10-K 1 a2183021z10-k.htm 10-K
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-K

(Mark One)  

ý

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

For the fiscal year ended December 31, 2007

OR

o

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

For the transition period from                                  to                                   

Commission file number 1-10521


CITY NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)


Delaware
(State or other jurisdiction of incorporation or organization)
  95-2568550
(I.R.S. Employer Identification No.)

City National Center
400 North Roxbury Drive,
Beverly Hills, California

(Address of principal executive offices)

 

90210
(Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:


Title of each class

  Name of each exchange on which
registered

Common Stock, $1.00 par value   New York Stock Exchange

No securities are registered pursuant to Section 12(g) of the Act.


         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý    No o

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes o    No ý

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

         Indicate by check mark 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. o

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

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

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

         As of June 30, 2007, the aggregate market value of the registrant's common stock ("Common Stock") held by non-affiliates of the registrant was approximately $3,127,954,972 based on the June 30, 2007 closing sale price of Common Stock of $76.09 per share as reported on the New York Stock Exchange.

         As of January 31, 2008, there were 48,068,909 shares of Common Stock outstanding.

Documents Incorporated by Reference

         The information required to be disclosed pursuant to Part III of this report either shall be (i) deemed to be incorporated by reference from selected portions of City National Corporation's definitive proxy statement for the 2008 annual meeting of stockholders, if such proxy statement is filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Corporation's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A not later than the end of such 120 day period.





TABLE OF CONTENTS

PART I        
Item 1.   Business   2
Item 1A.   Risk Factors   13
Item 1B.   Unresolved Staff Comments   16
Item 2.   Properties   16
Item 3.   Legal Proceedings   16
Item 4.   Submission of Matters to a Vote of Security Holders   16

PART II

 

 

 

 
Item 5.   Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   17
Item 6.   Selected Financial Data   18
Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations   18
Item 7A.   Quantitative and Qualitative Disclosures about Market Risk   18
Item 8.   Financial Statements and Supplementary Data   18
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   18
Item 9A.   Controls and Procedures   18
Item 9B.   Other Information   18

PART III

 

 

 

 
Item 10.   Directors and Officers of the Registrant   19
Item 11.   Executive Compensation   19
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   19
Item 13.   Certain Relationships and Related Transactions   19
Item 14.   Principal Accountant Fees and Services   19

PART IV

 

 

 

 
Item 15.   Exhibits and Financial Statement Schedules   20

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PART I

Item 1.    Business

General

        City National Corporation (the "Corporation"), a Delaware corporation organized in 1968, is a bank holding company and a financial holding company under the Gramm-Leach-Bliley Financial Modernization Act of 1999 (the "GLB Act"). The Corporation provides a wide range of banking, investing and trust services to its clients through its wholly-owned banking subsidiary, City National Bank (the "Bank" and together with the Corporation, its subsidiaries and its asset management affiliates the "Company"). The Bank, which has conducted business since 1954, is a national banking association headquartered in Beverly Hills, California and operating through 62 offices, including 15 full-service regional centers, in Southern California, the San Francisco Bay area, Nevada and New York City. As of December 31, 2007, the Corporation had a majority ownership interest in eight asset management affiliates and a minority interest in one other asset management firm. At December 31, 2007, the Company had consolidated total assets of $15.9 billion, loan balances of $11.6 billion, and assets under management or administration (excluding the minority-owned asset manager) of $58.5 billion. The Company focuses on providing affluent individuals and entrepreneurs, their businesses and their families with complete financial solutions. The organization's mission is to provide this banking and financial experience through an uncommon dedication to extraordinary service, proactive advice and total financial solutions.

        On February 28, 2007, the Company completed the acquisition of Business Bank Corporation ("BBC"), the parent of Business Bank of Nevada ("BBNV") and an unconsolidated subsidiary, Business Bancorp Capital Trust I, in a cash and stock transaction valued at $167 million. BBNV operated as a wholly owned subsidiary of City National Corporation until after the close of business on April 30, 2007, at which time it was merged into the Bank. Refer to the "Management's Discussion and Analysis" section of this report for further details regarding this acquisition.

        On May 1, 2007, the Corporation completed the acquisition of Lydian Wealth Management in an all-cash transaction. The wealth and investment advisory firm is headquartered in Rockville, Maryland and currently manages or advises on client assets totaling $8.9 billion. Lydian Wealth Management changed its name to Convergent Wealth Advisors ("Convergent Wealth") and became a subsidiary of Convergent Capital Management LLC, the Chicago-based asset management holding company that the Company acquired in 2003. Refer to the "Management's Discussion and Analysis" section of this report for further details regarding this acquisition.

        The Company has three reportable segments, Commercial and Private Banking, Wealth Management, and Other. All investment advisory affiliates and the Bank's Wealth Management Services are included in the Wealth Management segment. All other subsidiaries, the unallocated portion of corporate departments and inter-segment eliminations are included in the Other segment. Information about the Company's segments is provided in Note 21 to the Consolidated Financial Statements beginning on page A-45 of this report as well as in the "Management's Discussion and Analysis" beginning on page 28 of this report. In addition, the following information is provided to assist the reader in understanding the Company's business segments:

        The Bank's principal client base comprises small to mid-sized businesses, entrepreneurs, professionals, and affluent individuals. The Bank serves its clients through relationship banking. The Bank's value proposition is to provide the ultimate banking experience through depth of expertise, breadth of resources, focus and location, dedication to complete solutions, a relationship banking model and an integrated team approach. Through the use of private and commercial banking teams, product specialists and investment advisors, the Bank facilitates the use by the client, where appropriate, of multiple services and products offered by the Company. The Company offers a broad range of lending,

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deposit, cash management, international banking, equipment financing, and other products and services. The Company also lends, invests, and provides services in accordance with its Community Reinvestment Act ("CRA") commitments.

        The Bank's Wealth Management division and the Corporation's asset management subsidiaries make available the following investment advisory and wealth management resources and expertise to the Company's clients:

    investment management and advisory services and brokerage services, including portfolio management, securities trading and asset management;

    personal and business trust and investment services, including employee benefit trust services, 401(k) and defined benefit plans; and

    estate and financial planning and custodial services.

        The Bank also advises and makes available mutual funds under the name of CNI Charter Funds. The Corporation's asset management subsidiaries and the Bank's Wealth Management Division provide both proprietary and nonproprietary products to offer a full spectrum of asset classes and investment styles, including fixed-income instruments, mutual funds, domestic and international equities and alternative investments, such as hedge funds. Investment services are provided to institutional as well as individual clients.

        At December 31, 2007, the Company had 2,914 full-time equivalent employees.

Competition

        There is significant competition among commercial banks and other financial institutions in the Company's market areas. California, New York and Nevada are highly competitive environments for banking and other financial organizations providing private and business banking and wealth management services. The Bank faces competitive credit and pricing pressure as it competes with other banks and financial organizations. The Company's performance is also significantly influenced by California's economy. As a result of the GLB Act, the Company also competes with other providers of financial services such as money market mutual funds, securities firms, credit unions, insurance companies and other financial services companies. Furthermore, interstate banking legislation has promoted more intense competition by eroding the geographic constraints on the financial services industry.

        Our ability to compete effectively is due to our provision of personalized services resulting from management's knowledge and awareness of its clients' needs and its market areas. We believe this relationship banking approach and knowledge provide a business advantage in providing high client satisfaction and serving the small to mid-sized businesses, entrepreneurs, professionals and other affluent individuals that comprise the Company's client base. Our ability to compete also depends on our ability to continue to attract and retain our senior management and other key colleagues. Further, our ability to compete depends in part on our ability to continue to develop and market new and innovative products and services and to adopt or develop new technologies that differentiate our products and services.

Economic Conditions, Government Policies, Legislation, and Regulation

        The Company's profitability, like most financial institutions, is highly dependent on interest rate differentials. In general, the difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on its interest-earning assets, such as loans extended to its clients and securities held in its investment portfolio, comprise the major portion of the Company's earnings. These rates are highly sensitive to

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many factors that are beyond the Company's control, such as inflation, recession, and unemployment. Energy and commodity prices and the value of the dollar are additional primary sources of risk and volatility. The impact that future changes in domestic and foreign economic conditions might have on the Company cannot be predicted. See Item 1A—Risk Factors.

        The Company's business and earnings are affected by the monetary and fiscal policies of the federal government and its agencies, particularly the Board of Governors of the Federal Reserve System (the "Federal Reserve"). The Federal Reserve regulates the supply of money and credit in the United States. Among the instruments of monetary policy available to the Federal Reserve are its open-market operations in U.S. Government securities, including adjusting the required level of reserves for depository institutions subject to its reserve requirements, and varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve in these areas influence the growth of bank loans, investments, and deposits and also affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities. Changes in the policies of the Federal Reserve may have an effect on the Company's business, results of operations and financial condition.

        Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies, and other financial institutions and financial services providers are frequently introduced in the U.S. Congress, in the state legislatures, and before various regulatory agencies. The likelihood and timing of any proposals or legislation and the impact they may have on the Company cannot be determined at this time.

Supervision and Regulation

General

        The Corporation, the Bank and the Corporation's non-banking subsidiaries are subject to extensive regulation under both federal and state law. This regulation is intended primarily for the protection of depositors, the deposit insurance fund, and the banking system as a whole, and not for the protection of shareholders of the Corporation. Set forth below is a summary description of the significant laws and regulations applicable to the Corporation and the Bank. The description is qualified in its entirety by reference to the applicable laws and regulations.

Regulatory Agencies

        The Corporation is a legal entity separate and distinct from the Bank and its other subsidiaries. As a financial holding company and a bank holding company, the Corporation is regulated under the Bank Holding Company Act of 1956 (the "BHC Act"), and is subject to supervision, regulation and inspection by the Federal Reserve. The Corporation is also under the jurisdiction of the Securities and Exchange Commission ("SEC") and is subject to the disclosure and regulatory requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934, each administered by the SEC. The Corporation is listed on the New York Stock Exchange ("NYSE") under the trading symbol "CYN" and is subject to the rules of the NYSE for listed companies.

        The Bank, as a national banking association, is subject to broad federal regulation and oversight extending to all its operations by the Office of the Comptroller of the Currency ("OCC"), its primary regulator, and also by the Federal Reserve and the Federal Deposit Insurance Corporation.

        The Corporation's non-bank subsidiaries are also subject to regulation by the Federal Reserve and other federal and state agencies, including for those non-bank subsidiaries that are investment advisors, the SEC under the Investment Advisors Act of 1940. City National Securities, Inc. ("CNS") is regulated by the SEC, the Financial Industry Regulatory Authority ("FINRA") and state securities regulators.

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The Corporation

        The Corporation is a bank holding company and a financial holding company. In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve has determined to be so closely related to banking as to be a proper incident thereto. As a result of the GLB Act, which amended the BHC Act, bank holding companies that are financial holding companies may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve in consultation with the OCC) or (ii) complementary to a financial activity, and that does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as determined solely by the Federal Reserve). Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and agency, and making merchant banking investments.

        If a bank holding company seeks to engage in the broader range of activities that are permitted under the BHC Act for financial holding companies, (i) all of its depository institution subsidiaries must be "well capitalized" and "well managed" and (ii) it must file a declaration with the Federal Reserve that it elects to be a financial holding company. A depository institution subsidiary is considered to be "well capitalized" if it satisfies the requirements for this status discussed in the section captioned "Capital Adequacy and Prompt Corrective Action," included elsewhere in this item. A depository institution subsidiary is considered "well managed" if it received a composite rating and management rating of at least "satisfactory" in its most recent examination. In addition, the subsidiary depository institution must have received a rating of at least "satisfactory" in its most recent examination under the Community Reinvestment Act. (See the section captioned "Community Reinvestment Act" included elsewhere in this item.)

        Financial holding companies that do not continue to meet all of the requirements for such status will, depending on which requirement they fail to meet, face not being able to undertake new activities or acquisitions that are financial in nature, or losing their ability to continue those activities that are not generally permissible for bank holding companies. In addition, failure to satisfy conditions prescribed by the Federal Reserve to comply with any such requirements could result in orders to divest banking subsidiaries or to cease engaging in activities other than those closely related to banking under the BHC Act.

        The BHC Act, the Federal Bank Merger Act, and other federal and state statutes regulate acquisitions of commercial banks. The BHC Act requires the prior approval of the Federal Reserve for the direct or indirect acquisition of more than 5 percent of the voting shares of a commercial bank or its parent holding company. Under the Federal Bank Merger Act, the prior approval of the OCC is required for a national bank to merge with another bank or purchase the assets or assume the deposits of another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the applicant's performance record under the Community Reinvestment Act (see the section captioned "Community Reinvestment Act" included elsewhere in this item), fair housing laws and the effectiveness of the subject organizations in combating money laundering activities.

Source of Strength Doctrine

        Federal Reserve policy requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks and does not permit a bank holding company to conduct its operations in an unsafe or unsound manner. Under this "source of strength doctrine," a bank holding company is expected to stand ready to use its available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity, and to maintain resources and the

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capacity to raise capital that it can commit to its subsidiary banks. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment of deposits and to certain other indebtedness of such subsidiary banks. The BHC Act provides that, in the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment. In addition, under the National Bank Act, if the capital stock of the Bank is impaired by losses or otherwise, the OCC is authorized to require payment of the deficiency by assessment upon the Corporation. If the assessment is not paid within three months, the OCC could order a sale of the Bank stock held by the Corporation to make good the deficiency. Furthermore, the Federal Reserve has the right to order a bank holding company to terminate any activity that the Federal Reserve believes is a serious risk to the financial safety, soundness or stability of any subsidiary bank.

The Bank

        The OCC has extensive examination, supervision and enforcement authority over all national banks, including the Bank. If, as a result of an examination of a bank, the OCC determines that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the bank's operations are unsatisfactory or that the bank or its management is violating or has violated any law or regulation, various remedies are available to the OCC. These remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the Bank's deposit insurance.

        The OCC, as well as other federal banking agencies, has adopted regulations and guidelines establishing safety and soundness standards, including but not limited to such matters as loan underwriting and documentation, risk management, internal controls and audit systems, interest rate risk exposure, asset quality and earnings and compensation and other employee benefits.

        Various other requirements and restrictions under the laws of the United States affect the operations of the Bank. Statutes and regulations relate to many aspects of the Bank's operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements.

Anti-Money Laundering and OFAC Regulation

        A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The Bank Secrecy Act of 1970 ("BSA") and subsequent laws and regulations require the Bank to take steps to prevent the use of the Bank or its systems from facilitating the flow of illegal or illicit money and to file suspicious activity reports. Those requirements include ensuring effective Board and management oversight, establishing policies and procedures, developing effective monitoring and reporting capabilities, ensuring adequate training and establishing a comprehensive internal audit of BSA compliance activities. The USA Patriot Act of 2001 ("Patriot Act") significantly expanded the anti-money laundering ("AML") and financial transparency laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. Regulations promulgated under the Patriot Act impose various requirements on financial institutions, such as standards for verifying client identification at account opening and maintaining expanded records (including "Know Your Customer" and "Enhanced Due Diligence" practices) and other obligations to maintain appropriate policies, procedures and controls to aid the process of preventing,

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detecting, and reporting money laundering and terrorist financing. The Patriot Act also applies BSA procedures to broker-dealers. An institution subject to the Patriot Act must provide AML training to employees, designate an AML compliance officer and annually audit the AML program to assess its effectiveness. The OCC continues to issue regulations and new guidance with respect to the application and requirements of BSA and AML. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. Based on their administration by the U.S. Treasury Department Office of Foreign Assets Control ("OFAC"), these are typically known as the OFAC rules. The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on "U.S. persons" engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC.

        Failure of a financial institution to maintain and implement adequate BSA, AML and OFAC programs, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.

Dividends and Other Transfers of Funds

        The Corporation is a legal entity separate and distinct from the Bank. Dividends from the Bank constitute the principal source of cash revenues to the Corporation. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Corporation. The prior approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year would exceed the sum of the bank's net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits national banks from paying dividends that would be greater than the bank's undivided profits after deducting statutory bad debt in excess of the bank's allowance for loan and lease losses. In addition, federal bank regulatory authorities can prohibit the Bank from paying dividends, depending upon the Bank's financial condition and compliance with capital and non-capital safety and soundness standards established under the Federal Deposit Insurance Act, as described below. Federal regulatory authorities have indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings. See Note 19 of Notes to Consolidated Financial Statements for additional information.

        Federal law limits the ability of the Bank to extend credit to the Corporation or its other affiliates, to invest in stock or other securities thereof, to take such securities as collateral for loans, and to purchase assets from the Corporation or other affiliates. These restrictions prevent the Corporation and such other affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in the Corporation or to or in any other affiliate are limited individually to 10 percent of the Bank's capital stock and surplus and in the aggregate to 20 percent of the Bank's capital stock and surplus. See Note 19 of Notes to Consolidated Financial Statements on page A-41 of this report.

        Federal law also provides that extensions of credit and other transactions between the Bank and the Corporation or one of its non-bank subsidiaries must be on terms and conditions, including credit standards, that are substantially the same or at least as favorable to the Bank as those prevailing at the time for comparable transactions involving other non-affiliated companies, or, in the absence of

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comparable transactions, on terms and conditions, including credit standards, that in good faith would be offered to, or would apply to, non-affiliated companies. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of services.

Capital Adequacy and Prompt Corrective Action

        Each federal banking regulatory agency has adopted risk-based capital regulations under which a banking organization's capital is compared to the risk associated with its operations for both transactions reported on the balance sheet as assets as well as transactions which are off-balance sheet items, such as letters of credit and recourse arrangements. Under the capital regulations, the nominal dollar amounts of assets and the balance sheet equivalent amounts of off-balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0 percent for asset categories with low credit risk, such as certain U.S. Treasury securities, to 100 percent for asset categories with relatively high credit risk, such as commercial loans.

        In addition to the risk-based capital guidelines, federal banking regulatory agencies require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated composite 1 under the "Composite Uniform Financial Institutions Rating System ("CAMELS")" for banks, which indicates the lowest level of supervisory concern of the five categories used by the federal banking agencies to rate banking organizations ("5" being the highest level of supervisory concern), the minimum leverage ratio is 3 percent. For all banking organizations other than those rated composite 1 under the CAMELS system, the minimum leverage ratio is 4 percent. Banking organizations with supervisory, financial, operational, or managerial weaknesses, as well as organizations that are anticipating or experiencing significant growth, are expected to maintain capital ratios above the minimum levels. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the federal banking agencies have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.

        At December 31, 2007, the Corporation and the Bank each exceeded the required risk-based capital ratios for classification as "well capitalized" as well as the required minimum leverage ratios. See "Management's Discussion and Analysis—Balance Sheet Analysis—Capital" on page 66 of this report.

        The Federal Deposit Insurance Act (FDICIA) requires federal bank regulatory agencies to take "prompt corrective action" with respect to FDIC-insured depository institutions that do not meet minimum capital requirements. A depository institution's treatment for purposes of the prompt corrective action provisions will depend on how its capital levels compare to various capital measures and certain other factors, as established by regulation. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An "undercapitalized" bank must develop a capital restoration plan and its parent holding company must guarantee that bank's compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the bank's assets at the time it become "undercapitalized" or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards.

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        The existing U.S. federal bank regulatory agencies' risk-based capital guidelines are based upon the 1988 capital accord ("Basel I") of the Basel Committee on Banking Supervision ("BIS"). The BIS is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each country's supervisors in determining the supervisory policies they apply.

        The federal banking agencies have approved a final rule, effective April 1, 2008, to implement new risk-based capital requirements in the United States. These new requirements, often referred to as the "Basel II Accord," will, among other things, modify the capital charge applicable to credit risk and incorporate a capital charge for operational risk. The Basel II Accord also places greater reliance on market discipline than current standards. The Basel II standards will be mandatory with respect to banking organizations with total banking assets of $250 billion or more or total on-balance-sheet foreign exposure of $10 billion or more. Basel II's framework offers banks a choice of three methodologies for determining risk weights: (1) a "Standardized" approach, (2) an advanced internal ratings-based approach, and (3) an advanced measurements approach. Mandatory organizations may only use Basel II's most advanced methods.

        As of December 31, 2007, the Corporation would not have been mandatorily required to adopt the Basel II standards. Organizations, such as the Corporation, that do not meet the size criteria of a mandatory organization may choose voluntarily to comply with the more advanced requirements specified under the new capital framework and are called "opt in" organizations. "General" organizations, consisting of those institutions that choose not to "opt in," will continue to operate under existing risk-based capital rules, subject to any changes made to those standards.

