

  $ 783        $ 820        $ 2,463        $ 2,416   
 

 

 

     

 

 

     

 

 

     

 

 

 

Core efficiency ratio, excluding impact of privatization transaction (a)/(b)

    70.41       61.13       67.13       61.68
 

 

 

     

 

 

     

 

 

     

 

 

 

Income Tax Expense

Our effective tax rate in the third quarter of 2011 was 17 percent, compared to 38 percent for the third quarter of 2010. Our effective tax rate for the nine months ended September 30, 2011 was 31 percent, compared to 32 percent for the nine months ended September 30, 2010. The change in the effective tax rate for the third quarter of 2011 was primarily driven by income tax benefits related to a change in estimate to the valuation of FDIC covered assets, and the proportionately larger effect from a stable level of low income housing and alternative energy income tax credits compared to pre-tax income in the third quarter of 2011.

Our unrecognized tax benefits balance increased by $36 million to $268 million at September 30, 2011 from December 31, 2010, and the amount of unrecognized tax benefits that would affect the effective tax rate, if recognized, increased by $18 million. The increase in our unrecognized tax benefits balance relates to tax positions taken in prior periods.

 

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Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

For further information regarding income tax expense, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Income Tax Expense” and “Changes in our tax rates could affect our future results” in “Risk Factors” in Part I, Item 1A and Note 12 to the consolidated financial statements in our 2010 Form 10-K.

Securities

Our securities portfolio is managed to promote the maximization of return while maintaining prudent levels of quality, market risk and liquidity. At September 30, 2011, substantially all of our securities were investment grade. The amortized cost, gross unrealized gains, gross unrealized losses and fair values of securities are detailed in Note 4 to our consolidated financial statements included in this Form 10-Q. Substantially all of our securities available for sale are held for Asset and Liability Management (ALM) purposes.

Our securities held to maturity consist of collateralized loan obligations (CLOs), which primarily consist of Cash Flow CLOs. A Cash Flow CLO is a structured finance product that securitizes a diversified pool of loan assets into multiple classes of notes from the cash flows generated by such loans. Cash Flow CLOs pay the note holders through the receipt of interest and principal repayments from the underlying loans, unlike other types of CLOs that pay note holders through the trading and sale of underlying collateral.

Loans Held for Investment

The following table shows loans held for investment outstanding by loan type at the end of each period presented.

 

    September 30,
2011     
        December  31,
2010
         Increase / (Decrease)
September 30, 2011
From

December 31, 2010
 

(Dollars in millions)

               Amount          Percent  

Loans held for investment:

               

Commercial and industrial

  $ 17,545        $ 15,162         $ 2,383           16

Commercial mortgage

    7,927          7,816           111           1   

Construction

    966          1,460           (494        (34

Lease financing

    693          757           (64        (8
 

 

 

     

 

 

      

 

 

      

Total commercial portfolio

    27,131          25,195           1,936           8   
 

 

 

     

 

 

      

 

 

      

Residential mortgage

    19,043          17,531           1,512           9   

Home equity and other consumer loans

    3,730          3,858           (128        (3
 

 

 

     

 

 

      

 

 

      

Total consumer portfolio

    22,773          21,389           1,384           6   
 

 

 

     

 

 

      

 

 

      

Total loans held for investment, excluding
FDIC covered loans

    49,904          46,584           3,320           7   

FDIC covered loans

    1,094          1,510           (416        (28
 

 

 

     

 

 

      

 

 

      

Total loans held for investment

  $ 50,998        $ 48,094         $ 2,904           6
 

 

 

     

 

 

      

 

 

      

Commercial and Industrial Loans

Our commercial and industrial loans are extended principally to corporations, middle-market businesses and small businesses and are originated 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 variety of financial services to major corporations. These services include traditional commercial banking and specialized financing tailored to the needs of each customer’s specific industry. We are active in, among other sectors, power and utilities, oil and gas, manufacturing, wholesale trade, real estate and leasing, communications, healthcare, retailing, and finance and insurance services. These industries comprise the majority of our commercial and industrial portfolio. While loans extended within these sectors comprise the majority of our commercial and industrial portfolio, no individual industry sector exceeded 10 percent of our total loans held for investment at either September 30, 2011 or December 31, 2010.

The commercial and industrial portfolio increased $2.4 billion, or 16 percent, from December 31, 2010 to September 30, 2011, reflecting improved lending conditions. The overall credit quality of our portfolio of commercial and industrial loans continued to improve as borrowers’ financial condition improved and as they had access to more refinancing options.