        The banking agencies have issued a proposal that would allow the voluntary adoption of the Standardized approach to offer general organizations a set of regulatory capital requirements that have more risk sensitivity than the current Basel I rules, but less complexity than the Basel II advanced standards. The proposal would replace an earlier proposed rule in the area. Among other things, the proposal is being designed both to provide greater differentiation across corporate exposures based on borrowers' underlying credit quality and to recognize a broader spectrum of credit-risk mitigation techniques. It will establish fixed risk weights corresponding to each supervisory risk weight category and make use of the external credit assessments to enhance risk sensitivity compared with the current Basel Accord. The current goal is for the Standardized approach to be ready for implementation concurrently with the start of the first Basel II transition phase.

        The federal banking regulatory agencies are also considering revised capital standards that would apply to all financial institutions that are not subject to the Basel II Accord ("Basel 1A"), with the expressed intention to align those standards more closely with those that would be applicable to Basel II institutions. Among the key issues under consideration in connection with Basel 1A are: 1) the use of loan-to-value ratios to determine risk weights for most residential mortgages, 2) an increase in the number of risk weight categories to which credit exposures may be assigned, 3) expansion of the use of external credit ratings for certain externally-rated exposures, 4) expansion of the range of collateral and guarantors that may qualify as exposure for lower risk weights, and 5) assessment of a risk-based capital charge to reflect the risk in securitizations with early amortization provisions.

        At this time, the Corporation cannot predict the final form the optional Basel II Standardized approach will take, when it will be implemented, the effect that it might have on the Bank's financial condition or results of its operations, or how these effects might impact the Corporation. Accordingly, the Corporation has not yet determined whether it would opt to apply the Basel 1A or the Basel II provisions once they become effective.

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Premiums for Deposit Insurance

        The Bank's deposit accounts are insured by the Deposit Insurance Fund ("DIF"), as administered by the Federal Deposit Insurance Corporation (the "FDIC"), up to the maximum permitted by law. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC or the institution's primary regulator.

        The FDIC charges an annual assessment for the insurance of deposits, which as of December 31, 2007 ranged from 5 to 43 cents per $100 of insured deposits, based on the risk a particular institution poses to its deposit insurance fund. The risk classification is based on an institution's capital group and supervisory subgroup assignment. An institution's capital group is based on the FDIC's determination of whether the institution is well capitalized, adequately capitalized, or less than adequately capitalized. An institution's supervisory subgroup assignment is based on the FDIC's assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required. For 2007, the Bank was assessed at the lowest rate. In addition to its normal deposit insurance premium as a member of the DIF, the Bank must pay an additional premium toward the retirement of the Financing Corporation bonds ("FICO Bonds") issued in the 1980s to assist in the recovery of the savings and loan industry. In 2007, this premium was approximately $1.5 million, determined at the blended rate of 1.16 cents per $100 of insured deposits. The higher premiums assessed in 2007 were offset by credits allowed for institutions that were in existence as of December 31, 1996 and had previously paid deposit premiums or are successors to such institutions. Any further increase in the assessment rate in future years could have an adverse effect on the Company's earnings, depending on the amount of the increase.

Depositor Preference

        The Federal Deposit Insurance Act provides that, in the event of the "liquidation or other resolution" of an insured depository institution, the claims of depositors of the institutions, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

Interstate Banking and Branching

        The Riegle-Neal Interstate Banking and Branching Act permits banks and bank holding companies from any state to acquire banks located in any other state, subject to certain conditions, including certain nationwide and state-imposed concentration limits. The Company also has the ability, subject to certain restrictions, to acquire branches outside its home state by acquisition or merger. The establishment of new interstate branches is also possible in those states with laws that expressly permit de novo branching. The Corporation has established or acquired banking operations outside its home state of California in the states of New York and Nevada.

Community Reinvestment Act

        Under the Community Reinvestment Act of 1977 ("CRA"), the Bank has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's

10



discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with CRA. CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities and to take that record into account in its evaluation of certain applications by such institution, such as applications for charters, branches and other deposit facilities, relocations, mergers, consolidations and acquisitions or engage in certain activities pursuant to the GLB Act. An unsatisfactory rating may be the basis for denying the application. Based on its most recent examination report from January 2006, the Bank received an overall rating of "satisfactory." In arriving at the overall rating, the OCC rated the Bank's performance levels under CRA with respect to lending (high satisfactory), investment (outstanding) and service (high satisfactory).

Consumer Protection Laws

        The Company is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and various state law counterparts.

        In addition, federal law and certain state laws (including California) currently contain client privacy protection provisions. These provisions limit the ability of banks and other financial institutions to disclose non-public information about consumers to affiliated companies and non-affiliated third parties. These rules require disclosure of privacy policies to clients and, in some circumstance, allow consumers to prevent disclosure of certain personal information to affiliates or non-affiliated third parties by means of "opt out" or "opt in" authorizations. Pursuant to the GLB Act and certain state laws (including California) companies are required to notify clients of security breaches resulting in unauthorized access to their personal information.

Securities and Exchange Commission

        The Sarbanes-Oxley Act of 2002 ("SOX") imposed significant new requirements on publicly-held companies such as the Corporation, particularly in the area of external audits, financial reporting and disclosure, conflicts of interest, and corporate governance at public companies. The Company, like other public companies, has reviewed and reinforced its internal controls and financial reporting procedures in response to the various requirements of SOX and implementing regulations issued by the SEC and the New York Stock Exchange. The Company emphasized best practices in corporate governance before SOX and has continued to do so in compliance with SOX.

        The SEC regulations applicable to the Company's investment advisers cover all aspects of the investment advisory business, including compliance requirements, limitations on fees, record-keeping, reporting and disclosure requirements and general anti-fraud prohibitions.

11


Executive Officers of the Registrant

        Shown below are the names and ages of all executive officers of the Corporation and officers of the Bank who are deemed to be executive officers of the Corporation as of January 31, 2008, with indication of all positions and offices with the Corporation and the Bank.

Name

  Age
  Present principal occupation and principal occupation during the past five years
Russell D. Goldsmith (1)   57   President, City National Corporation since May 2005; Chief Executive Officer, City National Corporation and Chairman of the Board and Chief Executive Officer, City National Bank since October 1995; Vice Chairman of City National Corporation October 1995 to May 2005

Bram Goldsmith

 

84

 

Chairman of the Board, City National Corporation

Christopher J. Carey

 

53

 

Executive Vice President and Chief Financial Officer, City National Corporation and City National Bank since July 2004; Executive Vice President and Chief Financial Officer, Provident Financial Group, November 1998 to June 2004

Christopher J. Warmuth

 

53

 

Executive Vice President, City National Corporation and President, City National Bank since May 2005; Executive Vice President and Chief Credit Officer, City National Bank June 2002 to May 2005

Michael B. Cahill

 

54

 

Executive Vice President, Corporate Secretary and General Counsel, City National Bank and City National Corporation since June 2001; Interim Senior Risk Management Officer, October 2003 to July 2004

Brian Fitzmaurice

 

47

 

Executive Vice President and Chief Credit Officer, City National Bank since February 2006; Senior Risk Manager, Citibank West, FSB successor to California Federal Bank, FSB, November 2002 to February 2006; Senior Vice President and Chief Credit Officer, Commercial Banking, California Federal Bank, FSB, April 1998 to November 2002

Nancy Gilson

 

52

 

Senior Vice President and Controller, City National Corporation and City National Bank since April 2005; Assistant Controller, City National Bank, December 2004 to April 2005; Vice President, Financial Reporting, California National Bank, October 2002 to December 2004

(1)
Russell Goldsmith is the son of Bram Goldsmith.

Available Information

        The Company's home page on the Internet is www.cnb.com. The Company makes its web site content available for information purposes only. It should not be relied upon for investment purposes, nor is it incorporated by reference into this Form 10-K.

        The Company makes its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statement for its annual shareholder meetings, as well as any amendment to those reports, available free of charge through the Investor Relations page of its web site as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the SEC. More information about the Company can be obtained by reviewing the Company's SEC

12



filings on its web site. Information about the Corporation's Board of Directors (the "Board") and its committees and the Company's corporate governance policies and practices is available on the Corporate Governance section of the Investor Relations page of the Company's web site. The SEC also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including the Corporation.


Item 1A—Risk Factors

Forward-Looking Statements

        This report and other reports and statements issued by the Company and its officers from time to time contain forward-looking statements that are subject to risks and uncertainties. These statements are based on the beliefs and assumptions of our management, and on information currently available to our management. Forward-looking statements include information concerning our possible or assumed future results of operations, and statements preceded by, followed by, or that include the words "will," "believes," "expects," "anticipates," "intends," "plans," "estimates," or similar expressions.

        Our management believes these forward-looking statements are reasonable. However, you should not place undue reliance on the forward-looking statements, since they are based on current expectations. Actual results may differ materially from those currently expected or anticipated. Forward-looking statements are not guarantees of performance. By their nature, forward-looking statements are subject to risks, uncertainties, and assumptions. These statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements are made or to update earnings guidance including the factors that influence earnings. A number of factors, many of which are beyond the Company's ability to control or predict, could cause future results to differ materially from those contemplated by such forward-looking statements. These factors include, without limitation, the significant factors set forth below.

Factors That May Affect Future Results

        Changes in interest rates affect our profitability.    We derive our income mainly from the difference or "spread" between the interest earned on loans, securities, and other interest-earning assets, and interest paid on deposits, borrowings, and other interest-bearing liabilities. In general, the wider the spread, the more we earn. When market rates of interest change, the interest we receive on our assets and the interest we pay on our liabilities fluctuate. This causes our spread to increase or decrease and affects our net interest income. In addition, interest rates affect how much money we lend, and changes in interest rates may negatively affect deposit growth.

        Our results would be adversely affected if we suffered higher than expected losses on our loans due to a slowing economy, real estate cycles or other economic events which could require us to increase our allowance for credit losses.    We assume credit risk from the possibility that we will suffer losses because borrowers, guarantors, and related parties fail to perform under the terms of their loans. We try to minimize and monitor this risk by adopting and implementing what we believe are effective underwriting and credit policies and procedures, including how we establish and review the allowance for loan and lease losses. We assess the likelihood of nonperformance, track loan performance, and diversify our credit portfolio. Those policies and procedures may still not prevent unexpected losses that could adversely affect our results. The Company continually monitors changes in the economy, particularly housing prices and unemployment rates. We also monitor the value of collateral, such as real estate, for loans made by us. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Company's control, may require an increase in the allowance for loan and lease losses.

13


        General business and economic conditions may significantly affect our earnings.    Our business and earnings are sensitive to general business and economic conditions. These conditions include the characteristics and slope of the yield curve, inflation, available money supply, the value of the U.S. dollar as compared to foreign currencies, fluctuations in both debt and equity markets, and the strength of the U.S. economy and the local economies in which we conduct business. Changes in these conditions may adversely affect demand for our products and services, and may adversely affect the underlying financial strength and liquidity of our clients. A prolonged economic downturn could increase the number of clients who become delinquent or default on their loans. An increase in delinquencies or defaults could result in a higher level of nonperforming assets, charge-offs and provision for credit losses, which could adversely affect our earnings. A slowdown in real estate can adversely affect title and escrow deposit balances, a relatively low cost source of funds.

        A portion of the income generated by our Wealth Management division and asset management affiliates is subject to market valuation risks.    A substantial portion of trust and investment fee income is based on equity, fixed income and other market valuations. As a result, volatility in these markets can positively or negatively impact noninterest income.

        Bank clients could move their money to alternative investments causing us to lose a lower cost source of funding.    Demand deposits can decrease when clients perceive alternative investments, such as those available in our wealth management business, as providing a better risk/return tradeoff. Technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments or other deposit accounts offered by other financial institutions or non-bank service providers. When clients move money out of bank demand deposits and into other investments, we lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income.

        Significant changes in banking laws or regulations could materially affect our business.    The banking industry is subject to extensive federal and state regulations, and significant new laws or changes in, or repeals of, existing laws may cause results to differ materially. Also, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects our credit conditions, primarily through open market operations in U.S. government securities, the discount rate for member bank borrowing, and bank reserve requirements. A material change in these conditions would affect our results. Parts of our business are also subject to federal and state securities laws and regulations. Significant changes in these laws and regulations would also affect our business. For further discussion of the regulation of financial services, see "Supervision and Regulation" and the discussion under Item 1, Business, "Economic Conditions, Government Policies, Legislation and Regulation."

        Increased competition from financial service companies and other companies that offer banking and wealth management services could negatively impact our business.    Increased competition in our market may result in reduced loans, deposits and/or assets under management. Many competitors offer the banking services and wealth management services that we offer in our service area. These competitors, both domestic and foreign, include national, regional, and community banks. We also face intense competition from many other types of financial institutions, including, without limitation, savings and loans, finance companies, brokerage firms, insurance companies, credit unions, private equity funds, mortgage banks, and other financial intermediaries. Banks, trust companies, investment advisors, mutual fund companies, multi-family offices and insurance companies compete with us for trust and asset management business. In addition, technological advances and the growth of e-commerce have made it possible for non-depository institutions to offer products and services that were traditionally offered only by banks.

        We also face intense competition for talent. Our success depends, in large part, on our ability to hire and retain key people. Competition for the best people in most businesses in which we engage can be intense. If we are unable to attract and retain talented people, our business could suffer.

14


        Our controls and procedures could fail or be circumvented.    Management regularly reviews and updates our internal controls, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, but not absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these controls have been met. Any failure or circumvention of our controls and procedures, and any failure to comply with regulations related to controls and procedures could adversely affect our business, results of operations and financial condition.

        Changes in accounting standards or tax legislation.    Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time the Financial Accounting Standards Board ("FASB") and SEC change the financial accounting and reporting standards that govern the preparation of our financial statements or elected representatives approve changes to tax laws. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations.

        Acquisition risks.    We have in the past and may in the future seek to grow our business by acquiring other businesses. We cannot predict the frequency, size or timing of our acquisitions, and we typically do not comment publicly on a possible acquisition until we have signed a definitive agreement. There can be no assurance that our acquisitions will have the anticipated positive results, including results related to: the total cost of integration; the time required to complete the integration; the amount of longer-term cost savings; continued growth; or the overall performance of the acquired company or combined entity. Integration of an acquired business can be complex and costly. If we are not able to integrate successfully past or future acquisitions, there is a risk that results of operations could be adversely affected.

        Impairment of goodwill or amortizable intangible assets associated with acquisitions would result in a charge to earnings.    Goodwill is evaluated for impairment at least annually, and amortizable intangible assets are evaluated for impairment annually or when events or circumstances indicate that the carrying value of those assets may not be recoverable. We may be required to record a charge to earnings during the period in which any impairment of goodwill or intangibles is determined.

        Operational risks.    The potential for operational risk exposure exists throughout our organization. Integral to our performance is the continued efficacy of our technology and information systems, operational infrastructure and relationships with third parties and our colleagues in our day-to-day and ongoing operations. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes but is not limited to operational or systems failures, disruption of client operations and activities, ineffectiveness or exposure due to interruption in third party support as expected, as well as, the loss of key colleagues or failure on the part of key colleagues to perform properly.

        Negative public opinion could damage our reputation and adversely affect our earnings.    Reputational risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion can result from the actual or perceived manner in which we conduct our business activities, including activities in our private and business banking operations and investment and trust operations; our management of actual or potential conflicts of interest and ethical issues; and our protection of confidential client information. Negative public opinion can adversely affect our ability to keep and attract clients and can expose us to litigation and regulatory action. We take steps to minimize reputation risk in the way we conduct our business activities and deal with our clients, communities and vendors.

15



Item 1B—Unresolved Staff Comments

        The Company has no written comments regarding its periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of its 2007 fiscal year and that remain unresolved.

Item 2.    Properties

        The Company has its principal offices in the City National Center, 400 North Roxbury Drive, Beverly Hills, California 90210, which the Company owns and occupies. The property has a market value in excess of its depreciated value included in the Company's financial statements. As of December 31, 2007, the Bank owned four other banking office properties in Riverside and Sun Valley, California and in Cheyenne and Carson Valley, Nevada. In addition to the properties owned, the Company actively maintains operations in 54 banking offices and certain other properties.

        The Bank leases approximately 391,000 rentable square feet of commercial office space in downtown Los Angeles in the office tower located at 555 S. Flower Street ("City National Tower" and together with the three story plaza building adjacent to City National Tower at 525 S. Flower Street, "City National Plaza"). City National Tower serves as the Bank's administrative center, bringing together more than 24 departments. In addition, City National Plaza houses the Company's Downtown Los Angeles Regional Center, offering extensive private and business banking and wealth management capabilities.

        The remaining banking offices and other properties are leased by the Bank. Total annual rental payments (exclusive of operating charges and real property taxes) are approximately $26 million, with lease expiration dates for office facilities ranging from 2008 to 2022, exclusive of renewal options.

Item 3.    Legal Proceedings

        The Corporation and its subsidiaries are defendants in various pending lawsuits. Based on present knowledge, management, including in-house counsel, does not believe that the outcome of such lawsuits will have a material adverse effect upon the Company.

        The Corporation is not aware of any material proceedings to which any director, officer, or affiliate of the Corporation, any owner of record or beneficially of more than 5 percent of the voting securities of the Corporation as of December 31, 2007, or any associate of any such director, officer, affiliate of the Corporation, or security holder is a party adverse to the Corporation or any of its subsidiaries or has a material interest adverse to the Corporation or any of its subsidiaries.

Item 4.    Submission of Matters to a Vote of Security Holders

        There was no submission of matters to a vote of security holders during the fourth quarter of the year ended December 31, 2007.

16



PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

        The Corporation's common stock is listed and traded principally on the New York Stock Exchange under the symbol "CYN." Information concerning the range of high and low sales prices for the Corporation's common stock, and the dividends declared, for each quarterly period within the past two fiscal years is set forth below.

Quarter Ended

  High
  Low
  Dividends Declared
2007                  
March 31   $ 75.39   $ 68.00   $ 0.46
June 30     78.39     72.30     0.46
September 30     78.00     69.00     0.46
December 31     72.97     59.10     0.46

2006

 

 

 

 

 

 

 

 

 
March 31   $ 78.25   $ 71.95   $ 0.41
June 30     78.25     60.02     0.41
September 30     68.41     63.69     0.41
December 31     71.29     65.34     0.41

        As of January 31, 2008, the closing price of the Corporation's stock on the New York Stock Exchange was $56.88 per share. As of that date, there were approximately 2,166 holders of record of the Corporation's common stock. On January 24, 2008, the Board of Directors authorized a regular quarterly cash dividend on its common stock at a rate of $0.48 per share payable on February 20, 2008 to all shareholders of record on February 6, 2008.

        For a discussion of dividend restrictions on the Corporation's common stock, see Note 19 of the Notes to Consolidated Financial Statements on page A-41 of this report.

        The following table provides information about purchases by the Company of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act during the quarter ended December 31, 2007.

Period

  Total Number of Shares (or Units) Purchased
  Average Price Paid per Share (or Unit)
  Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
  Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
 
10/1/07 - 10/31/07   68,500   $ 65.57   68,500   851,300  
11/1/07 - 11/30/07   164,400   $ 63.50   164,400   686,900  
12/1/07 - 12/31/07   125,000   $ 59.87   125,000   561,900  
   
       
 
 
    357,900   $ 62.63   357,900 (1) 561,900 (1)
   
       
 
 

(1)
On August 7, 2007, the Company's Board of Directors authorized the Company to repurchase 1 million additional shares of the Company's stock following completion of its previously approved stock buyback initiative. Unless terminated earlier by resolution of our Board of Directors, the program will expire when the Company has repurchased all shares authorized for repurchase thereunder. During the fourth quarter of 2007, the Company repurchased an aggregate of 357,900 shares of our common stock pursuant to the repurchase program that we publicly announced on August 7, 2007, and there are 561,900 shares remaining to be purchased as of December 31, 2007. We received no shares in payment for the exercise price of stock options.

17


Item 6.    Selected Financial Data

        The information required by this item appears on page 27, under the caption "Selected Financial Information," and is incorporated herein by reference.

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        The information required by this item appears on pages 28 through 66, under the caption "Management's Discussion and Analysis," and is incorporated herein by reference.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

        The information required by this item appears on pages 48 through 52, under the caption "Management's Discussion and Analysis," and is incorporated herein by reference.

Item 8.    Financial Statements and Supplementary Data

        The information required by this item appears on page 68 under the captions "2007 Quarterly Operating Results" and "2006 Quarterly Operating Results," and on page A-4 through A-50 and is incorporated herein by reference.

Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

        None.

Item 9A.    Controls and Procedures

Disclosure Controls and Procedures

        Under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities and Exchange Act of 1934 (the "Exchange Act")). Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective.

Internal Control over Financial Reporting

Management's Report on Internal Control over Financial Reporting

        Management's Report on Internal Control Over Financial Reporting appears on page A-1 of this report. The Company's independent registered public accounting firm, KPMG LLP, has issued an audit report on the effectiveness of the Company's internal control over financial reporting. That report appears on page A-2.

Changes in Internal Controls

        There was no change in the Company's internal control over financial reporting that occurred during the Company's fourth fiscal quarter that has materially affected, or was reasonably likely to materially affect, the Company's internal control over financial reporting.

Item 9B.    Other Information

        None.

18



PART III

Item 10.    Directors and Executive Officers of the Registrant

        Information regarding executive officers is included in Part I of this Form 10-K as permitted by General Instruction G (3).

        The additional information required by this item will appear in the Corporation's definitive proxy statement for the 2008 Annual Meeting of Stockholders (the "2008 Proxy Statement"), and such information either shall be (i) deemed to be incorporated herein by reference from that portion of the 2008 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Corporation's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A not later than the end of such 120 day period.

Item 11.    Executive Compensation

        The information required by this item will appear in the 2008 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference from the 2008 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Corporation's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A not later than the end of such 120 day period.

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

        The information required by this item will appear in the 2008 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference from the 2008 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Corporation's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A not later than the end of such 120 day period.

Item 13.    Certain Relationships and Related Transactions

        The information required by this item will appear in the 2008 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference from the 2008 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Corporation's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A not later than the end of such 120 day period. Also see Note 6 to Notes to Consolidated Financial Statements on page A-22 of this report.

Item 14.    Principal Accountant Fees and Services

        The information required by this item will appear in the 2008 Proxy Statement, and such information either shall be (i) deemed to be incorporated herein by reference from the 2008 Proxy Statement, if filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Corporation's most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A not later than the end of such 120 day period.

19



PART IV

Item 15.    Exhibits and Financial Statement Schedules

    (a)
    The following documents are filed as part of this report:


1.   Financial Statements:
    Management's Report on Internal Control Over Financial Reporting   A-1
    Report of Independent Registered Public Accounting Firm   A-2
    Report of Independent Registered Public Accounting Firm   A-3
    Consolidated Balance Sheet at December 31, 2007 and 2006   A-4
    Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2007   A-5
    Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2007   A-6
    Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income for each of the years in the three-year period ended December 31, 2007   A-7
    Notes to Consolidated Financial Statements   A-8

2.

 

All other schedules and separate financial statements of 50 percent or less owned companies accounted for by the equity method have been omitted because they are not applicable.

3.

 

Exhibits
3.   (a)   Restated Certificate of Incorporation (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2004).
    (b)   Form of Certificate of Designations of Series A Junior Participating Cumulative Preferred Stock (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2004).
    (c)   Bylaws, as amended to date (This Exhibit is incorporated by reference from the Registrant's Report of Unscheduled Material events on Form 8-K filed September 21, 2007.)
4.   (a)   Specimen Common Stock Certificate for Registrant.
    (b)   6.75 percent Subordinated Notes Due 2011 in the principal amount of $150.0 million (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2006).
    (c)   Indenture dated as of February 13, 2003 between Registrant and U.S. Bank National Association, as Trustee pursuant to which Registrant issued its 5.125 percent Senior Notes due 2013 in the principal amount of $225.0 million and form of 5.125 percent Senior Note due 2013
    (d)   Certificate of Amendment of Articles of Incorporation of CN Real Estate Investment Corporation Articles of Incorporation
    (e)   CN Real Estate Investment Corporation Bylaws (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2006).
    (f)   CN Real Estate Investment Corporation Servicing Agreement (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2006).
    (g)   CN Real Estate Investment Corporation II Articles of Amendment and Restatement
    (h)   CN Real Estate Investment Corporation II Amended and Restated Bylaws

20


10.   (a)*   Employment Agreement made as of May 15, 2003, by and between Bram Goldsmith, and the Registrant and City National Bank. (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2003).
    (b)*   Amendment to Employment Agreement dated as of May 15, 2005 by and between Bram Goldsmith and City National Corporation and City National Bank. (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2005).
    (c)*   Second Amendment to Employment Agreement for Bram Goldsmith dated as of May 15, 2007, among Bram Goldsmith, City National Corporation and City National Bank. (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2007).
    (d)*   Employment Agreement made as of June 30, 2006 by and between Russell Goldsmith and the Registrant and City National Bank (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006).
    (e)*   1995 Omnibus Plan (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005)
    (f)*   Amendment to 1995 Omnibus Plan (This Exhibit is incorporated by reference form the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
    (g)*   Amended and Restated Section 2.8 of 1995 Omnibus Plan.
    (h)*   1999 Omnibus Plan (This Exhibit is incorporated by reference from the Registrants Annual Report on Form 10-K for the year ended December 31, 2004).
    (i)*   Amended and Restated 2002 Omnibus Plan (This Exhibit is incorporated by reference from the Registrant's Proxy Statement filed with the SEC for the Annual Meeting of Shareholders held on April 28, 2004).
    (j)*   Amended and Restated 1999 Variable Bonus Plan (This Exhibit is incorporated by reference from the Registrant's Proxy Statement filed with the SEC for the Annual Meeting of Shareholders held on April 28, 2004).
    (k)*   Form of Indemnification Agreement for directors and executive officers of the Company. (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2004).
    (l)*   2000 City National Bank Executive Deferred Compensation Plan. (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005.)
    (m)*   Amendment Number 3 to 2000 City National Bank Executive Deferred Compensation Plan.
    (n)*   Form of Change of Control Agreement for members of City National Bank executive committee (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2004).
    (o)*   2000 City National Bank Director Deferred Compensation Plan. (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005.)
    (p)*   Amendment Number 2 to 2000 City National Bank Director Deferred Compensation Plan.
    (q)*   City National Bank Executive Management Bonus Plan. (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005.)
    (r)*   City National Corporation 2001 Stock Option Plan. (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005.)

21


    (s)*   Form of Restricted Stock Unit Award Agreement Under the City National Corporation 2002 Amended and Restated Omnibus Plan (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).
    (t)*   Form of Stock Option Award Agreement Under the City National Corporation 2002 Amended and Restated Omnibus Plan (Compensation Committee and Board Approval) (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).
    (u)*   Form of Stock Option Award Agreement Under the City National Corporation 2002 Amended and Restated Omnibus Plan (Compensation Committee Approval)) (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).
    (v)*   Form of Restricted Stock Award Agreement Under the City National Corporation 2002 Amended and Restated Omnibus Plan) (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).
    (w)*   Form of Director Stock Option Agreement Under the City National Corporation Amended and Restated 2002 Omnibus plan (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).
    (x)*   City National Corporation 2006 Compensatory Agreement with CEO and Named Executive Officers filed in current report on Form 8-K dated March 1, 2006 (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2006).
    (y)*   First Amendment to the City National Corporation Amended and Restated 2002 Omnibus Plan. (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2005).
    (z)*   Form of Stock Option Award Agreement Under the City National Corporation Amended and Restated 2002 Omnibus Plan (2006 and later grants). (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.)
    10.1*   Form of Restricted Stock Award Agreement Under the City National Corporation Amended and Restated 2002 Omnibus Plan and Restricted Stock Unit Award Agreement Addendum (2006 and later grants). (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.)
    10.2*   Form of Restricted Stock Unit Award Agreement Under the City National Corporation Amended and Restated 2002 Omnibus Plan and Restricted Stock Unit Award Agreement Addendum (2006 and later grants). (This Exhibit is incorporated by reference from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.)
    10.3*   Form of Restricted Stock Unit Award Agreement (Cash Only Award) Under the City National Corporation Amended and Restated 2002 Omnibus Plan and Restricted Stock Unit Award Agreement (Cash Only Award) Addendum. (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2006).

22


    10.4   Lease dated September 30, 1996 between Citinational-Buckeye Building Co. and City National Bank, as amended by that certain First Lease Addendum dated as of May 1, 1998, by that certain Second Lease Addendum dated as of November 13, 1998, by that certain Third Lease Addendum dated as of November 1, 2002 and the 2003 Lease Supplement (as herein defined) (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2003).
    10.5   Lease dated November 1, 2002, between Citinational-Buckeye Building Co. and City National Bank as amended by the 2003 Lease Supplement (as herein defined)) (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2003).
    10.6   Lease dated August 1, 2000, between Citinational-Buckeye Building Co. and City National Bank, as amended by that certain First Lease Addendum dated as of November 1, 2002, and the 2003 Lease Supplement (as herein defined)) (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2003).
    10.7   Lease Supplement, dated May 28, 2003 (the "2003 Lease Supplement"), by and between Citinational Buckeye Building Co and City National Bank) (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2003).
    10.8   Lease dated November 19, 2003 between TPG Plaza Investments and City National Bank (Portions of this exhibit have been omitted pursuant to a request for confidential treatment)) (This Exhibit is incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended December 31, 2003).
    21   Subsidiaries of the Registrant
    23   Consent of KPMG LLP
    31.1   Certification of the Chief Executive Officer pursuant to Rule 13a-14 (a) or 15d-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
    31.2   Certification of the Chief Financial Officer pursuant to Rule 13a-14 (a) or 15d-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
    32.0   Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*
Management contract or compensatory plan or arrangement

23



SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

    CITY NATIONAL CORPORATION
(Registrant)

February 27, 2008

 

By:

/s/  
RUSSELL D. GOLDSMITH      
Russell D. Goldsmith
President and Chief Executive Officer

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature
  Title
  Date

 

 

 

 

 
/s/  RUSSELL D. GOLDSMITH      
Russell D. Goldsmith
(Principal Executive Officer)
  President/Chief Executive
Officer/Director
  February 27, 2008

/s/  
CHRISTOPHER J. CAREY      
Christopher J. Carey
(Principal Financial Officer and
Principal Accounting Officer)

 

Executive Vice President and
Chief Financial Officer

 

February 27, 2008

/s/  
BRAM GOLDSMITH      
Bram Goldsmith

 

Chairman of the Board/Director

 

February 27, 2008

/s/  
CHRISTOPHER J. WARMUTH      
Christopher J. Warmuth

 

Executive Vice President/Director

 

February 27, 2008

/s/  
RICHARD L. BLOCH      
Richard L. Bloch

 

Director

 

February 27, 2008

/s/  
KENNETH L. COLEMAN      
Kenneth L. Coleman

 

Director

 

February 27, 2008

24



/s/  
ASHOK ISRANI      
Ashok Israni

 

Director

 

February 27, 2008

/s/  
LINDA M. GRIEGO      
Linda M. Griego

 

Director

 

February 27, 2008

/s/  
MICHAEL L. MEYER      
Michael L. Meyer

 

Director

 

February 27, 2008

/s/  
RONALD L. OLSON      
Ronald L. Olson

 

Director

 

February 27, 2008

/s/  
BRUCE ROSENBLUM      
Bruce Rosenblum

 

Director

 

February 27, 2008

/s/  
PETER M. THOMAS      
Peter M. Thomas

 

Director

 

February 27, 2008

/s/  
KENNETH ZIFFREN      
Kenneth Ziffren

 

Director

 

February 27, 2008

25



FINANCIAL HIGHLIGHTS

Dollars in thousands,
except per share amounts (1)

  2007
  2006
  Percent
change

 
FOR THE YEAR                  
  Net income   $ 222,713   $ 233,523   (5 )%
  Net income per common share, basic     4.62     4.82   (4 )
  Net income per common share, diluted     4.52     4.66   (3 )
  Dividends per common share     1.84     1.64   12  

AT YEAR END

 

 

 

 

 

 

 

 

 
  Assets   $ 15,889,290   $ 14,884,309   7  
  Securities     2,756,010     3,101,154   (11 )
  Loans and leases     11,630,638     10,386,005   12  
  Deposits     11,822,505     12,172,816   (3 )
  Shareholders' equity     1,655,607     1,490,843   11  
  Book value per common share     34.61     31.39   10  

AVERAGE BALANCES

 

 

 

 

 

 

 

 

 
  Assets   $ 15,370,764   $ 14,715,512   4  
  Securities     2,833,489     3,488,005   (19 )
  Loans and leases     11,057,411     9,948,363   11  
  Deposits     12,236,383     11,869,927   3  
  Shareholders' equity     1,599,488     1,460,792   9  

SELECTED RATIOS

 

 

 

 

 

 

 

 

 
  Return on average assets     1.45 %   1.59 % (9 )
  Return on average shareholders' equity     13.92     15.99   (13 )
  Corporation's tier 1 leverage     7.97     8.81   (10 )
  Corporation's tier 1 risk-based capital     9.31     11.09   (16 )
  Corporation's total risk-based capital     11.27     13.60   (17 )
  Period-end shareholders' equity to period-end assets     10.42     10.02   4  
  Dividend payout ratio, per share     40.13     34.31   17  
  Net interest margin     4.45     4.58   (3 )
  Efficiency ratio (2)     58.21     55.97   4  

ASSET QUALITY RATIOS

 

 

 

 

 

 

 

 

 
  Nonaccrual loans to total loans and leases     0.65 %   0.20 % 225  
  Nonaccrual loans and OREO to total loans and leases and OREO     0.65     0.20   225  
  Allowance for loan and lease losses to total loans and leases     1.45     1.50   (3 )
  Allowance for loan and lease losses to nonaccrual loans     223.03     743.88   (70 )
  Net (charge-offs)/recoveries to average loans     (0.08 )   0.03   NM  

AT YEAR END

 

 

 

 

 

 

 

 

 
  Assets under management (3)   $ 37,268,529   $ 27,634,473   35  
  Assets under management or administration (3)     58,506,256     48,458,981   21  

(1)
Certain prior period balances have been reclassified to conform to the current period presentation.

(2)
The efficiency ratio is defined as noninterest expense excluding OREO expense divided by total revenue (net interest income on a tax-equivalent basis and noninterest income).

(3)
Excludes $12.4 billion and $9.1 billion of assets under management for the asset manager in which the Company holds a minority ownership interest as of December 31, 2007 and December 31, 2006, respectively.

26



SELECTED FINANCIAL INFORMATION

 
  As of or for the year ended December 31,
 
Dollars in thousands, except per share data (1)

 
  2007
  2006
  2005
  2004
  2003
 
Statement of Income Data:                                
  Interest income   $ 894,101   $ 826,315   $ 716,166   $ 602,180   $ 573,465  
  Interest expense     285,829     220,405     106,125     58,437     61,110  
   
 
 
 
 
 
  Net interest income     608,272     605,910     610,041     543,743     512,355  
  Provision for credit losses     20,000     (610 )           29,000  
  Noninterest income     303,202     242,370     210,368     186,410     179,485  
  Noninterest expense     529,245     476,046     438,178     395,410     364,178  
  Minority interest     8,856     5,958     5,675     4,992     4,039  
   
 
 
 
 
 
  Income before taxes     353,373     366,886     376,556     329,751     294,623  
  Income taxes     130,660     133,363     141,821     123,429     107,946  
   
 
 
 
 
 
    Net income   $ 222,713   $ 233,523   $ 234,735   $ 206,322   $ 186,677  
   
 
 
 
 
 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Net income per share, basic     4.62     4.82     4.77     4.21     3.84  
  Net income per share, diluted     4.52     4.66     4.60     4.04     3.72  
  Dividends per share     1.84     1.64     1.44     1.28     0.97  
  Book value per share     34.61     31.39     29.55     27.39     24.85  
  Shares used to compute income per share, basic     48,234     48,477     49,159     48,950     48,643  
  Shares used to compute income per share, diluted     49,290     50,063     51,062     51,074     50,198  

Balance Sheet Data—At Period End:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Assets   $ 15,889,290   $ 14,884,309   $ 14,581,809   $ 14,231,500   $ 13,028,213  
  Securities     2,756,010     3,101,154     4,010,757     4,142,430     3,409,262  
  Loans and leases     11,630,638     10,386,005     9,265,602     8,481,277     7,882,742  
  Interest-earning assets     14,544,176     13,722,062     13,520,922     13,333,792     11,985,678  
  Deposits     11,822,505     12,172,816     12,138,472     11,986,915     10,937,063  
  Shareholders' equity     1,655,607     1,490,843     1,457,957     1,348,522     1,219,256  

Balance Sheet Data—Average Balances:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Assets   $ 15,370,764   $ 14,715,512   $ 14,161,241   $ 13,395,993   $ 12,156,145  
  Securities     2,833,489     3,488,005     4,028,332     3,641,615     2,929,699  
  Loans and leases     11,057,411     9,948,363     8,875,358     8,106,657     7,729,150  
  Interest-earning assets     14,054,123     13,568,255     13,047,244     12,322,193     11,159,034  
  Deposits     12,236,383     11,869,927     11,778,839     11,275,017     10,045,267  
  Shareholders' equity     1,599,488     1,460,792     1,389,700     1,262,560     1,147,477  

Asset Quality:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Nonaccrual loans   $ 75,561   $ 20,883   $ 14,400   $ 34,638   $ 42,273  
  OREO                      
   
 
 
 
 
 
    Total nonaccrual loans and OREO   $ 75,561   $ 20,883   $ 14,400   $ 34,638   $ 42,273  
   
 
 
 
 
 

Performance Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Return on average assets     1.45 %   1.59 %   1.66 %   1.54 %   1.54 %
  Return on average shareholders' equity     13.92     15.99     16.89     16.34     16.27  
  Net interest spread     2.91     3.18     3.99     4.12     4.30  
  Net interest margin     4.45     4.58     4.79     4.54     4.74  
  Period-end shareholders' equity to period-end assets     10.42     10.02     10.00     9.48     9.36  
  Dividend payout ratio, per share     40.13     34.31     30.03     30.50     25.33  
  Efficiency ratio     58.21     55.97     53.29     53.83     52.14  

Asset Quality Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Nonaccrual loans to total loans and leases     0.65 %   0.20 %   0.16 %   0.41 %   0.54 %
  Nonaccrual loans and OREO to total loans and leases and OREO     0.65     0.20     0.16     0.41     0.54  
  Allowance for loan and lease losses to total loans and leases     1.45     1.50     1.66     1.75     1.98  
  Allowance for loan and lease losses to nonaccrual loans     223.03     743.88     1,069.33     428.91     369.13  
  Net (charge-offs)/recoveries to average total loans and leases     (0.08 )   0.03     0.10     (0.07 )   (0.36 )

(1)
Certain prior period balances have been reclassified to conform to the current period presentation.

27



MANAGEMENT'S DISCUSSION AND ANALYSIS

OVERVIEW

        City National Corporation, through its primary subsidiary, City National Bank (the "Bank"), provides private and business banking services, including investment and trust services to mid-size businesses, entrepreneurs, professionals and affluent individuals. The Bank is the largest independent commercial bank headquartered in Los Angeles. For over fifty years, the Bank has served clients through relationship banking. The Bank seeks to build client relationships with a high level of personal service and tailored products through private and commercial banking teams, product specialists and investment advisors to facilitate clients' use, where appropriate, of multiple services and products offered by the Company. The Company offers a broad range of lending, deposit, cash management, international banking and other products and services. The Company also lends, invests and provides services in accordance with its Community Reinvestment Act commitment. Through the Company's asset management firms, subsidiaries of the Corporation, and Wealth Management Services, a division of the Bank, the Company offers 1) investment management and advisory services and brokerage services, including portfolio management, securities trading and asset management; 2) personal and business trust and investment services, including employee benefit trust services; 401(k) and defined benefit plan administration, and; 3) estate and financial planning and custodial services. The Bank also advises and markets mutual funds under the name of CNI Charter Funds.

        City National Corporation ("the Corporation") is the holding company for the Bank. References to the "Company" mean the Corporation and its subsidiaries including the Bank. The financial information presented herein includes the accounts of the Corporation, its non-bank subsidiaries, the Bank, and the Bank's wholly owned subsidiaries. All material transactions between these entities are eliminated.

        See "Cautionary Statement for Purposes of the 'Safe Harbor' Provision of the Private Securities Litigation Reform Act of 1995," on page 67 in connection with "forward-looking" statements included in this report.