 

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Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Construction and Commercial Mortgage Loans

We engage in real estate lending that includes commercial mortgage loans and construction loans secured by deeds of trust. The commercial mortgage loan portfolio consists of loans secured by commercial income properties, 77 percent of which are located in California, 6 percent in Washington, and the remaining 17 percent in various other states.

Construction loans are extended primarily to commercial property developers and to residential builders. As of September 30, 2011, the construction loan portfolio consisted of approximately 81 percent of commercial income producing real estate and 19 percent with residential homebuilders. The construction loan portfolio decreased $0.5 billion or 34 percent from December 31, 2010 to September 30, 2011 mainly due to declines of $508 million, or 42 percent, in the income property portfolio and $17 million, or 9 percent, in the homebuilder portfolio. The income property portfolio reductions were concentrated mostly in the office and apartment property types. Geographically, 45 percent of the construction loan portfolio was domiciled in California as of September 30, 2011. The largest concentration outside of California was 11 percent in the state of Washington. The California portfolio is distributed as follows: 41 percent in the Los Angeles/Orange County region, including the Inland Empire, 21 percent in the San Francisco Bay Area, 13 percent in Sacramento and the Central Valley, 12 percent in San Diego, and 13 percent in the Central Coast region.

Residential Mortgage Loans

We originate residential mortgage loans secured by one-to-four family residential properties, through our multiple channel network (including branches, private bankers, mortgage brokers, and telephone centers) throughout California, Oregon and Washington, and we periodically purchase loans in our market area. We hold substantially all of the loans we originate. The residential mortgage portfolio increased $1.5 billion, or 9 percent, from December 31, 2010 to September 30, 2011, as we experienced strong new origination activity.

At September 30, 2011, 72 percent of our residential mortgage loans have current payment terms in which the monthly payment covers the full amount of interest due, but does not reduce the principal balance. At origination, these interest-only loans had strong credit profiles and had weighted average loan-to-value (LTV) ratios of approximately 67 percent. The remainder of the portfolio consists of regularly amortizing loans and a small amount of balloon loans.

We do not have a program for originating or purchasing subprime loan products. The Bank’s “no doc” and “low doc” loan origination programs were discontinued in 2008, except for a streamlined refinance process for existing Bank mortgages. At September 30, 2011, the outstanding balances of the “no doc” and “low doc” portfolios were approximately 36 percent of our total residential loan portfolio, and the loan delinquency rates with respect to these portfolios remained below the industry average for California prime loans. At September 30, 2011, the aggregate balance of “no doc” and “low doc” loans past due 30 days or more was $167 million, compared with $175 million at December 31, 2010.

Total residential mortgage loans 30 days or more delinquent were $382 million at September 30, 2011, compared with $350 million at December 31, 2010. Our residential loan delinquency rates remained below the industry average for California prime loans.

Home Equity and Other Consumer Loans

We originate home equity and other consumer loans and lines, principally through our branch network and Private Banking Offices. We had approximately 32 percent and 31 percent of these home equity loans and lines supported by first liens on residential properties at September 30, 2011 and December 31, 2010, respectively. Our total home equity loans and lines delinquent 30 days or more were $42 million at September 30, 2011, compared to $36 million at December 31, 2010. To manage risk associated with lending commitments, we review all equity-secured lines annually for creditworthiness and reduce or freeze limits, as permitted by laws and regulations.

Lease Financing

We offer two types of leases to our customers: direct financing leases, where the assets leased are acquired without additional financing from other sources; and leveraged leases, where a substantial portion of the financing is provided by debt with no recourse to us. At September 30, 2011, we had leveraged leases of $465 million, which were net of non-recourse debt of approximately $860 million. We utilize a number of special purpose entities for our leveraged leases. These entities do not function as vehicles to shift liabilities to other parties or to deconsolidate affiliates for financial reporting purposes. As allowed by US GAAP for leveraged leases, the gross lease receivable is offset by the qualifying non-recourse debt. In leveraged lease transactions, the third-party lender may only look to the collateral value of the leased assets for repayment in the event of lessee default.