        Over the last three years, the Company's total assets and loans have grown by 12 percent and 37 percent, respectively. The growth in loans occurred primarily in commercial and residential mortgage loans, and includes the acquisition of Business Bank of Nevada in the first quarter of 2007. Deposit balances decreased modestly for the same period primarily due to lower title and escrow deposits resulting from the nationwide slowdown in the housing market.

        The Company continues to experience strong growth in noninterest income which increased by 25 percent from 2006 and 44 percent from 2005 primarily due to growth in trust and investment fees. Noninterest income increased to 33 percent of total revenue in 2007 up from 29 percent of total revenue in 2006. The increase in noninterest income reflects internal growth as well as the acquisition of Independence Investments, LLC, in 2006 and Convergent Wealth Advisors in 2007.

        On February 28, 2007, the Company completed the acquisition of Business Bank Corporation ("BBC"), the parent of Business Bank of Nevada ("BBNV") and an unconsolidated subsidiary, Business Bancorp Capital Trust I, in a cash and stock transaction valued at $167 million. BBNV operated as a wholly owned subsidiary of City National Corporation until after the close of business on April 30, 2007, at which time it was merged into the Bank. BBC had assets of $496 million, loans of $395 million and deposits of $441 million on the date of acquisition.

        On May 1, 2007, the Corporation completed the acquisition of Lydian Wealth Management in an all-cash transaction. The investment advisory firm is headquartered in Rockville, Maryland and now manages or advises on client assets totaling $8.9 billion. Lydian Wealth Management changed its name to Convergent Wealth Advisors ("Convergent Wealth") and became a subsidiary of Convergent Capital Management LLC, the Chicago-based asset management holding company that the Company acquired

28



in 2003. All of the senior executives of Convergent Wealth signed employment agreements and acquired a significant minority ownership interest in Convergent Wealth.

CAPITAL ACTIVITY

        In 2005, the Company repurchased 630,500 shares of its common stock under a 1 million share buyback program approved by the Board of Directors in March 2004, and the remaining 369,500 shares were repurchased in 2006. On April 26, 2006 the Board of Directors authorized the repurchase of 1.5 million additional shares of City National Corporation stock, following the completion of the March 24, 2004 buyback initiative. The buyback was completed in August 2006 at an average cost of $69.04. On July 6, 2006, the Board of Directors authorized the repurchase of 1.5 million additional shares of City National Corporation stock, following the completion of the April 26, 2006 buyback initiative. In 2006, 442,300 shares were repurchased under this program at an average cost of $66.24. On August 7, 2007, the Company's Board of Directors authorized the Company to repurchase 1 million additional shares of the Company's stock following completion of its previously approved stock buyback initiative. The Company repurchased an aggregate of 1,495,800 shares of common stock in 2007 at an average price of $69.47. The shares purchased under the buyback programs may be reissued for acquisitions, upon the exercise of stock options, and for other general corporate purposes. On January 24, 2008, the Board of Directors authorized the repurchase of an additional 1 million shares of City National Corporation stock, following the completion of the August 7, 2007 buyback initiative. At January 31, 2008, 1,561,900 additional shares could be repurchased under the existing authority.

        The Corporation paid dividends of $1.84 per share of common stock in 2007 and $1.64 per share of common stock in 2006. On January 24, 2008, the Board of Directors authorized a regular quarterly cash dividend on common stock at an increased rate of $0.48 per share (or $1.92 per share for the year) to shareholders of record on February 6, 2008 payable on February 20, 2008. This reflects a 4 percent increase over the $0.46 per share paid in November 2007.

CRITICAL ACCOUNTING POLICIES

        The accounting and reporting policies of the Company conform with U.S. generally accepted accounting principles ("GAAP"). The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, contingent assets and liabilities, and revenues and expenses included in the consolidated financial statements. Circumstances and events that differ significantly from those underlying the Company's estimates and assumptions could cause actual financial results to differ from the estimates. The material estimates included in the financial statements relate to the allowance for loan and lease losses, the reserve for off-balance sheet credit commitments, valuation of stock options and restricted stock, income taxes, goodwill and intangible asset impairment and the valuation of financial assets and liabilities reported at fair value.

        Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. The Company has applied its critical accounting policies and estimation methods consistently in all periods presented in these financial statements and management has discussed these policies with the Audit Committee.

29


        Management believes the following are critical accounting policies that require the most significant judgments and estimates used in the preparation of its consolidated financial statements:

Accounting for securities

        All securities other than trading securities are classified as available-for-sale and are valued at fair value. Unrealized gains or losses on securities available-for-sale are excluded from net income but are included as separate components of comprehensive income, net of taxes. Premiums or discounts on securities available-for-sale are amortized or accreted into income using the interest method over the expected lives of the individual securities. Realized gains or losses on sales of securities available-for-sale are recorded using the specific identification method. Trading securities are valued at fair value with any unrealized gains or losses included in income.

        If available, quoted market prices provide the best indication of value. If quoted market prices are not available for fixed-maturity securities, the Company discounts the expected cash flows using market interest rates commensurate with the credit quality and maturity of the securities. The determination of market or fair value considers various factors, including time value and volatility factors; price activity for equivalent instruments; counterparty credit quality; and the potential impact on market prices or fair value of liquidating the Company's positions in an orderly manner over a reasonable period of time under current market conditions. Changes in assumptions could affect the fair values of investments.

        For the substantial majority of the Company's investments, fair values are determined based upon externally verifiable quoted prices. Using this information, the Company conducts quarterly reviews to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. Deteriorating global, regional or specific issuer-related economic conditions could adversely affect these values. The Company considers such factors as the length of time and the extent to which the market value has been less than cost and the Company's intent with regard to the securities in evaluating securities for other-than-temporary impairment. The value of securities is reduced when the declines are considered other-than-temporary, and a new cost basis is established for the securities. Any other-than-temporary impairment loss is included in net income.

Accounting for the allowance for loan and lease losses and reserve for off-balance sheet credit commitments

        The Company accounts for the credit risk associated with lending activities through its allowances for loan and lease losses, reserve for off-balance sheet credit commitments and provision for credit losses. The provision is the expense recognized in the income statement to adjust the allowance and reserve to the levels deemed appropriate by management, as determined through application of the Company's allowance methodology procedures. The provision for credit losses reflects management's judgment of the adequacy of the allowance for loan and lease losses and the reserve for off-balance sheet credit commitments. It is determined through quarterly analytical reviews of the loan and commitment portfolios and consideration of such other factors as the Company's loan and lease loss experience, trends in problem loans, concentrations of credit risk, underlying collateral values, and current economic conditions, as well as the results of the Company's ongoing credit review process. As conditions change, our level of provisioning and the allowance for loan and lease losses and reserve for off-balance sheet credit commitments may change.

        Nonperforming loans greater than $500,000 are individually evaluated for impairment based upon the borrower's overall financial condition, resources, and payment record, and the prospects for support from any financially responsible guarantors. In addition, the allowance for loan and lease losses attributed to these impaired loans considers all available evidence, including as appropriate, the probability that a specific loan will default, the expected exposure of a loan at default, an estimate of

30



loss given default, the present value of the expected future cash flows discounted using the loan's contractual effective rate, the secondary market value of the loan and the fair value of collateral.

        For commercial, non-homogenous loans that are not impaired, the bank derives loss factors via a process that begins with estimates of probable losses inherent in the portfolio based upon various statistical analyses. These include migration analysis, in which historical delinquency and credit loss experience is applied to the current aging of the portfolio, as well as analyses that reflect current trends and conditions. Each portfolio of smaller balance homogeneous loans including residential first mortgages, installment, revolving credit and most other consumer loans is collectively evaluated for loss potential. Management also establishes a qualitative reserve that considers overall portfolio indicators, including current and historical credit losses; delinquent, nonperforming and classified loans; trends in volumes and terms of loans; and an evaluation of overall credit quality and the credit process, including lending policies and procedures, economic, geographical, product and other environmental factors. Management also considers trends in internally risk-rated exposures, classified exposures, cash-basis loans, and historical and forecasted write-offs; as well as a review of industry, geographic, and portfolio concentrations, including current developments within those segments. In addition, management considers the current business strategy and credit process, including credit-limit setting and compliance, credit approvals, loan underwriting criteria and loan workout procedures.

        The quantitative portion of the allowance for loan and lease losses is adjusted for qualitative factors to account for model imprecision and to incorporate the range of probable outcomes inherent in the estimates used for the allowance. The qualitative portion of the allowance attempts to incorporate the risks inherent in the portfolio, economic uncertainties, competition, regulatory requirements and other subjective factors including industry trends, changes in underwriting standards, decline in the value of collateral for collateral dependent loans and existence of concentrations. The reserve for off-balance sheet credit commitments is established by converting the off-balance sheet exposures to a loan equivalent amount and then applying the methodology used for loans described above.

Accounting for goodwill and other intangible assets

        The Company accounts for acquisitions using the purchase method of accounting. Under the purchase method, assets acquired and liabilities assumed are recorded at their estimated fair values at the date of acquisition. Management utilizes various valuation techniques including discounted cash flow analyses to determine these fair values. Any excess of the purchase price over amounts allocated to acquired assets, including identifiable intangible assets, and liabilities assumed is recorded as goodwill.

        Goodwill and intangible assets are evaluated at least annually for impairment or more frequently if events or circumstances, such as changes in economic or market conditions, indicate that impairment may exist. Goodwill is tested for impairment at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment for which discrete financial information is available and regularly reviewed by management. If the fair value of the reporting unit including goodwill is determined to be less than the carrying amount of the reporting unit, a further test is required to measure the amount of impairment. If an impairment loss exists, the carrying amount of the goodwill is adjusted to a new cost basis. For purposes of the goodwill impairment test, fair value techniques based on multiples of earnings or book value are used to determine the fair value of the Company's reporting units. The multiples used in these calculations are consistent with current industry practice for valuing similar types of companies.

        Intangible assets include core deposit intangibles and client contract intangibles (combined, customer-relationship intangibles) originating from acquisitions of financial services firms. These assets are amortized over their estimated useful lives. Impairment testing of these assets is performed at the

31



individual asset level. Impairment exists if the carrying amount of the asset exceeds its fair value at the date of the impairment test. The fair value of a reporting unit is the amount at which the unit as a whole could be bought or sold in a current transaction between willing parties. For intangible assets, estimates of expected future cash flows (cash inflows less cash outflows) that are directly associated with an intangible asset are used to determine the fair value of that asset. Management makes certain estimates and assumptions in determining the expected future cash flows from customer-relationship intangibles including account attrition, expected lives, discount rates, interest rates, servicing costs and other factors. Significant changes in these estimates and assumptions could adversely impact the valuation of these intangible assets.

        If an impairment loss exists, the carrying amount of the intangible asset is adjusted to a new cost basis. The new cost basis is amortized over the remaining useful life of the asset.

Accounting for derivatives and hedging activities

        As part of its asset and liability management strategies, the Company uses interest-rate swaps to reduce cash flow variability and to moderate changes in the fair value of financial instruments. In accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended ("SFAS 133"), the Company recognizes derivatives as assets or liabilities on the balance sheet at their fair value. The treatment of changes in the fair value of derivatives depends on the character of the transaction.

        In accordance with SFAS 133, the Company documents its hedging relationships, including identification of the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction at the time the derivative contract is executed. This includes designating each derivative contract as either (i) a "fair value hedge" which is a hedge of a recognized asset or liability, (ii) a "cash flow hedge" which hedges a forecasted transaction or the variability of the cash flows to be received or paid related to a recognized asset or liability or (iii) an "undesignated hedge", a derivative instrument not designated as a hedging instrument whose change in fair value is recognized directly in the consolidated statements of income. All derivatives designated as fair value or cash flow hedges are linked to specific hedged items or to groups of specific assets and liabilities on the balance sheet. The Company did not have any significant undesignated hedges during 2007 or 2006.

        Both at inception and at least quarterly thereafter, the Company assesses whether the derivatives used in hedging transactions are highly effective (as defined in SFAS 133) in offsetting changes in either the fair value or cash flows of the hedged item. Retroactive effectiveness is assessed, as well as the expectation that the hedge will remain effective prospectively.

        For cash flow hedges, in which derivatives hedge the variability of cash flows (interest payments) on loans that are indexed to U.S. dollar LIBOR or to the Bank's prime interest rate, the effectiveness is assessed prospectively at the inception of the hedge, and prospectively and retrospectively at least quarterly thereafter. Ineffectiveness of the cash flow hedges is measured using the hypothetical derivative method described in Derivatives Implementation Group Issue G7, "Measuring the Ineffectiveness of a Cash Flow Hedge of Interest Rate Risk under Paragraph 30(b) When the Shortcut Method is not Applied." For cash flow hedges, the effective portion of the changes in the derivatives' fair value is not included in current earnings but is reported as other comprehensive income. When the cash flows associated with the hedged item are realized, the gain or loss included in other comprehensive income is recognized on the same line in the consolidated statements of income as the hedged item, i.e., included in interest income on loans. Any ineffective portion of the changes of fair value of cash flow hedges is recognized immediately in other noninterest income in the consolidated statements of income.

        For fair value hedges, the Company uses interest-rate swaps to hedge the fair value of certain certificates of deposits, subordinated debt and other long-term debt. The certificates of deposit are

32



single maturity, fixed-rate, non-callable, negotiable certificates of deposit that pay interest only at maturity and contain no compounding features. The certificates cannot be redeemed early except in the case of the holder's death. The interest-rate swaps are executed at the time the deposit transactions are negotiated. Interest-rate swaps are structured so that all key terms of the swaps match those of the underlying deposit or debt transactions, therefore ensuring there is no hedge ineffectiveness at inception. The Company ensures that the interest-rate swaps meet the requirements for utilizing the short cut method in accordance with paragraph 68 of SFAS 133 and maintains appropriate documentation for each interest-rate swap. On a quarterly basis, fair value hedges are analyzed to ensure that the key terms of the hedged items and hedging instruments remain unchanged, and the hedging counterparties are evaluated to ensure that there are no adverse developments regarding counterparty default, thus ensuring continuous effectiveness. For these fair value hedges, the effective portion of the changes in the fair value of derivatives is reflected in current earnings, on the same line in the consolidated statements of income as the related hedged item.

        The fair values of the interest-rate swaps are determined from verifiable third-party sources that have considerable experience with the interest-rate swap market. For both fair value and cash flow hedges, the periodic accrual of interest receivable or payable on interest-rate swaps is recorded as an adjustment to net interest income for the hedged items.

        The Company discontinues hedge accounting prospectively when (i) a derivative is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item, (ii) a derivative expires or is sold, terminated or exercised, (iii) a derivative is un-designated as a hedge, because it is unlikely that a forecasted transaction will occur, or (iv) the Company determines that designation of a derivative as a hedge is no longer appropriate. If a fair value hedge derivative instrument is terminated or the hedge designation removed, the previous adjustments to the carrying amount of the hedged asset or liability would be subsequently accounted for in the same manner as other components of the carrying amount of that asset or liability. For interest-earning assets and interest-bearing liabilities, such adjustments would be amortized into earnings over the remaining life of the respective asset or liability. If a cash flow hedge derivative instrument is terminated or the hedge designation is removed, related amounts reported in other comprehensive income are reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings.

Accounting for stock-based compensation

        The Company grants stock options, restricted stock and restricted stock units to employees in order to leverage the success of the Company by providing a means of aligning employees' interests with the interests of shareholders in increasing shareholder value, and by attracting, motivating, retaining, and rewarding key employees. The stock-based compensation plans are authorized and administered by the Compensation, Nominating & Governance Committee of the Board of Directors ("the Committee"). Awards may be granted to eligible employees, and shall not exceed 500,000 shares to an employee during any one-year period. Non-qualified and incentive options are issued with an exercise price equal to the market price of the Company's stock on the grant date. The options generally vest evenly over a four-year period, beginning on the first anniversary of the grant date, and have a term of ten years. Unvested options are forfeited upon termination of employment, except in the case of the retirement of a retirement-age employee for options granted prior to January 31, 2006, or upon the death of an employee, at which point the remaining unvested options are automatically vested. Certain options and stock awards provide for accelerated vesting if there is a change of control (as defined in the City National Corporation 2002 Amended and Restated Omnibus Plan). All unexercised options expire ten years from the grant date.

        On December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised), Share Based Payment, ("SFAS 123R") which replaced SFAS 123 and superseded APB 25. SFAS 123R requires the Company to measure the cost of employee services received in exchange for

33



an award of equity instruments, such as stock options or restricted stock, based on the fair value of the award on the grant date. This cost must be recognized in the income statement over the vesting period of the award.

        The Company adopted SFAS 123R effective January 1, 2006. The Company previously applied APB Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for stock-based compensation plans, and accordingly, no compensation cost had been recognized for stock options in the periods prior to January 1, 2006. The Company applied the Modified Prospective Application in its implementation of the accounting standard. In 2006, the Company recognized stock-based compensation expense on new awards and on existing awards that were modified, repurchased or cancelled after January 1, 2006, and on existing awards that were not fully vested as of the date of adoption, but did not restate prior periods. The Company did not make any modifications to outstanding stock options prior to the adoption of SFAS 123R. Pro forma net income for 2005 and earnings per share information for the current and prior years is provided in Note 11.

        Since 2003, stock-based compensation performance awards granted to colleagues of the Company have included grants of restricted stock or restricted stock units and fewer stock options. This reduced the total number of shares awarded but better aligned the interests of shareholders and colleagues. Restricted stock awards vest over a five-year period during which time the holder receives dividends and has full voting rights. Twenty-five percent of the restricted stock awards vest two years from the date of grant, then twenty-five percent vests on each of the next three consecutive grant anniversary dates. Restricted stock is valued at the closing price of the Company's stock on the date of award. The portion of the market value of the restricted stock related to the current service period is recognized as compensation expense. The portion of the market value of the restricted stock relating to future service periods is included in deferred equity compensation and is amortized over the remaining vesting period on a straight-line basis.

        The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses certain assumptions. The Company evaluates exercise behavior and values options separately for executive and non-executive employees. Expected volatilities are based on the historical volatility of the Company's stock. The Company uses historical data to predict option exercise and employee termination behavior. The expected term of options granted is derived from the actual historical exercise activity over the past 20 years and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield is equal to the dividend yield of the Company's stock at the time of the grant. As a practice, the exercise price of the Company's stock option grants equals the closing market price of the common stock on the date of the grant.

        The actual value, if any, which a grantee may realize will depend upon the difference between the option exercise price and the market price of the Company's common stock on the date of exercise.

Accounting for Income Taxes

        The calculation of the Company's income tax provision and related tax accruals requires the use of estimates and judgments. The provision for income taxes is based on amounts reported in the consolidated statements of income which are adjusted to reflect the permanent and temporary differences in the tax and financial accounting for certain assets and liabilities.

        Deferred income taxes represent the tax effect of the differences in tax and financial reporting basis arising from temporary differences in accounting treatment. On a quarterly basis, management evaluates its deferred tax assets to determine if these tax benefits are expected to be realized in future periods. This determination is based on facts and circumstances, including the Company's current and

34


future tax outlook. To the extent a deferred tax asset is no longer considered "more likely than not" to be realized, a valuation allowance is established.

        Accrued income taxes represent the estimated amounts due or received from the various taxing jurisdictions where the Company has established a business presence. The balance also includes a contingent reserve for potential taxes, interest and penalties related to uncertain tax positions. On a quarterly basis, management evaluates the contingent tax accruals to determine if they are sufficient based on a probability assessment of potential outcomes. The determination is based on facts and circumstances, including the interpretation of existing law, new judicial or regulatory guidance and the status of tax audits.

RECENT DEVELOPMENTS

        Continued upheaval in the credit markets has negatively affected the nation's economy with significant impact on the residential mortgage and for-sale housing sectors. Large housing inventories and increasing numbers of foreclosures will continue to drive the downturn in the housing market. In addition, higher oil prices and increases in unemployment will impact economic growth in the near term.

2007 HIGHLIGHTS

    Consolidated net income for 2007 was $222.7 million, or $4.52 per diluted common share, compared with $233.5 million, or $4.66 per diluted common share, in 2006. The decrease in net income is largely due to a $20.0 million, or $11.6 million after tax, provision for credit losses recorded in the fourth quarter. This was the first provision for loan losses recorded by the Company in almost four years and reflects significant loan growth, as well as the turmoil in the for-sale housing market.

    Full-year revenue increased to $911.5 million, an increase of 7 percent from $848.3 million for 2006.

    Fully taxable-equivalent net interest income reached $625.0 million in 2007, up slightly from $621.4 million for 2006. The Company's prime lending rate averaged 8.05 percent for 2007 compared with 7.96 percent for 2006.

    Noninterest income reached $303.2 million in 2007, up 25 percent from the previous year due to the acquisition of Convergent Wealth Advisors, as well as growth in trust and investment, cash management and international service fees. Noninterest income grew 13 percent from 2006 excluding the acquisition of Convergent Wealth Advisors in mid-2007 and Independence Investments in the second quarter of 2006. Noninterest income accounted for 33 percent of the Company's revenue in 2007, up from 29 percent in 2006.

    The Company's effective tax rate was 36.9 percent for the year, slightly higher than the 36.4 percent rate in 2006, due to a decrease in tax benefits from investments in affordable housing partnerships and an income tax expense of approximately $0.7 million related to the expected resolution of two pending tax matters.

    Total assets at December 31, 2007 reached $15.9 billion, up 7 percent from $14.9 billion at the end of 2006 and up 2 percent from the third quarter of 2007. The increase in total assets is primarily attributable to loan growth and the first-quarter 2007 acquisition of Business Bank of Nevada.

    Total average assets increased to $15.4 billion for 2007 from $14.7 billion for 2006, an increase of 4 percent.

35


    The return on average assets was 1.45 percent for 2007 compared with 1.59 percent for 2006. The return on average shareholders' equity was 13.92 percent for 2007 compared with 15.99 percent for the prior year.

    Average loan balances grew by 11 percent to $11.1 billion for 2007 compared with $9.9 billion for 2006.

    Nonaccrual loans totaled $75.6 million as of December 31, 2007, compared with $20.9 million at December 31, 2006. Net loan charge-offs were $8.5 million in 2007, compared with net loan recoveries of $2.8 million in 2006. The increase in nonaccruals and net charge-offs occurred primarily in the Company's for-sale housing construction portfolio.

    Average securities for 2007 totaled $2.8 billion, a decrease of 19 percent from $3.5 billion for 2006. The average duration of the total available-for-sale securities portfolio at December 31, 2007 was 3.4 years, compared with 3.3 years at December 31, 2006.

    Average deposits totaled $12.2 billion for 2007, a 3 percent increase from average deposits of $11.9 billion in 2006. The increase is due in large part to the acquisition of the Business Bank of Nevada as well as growth in time deposits and other interest-bearing deposits. Average noninterest-bearing deposits fell 3.5 percent from 2006, as some of the Bank's clients moved funds from core deposit accounts to higher-yielding instruments and title and escrow balances declined due to the weakness in the housing market.

OUTLOOK

        Based on its current assessment of economic conditions, management expects earnings per share to be 7 to 12 percent lower in 2008 than in 2007. Management's outlook is based upon its current view that the economy will grow at a nominal rate this year and that certain sectors, such as housing, will continue to put downward pressure on economic conditions. A material change in economic conditions would affect the Company's earnings expectations for 2008.

        In this economic environment, management anticipates moderate growth in loans and deposits this year as well as strong growth in noninterest income. The loan loss provision is expected to be higher in 2008 than in 2007, reflecting a more normal level. Growth in net interest income will be constrained due to lower interest rates, an increase in non-performing loans, and a moderate decline in commercial real estate loans. Noninterest expense is expected to grow at a lower rate than it did in 2007, despite significantly higher FDIC premiums, additional personnel costs and the impact of acquisitions made last year.

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RESULTS OF OPERATIONS

Summary

        A summary of the Company's results of operations on a fully taxable-equivalent basis for each of the last five years ended December 31 follows.

 
   
  Increase (Decrease)
   
  Increase (Decrease)
  Year Ended December 31,
Dollars in thousands
(except per share amounts)

  Year Ended 2007
  Year Ended 2006
  Amount
  %
  Amount
  %
  2005
  2004
  2003
Interest income (1)   $ 910,854   $ 69,099   8   $ 841,755   $ 110,818   15   $ 730,937   $ 618,060   $ 590,206
Interest expense     285,829     65,424   30     220,405     114,280   108     106,125     58,437     61,110
   
 
 
 
 
 
 
 
 
Net interest income     625,025     3,675   1     621,350     (3,462 ) (1 )   624,812     559,623     529,096
Provision for credit losses     20,000     20,610   NM     (610 )   (610 ) NM             29,000
Noninterest income     303,202     60,832   25     242,370     32,002   15     210,368     186,410     179,485
Noninterest expense:                                                  
  Staff expense     331,091     35,940   12     295,151     31,753   12     263,398     239,583     217,494
  Other expense     198,154     17,259   10     180,895     6,115   3     174,780     155,827     146,684
   
 
 
 
 
 
 
 
 
    Total     529,245     53,199   11     476,046     37,868   9     438,178     395,410     364,178
Minority interest expense     8,856     2,898   49     5,958     283   5     5,675     4,992     4,039
Income before income taxes     370,126     (12,200 ) (3 )   382,326     (9,001 ) (2 )   391,327     345,631     311,364
Income taxes     130,660     (2,703 ) (2 )   133,363     (8,458 ) (6 )   141,821     123,429     107,946
Less: adjustments (1)     16,753     1,313   9     15,440     669   5     14,771     15,880     16,741
   
 
 
 
 
 
 
 
 
    Net income   $ 222,713   $ (10,810 ) (5 ) $ 233,523   $ (1,212 ) (1 ) $ 234,735   $ 206,322   $ 186,677
   
 
 
 
 
 
 
 
 
    Net income per share, diluted   $ 4.52   $ (0.14 ) (3 ) $ 4.66   $ 0.06   1   $ 4.60   $ 4.04   $ 3.72
   
 
 
 
 
 
 
 
 

(1)
Includes amounts to convert nontaxable income to a fully taxable-equivalent yield. To compare tax-exempt asset yields to taxable yields, amounts are adjusted to pre-tax equivalents based on the marginal corporate federal tax rate of 35 percent.

NM—Not
Meaningful 

Net Interest Income

        Net interest income is the difference between interest income (which includes yield-related loan fees) and interest expense. Net interest income on a fully taxable-equivalent basis expressed as a percentage of average total earning assets is referred to as the net interest margin, which represents the average net effective yield on earning assets.

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        The following table shows average balances, interest income and yields for the last five years.

Net Interest Income Summary

 
  2007
  2006
 
Dollars in thousands

  Average Balance
  Interest income/ expense (1)(4)
  Average interest rate
  Average Balance
  Interest income/ expense (1)(4)
  Average interest rate
 
Assets (2)                                  
  Interest-earning assets                                  
    Loans and leases                                  
      Commercial   $ 4,279,523   $ 310,869   7.26 % $ 3,882,466   $ 268,364   6.91 %
      Commercial real estate mortgages     1,878,671     136,446   7.26     1,786,024     133,429   7.47  
      Residential mortgages     3,020,316     166,823   5.52     2,764,599     147,573   5.34  
      Real estate construction     1,291,708     110,483   8.55     955,456     84,462   8.84  
      Equity lines of credit     404,493     30,456   7.53     364,744     27,938   7.66  
      Installment     182,700     13,539   7.41     195,074     14,760   7.57  
   
 
     
 
     
        Total loans and leases (3)     11,057,411     768,616   6.95     9,948,363     676,526   6.80  
    Due from banks—interest-bearing     88,787     2,089   2.35     54,843     795   1.45  
    Federal funds sold and securities purchased under resale agreements     13,066     686   5.25     30,417     1,525   5.01  
    Securities available-for-sale     2,757,304     131,733   4.78     3,438,002     157,574   4.58  
    Trading account securities     76,185     3,959   5.20     50,003     2,803   5.61  
    Other interest-earning assets     61,370     3,771   6.14     46,627     2,532   5.43  
   
 
     
 
     
        Total interest-earning assets     14,054,123     910,854   6.48     13,568,255     841,755   6.20  
         
           
     
    Allowance for loan and lease losses     (157,012 )             (157,433 )          
    Cash and due from banks     423,526               428,742            
    Other non-earning assets     1,050,127               875,948            
   
           
           
        Total assets   $ 15,370,764             $ 14,715,512            
   
           
           
Liabilities and Shareholders' Equity (2)                                  
  Interest-bearing deposits                                  
    Interest checking accounts   $ 784,293   $ 4,739   0.60   $ 758,164   $ 2,427   0.32  
    Money market accounts     3,654,508     111,827   3.06     3,303,373     76,293   2.31  
    Savings deposits     147,764     715   0.48     168,853     685   0.41  
    Time deposits—under $100,000     240,388     9,518   3.96     183,972     6,355   3.45  
    Time deposits—$100,000 and over     1,876,184     87,881   4.68     1,721,292     73,264   4.26  
   
 
     
 
     
        Total interest-bearing deposits     6,703,137     214,680   3.20     6,135,654     159,024   2.59  
    Federal funds purchased and securities sold under repurchase agreements     662,928     32,491   4.90     541,671     26,463   4.89  
    Other borrowings     644,633     38,658   6.00     627,409     34,918   5.57  
   
 
     
 
     
        Total interest-bearing liabilities     8,010,698     285,829   3.57     7,304,734     220,405   3.02  
         
           
     
  Noninterest-bearing deposits     5,533,246               5,734,273            
  Other liabilities     227,332               215,713            
  Shareholders' equity     1,599,488               1,460,792            
   
           
           
        Total liabilities and shareholders' equity   $ 15,370,764             $ 14,715,512            
   
           
           
Net interest spread               2.91 %             3.18 %
Fully taxable-equivalent net interest and dividend income         $ 625,025             $ 621,350      
         
           
     
Net interest margin               4.45 %             4.58 %
               
             
 
Less: Dividend income included in other income           3,771               2,532      
         
           
     
Fully taxable-equivalent net interest income         $ 621,254             $ 618,818      
         
           
     

(1)
Net interest income is presented on a fully taxable-equivalent basis.

(2)
Certain prior period balances have been reclassified to conform to the current period presentation.

(3)
Includes average nonaccrual loans of $28,512, $16,725, $22,495, $39,266, and $66,675 for 2007, 2006, 2005, 2004, and 2003, respectively.

(4)
Loan income includes loan fees of $15,684, $16,249, $24,894, $20,354, and $21,648 for 2007, 2006, 2005, 2004, and 2003, respectively.

38     


Net Interest Income Summary

 
  2005
  2004
  2003
 
 
  Average Balance
  Interest income/ expense (1)(4)
  Average interest rate
  Average Balance
  Interest income/ expense (1)(4)
  Average interest rate
  Average Balance
  Interest income/ expense (1)(4)
  Average interest rate
 
                                                   
                                                   
                                                     
    $ 3,306,277   $ 202,672   6.13 % $ 3,042,167   $ 158,738   5.22 %% $ 3,256,646   $ 170,561   5.24 %
      1,836,904     132,245   7.20     1,776,193     111,992   6.31     1,681,056     113,830   6.77  
      2,481,122     129,314   5.21     2,138,365     115,042   5.38     1,832,682     110,430   6.03  
      749,911     56,930   7.59     756,022     41,734   5.52     647,851     33,593   5.19  
      298,751     18,029   6.03     216,206     9,649   4.46     173,937     7,528   4.33  
      202,393     14,022   6.93     177,704     10,843   6.10     136,978     8,883   6.48  
   
 
     
 
     
 
     
      8,875,358     553,212   6.23     8,106,657     447,998   5.53     7,729,150     444,825   5.76  
                                                   
          46,705     282   0.60     63,042     699   1.11     66,755     576   0.86  
      50,287     1,617   3.22     463,979     6,884   1.48     386,388     4,185   1.08  
      3,990,687     172,155   4.31     3,609,139     159,906   4.43     2,897,401     138,021   4.76  
      37,645     1,396   3.71     32,476     331   1.02     32,298     211   0.65  
      46,562     2,275   4.89     46,900     2,242   4.78     47,042     2,388   5.08  
   
 
     
 
     
 
     
      13,047,244     730,937   5.60     12,322,193     618,060   5.02     11,159,034     590,206   5.29  
         
           
           
     
      (150,303 )             (153,266 )             (161,869 )          
      443,828               442,570               436,870            
      820,472               784,496               722,110            
   
           
           
           
    $ 14,161,241             $ 13,395,993             $ 12,156,145            
   
           
           
           
                                                   
                                                   
    $ 828,530   $ 1,067   0.13   $ 792,424   $ 697   0.09   $ 652,238   $ 1,218   0.19  
      3,557,633     43,880   1.23     3,711,983     27,670   0.75     3,205,041     26,078   0.81  
      196,590     540   0.27     249,081     533   0.21     285,584     614   0.21  
      183,888     3,034   1.65     190,821     2,902   1.52     209,520     3,521   1.68  
      1,013,486     27,524   2.72     849,489     12,456   1.47     1,003,012     14,377   1.43  
   
 
     
 
     
 
     
      5,780,127     76,045   1.32     5,793,798     44,258   0.76     5,355,395     45,808   0.86  
                                                   
      278,576     8,583   3.08     119,251     1,422   1.19     147,883     1,538   1.04  
      533,755     21,497   4.03     571,807     12,757   2.23     645,578     13,764   2.13  
   
 
     
 
     
 
     
      6,592,458     106,125   1.61     6,484,856     58,437   0.90     6,148,856     61,110   0.99  
         
           
           
     
      5,998,712               5,481,219               4,689,872            
      180,371               167,358               169,940            
      1,389,700               1,262,560               1,147,477            
   
           
           
           
    $ 14,161,241             $ 13,395,993             $ 12,156,145            
   
           
           
           
                3.99 %             4.12 %             4.30 %
          $ 624,812             $ 559,623             $ 529,096      
         
           
           
     
                4.79 %             4.54 %             4.74 %
               
             
             
 
            2,275               2,242               2,388      
         
           
           
     
          $ 622,537             $ 557,381             $ 526,708      
         
           
           
     

              39


        Net interest income is impacted by the volume (changes in volume multiplied by prior rate), interest rate (changes in rate multiplied by prior volume) and mix of interest-earning assets and interest-bearing liabilities. The following table shows changes in net interest income between 2007 and 2006 as well as between 2006 and 2005 broken down between volume and rate.

Changes In Net Interest Income

 
  2007 vs 2006
  2006 vs 2005
 
 
  Increase (decrease)
due to

   
  Increase (decrease)
due to

   
 
Dollars in thousands

  Net increase (decrease)
  Net increase (decrease)
 
  Volume
  Rate
  Volume
  Rate
 
Interest earned on:                                      
Loans and leases   $ 76,878   $ 15,212   $ 92,090   $ 70,193   $ 53,121   $ 123,314  
Securities available-for-sale     (32,439 )   6,598     (25,841 )   (24,878 )   10,297     (14,581 )
Due from banks—interest-bearing     646     648     1,294     56     457     513  
Trading account securities     1,374     (218 )   1,156     549     858     1,407  
Federal funds sold and securities purchased under resale agreements     (909 )   70     (839 )   (786 )   694     (92 )
Other interest-earning assets     876     363     1,239     3     254     257  
   
 
 
 
 
 
 
  Total interest-earning assets     46,426     22,673     69,099     45,137     65,681     110,818  
   
 
 
 
 
 
 

Interest paid on:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Interest checking deposits     87     2,225     2,312     (98 )   1,458     1,360  
Money market deposits     8,764     26,770     35,534     (3,344 )   35,757     32,413  
Savings deposits     (87 )   117     30     (87 )   232     145  
Time deposits     9,329     8,451     17,780     23,573     25,488     49,061  
Other borrowings     7,482     2,286     9,768     16,020     15,281     31,301  
   
 
 
 
 
 
 
  Total interest-bearing liabilities     25,575     39,849     65,424     36,064     78,216     114,280  
   
 
 
 
 
 
 
    $ 20,851   $ (17,176 ) $ 3,675   $ 9,073   $ (12,535 ) $ (3,462 )
   
 
 
 
 
 
 

Comparison of 2007 with 2006

        Net interest income was negatively impacted by changes in interest rates during 2007. The carryover effect of interest rate increases in 2006 caused the cost of interest-bearing liabilities to increase by 55 basis points in 2007 compared to a 28 basis point rise in the yield on earning assets. The net effect of these rate changes was a decrease in net interest income of $17.2 million, which was more than offset by the additional interest income related to the increase in average earning assets. The impact of changes in interest-bearing assets and liabilities caused net interest income to increase by $20.9 million. This benefit was partially offset by reduced average noninterest-bearing deposit balances which declined by $201 million. Interest rate increases also had a positive effect on service charges and fees on deposits which increased slightly due to lower earnings credits on deposit balances. Together, these changes caused the net interest margin to decline by 13 basis points, despite the $3.7 million increase in net interest income.

        Taxable-equivalent net interest income totaled $621.3 million in 2007, compared with $618.8 million for 2006. Higher loan balances and a higher average prime lending rate in 2007 compared with 2006 contributed to the increase. Although the prime rate declined during the fourth quarter of 2007, the average rate for the year was slightly higher than it was in 2006. The average cost of interest-bearing deposits increased to 3.20 percent for 2007 compared with 2.59 percent for 2006. Net interest income for 2007 also includes $5.4 million in expense from the net settlement of interest-rate swaps compared with $9.6 million in 2006. Interest income recovered on charged-off loans

40



included above was $1.7 million in 2007, compared with $2.0 million for 2006. The fully taxable-equivalent net interest margin in 2007 was 4.45 percent, compared with 4.58 percent for 2006.

        Average loans and leases for 2007 increased to $11.1 billion for 2007, an 11 percent increase from average loans and leases of $9.9 billion for 2006. Loan growth was led by a 16 percent increase in commercial real estate and construction loans to $3.2 billion, and a 10 percent increase in commercial loans to $4.3 billion compared with 2006. In addition, average single-family residential loans increased 9 percent from the prior year. excluding the acquisition of the Business Bank of Nevada average loans grew by 7 percent in 2007.

        Average total securities in 2007 were $2.8 billion, a decrease of $654.5 million, or 19 percent, from 2006.

        Average core deposits, which continued to provide substantial benefits to the bank's cost of funds, increased 2 percent to $10.4 billion from $10.1 billion for 2006. Average core deposits, which do not include certificates of deposit of $100,000 or more, represented 84.7 percent of the total average deposit base for the year. Included in core deposits are specialty deposits. Average specialty deposits, primarily from title and escrow companies, were $1.2 billion in 2007, compared with $1.3 billion in 2006, a decrease of 6 percent. Specialty deposit balances declined due to the slowdown in the housing market.

        Average interest-bearing core deposits increased to $4.8 billion in 2007 from $4.4 billion in 2006, an increase of $413 million, or 9 percent. Average noninterest-bearing deposits decreased to $5.5 billion in 2007 from $5.7 billion in 2006, a decrease of $201 million, or 4 percent. Average time deposits in denominations of $100,000 or more increased by $155 million, or 9 percent, to $1.9 billion, between 2006 and 2007. The decrease in noninterest-bearing deposits and increase in time deposits occurred as some of the Bank's clients shifted funds to higher-yielding accounts.

Comparison of 2006 with 2005

        Taxable-equivalent net interest income totaled $618.8 million in 2006, compared with $622.5 million for 2005. The decrease in net interest income was due primarily to higher deposit costs. Included in 2006 was $9.6 million from the receipt of net settlements of interest rate risk management instruments compared to $9.9 million in 2005. Interest income recovered on charged-off loans included above was $2.0 million in 2006, compared with $2.5 million for 2005. The fully taxable-equivalent net interest margin in 2006 was 4.58 percent, compared with 4.79 percent for 2005.

        Average loans for 2006 were $9.9 billion, $1.1 billion or 12 percent higher than 2005, due to strong demand and to the acquisition of new clients. Compared with 2005 averages, residential mortgage loans rose 11 percent to $2.8 billion, commercial loans increased 17 percent to $3.9 billion and the combined total of commercial real estate mortgage loans and real estate construction loans increased 6 percent to $2.7 billion.

        Average total securities in 2006 were $3.5 billion, a decrease of $552.7 million, or 14 percent, from 2005.

        Average core deposits, which continued to provide substantial benefits to the bank's cost of funds in 2006, fell to $10.1 billion, an decrease of 6 percent from 2005. Average core deposits represented 85.5 percent of the total average deposit base for the year. Included in core deposits are specialty deposits. Average specialty deposits, primarily from title and escrow companies, were $1.3 billion in 2006, compared to $1.6 billion in 2005, a decrease of 22 percent.