FDIC Covered Loans

We acquired loans as part of the FDIC-assisted acquisitions of certain assets and assumption of certain liabilities of Frontier Bank (Frontier) and Tamalpais Bank (Tamalpais) during the second quarter of 2010. All of the acquired loans are covered under loss share agreements with the FDIC and are referred to as “FDIC covered loans.” We will be reimbursed for a substantial portion of any

 

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Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

future losses on the FDIC covered loans under the terms of the FDIC loss share agreements. Total FDIC covered loans outstanding at September 30, 2011 were composed of $1.0 billion in commercial mortgage, construction and commercial and industrial loans, and $0.1 billion in residential mortgage and other consumer loans. See Notes 1 and 2 to our consolidated financial statements included in our 2010 Form 10-K for more information on covered assets and FDIC loss share agreements.

Cross-Border Outstandings

Our cross-border outstandings reflect certain additional economic and political risks that are not reflected in domestic outstandings. These risks include those arising from exchange rate fluctuations and restrictions on the transfer of funds. Our total cross-border outstandings for Canada, the only country where such outstandings exceeded one percent of total assets, were $989 million and $804 million, as of September 30, 2011 and December 31, 2010, respectively. The cross-border outstandings are based on 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.

Allowance for Credit Losses

Allowance Policy and Methodology

We maintain an allowance for credit losses (defined as both the allowance for loan losses and the allowance for off-balance sheet commitment losses) to absorb losses inherent in the loan portfolio as well as for leases and off-balance sheet commitments. Understanding our policies on the allowance for credit losses is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly, our significant policies and methodology on the allowance for credit losses are discussed in detail in Note 1 to our consolidated financial statements and in the section “Allowances for Credit Losses” included in our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2010 Form 10-K.

Total Allowance and Related Provision for Credit Losses

At September 30, 2011 and December 31, 2010, our total allowance for credit losses, excluding FDIC covered loans, was $882 million, or 1.77 percent of total loans held for investment, and $1.3 billion, or 2.85 percent of total loans held for investment, respectively. At September 30, 2011, our total allowance for credit losses, excluding FDIC covered loans, of $882 million consisted of $751 million for loan losses and $131 million for losses on off-balance sheet commitments. The allowance for credit losses was composed of $755 million of allocated allowance and $127 million of unallocated allowance for loan losses. At September 30, 2011 and December 31, 2010, our allowance for loan losses on FDIC covered loans was $17 million and $25 million, respectively.

We recorded a reversal of the provision for loan losses, excluding FDIC covered loans, of $13 million in the third quarter of 2011, compared to a provision for loan losses of $8 million during the third quarter of 2010. In the third quarter of 2011, the reversal of the provision, excluding FDIC covered loans, was primarily attributable to the improved credit quality of the loan portfolio. The improved credit quality of the loan portfolio was particularly evident in lower levels of criticized credits in the commercial segment, which declined from $3.4 billion at December 31, 2010 to $2.0 billion at September 30, 2011, continuing the significant downward trend that was observed during the second half of 2010. The ratio of nonaccrual loans to total loans held for investment, excluding FDIC covered loans, decreased to 1.34 percent at September 30, 2011 from 1.82 percent at December 31, 2010. In addition, annualized net loans charged off to average loans outstanding, excluding FDIC covered loans, for the third quarter of 2011 decreased to 0.36 percent from 0.77 percent for the third quarter of 2010.

At September 30, 2011, the allocated portion of the allowance for credit losses included $248 million related to criticized credits, compared to $468 million at December 31, 2010. Criticized 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.

Changes in the Unallocated Allowance

The decrease from December 31, 2010 to September 30, 2011 was primarily due to broad-based improvements in the commercial loan portfolios and the sustained yet mild recovery which has reduced, in management’s opinion, the inherent losses not already reflected in the allocated allowance. The unallocated allowance continues to reflect higher than normal default rates for smaller balance commercial mortgages, the fiscal challenges for the State of California and local governments, extended collection periods for residential mortgage loans, and the continuation of historically low natural gas prices.

 

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Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Change in the Total Allowance for Credit Losses

The following table sets forth a reconciliation of changes in our allowance for credit losses.

 

        For the Three Months    
Ended  September 30,
          Increase /(Decrease)
    For the Three Months Ended     
September 30, 2011
From
September 30, 2010
              For the Nine Months    
Ended  September 30,
          Increase /(Decrease)
    For the Nine Months Ended     
September 30, 2011
From
September 30, 2010
       

(Dollars in millions)

  2011           2010           Amount     Percent           2011           2010           Amount     Percent        

Beginning balance of allowance for loan losses

  $ 826        $ 1,358        $ (532     (39     %      $ 1,191        $ 1,357        $ (166     (12     %   

(Reversal of) provision for loan losses, excluding FDIC covered loans

    (13       8          (21     nm          (207       222          (429     (193  

(Reversal of) provision for FDIC covered loan losses not subject to FDIC indemnification