        Average interest-bearing core deposits decreased to $4.4 billion in 2006 from $4.8 billion in 2005, a decrease of $352.3 million, or 7 percent. Average noninterest-bearing deposits decreased to $5.7 billion

41



in 2006 from $6.0 billion in 2005, a decrease of $264.4 million, or 4 percent. Average time deposits in denominations of $100,000 or more increased $707.8 million, or 70 percent, between 2005 and 2006.

Provision for Credit Losses

        The Company accounts for the credit risk associated with lending activities through its allowance for loan and lease losses, reserve for off-balance sheet credit commitments and provision for credit losses. The provision is the expense recognized in the income statement to adjust the allowance and reserve to the levels deemed appropriate by management, as determined through its application of the Company's allowance methodology procedures (see "Critical Accounting Policies" on page 29).

        The provision for credit losses primarily reflects management's ongoing assessment of the credit quality and growth of the loan and commitment portfolios as well as the levels of net loan (charge-offs)/recoveries and nonaccrual loans, and changes in the economic environment during the period.

        The Company recorded expense of $20.0 million through the provision for credit losses in 2007 and income of $0.6 million during 2006. No provision for credit losses was recorded in 2005. The provision recorded in the fourth quarter of 2007 reflects management's ongoing assessment of the credit quality of the Company's portfolio, which is impacted by various economic factors including weakness in the housing sector. Additional factors affecting the provision include net loan charge-offs, increased nonaccrual loans, risk rating migration and growth in the loan portfolio. See "Balance Sheet Analysis—Asset Quality—Allowance for Loan and Lease Losses and Reserve for Off-Balance Sheet Credit Commitments" for further information on factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for loan and lease losses.

        Total nonaccrual loans increased to $75.6 million at December 31, 2007, from $20.9 million at December 31, 2006 and $26.2 million at September 30, 2007. The increase in nonaccruals occurred primarily in the Company's for-sale housing construction portfolio. For-sale housing loans represented approximately 5 percent of the $11.6 billion loan portfolio at December 31, 2007.

        The Company has not originated nor purchased subprime or option adjustable-rate mortgages.

        Net loan charge-offs totaled $8.5 million for the year ended December 31, 2007 compared with net loan recoveries of $2.8 and $9.3 million for the years ended December 31, 2006 and 2005, respectively. The charge-offs occurred primarily in the for-sale construction portfolio.

        Based on its current assessment of economic conditions, management expects the loan loss provision to be higher in 2008 than in 2007. Credit quality will be influenced by underlying trends in the economic cycle, particularly in California, and other factors which are beyond management's control. Consequently, no assurances can be given that the Company will not sustain loan or lease losses, in any particular period, that are sizable in relation to the allowance for loan and lease losses. Additionally, subsequent evaluation of the loan and commitment portfolios by the Company and its regulators, in light of factors then prevailing, may warrant an adjustment to the amount of the projected provision.

Noninterest Income

        The Company experienced continued strong growth in noninterest income in 2007. Noninterest income for the year totaled $303.2 million, an increase of $60.8 million, or 25 percent, from 2006. Noninterest income increased $32.0 million, or 15 percent, between 2006 and 2005. Noninterest income represented 33 percent of total revenues in 2007, compared with 29 percent and 26 percent in 2006 and 2005, respectively.

42


        A breakdown of noninterest income by category is provided in the table below:

Analysis of Changes in Noninterest Income

 
   
  Increase
(Decrease)

   
  Increase
(Decrease)

   
Dollars in millions (1)

   
   
   
  2007
  Amount
  %
  2006
  Amount
  %
  2005
Trust and investment fees   $ 140.7   $ 33.2   30.9   $ 107.5   $ 26.7   33.0   $ 80.8
Brokerage and mutual fund fees     60.3     10.0   19.9     50.3     8.4   20.0     41.9
Cash management and deposit transaction fees     35.3     3.7   11.7     31.6     (2.5 ) (7.3 )   34.1
International services fees     30.4     4.2   16.0     26.2     3.0   12.9     23.2
Bank-owned life insurance     2.7     (0.3 ) (10.0 )   3.0     (0.2 ) (6.3 )   3.2
Other service charges and fees     29.2     3.7   14.5     25.5     0.7   2.8     24.8
   
 
     
 
     
  Total noninterest income before gain (loss)     298.6     54.5   22.3     244.1     36.1   17.4     208.0
Gain on sale of other assets     6.0     3.2   114.3     2.8     1.7   154.5     1.1
(Loss) gain on sale of securities     (1.4 )   3.1   68.9     (4.5 )   (5.8 ) (446.2 )   1.3
   
 
     
 
     
  Total   $ 303.2   $ 60.8   25.1   $ 242.4   $ 32.0   15.2   $ 210.4
   
 
     
 
     

(1)
Certain prior period balances have been reclassified to conform to the current period presentation.

        Trust and investment fee revenue includes fees from trust, investment and asset management, and other wealth advisory services. A portion of these fees are based on the market valuations of client assets managed, administered or held in custody. Increases in market values are reflected in fee income primarily on a trailing-quarter basis. The remaining portion of these fees, such as those for estate and financial planning, is based on the specific service provided or may be a fixed fee. Trust and investment fees increased 31 percent to $140.7 million for 2007 compared with a year earlier. The increase is attributable to continued growth in the Company's core trust business, a full-year of results for Independence Investments, and the acquisition of Convergent Wealth in May 2007. Convergent Wealth contributed $21.8 million to trust and investment fee revenue in 2007. Excluding Convergent Wealth, trust and investment fee revenue increased to $119.0 million, or 11 percent, over 2006. Trust and investment fee revenue increased by $26.7 million, or 33 percent, in 2006 compared with 2005. The increase was largely due to the acquisition of Independence Investments in May 2006.

        Assets under management ("AUM") include assets for which the Company makes investment decisions on behalf of its clients and assets under advisement for which the Company receives advisory fees from its clients. Assets under administration are assets the Company holds in a fiduciary capacity or otherwise provides non-advisory related services. Assets managed for clients include equities, fixed income instruments, cash and other assets. The type or mix of assets held in managed accounts can have a significant impact on revenue. Changes in the value of AUM are not directly correlated with changes in revenue or the number of customer accounts. The value of AUM fluctuates with changes in market valuations and other account activity, particularly trust or other account disbursements. Management believes that changes in revenue are a better indicator of trends in the wealth management business than the level of AUM.

        At December 31, 2007, the Company had AUM of $37.3 billion, an increase of 35 percent from AUM of $27.6 billion at December 31, 2006. Excluding Convergent Wealth, AUM increased by 3 percent to $28.3 billion at December 31, 2007. Assets under management or administration increased 21 percent to $58.5 billion at December 31, 2007 from $48.5 billion at December 31, 2006.

43


        Brokerage and mutual fund revenue includes fees on client securities transactions and shareholder, advisory and administrative fees associated with mutual funds. Brokerage and mutual fund revenue increased by $10.0 million, or 20 percent, in 2007 compared with 2006. The increase is due to higher transaction volumes and the addition of new clients.

        Cash management and deposit transaction fees increased $3.7 million, or 12 percent, in 2007, compared with a 7 percent decrease in 2006 from 2005. The growth in deposit-related fee income from the prior year is due to increased sales of cash management products to new and existing customers.

        International services income for 2007 increased $4.2 million, or 16 percent, over 2006, compared with a 13 percent increase in 2006 over 2005. International services income includes foreign exchange fees, fees on commercial letters of credit and standby letters of credit, and foreign collection fees. The increase in 2007 reflects increasing demand for both foreign exchange services and letters of credit. In 2006, international services income increased $3.0 million over 2005 due to the continued demand for the Company's international services including letters of credit.

        Other service charges and fees increased $3.7 million in 2007 over 2006, or 15 percent. The growth occurred in a number of categories including funds transfer fees and debit card fees and interchange fees, due to higher transaction volumes. Other service charges and fees increased $0.7 million in 2006 over 2005, or 3 percent, due to higher miscellaneous fees.

        The Company sold certain securities in 2007 and 2006 in order to reduce borrowings, improve liquidity and reduce prepayment risk. Losses on the sale of securities available-for-sale totaled $1.4 million and $4.5 million in 2007 and 2006, respectively. The Company realized gains on the sale of securities available-for-sale of $1.3 million in 2005.

        Gain on sale of other assets for 2007 includes a $5.1 million gain on the recovery of an investment in liquidation and a $0.6 million gain on the sale of an insurance policy.

        Other noninterest income for 2007 includes a $1.0 million relocation incentive payment received from the landlord of one of the Bank's operations facilities.

Noninterest Expense

        Noninterest expense (including minority interest expense) was $538.1 million in 2007, an increase of $56.1 million, or 12 percent, over 2006. Noninterest expense increased $38.1 million, or 9 percent, in 2006 over 2005. Noninterest expense grew in 2007 largely due to the acquisitions of BBNV and Convergent Wealth. Excluding the impact of acquisitions, noninterest expense increased 6 percent from the prior year.

44


        The following table provides a summary of noninterest expense by category:

Analysis of Changes in Noninterest Expense

 
   
  Increase
(Decrease)

   
  Increase
(Decrease)

   
Dollars in millions (1)

   
   
   
  2007
  Amount
  %
  2006
  Amount
  %
  2005
Salaries and employee benefits   $ 331.1   $ 35.9   12.2   $ 295.2   $ 31.8   12.1   $ 263.4
   
 
 
 
 
 
 

All Other:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Net occupancy of premises     43.5     3.3   8.2     40.2     5.1   14.5     35.1
  Legal and professional fees     36.0     1.0   2.9     35.0     (4.1 ) (10.5 )   39.1
  Information services     23.4     1.6   7.3     21.8     2.3   11.8     19.5
  Marketing and advertising     21.8     3.1   16.6     18.7     2.5   15.4     16.2
  Depreciation and amortization     20.9     1.8   9.4     19.1     0.7   3.8     18.4
  Office services     12.3     1.5   13.9     10.8     0.1   0.9     10.7
  Amortization of intangibles     8.9     3.6   67.9     5.3     (1.3 ) (19.7 )   6.6
  Equipment     3.2     0.4   14.3     2.8     0.4   16.7     2.4
  Minority interest expense     8.9     3.0   50.8     5.9     0.2   3.5     5.7
  Other operating     28.1     0.9   3.3     27.2     0.4   1.5     26.8
   
 
     
 
     
    Total all other     207.0     20.2   10.8     186.8     6.3   3.5     180.5
   
 
     
 
     
      Total   $ 538.1   $ 56.1   11.6   $ 482.0   $ 38.1   8.6   $ 443.9
   
 
     
 
     

(1)
Certain prior period balances have been reclassified to conform to the current period presentation.

        Salaries and employee benefits expense increased to $331.1 million, or 12 percent in 2007 from $295.2 million in 2006 primarily due to the acquisitions of BBNV and Convergent Wealth and to higher performance-based compensation costs. Salaries and benefits expense for 2007 includes $13.9 million related to stock-based compensation plans compared with $12.3 million for 2006 and $4.2 million for 2005. Salaries and benefits expense increased 12 percent in 2006 from 2005 largely due to the acquisition of Independence Investments in May 2006 and increases in performance-based compensation including the recognition of expense for unvested stock options. Full-time equivalent staff increased to 2,914 at December 31, 2007 from 2,689 at December 31, 2006 and 2,539 at December 31, 2005.

        As described in Note 1 of Notes to Consolidated Financial Statements and "Critical Accounting Policies", the Company adopted SFAS 123(R) effective January 1, 2006. The Company previously applied APB Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for stock-based compensation plans and accordingly, no compensation cost had been recognized for these plans in the prior period financial statements. Prior period amounts have not been restated. As a result of adopting Statement 123(R), the Company recorded $8.1 and $6.9 million of additional stock-based compensation expense for the years ended of December 31, 2007 and 2006, respectively.

        The remaining noninterest expense categories increased $20.2 million or 11 percent, between 2006 and 2007. Occupancy costs increased $3.3 million and information services expenses increased by $1.6 million, respectively, largely due to the acquisitions of BBNV and Convergent Wealth. Marketing and advertising expense increased by $3.1 million over 2006 due to the costs associated with new advertising campaigns and integrating BBNV into the Company's marketing programs. Office services expense increased by $1.5 million from the prior year due to higher postage and mailing expenses, and higher telephone and office supplies expense related to the addition of new offices and the acquisitions of BBNV and Convergent Wealth. Amortization of intangible assets, which include customer-relationship intangibles, increased by $3.6 million from the year-earlier due to the aforementioned

45



acquisitions. Minority interest expense, representing minority shareholders' interests in the net income of affiliates, increased by $3.0 million from 2006 primarily due to the acquisition of Convergent Wealth and increased income at our other majority-owned affiliates.

        The remaining noninterest expense categories increased $6.3 million, or 4 percent, between 2005 and 2006. Occupancy costs increased $5.1 million in 2006 from a year earlier due to the acquisition of Independence Investments, rent increases and a $0.8 million accrual for facility exit costs.

Segment Operations

        The Company's reportable segments are Commercial and Private Banking, Wealth Management and Other. For a more complete description of the segments, including summary financial information, see Note 21 on page A-45 of the Notes to Consolidated Financial Statements.

Commercial and Private Banking

        Total revenue for the Commercial and Private Banking segment increased $41.7 million, or 6 percent, in 2007 over 2006. Revenue also increased 6 percent in 2006 over 2005. The increase in Commercial and Private Banking revenue in both years was driven by strong loan growth, primarily in commercial and industrial and residential mortgage loans, but higher interest income on loans in both years was offset in large part by higher funding costs due to a change in the deposit mix and increases in deposit rates. Net income for this segment in 2007 of $201.5 million represented a decrease of approximately $7.3 million from the $208.8 million recorded in 2006. The decrease in net income is primarily attributable to the $20.0 million provision for credit losses recorded in the fourth quarter. Net income increased $10.5 million, or 5 percent, in 2006 compared with 2005. Average loans were $11.0 billion in 2007, an increase of 11 percent from $9.8 billion in 2006. Average loans were up 12 percent from 2005 compared with 2006. Average deposits were $11.1 billion in 2007, an increase of 5 percent from 2006. Average deposits decreased $454.5 million, or 4 percent, in 2006 compared with 2005. Noninterest income rose 15 percent in 2007 compared to 2006, and 14 percent from 2005 to 2006. Noninterest expense, including depreciation and amortization expense, was 7 percent, or $29.7 million, higher in 2007 than in 2006 due to the acquisition of BBNV, higher staffing costs, including the expense for unvested stock options and the expense of new banking offices. Noninterest expense increased 8 percent, or $30.8 million, in 2006 compared to 2005 due to higher staffing costs, including the expense for unvested stock options, the expense of new banking offices and the expense associated with promoting new banking products.

Wealth Management

        The Wealth Management segment had total revenue of $205.8 million in 2007 compared to $158.0 million in 2006. The 30 percent increase is attributable to the acquisition of Convergent Wealth in 2007, a full year of income for Independence Investments, growth in the Company's trust business and higher transaction volumes. Revenue grew 25 percent in 2006 compared with 2005 as a result of the acquisition of Independence Investments, the addition of new clients and higher transaction volumes. Net income for this segment was $37.9 million in 2007 compared with $26.1 million in 2006 and $17.4 million in 2005. The 46 percent increase in net income in 2007 is attributable to the factors discussed above. Noninterest expense, including depreciation and amortization, was $28.1 million, or 24 percent, higher in 2007 compared with 2006 due to the acquisition of Convergent Wealth, a full year's results for Independence Investments and higher staffing costs. Noninterest expense increased $18.0 million, or 18 percent, in 2006 compared with 2005 due to the acquisition of Independence Investments and higher staffing costs.

46


Other

        Total revenue for the Other segment decreased $26.3 million in 2007 compared with 2006 and decreased $42.8 million in 2006 compared with 2005. Net income for the Other segment declined $15.4 million in 2007 from 2006 and declined $20.4 million in 2006 compared with 2005. The declines are related to higher funding costs, lower prepayment fees and higher expense on interest-rate swaps in the Asset Liability Funding Center.

Income Taxes

        The effective tax rate for 2007 was 36.9 percent, compared with 36.4 percent for 2006 and 37.7 percent for 2005. The effective tax rates differ from the applicable statutory federal and state tax rates due to various factors, including tax benefits from investments in affordable housing partnerships and tax-exempt income on municipal bonds and bank-owned life insurance. See Note 8 of the Notes to Consolidated Financial Statements on page A-25.

        The Internal Revenue Service has completed its audit of the Company's tax returns for the years 2002-2003 The Company is currently in IRS appeals proceedings related to certain tax positions taken in these years and expects resolution on these items in the first quarter of 2008. The Company does not expect the final settlement of these matters to vary materially from the Company's current tax accrual for these matters as of December 31, 2007.

        The Company is also under examination by the California Franchise Tax Board for the years 1998-2004. The Company expects the Franchise Tax Board to complete its examination for the years 1998 through 2003 within the next 12 months. The potential financial statement impact resulting from the completion of the audit is not determinable at this time.

        From time to time, there may be differences in opinions with respect to the Company's tax treatment of certain transactions. A tax position which was previously recognized on the financial statements is not reversed unless it appears the benefits are no longer "more likely than not" to be sustained upon a challenge from the taxing authorities. The Company did not have any tax positions for which previously recognized benefits were reversed during the year ended December 31, 2007.

        As previously reported, on December 31, 2003, the California Franchise Tax Board ("FTB") announced that it had taken the position that certain REIT and regulated investment company ("RIC") tax deductions would be disallowed consistent with notices issued by the State of California that stipulate that the REIT and RIC are listed transactions under California tax-shelter legislation. Prior to this announcement, the Company had created two REITs (one of which was formed as a RIC in 2000) to raise capital for the Bank. While management continues to believe that the tax benefits related to the REITs are appropriate, the Company deemed it prudent to participate in the statutory Voluntary Compliance Initiative—Option 2, requiring payment of all California taxes and interest on potential tax exposures from the 2000-2002 tax years. The Company may then claim a refund for the taxes paid while avoiding potential penalties. Management continues to aggressively pursue its claims with the Franchise Tax Board for the REIT and RIC refunds for the tax years 2000 through 2004. While an outcome from the claims cannot be predicted with certainty, a potentially adverse result will not have any material impact on the Company's financial statements. See Note 8 of the Notes to Consolidated Financial Statements on page A-25 for additional information.

47


QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Market risk results from the variability of future cash flows and earnings due to changes in the financial markets. These changes may also impact the fair values of loans, securities and borrowings. The values of financial instruments may change because of interest rate changes, foreign currency exchange rate changes, changes in credit ratings or other market changes. The Company's asset/liability management process entails the evaluation, measurement and management of interest rate risk, market risk and liquidity risk. The principal objective of asset/liability management is to optimize net interest income subject to margin volatility and liquidity constraints over the long term. Margin volatility results when the rate reset (or repricing) characteristics of assets are materially different from those of the Company's liabilities. The Board of Directors approves asset/liability policies and sets limits within which the risks must be managed. The Asset/Liability Management Committee ("ALCO"), which is comprised of senior management and key risk management individuals, sets risk management guidelines within the broader limits approved by the Board, monitors the risks and periodically reports results to the Board.

Risk Management Framework

        Risk management oversight and governance is provided through the Board of Directors' Audit and Risk Committee and facilitated through multiple management committees. Consisting of four outside directors, the Audit and Risk Committee monitors the Company's overall aggregate risk profile as established by the Board of Directors including all credit, market, operational and regulatory risk management activities. The Committee reviews and approves the activities of key management governance committees that regularly evaluate risks and internal controls for the Company. These management committees include the Asset/Liability Management Committee, the Credit Policy Committee, the Senior Operations Risk Committee and the Risk Council, among others. The Risk Council reviews the development, implementation and maintenance of risk management processes from a Company-wide perspective, and assesses the adequacy and effectiveness of the Company's risk management policies and the Enterprise Risk Management program. Other management committees, with representatives from the Company's various lines of business and affiliates, address and monitor specific risk types, including the Compliance Committee, the Wire Risk Committee, and the Information Technology Steering Committee, and report periodically to the key management committees. The Senior Risk Management Officer and the Internal Audit and Credit Risk Review units provide the Audit and Risk Committee with independent assessments of the Company's internal control structure and related systems and processes.

Liquidity Risk

        Liquidity risk results from the mismatching of asset and liability cash flows. Funds for this purpose can be obtained in cash markets, by borrowing, or by selling certain assets. The objective of liquidity management is to manage cash flow and liquidity reserves so that they are adequate to fund the Company's operations and meet obligations and other commitments on a timely and cost-effective basis. The Company achieves this objective through the selection of asset and liability maturity mixes that it believes best meet its needs. The Company's liquidity position is enhanced by its ability to raise additional funds as needed in the wholesale markets.

        In recent years, the Company's core deposit base has provided the majority of the Company's funding requirements. This relatively stable and low-cost source of funds has, along with shareholders' equity, provided 78 percent and 79 percent of funding for average total assets in 2007 and 2006, respectively.

        A significant portion of remaining funding of average total assets is provided by short-term federal fund purchases and, to a lesser extent, sales of securities under repurchase agreements. These funding

48



sources, on average, totaled $662.9 million and $541.7 million in 2007 and 2006, respectively. The Company also increased its funding from other longer-term borrowings to $644.6 million on average in 2007 from $627.4 million in 2006.

        Liquidity is also provided by assets such as federal funds sold and trading account securities, which may be immediately converted to cash at minimal cost. The aggregate of these assets averaged $89.3 million during 2007 compared with $80.4 million in 2006. Liquidity is also provided by the portfolio of securities available-for-sale, which averaged $2.8 billion and $3.4 billion in 2007 and 2006, respectively. The unpledged portion of securities available-for-sale at December 31, 2007 totaled $1.3 billion and could be sold under certain circumstances or made available as collateral for borrowing. Maturing loans provide additional liquidity, and $3.9 billion, or 34 percent, of the Company's loans are scheduled to mature in 2008.

Interest Rate Risk

        Interest rate risk is inherent in financial services businesses. Interest rate risk results from assets and liabilities maturing or repricing at different times; assets and liabilities repricing at the same time but in different amounts or from short-term and long-term interest rates changing by different amounts (changes in the yield curve).

        The Company has established two primary measurement processes to quantify and manage exposure to interest rate risk: net interest income simulation modeling and present value of equity analysis. Net interest income simulations are used to identify the direction and severity of interest rate risk exposure across a 12 and 24 month forecast horizon. Present value of equity calculations are used to estimate the price sensitivity of shareholders' equity to changes in interest rates. The Company also uses gap analysis to provide insight into structural mismatches of asset and liability cash flows.

        Net Interest Income Simulation:    The Company is naturally asset-sensitive due to its large portfolio of rate-sensitive commercial loans that are funded in part by rate-stable core deposits. As a result, if there are no significant changes in the mix of assets or liabilities, the net interest margin increases when interest rates increase and decreases when interest rates decrease. As part of its overall interest rate risk management process, the Company performs stress tests on net interest income projections based on a variety of factors, including interest rate levels, changes in the relationship between the prime rate and short-term interest rates, and the shape of the yield curve. The Company uses a simulation model to estimate the severity of this risk and to develop mitigation strategies, including interest-rate hedges. The magnitude of the change is determined from historical volatility analysis. The assumptions used in the model are updated periodically and reviewed and approved by the Asset/ Liability Management Committee. In addition, the Board of Directors has adopted limits within which interest rate exposure must be contained. Within these broader limits, ALCO sets management guidelines to further contain interest rate risk exposure.

        During 2007 the Company maintained a slightly asset-sensitive interest rate position. The average prime rate increased 9 basis points in 2007. The Company's net interest margin decreased by 13 basis points, primarily due to loan growth, a decline in demand deposits related to the title and escrow business, and competitive pricing pressures on deposits. The simulation model is based on the balance sheet as of year end, and projects net interest income assuming no change in loan or deposit mix. Interest rate scenarios include stable rates and 100 and 200 basis point parallel shifts in the yield curve occurring gradually over a twelve-month period. As of December 31, 2007, the simulation model indicates that a 100 basis point decline in the yield curve over a twelve-month horizon would result in a decrease in projected net interest income of approximately 0.1 percent while a 200 basis point decline would reduce projected net interest income by approximately 3.2 percent. This compares to a decrease in projected net interest income of 0.3 percent with a 100 basis point decline and 1.0 percent with a 200 basis point decline at December 31, 2006. At December 31, 2007, a gradual 100 basis point parallel

49



increase in the yield curve over the next 12 months would result in an increase in projected net interest income of approximately 1.4 percent while a 200 basis point increase would increase projected net interest income by approximately 2.6 percent. This compares to an increase in projected net interest income of 0.9 percent with a 100 basis point increase and 1.8 percent with a 200 basis point increase at December 31, 2006. The Company's interest rate risk exposure remains within Board limits and ALCO guidelines.

        Market Value of Portfolio Equity:    The market value of portfolio equity ("MVPE") model is used to evaluate the vulnerability of the market value of shareholders' equity to changes in interest rates. The MVPE model calculates the expected cash flow of all of the Company's assets and liabilities under sharply higher and lower interest rate scenarios. The present value of these cash flows is calculated by discounting them using the interest rates for that scenario. The difference between the present value of assets and the present value of liabilities in each scenario is the MVPE. The assumptions about the timing of cash flows, level of interest rates and shape of the yield curve are the same as those used in the net interest income simulation. They are updated periodically and are reviewed by ALCO at least annually.

        The MVPE model indicates that MVPE is somewhat vulnerable to a sudden and substantial increase in interest rates. As of December 31, 2007, a 200 basis point increase in interest rates results in a 3.5 percent decline in MVPE. This compares to a 3.0 percent decline a year earlier. The higher sensitivity is due to changes in the deposit mix and greater reliance on wholesale funding sources. As of December 31, 2007, a 200 basis point decrease in rates would improve MVPE by 1.4 percent. As of December 31, 2006, the MVPE would improve 1.5 percent as rates decreased.

        Gap Analysis:    The gap analysis is based on the contractual cash flows of all asset and liability balances on the Company's books. Contractual lives of assets and liabilities may differ substantially from their expected lives. For example, checking accounts are subject to immediate withdrawal. However, experience suggests that these accounts will have longer average lives. Also, certain loans, such as first mortgages, are subject to prepayment. The gap analysis may be used to identify periods in which there is a substantial mismatch between asset and liability cash flows. These mismatches can be moderated by investments or interest-rate derivatives. Gap analysis is used to support both interest rate risk and liquidity risk management.

        Interest-rate swaps are used to reduce cash flow variability and to moderate changes in the fair value of long-term financial instruments. Net interest income or expense associated with interest-rate swaps (the difference between the fixed and floating rates paid or received) is included in net interest income in the reporting periods in which they are earned.

        Interest-rate swap transactions involve dealing with counterparties and the risk that they may not meet their contractual obligations. Counterparties must receive appropriate credit approval before the Company enters into an interest rate contract. Notional principal amounts express the volume of these transactions, although the amounts subject to credit and market risk are much smaller. At December 31, 2007 the Company's interest-rate swaps were entered into as hedges of the variability in interest cash flows generated from LIBOR and prime-based loans due to fluctuations in the LIBOR and prime indices or to convert fixed-rate deposits and borrowings into floating-rate liabilities. As discussed in "Critical Accounting Policies—Accounting for derivatives and hedging activities," all derivatives are recorded on the balance sheet at their fair value. The treatment of changes in the fair value of derivatives depends on the character of the transaction.

        As of December 31, 2007, the Company had $0.9 billion notional amount of interest-rate swaps designated as hedges, of which $511 million were designated as fair value hedges and $350 million were designated as cash flow hedges. The positive mark-to-market on the fair value hedges resulted in the recognition of other assets and an increase in hedged deposits and borrowings of $12.0 million. The

50



positive mark-to-market on the cash flow hedges of variable-rate loans resulted in the recognition of other assets and other comprehensive income of $4.7 million, before taxes of $2.0 million.

        The subordinated debt and other long-term debt consists of City National Bank ten-year subordinated notes with a face value of $115.9 million due on January 15, 2008, City National Bank ten-year subordinated notes with a face value of $150.0 million due on September 1, 2011, and City National Corporation senior notes with a face value of $225.0 million due on February 15, 2013. In addition, the Company has outstanding Trust Preferred Debentures with a face value of $5.2 million due on November 23, 2034.

        Amounts to be paid or received on the cash flow hedge interest-rate swaps will be reclassified into earnings upon receipt of interest payments on the underlying hedged loans, including amounts totaling $4.7 million that reduced net interest income during 2007. Comprehensive gains expected to be reclassified into net interest income within the next 12 months are $3.3 million.

 
  December 31, 2007
  December 31, 2006
  December 31, 2005
Dollars in millions

  Notional
Amount

  Fair
Value

  Duration
  Notional
Amount

  Fair
Value

  Duration
  Notional
Amount

  Fair
Value

  Duration
Fair Value                                                
  Interest Rate Swaps                                                
    Certificates of deposit   $ 20.0   $ 0.9   2.7   $ 175.0   $ (0.1 ) 0.2   $ 15.0   $   0.6
    Long-term and subordinated debt     490.9     11.1   3.0     490.9     (2.5 ) 3.8     490.9     5.7   4.5
   
 
     
 
     
 
   
      Total fair value hedge swaps     510.9     12.0   3.0     665.9     (2.6 ) 2.8     505.9     5.7   4.4

Cash Flow Hedge

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Interest Rate Swaps                                                
    US Dollar LIBOR based loans     100.0     3.9   2.3     325.0     (1.8 ) 0.6     600.0     (7.9 ) 0.8
    Prime based loans     250.0     0.8   0.4     375.0     (3.1 ) 0.6     425.0     (3.3 ) 1.7
   
 
     
 
     
 
   
      Total cash flow hedge swaps     350.0     4.7   0.9     700.0     (4.9 ) 0.6     1,025.0     (11.2 ) 1.2
   
 
     
 
     
 
   
Fair Value and Cash Flow Hedge                                                
  Interest Rate Swaps   $ 860.9   $ 16.7  (1) 2.2   $ 1,365.9   $ (7.5 ) 1.7   $ 1,530.9   $ (5.5 ) 2.2
   
 
     
 
     
 
   

(1)
Net Fair value is the estimated net gain (loss) to settle derivative contracts in 2007. The net fair value for 2007 of $16.7 million is the mark-to-market asset on swaps.

        The Company has not entered into any hedge transactions involving any other interest-rate derivative instruments, such as interest-rate floors, caps, and interest-rate futures contracts for its own portfolio. The Company could consider using such financial instruments in the future if they offered a significant advantage over interest-rate swaps.

51


        The table below shows the notional amounts of the Company's interest-rate swap maturities and average rates at December 31, 2007 and December 31, 2006. Average interest rates on variable-rate instruments are based upon the Company's interest rate forecast.

Interest Rate Swap Maturities and Average Rates
December 31, 2007

Dollars in millions

  2008
  2009
  2010
  2011
  2012
  Thereafter
  Total
  Fair
Value

Notional amount   $ 340.9   $ 25.0   $ 110.0   $ 160.0   $   $ 225.0   $ 860.9   $ 16.7
Weighted average rate received     6.99 %   7.97 %   5.31 %   5.57 %       4.38 %   5.86 %    
Weighted average rate paid     6.62 %   7.25 %   4.66 %   5.11 %       4.87 %   5.65 %    
                                                    

Interest Rate Swap Maturities and Average Rates
December 31, 2006

Dollars in millions

  2007
  2008
  2009
  2010
  2011
  Thereafter
  Total
  Fair
Value

 
Notional amount   $ 600.0   $ 340.9   $ 50.0   $   $ 150.0   $ 225.0   $ 1,365.9   $ (7.5 )
Weighted average rate received     4.91 %   6.99 %   5.15 %       5.57 %   4.38 %   5.42 %      
Weighted average rate paid     6.05 %   7.35 %   5.33 %       5.37 %   5.37 %   6.16 %      

        The Company also offers interest-rate swaps, cross-currency interest-rate swaps and interest-rate caps, floors and collars to its clients to assist them in hedging their lending activities. These derivative contracts are offset by paired trades with unrelated third parties. They are not designated as hedges under SFAS 133, and the positions are marked-to-market each reporting period. As of December 31, 2007, the Company had entered into swaps with clients (and offsetting derivative contracts with counterparties) having a notional balance of $48.1 million.

Market Risk-Foreign Currency Exchange

        The Company enters into foreign-exchange contracts with its clients and counterparty banks primarily for the purpose of offsetting or hedging clients' transaction and economic exposures arising out of commercial transactions. The Company's policies also permit taking proprietary currency positions within certain approved limits. The Company actively manages its foreign exchange exposures within prescribed risk limits and controls. At December 31, 2007, the Company's outstanding foreign exchange contracts, both proprietary and for customer accounts, totaled $185.6 million. All foreign exchange contracts outstanding at December 31, 2007 had remaining maturities of 12 months or less and the mark-to-market included in other assets totaled $0.6 million.

52


BALANCE SHEET ANALYSIS

Securities

        Comparative period-end balances for available-for-sale securities are presented below:

Securities Available-for-Sale

 
  December 31, 2007
  December 31, 2006
Dollars in thousands

  Cost
  Fair Value
  Cost
  Fair Value
U.S. Treasury   $ 45,106   $ 45,228   $ 49,937   $ 49,938
Federal Agency     50,996     51,042     263,227     258,778
CMOs     1,041,692     1,027,439     1,247,161     1,215,397
Mortgage-backed     822,193     807,534     1,017,409     983,917
State and Municipal     391,790     395,455     360,759     362,318
Other     32,870     31,001     10,166     10,064
   
 
 
 
  Total debt securities     2,384,647     2,357,699     2,948,659     2,880,412
Equity securities     100,256     104,956     68,531     72,835
   
 
 
 
  Total securities   $ 2,484,903   $ 2,462,655   $ 3,017,190   $ 2,953,247
   
 
 
 

        At December 31, 2007, the fair value of securities available-for-sale totaled $2.46 billion, a decrease of $490.6 million, or 17 percent from December 31, 2006. The decrease was due to scheduled maturities of $256.0 million, paydowns of $356.8 million, and the sale of $196.3 million of securities to fund loan growth, improve liquidity and reduce prepayment risk, offset in part by additional purchases of $211.5 million. The average duration of total available-for-sale securities at December 31, 2007 and December 31, 2006 was 3.4 and 3.3 years, respectively.

        At December 31, 2007, the securities available-for-sale portfolio had a net unrealized loss of $22.2 million, comprised of $11.6 million of unrealized gains and $33.9 million of unrealized losses. At December 31, 2006, the securities available-for-sale portfolio had a net unrealized loss of $63.9 million, comprised of $8.4 million of unrealized gains and $72.3 million of unrealized losses. The unrealized gain or loss on securities available-for-sale is reported on an after-tax basis as a component of other comprehensive income.

        The investment portfolio is composed of fixed-rate medium-term securities. It generates a stable income stream and provides a liquidity reserve. It is mainly composed of securities that are backed by prime-based residential mortgages. At December 31, 2007, the Company owned mortgage-backed securities with a fair value of $1.9 billion, of which $1.5 billion are guaranteed by GNMA, FNMA or Freddie Mac, and $0.4 billion are AAA-rated collateralized mortgage obligations (CMOs) secured by prime-based mortgages. The Company also owned fixed-rate medium-term municipal bonds with a fair value of $0.4 billion. None of the bonds in the Company's investment portfolio has suffered a ratings downgrade and none of them are on negative credit watch. Management assessed the portfolio for other-than-temporary impairment and concluded that no impairment existed as of December 31, 2007 or 2006, as the unrealized losses are due only to changes in interest rates and the Company has the ability and intent to hold the securities until recovery.

        Dividend income included in interest income on securities available-for-sale in the consolidated statements of income was $7.2 million and $4.8 million for the years ended December 31, 2007 and 2006, respectively.

        The following table provides the expected remaining maturities and yields (taxable-equivalent basis) of debt securities included in the securities portfolio at December 31, 2007, except for mortgage-backed securities which are allocated according to average expected maturities. Average expected

53



maturities will differ from contractual maturities because mortgage debt issuers may have the right to repay obligations prior to contractual maturity. To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pre-tax equivalents based on the marginal corporate federal tax rate of 35 percent.

Debt Securities Available-for-Sale

 
  One year
or less

  Over 1 year
thru 5 years

  Over 5 years
thru 10 years

  Over 10 years
  Total
Dollars in thousands

  Amount
  Yield
(%)

  Amount
  Yield
(%)

  Amount
  Yield
(%)

  Amount
  Yield
(%)

  Amount
  Yield
(%)

U.S. Treasury   $ 45,228   4.62   $     $     $     $ 45,228   4.62
Federal Agency     30,932   3.94     20,110   4.01                 51,042   3.97
CMO's     70,639   5.36     798,787   4.43     158,013   5.37           1,027,439   4.64
Mortgage-backed           618,426   4.23     182,387   4.49     6,721   6.07     807,534   4.31
State and Municipal     42,541   4.34     120,279   3.95     201,207   3.87     31,428   3.96     395,455   3.95
Other                 31,001   5.71           31,001   5.71
   
     
     
     
     
   
  Total debt securities   $ 189,340   4.72   $ 1,557,602   4.31   $ 572,608   4.58   $ 38,149   4.33   $ 2,357,699   4.41
   
     
     
     
     
   
  Amortized cost   $ 189,524       $ 1,578,305       $ 578,722       $ 38,096       $ 2,384,647    
   
     
     
     
     
   

Loan Portfolio

        Total loans were $11.6 billion, $10.4 billion, and $9.3 billion at December 31, 2007, 2006, and 2005, respectively. Total loans increased $1.2 billion during 2007 due to increased loan demand augmented by the acquisition of BBNV. Commercial loans, including lease financing, increased $0.4 billion. Residential mortgage loans grew $0.3 billion while construction loans and commercial real estate mortgages increased $0.6 billion.

        Total loans increased $1.1 billion during 2006 due to strong loan demand. Residential mortgage loans grew $0.2 billion, while commercial loans, including lease financing, grew $0.6 billion. The combined total of construction loans and commercial real estate mortgages increased $0.2 billion.

54


        The following table shows the Company's consolidated loans by type of loan and their percentage distribution:

 
  December 31,
 
Dollars in thousands

 
  2007
  2006
  2005
  2004
  2003
 
Commercial   $ 4,193,436   $ 3,869,161   $ 3,388,640   $ 2,851,790   $ 3,035,462  
Residential mortgages     3,176,322     2,869,775     2,644,030     2,299,600     1,986,052  
Commercial real estate mortgages     1,954,539     1,710,113     1,857,273     1,841,974     1,765,451  
Real estate construction     1,429,761     1,115,958     724,879     834,445     637,590  
Equity lines of credit     432,513     404,657     333,548     255,194     188,710  
Installment loans     178,195     201,125     200,296     219,701     149,266  
Lease financing     265,872     215,216     116,936     178,573     120,211  
   
 
 
 
 
 
Total loans and leases   $ 11,630,638   $ 10,386,005   $ 9,265,602   $ 8,481,277   $ 7,882,742  
   
 
 
 
 
 

Commercial

 

 

36.1

%

 

37.3

%

 

36.6

%

 

33.6

%

 

38.5

%
Residential mortgages     27.3     27.6     28.5     27.1     25.2  
Commercial real estate mortgages     16.8     16.5     20.0     21.7     22.4  
Real estate construction     12.3     10.7     7.8     9.9     8.1  
Equity lines of credit     3.7     3.9     3.6     3.0     2.4  
Installment loans     1.5     1.9     2.2     2.6     1.9  
Lease financing     2.3     2.1     1.3     2.1     1.5  
   
 
 
 
 
 
Total loans and leases     100.0 %   100.0 %   100.0 %   100.0 %   100.0 %
   
 
 
 
 
 

        The Company's loan portfolio consists primarily of loans for business and real estate purposes. Generally, loans are made on the basis of an available cash-flow repayment source as the first priority, with collateral being a secondary source for loan qualification. Although the legal lending limit for any one borrowing relationship was $218.9 million at December 31, 2007, the Bank has established "house limits" for individual borrowings. These limits vary by risk rating.

Commercial

        Commercial loans, including lease financing, were $4.46 billion at December 31, 2007, representing 38.3 percent of the loan portfolio compared with $4.08 billion, or 39.3 percent of the loan portfolio, at December 31, 2006. The average outstanding individual note balance in the commercial loan portfolio at December 31, 2007 was $643,895. See also "Results of Operations—Net Interest Income."