    -          -          -        -          (2       -          (2     nm     

Decrease in allowance covered by FDIC indemnification

    -          -          -        -          (5       -          (5     nm     

Other

    (1       -          (1     100          (1       -          (1     100     

Loans charged off:

                           

Commercial and industrial

    (20       (37       17        (46       (54       (134       80        (60  

Commercial mortgage

    (10       (27       17        (63       (48       (110       62        (56  

Construction

    -          (2       2        (100       (4       (28       24        (86  

Lease financing

    (5       -          (5     nm          (76       -          (76     nm     
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Total commercial portfolio

    (35       (66       31        (47       (182       (272       90        (33  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Residential mortgage

    (13       (25       12        (48       (40       (47       7        (15  

Home equity and other consumer loans

    (8       (11       3        (27       (29       (30       1        (3  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Total consumer portfolio

    (21       (36       15        (42       (69       (77       8        (10  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

FDIC covered loans

    (1       -          (1     nm          (2       -          (2     nm     
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Total loans charged off

    (57       (102       45        (44       (253       (349       96        (28  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Recoveries of loans previously charged off:

                           

Commercial and industrial

    5          5          -        -          20          26          (6     (23  

Commercial mortgage

    1          1          -        -          11          -          11        nm     

Construction

    4          7          (3     (43       10          17          (7     (41  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Total commercial portfolio

    10          13          (3     (23       41          43          (2     (5  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Residential mortgage

    1          -          1        100          1          3          (2     (67  

Home equity and other consumer loans

    1          -          1        nm          2          1          1        100     
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Total consumer portfolio

    2          -          2        nm          3          4          (1     (25  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

FDIC covered loans

    1          -          1        nm          1          -          1        nm     
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Total recoveries of loans previously charged off

    13          13          -        -          45          47          (2     (4  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Net loans charged off

    (44       (89       45        (51       (208       (302       94        (31  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Ending balance of allowance for loan losses

  $ 768        $ 1,277        $ (509     (40     $ 768        $ 1,277        $ (509     (40  

Allowance for losses on off-balance sheet commitments

    131          164          (33     (20       131          164          (33     (20  
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Allowance for credit losses

  $ 899        $ 1,441        $ (542     (38     %      $ 899        $ 1,441        $ (542     (38     %   
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Components of allowance for loan losses and credit losses:

                           

Allowance for loan losses, excluding allowance on FDIC covered loans

  $ 751        $ 1,277        $ (526     (41     %      $ 751        $ 1,277        $ (526     (41     %   

Allowance for loan losses on FDIC covered loans

    17          -          17        nm          17          -          17        nm     
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Total allowance for loan losses

  $ 768        $ 1,277        $ (509     (40     %      $ 768        $ 1,277        $ (509     (40     %   
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Allowance for credit losses, excluding allowance on FDIC covered loans

  $ 882        $ 1,441        $ (559     (39     %      $ 882        $ 1,441        $ (559     (39     %   

Allowance for credit losses on FDIC covered loans

    17          -          17        nm          17          -          17        nm     
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Total allowance for credit losses

  $ 899        $ 1,441        $ (542     (38     %      $ 899        $ 1,441        $ (542     (38     %   
 

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

     

Allowance for loan losses to total loans held for investment

    1.51        %        2.67        %              1.51        %        2.67        %         

Allowance for credit losses to total loans held for investment

    1.76          3.01                1.76          3.01           

Net loans charged off to average loan soutstanding for the period (2)

    0.35          0.74                0.57          0.85           

Excluding FDIC covered loans (1):

                           

Allowance for loan losses to total loans held for investment

    1.51        %        2.76        %              1.51        %        2.76        %         

Allowance for credit losses to total loans held for investment

    1.77          3.12                1.77          3.12           

Net loans charged off to average loans outstanding for the period (2)

    0.36          0.77                0.58          0.87           

 

(1) These ratios exclude the impact of the FDIC covered loans, which are covered under loss share agreements between

Union Bank, N.A. and the FDIC. Such agreements are related to the April 2010 acquisitions of certain assets and the

assumption of certain liabilities of Frontier and Tamalpais.

(2) Annualized.

nm = not meaningful

 

16


Table of Contents

UnionBanCal Corporation and Subsidiaries

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Nonperforming Assets

Nonperforming assets consist of nonaccrual loans, including troubled debt restructurings (TDRs) that are nonper