        To grow and diversify its portfolio, the bank purchases and sells participations in loans. Included in this portfolio are purchased participations in shared national credits ("SNCs"). As of December 31, 2007 purchased SNC commitments totaled $1.3 billion or 7.3 percent of total loan commitments. Outstanding loan balances on purchased SNCs were $495 million or 4.2 percent of total loans outstanding. At December 31, 2006, purchased SNC commitments totaled $1 billion, and outstanding balances totaled $388 million. The growth in the purchased SNC portfolio during 2007 was related to commercial credits.

        The commercial loan portfolio also includes $111.0 million of loans to borrowers in the for-sale housing industry.

55


        Following is a breakdown of commercial loans and lease financing to businesses engaged in the industries listed.

Commercial Loans and Leases by Industry

 
  December 31,
Dollars in thousands

  2007
  %
  2006
  %
Services (1)   $ 908,755   20.4   $ 764,417   18.7
Entertainment     795,281   17.8     826,232   20.2
Wholesale Trade     292,034   6.5     330,645   8.1
Manufacturing     375,580   8.4     318,168   7.8
Public Finance     187,322   4.2     200,003   4.9
Real estate owner/lessors (2)     541,702   12.1     533,794   13.1
Construction and development (2)     211,593   4.7     189,144   4.6
Finance and Insurance     525,290   11.8     392,374   9.6
Retail Trade     334,103   7.5     283,938   7.0
Other     287,648   6.6     245,662   6.0
   
 
 
 
  Total   $ 4,459,308   100.0   $ 4,084,377   100.0
   
 
 
 
Nonaccrual loans   $ 17,103       $ 2,977    
   
     
   
Percentage of total commercial loans     0.38 %       0.07 %  
   
     
   

(1)
Legal, membership organizations, engineering and management services, etc.

(2)
Not secured by real estate.

Residential Mortgage

        Residential mortgage loans, which comprised 27.3 percent of total loans in 2007, grew $306.5 million, or 10.7 percent, to $3.18 billion at December 31, 2007. In 2007, 100 percent of the portfolio was originated internally, primarily to existing clients. The Company has not purchased any loans since 1997, except for CRA purposes. The residential first mortgage loans originated internally, primarily as an accommodation to existing clients, have a weighted average loan-to-value ratio of 51 percent at origination. The average outstanding individual note balance at December 31, 2007 was $780,956.

Commercial Real Estate Mortgage

        Commercial real estate mortgages, representing 16.8 percent of the loan portfolio, were comprised of 95.9 percent commercial properties and 4.1 percent multi-family condominium or apartment loans.

56



The average outstanding individual note balance at December 31, 2007 was $1,458,117. A breakdown of real estate mortgage loans by collateral type follows:

Commercial Real Estate Mortgage Loans by Collateral Type

 
  December 31,
Dollars in thousands

  2007
  %
  2006
  %
Industrial   $ 887,669   45.4   $ 838,025   49.0
Office buildings     331,872   17.0     307,476   18.0
Shopping centers     164,187   8.4     115,419   6.7
Land, agriculture     47,134   2.4     29,163   1.7
Non-Profit (religious/schools)     68,970   3.5     41,944   2.5
Auto dealership     95,725   4.9     73,742   4.3
Condominiums/apartments     79,639   4.1     75,760   4.4
Other     279,343   14.3     228,584   13.4
   
 
 
 
  Total   $ 1,954,539   100.0   $ 1,710,113   100.0
   
 
 
 
Nonaccrual loans   $ 1,621       $ 4,849    
   
     
   
Percentage of total commercial real estate mortgage loans     0.08 %       0.28 %  
   
     
   

Real Estate Construction

        The real estate construction portfolio includes land loans and loans to develop or construct and sell residential and commercial properties. These loans represent 12.3 percent of the Company's $11.6 billion loan portfolio and a vast majority of the loans have guarantees. The Real estate construction portfolio includes approximately $519 million of loans to borrowers in the for-sale housing industry. Real estate construction loans are made on the basis of the economic viability for the specific project, the cash flow resources of the developer, the developer's equity in the project, and the underlying financial strength of the borrower. The Company's policy is to monitor each loan with respect to the project's incurred costs, sales price and absorption. The average outstanding individual note balance at December 31, 2007 was $4,076,906. Following is a breakdown of real estate construction loans by collateral type:

Real Estate Construction Loans by Collateral Type

 
  December 31,
Dollars in thousands

  2007
  %
  2006
  %
Industrial   $ 151,726   10.6   $ 110,010   9.9
1-4 family     359,473   25.1     226,539   20.3
Office buildings     181,087   12.7     161,331   14.5
Land, Commercial     240,273   16.8     114,862   10.3
Land, residential     164,090   11.5     130,447   11.7
Shopping centers     163,863   11.5     102,684   9.2
Condominiums/apartments     119,002   8.3     191,598   17.2
Other     50,247   3.5     78,487   6.9
   
 
 
 
  Total   $ 1,429,761   100.0   $ 1,115,958   100.0
   
 
 
 
Nonaccrual loans   $ 55,632       $ 12,678    
   
     
   
Percentage of total real estate construction loans     3.89 %       1.14 %  
   
     
   

57


Equity Lines of Credit

        Equity lines of credit which comprised 3.7 percent of total loans at December 31, 2007 are made primarily to existing clients. The average LTV at origination for these loans was 55.0 percent. The average outstanding individual note balance at December 31, 2007 was $243,534. At December 31, 2007, equity lines of credit totaling approximately $679,000 were on nonaccrual.

Installment

        Installment loans consist primarily of loans to individuals for personal purchases. At December 31, 2007 installment loans comprised 1.5 percent of total loans and loans totaling approximately $139,000 were on nonaccrual. The average outstanding individual note balance at December 31, 2007 was $69,611.

Portfolio Characteristics

        The Company's lending activities are predominantly in California, and to a lesser extent, New York and Nevada. Concentrations of credit risk arise when a number of clients are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions. Although the Company has a diversified loan portfolio, a substantial portion of the loan portfolio and credit performance depends on the economic stability of Southern California. Credit performance also depends, to a lesser extent, on economic conditions in the San Francisco Bay area, New York and Nevada.

        Inherent in any loan portfolio are risks associated with certain types of loans. The Company assesses and manages credit risk on an ongoing basis through diversification guidelines, lending limits, credit review and approval policies, and internal monitoring. As part of the control process, an independent credit risk review department regularly examines the Company's loan portfolio and other credit-related products, including unused commitments and letters of credit. In addition to this internal credit process, the Company's loan portfolio is subject to examination by external regulators in the normal course of business. Credit quality is influenced by underlying trends in the economic and business cycle. The Company also seeks to manage and control its risk through diversification of the portfolio by type of loan, industry concentration, and type of borrower as well as specific maximum loan-to-value ("LTV") limitations at origination for various categories of real estate-related loans other than residential first mortgage loans. These ratios are as follows:

Maximum LTV Ratios

Category of Real Estate Collateral

  Maximum
LTV Ratio

 
1-4 family   80 %
Multi-family   75  
Equity lines of credit   80  
Industrial   75  
Shopping centers   75  
Churches/religious   65  
Office building   70  
Other improved property   65  
Acquisition and development   65  
Land, nonresidential   50  

        The Company's loan policy provides that any term loan on income-producing properties should have minimum debt service coverage at origination of at least 1.20 to 1 for non-owner-occupied

58



property. Any exception to these guidelines requires approval at higher levels of authority based on the type of exception. Exceptions are reviewed by the Credit Policy Committee of the Bank.

        The federal banking regulatory agencies issued final guidance on December 6, 2006 on risk management practices for financial institutions with high or increasing concentrations of commercial real estate ("CRE") loans on their balance sheets. The regulatory guidance provides for an increased level of regulatory oversight and monitoring for those institutions that have experienced rapid growth in CRE lending, have notable exposure to specific type of CRE, or are approaching or exceeding the supervisory criteria used to evaluate the CRE concentration risk, but the guidance is not to be construed as a limit for CRE exposure. The supervisory criteria are: total reported loans for construction, land development and other land represent 100 percent or more of the institution's total risk-based capital; total CRE loans represent 300 percent or more of the institution's total risk-based capital and the institution's CRE loan portfolio has increased 50 percent or more within the last 36 months. The Company is within the thresholds specified by the guidance. As of December 31, 2007, total loans for construction, land development and other land represented 100 percent of total risk-based capital; total CRE loans represented 207 percent of total risk-based capital and the total portfolio of loans for construction, land development, other land and CRE increased 42 percent over the last 36 months.

        The Company has no residential mortgage loans with high LTVs (as defined in FDICIA as greater than 90 percent), loans with option ARM terms, as defined in SOP 94-6-1, "Terms of Loan Products that May Give Rise to a Concentration of Credit Risk," or that allow for negative amortization. The Company does offer interest-only loans. As of December 31, 2007, there were interest-only residential mortgages totaling approximately $612.9 million and home equity lines of credit totaling approximately $432.5 million. As of December 31, 2006, there were interest-only residential mortgages totaling approximately $372.8 million and home equity lines of credit totaling approximately $404.7 million.

        Floating-rate loans comprised 61.1 percent of the total loan portfolio at December 31, 2007 compared to 57.8 percent at December 31, 2006. At December 31, 2007, 76.3 percent of outstanding commercial loans, including lease financing, 57.8 percent of commercial real estate loans, 44.8 percent of residential real estate loans, and 71.4 percent of installment loans were floating-rate loans. Hybrid loans, which convert from fixed to floating rates, are included in floating-rate loans.

        One of the significant risks associated with real estate lending involves environmental hazards on or in property affiliated with the loan. The Company analyzes such risks through an evaluation performed by the Bank's Environmental Risk Management Unit for all loans secured by real estate. A Phase I Environmental Site Assessment ("ESA") report may be required if the evaluation determines it appropriate. Other reasons would include the industrial use of environmentally sensitive substances or the proximity to other known environmental problems. A more comprehensive Phase II ESA report is required in certain cases, depending on the outcome of the Phase I report.

        The loan maturities shown in the table below are based on contractual maturities. As is customary in the banking industry, loans that meet sound underwriting criteria can be renewed by mutual agreement between the Company and the borrower. Because the Company is unable to estimate the extent to which its borrowers will renew their loans, the table is based on contractual maturities.

59


Loan Maturities

 
  December 31, 2007
Dollars in thousands

  Commercial
  Residential
Mortgages

  Commercial
Real Estate
Mortgages

  Real Estate
Construction

  Equity Lines
of Credit

  Installment
  Total
Aggregate maturities of balances due:                                          
In one year or less                                          
  Interest rate—floating   $ 2,467,405   $ 8,949   $ 152,638   $ 974,406   $ 16,211   $ 111,501   $ 3,731,110
  Interest rate—fixed     167,267     4,121     8,397     18,629         592     199,006
After one year but within five years                                          
  Interest rate—floating     692,907     14,362     158,399     421,610     23,731     10,859     1,321,868
  Interest rate—fixed     381,351     31,842     31,933     7,205         15,027     467,358
After five years                                          
  Interest rate—floating     241,761     1,161,141     245,500     4,039     392,571     4,937     2,049,949
  Interest rate—fixed     508,617     1,955,907     1,357,672     3,872         35,279     3,861,347
   
 
 
 
 
 
 
    Total loans   $ 4,459,308   $ 3,176,322   $ 1,954,539   $ 1,429,761   $ 432,513   $ 178,195   $ 11,630,638
   
 
 
 
 
 
 

Asset Quality

Allowance for Loan and Lease Losses and Reserve for Off-Balance Sheet Credit Commitments

        A consequence of lending activities is that losses may be experienced. The amount of such losses will vary from time to time depending upon the risk characteristics of the loan portfolio as affected by economic conditions, changing interest rates, and the financial performance of borrowers. The allowance for loan and lease losses and the reserve for off-balance sheet credit commitments which provide for the risk of losses inherent in the credit extension process, are increased by the provision for credit losses charged to operating expense and allowances acquired through acquisitions. The allowance for loan and lease losses is decreased by the amount of charge-offs, net of recoveries. There is no exact method of predicting specific losses or amounts that ultimately may be charged off on particular segments of the loan portfolio.

        The Company has an internal credit risk analysis and review staff that issues reports to the Audit and Risk Committee of the Board of Directors and continually reviews loan quality. This analysis includes a detailed review of the classification and categorization of problem loans, potential problem loans and loans to be charged off, an assessment of the overall quality and collectibility of the portfolio, consideration of the credit loss experience, trends in problem loans and concentration of credit risk, as well as current economic conditions, particularly in California. Management then evaluates the allowance, determines its desired level, determines appropriate provisions, and reviews the results with the Audit and Risk Committee which ultimately approves management's recommendation.

        The provision is the expense recognized in the income statement to adjust the allowance and reserve to the level deemed appropriate by management, as determined through application of the Company's allowance methodology procedures. See "Critical Accounting Policies" on page 29.

        In accordance with the Company's allowance for loan and lease losses methodology, the Company recorded $20.0 million of expense through the provision for credit losses for the year ended December 31, 2007, and recorded $0.6 million of income through the provision for credit losses for the year ended December 31, 2006. Prior to 2007, the Company had not recorded a provision expense for credit losses since the second quarter of 2003. For additional discussion of the provision for credit losses see "Results of Operations—Provision for Credit Losses."

60


        The following table summarizes the activity in the allowance for loan and lease losses and the reserve for off-balance sheet credit commitments for the five years ended December 31, 2007:

 
  Year ended December 31,
 
Dollars in thousands

 
  2007
  2006
  2005
  2004
  2003
 
Loans and leases outstanding   $ 11,630,638   $ 10,386,005   $ 9,265,602   $ 8,481,277   $ 7,882,742  
   
 
 
 
 
 
Average amount of loans and leases outstanding   $ 11,057,411   $ 9,948,363   $ 8,875,358   $ 8,106,657   $ 7,729,150  
   
 
 
 
 
 
Balance of allowance for loan and lease losses, beginning of year   $ 155,342   $ 153,983   $ 148,568   $ 156,015   $ 156,598  
Loans charged-off:                                
  Commercial     (7,768 )   (7,320 )   (6,575 )   (24,265 )   (38,314 )
  Residential mortgages                 (3 )    
  Commercial real estate mortgages     (297 )   (94 )   (1,898 )   (3,920 )    
  Real estate construction     (5,929 )   (684 )           (1,524 )
  Equity lines of credit     (50 )   (11 )            
  Installment     (187 )   (62 )   (95 )   (337 )   (184 )
   
 
 
 
 
 
    Total loans charged-off     (14,231 )   (8,171 )   (8,568 )   (28,525 )   (40,022 )
   
 
 
 
 
 
Recoveries of loans previously charged-off:                                
  Commercial     5,265     9,482     16,055     21,628     11,544  
  Residential mortgages             3     14     13  
  Commercial real estate mortgages     11     1,305     345     1,046     440  
  Real estate construction     438     68     1,300     100     411  
  Equity lines of credit             41     3     42  
  Installment     40     113     84     67     56  
   
 
 
 
 
 
    Total recoveries     5,754     10,968     17,828     22,858     12,506  
   
 
 
 
 
 
Net loans (charged-off)/recovered     (8,477 )   2,797     9,260     (5,667 )   (27,516 )
Provision for credit losses     20,000     (610 )           29,000  
Transfers to reserve for off-balance sheet credit commitments     (2,855 )   (828 )   (3,845 )   (1,780 )   (2,067 )
Allowance of acquired institution     4,513                  
   
 
 
 
 
 
Balance, end of year   $ 168,523   $ 155,342   $ 153,983   $ 148,568   $ 156,015  
   
 
 
 
 
 
Net (charge-offs)/recoveries to average loans and leases     (0.08 )%   0.03 %   0.10 %   (0.07 )%   (0.36 )
   
 
 
 
 
 
Ratio of allowance for loan and lease losses to total period-end loans and leases     1.45 %   1.50 %   1.66 %   1.75 %   1.98  
   
 
 
 
 
 

Reserve for off-balance sheet credit commitments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Balance, beginning of the year   $ 16,424   $ 15,596   $ 11,751   $ 9,971   $ 7,904  
Recovery of prior charge-off     (67 )                
Reserve of acquired institution     492                  
Transfers from allowance     2,855     828     3,845     1,780     2,067  
   
 
 
 
 
 
Balance, end of the year   $ 19,704   $ 16,424   $ 15,596   $ 11,751   $ 9,971  
   
 
 
 
 
 

61


        Net loan charge-offs were $8.5 million for 2007 or 0.08 percent of average loans and leases. Net loan recoveries for 2006 and 2005 were $2.8 million, or 0.03 percent of average loans, and $9.3 million, or 0.1 percent of average loans and leases, respectively.

        The allowance for loan and lease losses as a percentage of total loans and leases was 1.45 percent, 1.50 percent, and 1.66 percent at December 31, 2007, 2006, and 2005, respectively. The allowance for loan and lease losses as a percentage of nonperforming loans was 223.0 percent, 743.9 percent, and 1,069.3 percent at December 31, 2007, 2006, and 2005, respectively. See "Nonaccrual, Past Due, and Restructured Loans" below for additional discussion of nonperforming and restructured loans.

        Based on an evaluation of individual credits, previous loan and lease loss experience, management's evaluation of the current loan portfolio, and current economic conditions, management has allocated the allowance for loan and lease losses as shown for the past five years in the table below.

Allocation of Allowance for Loan and Lease Losses

 
  Allowance amount
  Percent of loans to total loans
 
Dollars in thousands

 
  2007
  2006
  2005
  2004
  2003
  2007
  2006
  2005
  2004
  2003
 
Commercial   $ 81,221   $ 82,984   $ 82,120   $ 79,093   $ 96,893   38 % 39 % 38 % 36 % 40 %
Residential mortgages     9,255     8,778     8,423     7,967     5,236   27   28   29   27   25  
Commercial real estate mortgages     33,241     35,630     37,010     39,549     36,580   17   16   20   22   22  
Real estate construction     38,455     17,309     15,082     14,994     12,350   12   11   8   10   8  
Equity lines of credit     2,997     6,951     6,500     4,964     3,210   4   4   4   3   2  
Installment     3,354     3,690     4,848     2,001     1,746   2   2   1   2   3  
   
 
 
 
 
 
 
 
 
 
 
  Total   $ 168,523   $ 155,342   $ 153,983   $ 148,568   $ 156,015   100 % 100 % 100 % 100 % 100 %
   
 
 
 
 
 
 
 
 
 
 

        While the allowance is allocated by loan type above, the allowance is general in nature and is available for the portfolio in its entirety. The increased allowance allocation to real estate construction loans is due to the ongoing weakness in the housing sector. Refer to the Recent Developments section of this report for further discussion of the credit markets. In 2006 and 2005, increased allocations to commercial loans and residential mortgages reflect the growth of the portfolios.

        At December 31, 2007, there were $71.4 million of impaired loans included in nonaccrual loans that had an allowance of $8.4 million allocated to them. On a comparable basis, at December 31, 2006, there were $19.0 million of impaired loans which had an allowance of $0.5 million allocated to them.

        Loans, other than those included in large groups of smaller-balance homogeneous loans, are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. The assessment for impairment occurs when and while such loans are on nonaccrual, or when the loan has been restructured. When a loan with unique risk characteristics has been identified as being impaired, the amount of impairment will be measured by the Company using discounted cash flows, except when it is determined that the primary (remaining) source of repayment for the loan is the operation or liquidation of the underlying collateral. In these cases, the current fair value of the collateral, reduced by costs to sell, will be used in place of discounted cash flows. As a final alternative, the observable market price of the debt may be used to assess impairment. Impaired loans with commitments of less than $500,000 are aggregated for the purpose of measuring impairment using historical loss factors as a means of measurement.

        If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net deferred loan fees or costs and unamortized premium or discount), an impairment allowance is recognized by creating or adjusting the existing allocation of the allowance for

62



loan and lease losses. The Company's policy is to record cash receipts on impaired loans first as reductions in principal and then as interest income.

Nonaccrual, Past Due, and Restructured Loans

        Total nonperforming assets (nonaccrual loans and OREO) were $75.6 million, or 0.65 percent of total loans at December 31, 2007, compared with $20.9 million, or 0.20 percent of total loans, at December 31, 2006. The Company had no OREO or troubled debt restructured at December 31, 2007 or December 31, 2006.

        The following table presents information concerning nonaccrual loans, OREO and loans which are contractually past due 90 days or more as to interest or principal payments and still accruing:

 
  December 31,
 
Dollars in thousands

 
  2007
  2006
  2005
  2004
  2003
 
Nonaccrual loans: