ITEM 1. BUSINESS
THIS DOCUMENT INCLUDES FORWARD-LOOKING INFORMATION WHICH IS SUBJECT TO THE "SAFE HARBOR" CREATED BY SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTS, WHICH INVOLVE OUR PLANS, BELIEFS AND GOALS, REFER TO ESTIMATES OR USE SIMILAR TERMS, INVOLVE CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, THE FOLLOWING FACTORS: ADVERSE ECONOMIC CONDITIONS IN CALIFORNIA, ADVERSE ECONOMIC CONDITIONS AFFECTING CERTAIN INDUSTRIES, FLUCTUATIONS IN INTEREST RATES, CONTROLLING INTEREST IN US BY THE BANK OF TOKYO-MITSUBISHI, LTD., COMPETITION IN THE BANKING INDUSTRY, RESTRICTIONS ON DIVIDENDS, ADVERSE EFFECTS OF CURRENT AND FUTURE BANKING REGULATIONS, STRATEGIES, AND RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS, DIVESTITURES OR RESTRUCTURINGS. WE UNDERTAKE NO OBLIGATION TO REVISE OR PUBLICLY RELEASE THE RESULTS OF ANY REVISION TO THESE FORWARD-LOOKING STATEMENTS. SEE ALSO THE SECTION ENTITLED "CERTAIN BUSINESS RISK FACTORS" ON PAGE.
GENERAL
UnionBanCal Corporation is a commercial bank holding company incorporated in the State of California in 1952 and is among the oldest banks on the West Coast, having roots as far back as 1864. We were formed as a result of the combination of Union Bank with BanCal Tri-State Corporation on April 1, 1996. At December 31, 1999, Union Bank of California, N.A. our bank subsidiary, was the third largest commercial bank in California, based on total assets and total deposits, and one of the 30 largest commercial banks in the United States. At December 31, 1999, we were 64 percent owned by The Bank of Tokyo-Mitsubishi, Ltd. and 36 percent owned by other shareholders.
We provide a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, primarily in California, Oregon, and Washington, but nationally and internationally as well.
BANKING
Our operations are divided into four primary segments, which are described more fully in Note 23 of the Consolidated Financial Statements.
THE COMMUNITY BANKING AND INVESTMENT SERVICES GROUP. This group offers its customers a complete spectrum of financial products under one convenient umbrella. With a full line of checking and savings, investment, loan and fee-based banking products, individual and business clients, including not-for-profit, small and institutional investors, can each have their specific needs met. These products are offered in 249 full-service branches, primarily in California, as well as in Oregon, Washington, Guam, and Saipan. In addition, the group offers international and settlement services, e-banking through our web site, check cashing services at our Cash & Save-Registered Trademark- locations and tailored loan investment products to our high net worth consumer customers through the Private Bank. Institutional customers are offered employee benefit, 401(k) administration, corporate trust, securities lending and custody (global and domestic) services. The group also includes a registered broker-dealer and a registered investment advisor, which manages a proprietary fund family.
THE COMMERCIAL FINANCIAL SERVICES GROUP. This group offers a variety of commercial financial services, including commercial and project loans, real estate financing, asset-based and leveraged commercial financing, trade finance and letters of credit, lease financing, customized cash management services and selected capital markets products. The group's customers include middle-market companies, large corporations, real estate companies and other more specialized industry customers. In addition, specialized depository services are offered to title and escrow companies, retailers, domestic financial institutions and other customers with significant deposit volumes.
THE INTERNATIONAL BANKING GROUP. This group primarily provides correspondent banking and trade finance-related products and services to financial institutions worldwide, primarily in Asia. The group also serves selected foreign firms and U.S. corporate clients in selected countries worldwide, particularly in Asia. This group has a long and stable history of providing correspondent and trade-related services to international financial institutions.
THE GLOBAL MARKETS GROUP. This group, in collaboration with our other business groups, offers customers a broad range of products. They include a variety of foreign exchange products and risk management products, such as interest rate swaps and caps. The group trades money market and fixed income securities in the secondary market and serves institutional investment needs. The group manages the market-related risks for us as part of its responsibilities for asset/liability management, including funding our own liquidity needs and addressing our interest rate risk.
SUBSIDIARIES
UnionBanCal Corporation has eleven active nonbank subsidiaries that provide various types of services to us and our customers.
- Bankers Commercial Corporation, UNBC Leasing, Inc. and UnionBanCal Leasing Corporation engage in equipment leasing and other lease related financing.
- Cal First Properties, Inc. holds and manages various properties used by us.
- UnionBanCal Venture Corporation is a small business investment company licensed under the Small Business Investment Act of 1958.
- UnionBanCal Commercial Funding Corporation sells commercial paper and invests the proceeds in Eurodollar placements with Union Bank of California, N.A.
- UnionBanCal Equities, Inc. invests in equity securities of other companies.
- Mills-Ralston, Inc. was established to hold and dispose of problem assets, including other real estate owned (OREO).
- Stanco Properties, Inc. engages in custodian activities in connection with tax-deferred exchanges of real property under Section 1031 of the Internal Revenue Code.
- UnionBanCal Mortgage Corporation acts as trustee under deeds of trust on behalf of us.
- HighMark Capital Management, Inc. provides investment management and advice, mutual fund support services and sponsors and underwrites closed-end funds.
Union Bank of California, N.A. has three active subsidiaries.
- UBOC Investment Services, Inc. (UBOCIS), a registered securities broker-dealer and member of the National Association of Securities Dealers (NASD), offers a wide range of investment products. These products include a wide range of securities, including publicly traded stocks, U.S. treasury and government agency issues, stock options, corporate and municipal bonds, and mutual funds. In addition, it provides a wholesale investment program to other financial institutions.
- Union Bank of California International is an Edge Act subsidiary supporting Union Bank of California, N.A.'s international correspondent banking business.
- Inland Property Company is a subsidiary investing in low-income housing tax credit partnerships.
EMPLOYEES
At January 31, 2000, we had 8,776 full-time-equivalent employees.
COMPETITION
Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business in California, Oregon, and Washington, as well as nationally and internationally. Our competitors include a large number of state and national banks and major foreign-affiliated or foreign banks, as well as many financial and nonfinancial firms which offer services similar to those offered by us or our subsidiaries.
We believe that continued emphasis on enhanced services and distribution systems, an expanded customer base, increased productivity and strong credit quality, together with an established capital base, will position us to meet the challenges provided by this competition.
MONETARY POLICY
The operations of bank holding companies and their subsidiaries are affected by the credit and monetary policies of the Federal Reserve Board (FRB). The FRB influences the financial performance of bank holding companies and their subsidiaries through its management of the discount rate, the money supply, and reserve requirements on bank deposits. Monetary policies of the FRB have had, and will continue to have, a significant effect on the operating results of financial institutions, including us.
SUPERVISION AND REGULATION
We and The Bank of Tokyo-Mitsubishi, Ltd., as a result of its ownership in us, are subject to regulation under the Bank Holding Company Act of 1956 (BHCA), as amended, which subjects us to FRB reporting and examination requirements. Generally, the BHCA restricts any investment that we may make to no more than 5 percent of the voting shares of any non-banking entity, and we may not acquire more than 5 percent of the voting shares of any domestic bank without the prior approval of the FRB. Our activities are limited, with some exceptions, to banking, the business of managing or controlling banks, and activities which the regulatory authorities deem to be so closely related to banking as to be a "proper incident thereto".
Union Bank of California, N.A. and most of its subsidiaries are regulated by the Office of the Comptroller of the Currency (OCC). Our subsidiaries are also subject to extensive regulation, supervision, and examination by various other federal and state regulatory agencies. In addition, Union Bank of California, N.A. and its subsidiaries are subject to certain restrictions under the Federal Reserve Act, including restrictions on affiliate transactions. Dividends payable by Union Bank of California, N.A. to us are subject to a formula imposed by the OCC unless express approval is given to deviate from the formula. For more information regarding restrictions on loans and dividends by Union Bank of California, N.A. to its affiliates and on transactions with affiliates, see Notes 17 and 22 to our Consolidated Financial Statements included in this Form 10-K.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) imposed stricter capital requirements on banks. FDICIA requires federal bank regulatory authorities to take "prompt corrective action" in dealing with inadequately capitalized banks. FDICIA established five tiers of capital measurement ranging from "well capitalized" to "critically undercapitalized". It is our policy to maintain risk-based capital ratios at or above the required minimum capital adequacy levels for both Union Bank of California, N.A. and us. At December 31, 1999, we believe that Union Bank of California, N.A. met the requirements of a "well capitalized" institution.
Furthermore, the activities of HighMark Capital Management, Inc. and UBOCIS are subject to the rules and regulations of the Securities and Exchange Commission as well as state securities regulators. UBOCIS is also subject to the rules and regulations of the National Association of Securities Dealers, Inc.
There are additional requirements and restrictions in the laws of the United States and the states of California, Oregon, and Washington, as well as other states in which Union Bank of California, N.A. and
its subsidiaries may conduct operations. These include restrictions on the amount of loans and the nature and amount of investments, as well as activities as an underwriter of securities, the opening and closing of branches and the acquisition of other financial institutions. The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (CRA) activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantive penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities.
The international activities of Union Bank of California, N.A. are subject to the laws and regulations of the jurisdiction where business is being conducted, which may change from time to time and affect Union Bank of California, N.A.'s business opportunities and competitiveness in these jurisdictions. Furthermore, due to the controlling ownership of us by The Bank of Tokyo-Mitsubishi, Ltd., regulatory requirements adopted or enforced by the Government of Japan may have an effect on the activities and investments of Union Bank of California, N.A. and us in the future.
On November 12, 1999 President Clinton signed into law the Gramm-Leach-Bliley Act (the GLB Act), key portions of which became effective on March 11, 2000. The GLB Act repeals provisions of the Glass-Steagall Act, which prohibit commercial banks and securities firms from affiliating with each other and engaging in each other's businesses. Thus, many of the barriers prohibiting affiliations between commercial banks and securities firms have been eliminated. The BHCA is also amended by the GLB Act, to allow new "financial holding companies" (FHC) to offer banking, insurance, securities and other financial products to consumers. Specifically, the GLB Act amends section 4 of the BHCA in order to provide for a framework to engage in new financial activities. Bank holding companies (BHC) such as we may elect to become a financial holding company if all of their subsidiary depository institutions are well-capitalized and well-managed. Under current FRB interpretations, a foreign bank, such as The Bank of Tokyo-Mitsubishi Ltd., which owns a subsidiary U.S. bank holding company, must make the election on behalf of itself and its U.S. holding company. In addition, the foreign bank must be well capitalized and well managed in accordance with standards comparable to those required of U.S. banks as determined by the FRB and must have a satisfactory or better CRA rating. We do not expect that The Bank of Tokyo-Mitsubishi, Ltd. will make a financial holding company election in the immediate future. Under the GLB Act, national banks (as well as FDIC-insured state banks, subject to various requirements), such as Union Bank of California, N.A., are permitted to engage through "financial subsidiaries" in certain financial activities permissible for affiliates of FHCs. However, to be able to engage in such activities, the national bank must also be well-capitalized and well-managed and receive at least a "satisfactory" rating in its most recent CRA examination. In addition, if the national bank ranks as one of the top 50 largest insured banks in the United States, as we do, it must have an issue of outstanding long-term debt rated in one of the 3 highest rating categories by an independent rating agency, which we presently do not. If the national bank falls within the next group of 50, it must either meet the debt rating test described above or satisfy a comparable test jointly agreed to by the FRB and the Treasury Department. No debt rating is required for a national bank not within the top 100 largest insured banks in the United States.
We cannot be certain of the effect of the foregoing recently enacted legislation on our business, although there is likely to be consolidation among financial services institutions and increased competition for us.
Changes in the laws, regulations, or policies that impact Union Bank of California, N.A. and us cannot necessarily be predicted and may have a material effect on the business and earnings thereof.
See Consolidated Financial Statements starting on page for specific financial information on UnionBanCal Corporation.
ITEM 2.
ITEM 2. PROPERTIES
At December 31, 1999, we operated 240 full service branches in California, 6 full service branches in Oregon and Washington, and 18 overseas branches and business offices. In addition, we have another 42 limited service branches, including 5 Cash & Save-Registered Trademark- facilities, and 4 Private Bank offices. We own the property occupied by 85 of the domestic offices and lease the remaining properties for periods of five to twenty years.
We own two administrative facilities in San Francisco and three in San Diego. Other administrative offices in San Francisco, Los Angeles, Portland, Seattle, and New York operate under long-term leases expiring in one to twenty-six years.
Rental expense for branches and administrative premises are included in Note 4 to our Consolidated Financial Statements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various pending and threatened legal actions that arise in the normal course of business. We maintain reserves for losses from legal actions that are both probable and estimable. In the opinion of management, the disposition of claims currently pending will not have a material adverse effect on our financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 1999.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following information pertains to our executive officers:
The term of office of the executive officer extends until the officer resigns, is removed, retires, or is otherwise disqualified for service. There is no family relationship among any such officers.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange under the symbol UB. As of January 31, 2000, our common stock was held by approximately 2,222 registered shareholders. At December 31, 1999, The Bank of Tokyo-Mitsubishi, Ltd. held 64 percent of our common stock. During 1998 and 1999, the average daily trading volume of our common stock was approximately 150,057 shares and 398,925 shares, respectively. At December 31, 1997, 1998 and 1999, our common stock closed at $35.83 per share, $34.06 per share, and $39.44 per share, respectively. The following table presents stock quotations for each quarterly period for the two years ended December 31, 1999.
The following table presents quarterly per share cash dividends declared for 1998 and 1999:
On November 18, 1998, our Board of Directors approved a 36 percent increase in our quarterly common stock dividend for the fourth quarter of 1998 from $0.14 per share to $0.19 per share. On November 17, 1999 our Board of Directors approved a 32 percent increase in our quarterly common stock dividend for the fourth quarter of 1999 from $0.19 per share to $0.25 per share. Future dividends will depend upon our earnings, financial condition, capital requirements and other factors as our Board of Directors may deem relevant.
We offer a dividend reinvestment and stock purchase plan that allows shareholders to reinvest dividends in our common stock at 5 percent below the market price. The Bank of Tokyo-Mitsubishi, Ltd. did not participate in the plan during 1998 and 1999. For further information about these plans, see Note 13 to our Consolidated Financial Statements.
The availability of our retained earnings for the payment of dividends is affected by certain legal restrictions. See Note 17 to our Consolidated Financial Statements.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
See page of this Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
See pages through of this Form 10-K.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See pages through of this Form 10-K.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See pages through of this Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to our Proxy Statement for the April 26, 2000 Annual Meeting of Shareholders for incorporation by reference of information concerning directors and persons nominated to become directors of UnionBanCal Corporation. Information concerning our executive officers as of January 31, 2000 is included in Part I above in accordance with Instruction 3 to Item 401(b) of Regulation S-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated by reference from the text under the caption "Compensation and Other Transactions with Management and Others" in the Proxy Statement for the April 26, 2000 Annual Meeting of Shareholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning ownership of the equity stock of UnionBanCal Corporation by certain beneficial owners and management is incorporated by reference from page 1 and the text under the caption "Election of Directors" in the Proxy Statement for the April 26, 2000 Annual Meeting of Shareholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions with officers, directors, and The Bank of Tokyo-Mitsubishi, Ltd. is incorporated by reference from the text under the caption "Transactions with Management and Others" in the Proxy Statement for the April 26, 2000 Annual Meeting of Shareholders.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
Our Consolidated Financial Statements, the Management Statement, and the independent auditors' report are set forth on pages through. (See index on page).
(a)(2) Financial Statement Schedules
All schedules to our Consolidated Financial Statements are omitted because of the absence of the conditions under which they are required or because the required information is included in our Consolidated Financial Statements or accompanying notes.
(a)(3) Exhibits
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(1) Incorporated by reference to Form 10-K for the year ended December 31, 1998.
(2) Incorporated by reference to Form 10-Q for the quarter ended March 31, 1999.
(3) Incorporated by reference to Form 10-K for the year ended December 31, 1997.
(4) Incorporated by reference to Form 10-K for the year ended December 31, 1996.
(5) Incorporated by reference to Form 10-Q for the quarter ended June 30, 1999.
(6) Incorporated by reference to Form 10-Q for the quarter ended September 30, 1998.
(7) Incorporated by reference to Form 8-K dated April 1, 1996 (filed as exhibit 10.12).
(8) Incorporated by reference to Form 8-K dated April 1, 1996 (filed as exhibit 10.14).
(9) Filed herewith.
* Management contract or compensatory plan, contract or arrangement.
(b) Reports on Form 8-K:
We filed a report on Form 8-K on August 19, 1999 under Item 5 to report the announcement of Mission Excel, a plan to fund significant new business growth as well as to control costs by streamlining operations.
UNIONBANCAL CORPORATION AND SUBSIDIARIES MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SELECTED FINANCIAL DATA
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(1) Amounts are on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
(2) Dividends per share reflect dividends declared on UnionBanCal Corporation's common stock outstanding as of the declaration date. Amounts prior to the merger are based on Union Bank only and do not include the dividend of $145 million paid to The Mitsubishi Bank Limited in the first quarter of 1996 by BanCal Tri-State Corporation and The Bank of California, N.A.
(3) The efficiency ratio is noninterest expense, excluding foreclosed asset expense (income), as a percentage of net interest income (taxable-equivalent) and noninterest income. Foreclosed asset expense (income) was $(3.2) million, $2.9 million, $(1.3) million, $(2.8) million, and $(1.3) million for 1995 through 1999, respectively.
THIS DOCUMENT INCLUDES FORWARD-LOOKING INFORMATION WHICH IS SUBJECT TO THE "SAFE HARBOR" CREATED BY SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTS, WHICH INVOLVE OUR PLANS, BELIEFS AND GOALS, REFER TO ESTIMATES OR USE SIMILAR TERMS, INVOLVE CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, THE FOLLOWING FACTORS: ADVERSE ECONOMIC CONDITIONS IN CALIFORNIA, ADVERSE ECONOMIC CONDITIONS AFFECTING CERTAIN INDUSTRIES, FLUCTUATIONS IN INTEREST RATES, CONTROLLING INTEREST IN US BY THE BANK OF TOKYO-MITSUBISHI, LTD., COMPETITION IN THE BANKING INDUSTRY, RESTRICTIONS ON DIVIDENDS, ADVERSE EFFECTS OF CURRENT AND FUTURE BANKING REGULATIONS, STRATEGIES, AND RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS, DIVESTITURES OR RESTRUCTURINGS. WE UNDERTAKE NO OBLIGATION TO REVISE OR PUBLICLY RELEASE THE RESULTS OF ANY REVISION TO THESE FORWARD-LOOKING STATEMENTS. SEE ALSO THE SECTION ENTITLED "CERTAIN BUSINESS RISK FACTORS" ON PAGE.
You should read the following discussion and analysis of our consolidated financial position and the results of our operations for the years ended December 31, 1997, 1998 and 1999 together with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included in this Form 10-K. Averages as presented in the following tables are substantially all based upon daily average balances.
INTRODUCTION
We are a California-based, commercial bank holding company with consolidated assets of $33.7 billion at December 31, 1999. At year-end 1999, Union Bank of California, N.A. was the third largest commercial bank in California, based on total assets and total deposits in California, and one of the 30 largest commercial banks in the United States.
UnionBanCal Corporation and its banking subsidiary, Union Bank of California, N.A., (the Bank) was created on April 1, 1996 by the combination of Union Bank with BanCal Tri-State Corporation and its banking subsidiary, The Bank of California, N.A. The combination was accounted for as a reorganization of entities under common control, similar to a pooling of interests. Accordingly, all historical financial information has been restated as if the combination had been in effect for all periods presented.
On March 3, 1999, we completed a secondary offering of 28.75 million shares of our Common Stock owned by our majority shareholder, The Bank of Tokyo-Mitsubishi, Ltd. We received no proceeds from this transaction. Concurrent with the secondary offering, we repurchased 8.6 million shares of our outstanding Common Stock from The Bank of Tokyo-Mitsubishi, Ltd. and 2.1 million shares owned by Meiji Life Insurance Company with $312 million of the net proceeds from the issuance of $350 million of 7 3/8 percent capital securities early in 1999. After the secondary offering and the repurchase, The Bank of Tokyo-Mitsubishi, Ltd. owns 64 percent of our stock, or 105.6 million shares, compared with 82 percent prior to the transaction.
SELECTED SUPPLEMENTAL PRO FORMA FINANCIAL DATA
To facilitate the discussion of the results of operations, the following table includes certain pro forma earnings disclosures and ratios. These presentations supplement the Consolidated Statements of Income on page which are prepared in accordance with generally accepted accounting principles, primarily with respect to the treatment of the restructuring charge, which was recorded in the third quarter of 1999, and the 1998 reduction of California Franchise Tax liability, which related to 1997. Management believes that it is meaningful to understand the operating results and trends excluding these expenses and,
therefore, has included information in this table and in the MD&A which follows, that presents income excluding these items and related pro forma ratio and per share calculations.
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(1) Excludes 3rd Quarter 1998 reduction in California Franchise Tax liability of $29.250 million (net of federal tax), which related to 1997.
(2) Excludes the income tax expense related to the restructuring charge of $29.816 million.
(3) The pro forma efficiency ratio is noninterest expense, excluding foreclosed asset income and restructuring charge, as a percentage of net interest income (taxable-equivalent) and noninterest income. Foreclosed asset income was $2.8 million in 1998 and $1.3 million in 1999.
Reported net income was $466.5 million, or $2.65 per diluted common share in 1998, compared with $441.7 million, or $2.64 per diluted common share in 1999. Excluding the effects of the $85 million restructuring charge ($55.2 million net of tax), which was recorded in the third quarter of 1999, and the effects of the $29.3 million in reduced California Franchise Tax liabilities (related to tax year 1997), recorded in 1998, pro forma net earnings were $437.2 million, or $2.49 per diluted common share in 1998, compared to $496.9 million, or 2.97 per diluted common share in 1999. This increase in pro forma diluted earnings per share of 19 percent in 1999 was due to a $96.4 million, or 7 percent, increase in net interest income, and a $53.2 million, or 10 percent, increase in noninterest income, offset by an increase of $20.0 million, or 44 percent in the provision for credit losses, and a $61.8 million, or 5 percent, increase in noninterest expense. Other highlights in 1999 include:
- Net interest income, on a taxable-equivalent basis, was $1.4 billion in 1999, an increase of $96.4 million, or 7 percent from 1998. Net interest margin for 1999 was 4.89 percent, or 8 basis points higher than 1998.
- The provision for credit losses was $65.0 million in 1999, compared with $45.0 million in 1998.
- Noninterest income was $586.8 million in 1999, an increase of $53.2 million, or 10 percent from 1998. Excluding a $17.1 million pre-tax gain ($10.3 million after tax) from the sale of our $253 million credit card portfolio in April 1998, noninterest income increased $70.3 million, or 14 percent in 1999.
- Noninterest expense, excluding the restructuring charge, was $1.2 billion in 1999, an increase of $61.8 million, or 5 percent over 1998.
- Our pro forma effective tax rate in 1998 was 35 percent (excluding the effects of the California Franchise Tax liability reduction discussed on ), compared with 33 percent in 1999.
- Reported return on average assets in 1999 was 1.37 percent, while reported return on average common equity for the same period was 15.03 percent. Our pro forma return on average assets in 1999 increased to 1.55 percent, compared to 1.43 percent in 1998. Our pro forma return on average common equity in 1999 increased to 16.83 percent, compared to 15.36 percent in 1998.
MISSION EXCEL
During the second quarter of 1999 we began a project, which we refer to as "Mission Excel." Mission Excel is a company-wide initiative to slow the rate of growth of our expenses, increase sustainable growth in our revenues, and increase productivity through elimination of unnecessary or duplicate functions. The goal of this project is to help us achieve an efficiency ratio of 54% to 56% by the fourth quarter 2000. Project Mission Excel has been a full-time effort on the part of many of our most senior staff who solicited and reviewed all ideas submitted.
The first phase of the Mission Excel project was the development of an implementation plan. The implementation plan was finalized and approved by our Board of Directors on August 13, 1999. Implementation of the Mission Excel project, which is being overseen by dedicated senior staff, is expected to be complete in the first quarter of 2001.
In connection with Mission Excel, we incurred an $85 million restructuring charge in the third quarter of 1999. The charge consists of $70 million in personnel expense for approximately 1,400 employees to be terminated under the plan, $63 million of which relates to direct severance payments to employees. The remaining $15 million relates to lease termination costs for eight facilities that will be vacated and professional services cost incurred in connection with Mission Excel. The projected annualized financial impact (pre-tax) of Mission Excel will approximate $225 million, which is comprised of $90 million of additional revenues and $135 million of reduced expenses. No assurances can be given that these projections will be realized.
At the completion of the plan, we expect to have terminated approximately 1,400 employees, a 15 percent company-wide reduction in employees. From August 16, 1999 to December 31, 1999, 450 employees were terminated under the plan. Another 530 positions are scheduled to be eliminated during the first six months of 2000. Most, if not all of the remaining employees will have been notified of their termination by June 30, 2000. These terminations are not concentrated in any one particular group or class of staff.
The terminations arising from Mission Excel will reduce the number of employees in each business unit as follows:
The following table presents the restructuring reserve for the period, the cash and noncash utilization of the reserve, and the resulting balance as of December 31, 1999.
BUSINESS SEGMENTS
We segregate our operations into four primary business units for the purpose of management reporting, as shown in the table on the following pages. The results show the financial performance of our major business units.
During 1999, we introduced a new method for measuring the contribution provided by each of our business units. The Risk Adjusted Return on Capital (RAROC) methodology seeks to attribute economic capital to business units consistent with the level of risk they assume. These risks are primarily credit risk, market risk and operational risk. Credit risk is the potential loss in economic value due to the likelihood that the obligor will not perform as agreed. Market risk is the potential loss in fair value due to changes in interest rates, currency rates and volatilities. Operational risk is the potential loss due to failures in internal controls, system failures, or external events.
The following table reflects the condensed income statements, selected balance sheet items and selected financial ratios for each of our primary business units. The information presented does not necessarily represent the business units' financial condition and results of operations as if they were independent entities. Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies.
The significant changes in the RAROC measurement methodology concern the recognition of credit expense for expected losses arising from credit risk and the attribution of economic capital related to unexpected losses arising from credit, market and operational risks. Business unit results are based on an internal management reporting system used by management to measure the performance of the units and UnionBanCal Corporation as a whole. The management reporting system identifies balance sheet and income statement items to each business unit based on internal management accounting policies. Net interest income is determined using our internal funds transfer pricing system, which assigns a cost of funds to assets or a credit for funds to liabilities and capital, based on their type, maturity or repricing characteristics. Noninterest income and expense directly or indirectly attributable to a business unit are assigned to that business.
We have restated the business units' results for the prior periods to reflect the new RAROC methodology, as well as any reorganizational changes that have occurred.
- ---------------------------------- (1) Performance center earnings (expense) represent the allocation of net interest income, noninterest income and noninterest expense between the business segments for products and services originated in one segment but managed by another.
(2) Represents loans and deposits for each business segment before allocation between the segments of loans and deposits originated in one segment but managed by another.
(3) The increase in 1998 over the prior year for the Community Banking and Investment Services Group was partially due to the sale of the credit card portfolio as discussed on page.
(4) "Other" includes 3rd quarter 1999 restructuring charge of $85.0 million ($55.2 million, net of tax).
na = not applicable
COMMUNITY BANKING AND INVESTMENT SERVICES GROUP
The Community Banking and Investment Services Group provides its customers with a full line of checking and savings, investment, trust, loan and fee-based banking products. During 1999, and as part of the Mission Excel initiatives, we merged the Community Banking Group with the Trust and Private Financial Services Group to form the Community Banking and Investment Services Group. The merging of these two groups under one leadership provides our retail and business client base with a full range of products and services through one coordinated and responsive delivery channel. It is expected that when this strategy is fully implemented, we will improve customer service, increase revenues and lower expenses.
In 1999, net income increased $27.5 million compared to 1998. Total revenue increased $79.0 million in 1999 compared to a year ago. Excluding the $17.1 million gain on the sale of the credit card portfolio in the second quarter 1998, total revenue increased $96.1 million, or 10 percent from a year ago. The revenue increases relate to higher net interest income, trust fees, investment management fees and brokerage commissions. Noninterest expense increased $38.0 million from the prior year primarily to support the revenue increase. Credit expense decreased $2.3 million from a year ago primarily due to the sale of the credit card portfolio.
Organizational changes will continue in the near term as our strategy is implemented. However, at December 31, 1999, the group was divided into three major divisions: Community Banking, Wealth Management and Institutional Services and Asset Management.
COMMUNITY BANKING serves over one million consumer households and businesses through its 240 full-service branches in California, six full-service branches in Oregon and Washington, three full-service branches in Guam and Saipan and its network of over 380 proprietary ATMs. Customers may also access our services 24 hours a day by telephone or personal computer. In addition, the division offers automated teller and point-of-sale debit services through our founding membership in the Star System-Registered Trademark-, the largest shared ATM network in the Western United States.
This division is organized by service delivery method, by markets and by geography. We serve our customers in the following ways:
- Through community banking branches, which serve consumers and businesses
- Through business banking centers, which serve businesses with sales between $3 million and $20 million,
- Through in-store branches, which also serve consumers and businesses,
- Through middle market and agricultural lending offices, and
- Through the Consumer Asset Management division, which is responsible for indirect auto finance, auto leasing and residential real estate lending.
WEALTH MANAGEMENT provides private banking and other specialized financial services to our affluent clientele as well as brokerage products and services.
- Private Banking focuses primarily on delivering integrated and customized financial services to high net worth individuals with sophisticated financial needs. Specific products and services include trust and estate services, investment account management services, offshore trust services and customized deposit and credit products. The Private Banking strategy is to expand its business by increasing its geographic market coverage and the breadth of its products and services. Through its 4 offices, the Private Bank sales staff offers all of the bank's available products and services.
- Our brokerage products and services are provided through Union Bank of California, N.A. Investment Services, Inc., a registered broker/dealer offering a full line of investment products to individuals and institutional clients. Their primary strategy is to further penetrate our existing client base.
INSTITUTIONAL SERVICES AND ASSET MANAGEMENT provides investment management and administration services for a broad range of individuals and institutions.
- HighMark Capital Management, Inc., a registered investment advisor, manages our proprietary HighMark family of mutual funds. It also provides investment management services to institutions, pension plans and individuals, including to clients of other divisions. HighMark Capital Management's strategy is to expand distribution of its mutual funds by targeting its marketing efforts at registered investment advisors and regional broker/dealers. In addition, HighMark Capital Management, Inc. is working with The Bank of Tokyo-Mitsubishi, Ltd. and other third parties to establish mutual funds offshore that HighMark will advise and which will be offered to non-U.S. investors. HighMark also serves as a sub-advisor for funds managed by Tokyo-Mitsubishi Asset Management, Ltd. in Japan.
- Business Trust provides businesses, government agencies, unions and non-profit organizations with trustee services, investment management and 401(k) valuation and recordkeeping services. Business Trust's strategy is to expand its third-party distribution network to include insurance companies, investment managers, brokers and mutual funds.
- Securities Services is engaged in domestic and global securities custody, safekeeping, mutual fund accounting, securities lending, and corporate trust services. Its client base includes financial institutions, businesses, government agencies, union, investment managers and non-profit organizations. Securities Services is the only West Coast based provider of a full range of institutional financial services.
Through alliances with other financial institutions, the group offers additional products and services, such as credit cards, leasing, and asset-based and leveraged financing.
The group competes with larger banks by providing service quality superior to that of its major competitors. We are recognized as among the highest rated banks in California for customer service quality and satisfaction.
The group's primary means of competing with community banks include its large and convenient branch network and its reputation for innovative use of technology to deliver banking services. We have the fifth largest branch network among depository institutions in California. We also offer convenient banking hours to consumers through our drive-through banking locations and selected branches that are open seven days a week.
The group competes with a number of commercial banks, internet banks, savings associations and credit unions, as well as more specialized financial service providers such as investment brokerage companies, consumer finance companies, and residential real estate lenders. The group's primary competitors are other major depository institutions such as Bank of America, California Federal, Washington Mutual and Wells Fargo, as well as smaller community banks in the markets in which we operate.
COMMERCIAL FINANCIAL SERVICES GROUP
The Commercial Financial Services Group offers a variety of commercial financial services, including:
- commercial and project loans,
- real estate financing,
- commercial financing based on accounts receivable, inventory, or other short term assets,
- trade financing, which is the short-term extension of credit to support export/import transactions, including letters of credit,
- lease financing,
- customized cash management services, and
- selected capital markets products.
The group's customers provide a significant source of opportunities for us to sell products and services of other units of the bank, including treasury, trust, and retail banking services. In 1999, net income increased $62.8 million compared to 1998. Total revenue increased $116.7 million, due to the $2.5 billion growth in average loans and leases year over year, which contributed to the significant increase in net interest income accompanied by increases in fee income. Noninterest expense increased $5.4 million primarily due to an increase in salaries and employee benefits, as well as additional expenses incurred to support higher deposit volumes. Credit expense increased $19.6 million from a year ago, due to the loan growth mentioned above.
The group is divided into the following business units, which serve specific markets and industries:
- the Commercial Banking Group, which serves California middle-market companies and larger companies most often headquartered in the Western United States,
- the Real Estate Industries Group, which serves real estate developers and real estate investment trusts,
- the Specialized Lending Group, which serves companies operating in various industries, including oil and gas, utilities, media, communications, healthcare, finance, and retailing, and
- the Institutional and Deposit Markets Group, which serves title and escrow companies, domestic financial institutions, retailers, bankruptcy trustees, and other customers with large pools of deposits.
The Commercial Customer Service Unit supports these business units by providing centralized customer service support.
The group competes with other banks primarily on the basis of its reputation as a "business bank," the quality of its relationship managers, and the delivery of superior customer service. We are recognized in California as having a superior "business banking" reputation relative to other large banks. We are also highly rated among financial institutions for our cash management services and systems.
The group's main strategy is to target industries and companies for which the group can reasonably expect to be one of a customer's primary banks. Consistent with its strategy, the group attempts to serve a large part of its targeted customers' credit and depository needs.
The group competes with a variety of other financial services companies. Competitors include other major California banks, as well as regional, national and international banks. In addition, we compete with investment banks, commercial finance companies, leasing companies, and insurance companies.
INTERNATIONAL BANKING GROUP
The International Banking Group mainly provides correspondent banking and trade finance-related products and services to international financial institutions worldwide, primarily in Asia. This includes providing products and services that facilitate trade finance transactions, including payments, collection and the extension of short-term credit. The group also serves selected foreign firms and U.S. corporate clients in selected countries worldwide, particularly in Asia. In the U.S., the group serves subsidiaries and affiliates of non-Japanese Asian companies and U.S. branches and agencies of foreign banks. The group also provides international services to domestic corporate clients along the West Coast. The group's revenue predominately relates to foreign customers. In 1999, net income decreased $1.4 million compared to 1998. Total revenue decreased $7.6 million due to continuing reductions in credit exposures, narrower credit spreads, and lower market pricings on those exposures. Noninterest expense decreased $1.5 million primarily due to personnel expenses. Credit expense decreased $2.4 million from a year ago, due to the reduction in credit exposures. Expected losses related to credit risk on foreign exposures have not been finalized and results could change in the future.
The group has a long and stable history of providing correspondent and trade-related services to international financial institutions. We believe that we have achieved a leading market position and strong customer loyalty in the Asia/Pacific correspondent banking market because we provide high quality, customized products, and services at competitive prices. The group maintains branches in Tokyo, Taipei, Seoul, Manila and Hong Kong, representative offices in other parts of Asia and Latin America, and an international banking subsidiary in New York.
One of the group's primary services is international trade finance. Trade finance is typically short-term, which means it generally has a lower credit risk. Despite this relatively lower credit risk compared to some other forms of commercial credit, we have reduced the amount of credit we have extended to our customers and the average maturity of this portfolio in response to continuing concern in global markets.
The group's strategy is to improve its global operations by reducing costs and improving productivity. It competes with both U.S. and foreign banks. Approximately 25 U.S. banks compete with the group to provide correspondent banking and trade-related services to Asian banks. The group's primary competitors include First Union, Bank of New York, Chase Manhattan, Citibank, Bank of America and Bank of Hawaii.
GLOBAL MARKETS GROUP
The Global Markets Group conducts business activities primarily to support the previously described business groups and their customers. This group offers a broad range of risk management products, such as foreign exchange and interest rate swaps, caps and floors. Additionally, it places debt securities, including Union Bank of California, N.A.'s own liabilities, with institutional investors and trades debt instruments in the secondary market. This group also manages our market-related risks as part of its responsibilities for asset/liability management. The group is also responsible for maintaining Union Bank of California, N.A.'s investment securities portfolio. In 1999, net income increased $2.8 million compared to 1998. Total revenue decreased $1.3 million primarily due to the decision made earlier in the year to exit the municipal underwriting and certain capital market activities. Noninterest expense decreased $3.8 million largely due to personnel expense reductions.
The group manages our securities portfolio, trading operations, wholesale funding needs, and interest rate and liquidity risk. The group includes products that support corporate lending, customer interest rate risk management needs and foreign exchange.
OTHER
"Other" includes the following items:
- Corporate activities that are not directly attributable to one of the four major business units. Included in this category are goodwill, merger and integration expense, restructuring charges, certain parent company non-bank subsidiaries, and the elimination of the fully taxable-equivalent amounts.
- The adjustment between the credit expense under RAROC and the provision for credit losses under generally accepted accounting principles, the net impact of transfer pricing, and earnings associated with unallocated equity capital.
- The Credit and Compliance Group, which includes $120 million of average nonperforming assets.
- The Pacific Rim Corporate Group, which offers a range of credit, deposit, and investment management products and services to companies in the U.S., which are affiliated with companies headquartered outside the U.S., mostly in Japan.
- The residual costs of support groups.
STRATEGIC INITIATIVES
In connection with our strategic repositioning, during 1999, we developed long-term financial performance goals. These goals will serve as a tool for measuring the long-term success of our operating strategies, based on normal business operations, without including nonrecurring events that may occur from time to time. Our long-term financial performance goals include:
Although we believe these goals are realizable given our proposed operating strategies and our current asset quality, we cannot assure you that we will attain these long-term financial performance goals at any particular time. See paragraph on certain business risk factors on page.
NET INTEREST INCOME
The table below shows the major components of net interest income and net interest margin.
- ---------------------------------- (1) Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
(2) Average balances on loans outstanding include all nonperforming and renegotiated loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield.
(3) Foreign loans and deposits are those loans and deposits originated in foreign branches.
(4) For the purpose of the net interest margin analysis, yields on securities available for sale are based on fair value.
Net interest income is interest earned on loans and investments less interest expense on deposit accounts and borrowings. Primary factors affecting the level of net interest income include the margin between the yield earned on interest earning assets and the rate paid on interest bearing liabilities, as well as the volume and composition of average interest earning assets and average interest bearing liabilities.
Net interest income, on a taxable-equivalent basis, was $1.3 billion in 1998, compared with $1.4 billion in 1999. The increase of $96.4 million, or 7 percent, was mostly attributable to a $1.5 billion, or 6 percent, increase in average earning assets largely funded by a $0.5 billion, or 6 percent, increase in average noninterest bearing deposits. Net interest margin increased 8 basis points to 4.89%. The favorable impact of the lower interest rate environment that contributed to lower rates on interest bearing deposits was mostly offset by lower yields on loans and other average earning assets.
Average earning assets were $27.5 billion in 1998, compared with $29.0 billion in 1999. This growth was primarily attributable to a $1.8 billion, or 8 percent, increase in average loans and a $207.0 million, or 7 percent, increase in average securities, partially offset by a $347.1 million decrease in average interest bearing deposits in banks and average trading account assets and a $139.4 million decrease in federal funds sold and securities purchased under resale agreements. The growth in average loans was attributable to the increase in average commercial, financial and industrial loans of $1.8 billion, partially offset by the decrease in average consumer loans of $311.0 million, primarily related to the sale of the credit card portfolio. See "Loans" on page for additional commentary on growth in the loan portfolio.
The $1.5 billion, or 6 percent, growth in average earning assets over 1998 was primarily funded by a $0.5 billion increase in average noninterest bearing deposits, a $0.5 billion increase in large time deposits and a $0.4 billion increase in other borrowed funds. The increase in average noninterest bearing deposits in 1999 was partially due to an influx of new customer relationships, arising from the merger and acquisition activities of other financial institutions in the California market during 1998 and 1999.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
The following table shows the changes in the components of net interest income on a taxable-equivalent basis. The changes in net interest income between periods have been reflected as attributable either to volume or to rate changes. For purposes of this table, changes that are not solely due to volume or rate changes are allocated to rate.
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(1) Foreign loans and deposits are those loans and deposits originated in foreign branches.
Interest income on a taxable-equivalent basis increased $75.5 million in 1999, primarily due to growth in interest income from average domestic loans and average taxable securities of $112.3 million and $13.5 million, respectively, partially offset by lower interest income from average foreign loans and trading account assets of $20.4 million and $13.5 million, respectively. These changes reflected higher average balances outstanding on average domestic loans and average taxable securities, partially offset by a lower average yield on average domestic loans and a lower average balance outstanding on average interest bearing deposits and trading account assets.
Interest expense decreased $20.9 million in 1999 due to lower interest expense on average interest bearing deposits, primarily reflecting lower average rates, partially offset by higher average volume. Interest expense on borrowed funds increased $16.4 million in 1999, reflecting higher volumes and the
issuance of the Trust Preferred securities in the first quarter of 1999, offset by a 17 basis point decrease in the average rate paid.
NONINTEREST INCOME
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nm = not meaningful
Noninterest income in 1999 was $586.8 million, an increase of $53.2 million, or 10 percent, over 1998. Included in 1998 noninterest income was a $17.1 million gain from the sale of the credit card portfolio. Affecting the net increase were the following:
- Revenue from service charges on deposit accounts of $172.7 million, an increase of 24 percent over 1998. The increase was primarily attributable to a 5 percent increase in average deposits coupled with higher ATM surcharges and the expansion of several products and services.
- Trust and investment management fees of $140.9 million, an increase of 16 percent over 1998. The increase was due to strong growth in trust accounts and assets under management, which resulted in higher mutual fund management fees.
- International commissions and fees of $70.8 million, a decrease of 2 percent over 1998. The decrease was primarily due to narrower pricings on Korean bankers' acceptances than had been experienced during 1998.
- Merchant transaction processing fees of $68.0 million, an increase of 20 percent over 1998. The increase was due to increased volume and an increase in the merchant discount rate in April 1999.
- Merchant banking fees of $38.0 million, an increase of 21 percent over 1998. The increase was primarily due to increased loan syndication activities by the Commercial Financial Services Group.
- Brokerage commissions and fees of $27.0 million, an increase of 42 percent over 1998. The increase was primarily attributable to brokerage commissions on non-proprietary mutual fund sales and growth in corporate sweep products.
- Other noninterest income of $40.9 million, a decrease of 21 percent from 1998. The decrease was primarily due to a $15.0 million charge related to auto lease residual valuation adjustments that were recorded in the third and fourth quarters of 1999, partially offset by higher investment service fee income of $8.0 million.
NONINTEREST EXPENSE
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Noninterest expense, excluding the restructuring charge, in 1999 was $1.2 billion, an increase of $61.8 million, or 5 percent, over 1998. Affecting the net increase were the following:
- Personnel-related expense of $661.3 million, an increase of 7 percent over 1998. This increase was primarily due to a $19.6 million increase in performance-based incentive compensation and a $12.7 million increase in exempt pay, due to regular merit increases. Decreases in personnel-related expense due to Mission Excel reductions were offset by a loss of $6.1 million related to the reduction in staff and the impact on future post-retirement benefits.
- Equipment expense of $67.1 million, an increase of 19 percent over 1998, primarily due to higher depreciation expense on personal computers related to our intranet upgrade and a decrease in the estimated useful lives.
- Merchant transaction processing expense of $49.4 million, an increase of 13 percent over 1998, primarily due to higher merchant volumes.
YEAR 2000 EXPENSES
We achieved a successful transition to the Year 2000. (See "Year 2000" on page for a detailed discussion of our year 2000 program.) We estimate that the total cost of the year 2000 project will be approximately $45.8 million, including capital expenditures, which we have capitalized and which are being depreciated over their estimated useful lives. As of December 31, 1999, we have spent $40.6 million on the year 2000 project, $2.2 million in 1997, $21.6 million in 1998 and $16.8 million in 1999. Of the $40.6 million spent as of December 31, 1999, $6.8 million related to capital expenditures, $0.8 million in 1997, $5.2 million in 1998, and $0.8 million in 1999. We do not anticipate any additional capital expenditures related to this project. The remaining budget of $5.2 million includes $4.9 million for staff and professional services. We are funding the cost of the year 2000 project with normal operating cash and are staffing it with external resources as well as internal staff re-deployed from less time-sensitive assignments.
INCOME TAX EXPENSE
Our effective tax rate in 1998 was 31 percent compared with 33 percent in 1999. Our effective tax rate in 1999 was affected by various tax refunds of $10.7 million. The lower 1998 effective tax rate was due to our ability to file our 1997 and 1998 California franchise tax returns on a worldwide unitary basis, incorporating the financial results of The Bank of Tokyo-Mitsubishi, Ltd. and its worldwide affiliates. As a result, we reduced our state income tax liabilities by $29 million, net of federal tax, for previously accrued 1997 state tax liabilities, and lowered our 1998 state tax provision by $31 million, net of federal tax. It is our intention to file our 1999 California franchise tax returns on a worldwide unitary basis as well. In 1997, we received an after-tax refund from the California Franchise Tax Board (FTB) of $25 million to settle litigation, administration, and audit disputes covering the years 1975-1987. Excluding the various tax refunds, the effective tax rates were 36 percent in 1997, 35 percent in 1998, and 34 percent in 1999.
CREDIT RISK MANAGEMENT
Our principal business activity is the extension of credit in the form of loans or other credit substitutes to individuals and businesses. Our policies and applicable laws and regulations, governing the extension of credit, require risk analysis as well as ongoing portfolio and credit management through loan product diversification, lending limit constraints, credit review and approval policies, and extensive internal monitoring.
We manage and control credit risk through diversification of the portfolio by type of loan, industry concentration, dollar limits on multiple loans to the same borrower, geographic distribution and type of borrower. Geographic diversification of loans originated through our branch network is generally within California, Oregon and Washington, which we consider to be our principal markets. In addition, we will continue to originate and participate in lending activities outside these states, as well as internationally.
In analyzing our existing loan portfolios, we apply specific monitoring policies and procedures that vary according to the relative risk profile and other characteristics of the loans within the various portfolios. Our residential and consumer loans are relatively homogeneous and no single loan is individually significant in terms of its size or potential risk of loss. Therefore, we review our residential and consumer portfolios by analyzing their performance as a pool of loans. In contrast, our monitoring process for the commercial, financial and industrial, construction, commercial mortgage, and foreign loan portfolios includes a periodic review of individual loans. Loans that are performing but have shown some signs of
weakness are subjected to more stringent reporting and oversight. We review these loans to assess the ability of the borrowing entity to continue to service all of its interest and principal obligations and as a result may adjust the risk grade accordingly. In the event that we believe that full collection of principal and interest is not reasonably assured, the loan will be appropriately downgraded and, if warranted, placed on nonaccrual status, even though the loan may be current as to principal and interest payments.
We have a Credit Policy Forum, composed of the Chief Credit Officer, senior credit officers, and appropriate line officers, that establishes policy, credit quality criteria, portfolio guidelines and other controls. Credit Administration, together with a series of loan committees, have the responsibility for administering the credit approval process, as well as the implementation and administration of our credit policies and lending practices and procedures. These policies require an extensive evaluation of credit requests and continuing review of existing credits in order to promptly identify, monitor, and quantify evidence of deterioration of asset credit quality or potential loss.
As another part of the control process, an independent internal credit review and examination function provides quality assurance that loans and commitments are made and maintained as prescribed by our credit policies and that the assets are appropriately and timely risk graded. This includes a review of compliance with our underwriting policies when the loan is initially extended and subsequent on-site examinations to ensure continued compliance.
LOANS
The following table shows loans outstanding by loan type and as a percentage of total loans for 1995 through 1999.
Our lending activities are predominantly domestic, with such loans comprising approximately 96 percent of the total loan portfolio at December 31, 1999. Total loans at December 31, 1999 were $25.9 billion, an increase of $1.6 billion, or 6.7 percent, from one year earlier. The increase from 1998 was primarily
attributable to growth in the commercial, financial and industrial loan portfolio, which increased $1.1 billion, and the commercial mortgage loan portfolio, which increased $597 million.
COMMERCIAL, FINANCIAL AND INDUSTRIAL LOANS
Commercial, financial and industrial loans represent the largest category in the loan portfolio. These loans are extended principally to major corporations, middle market businesses, and small businesses, with no industry concentration exceeding 10 percent of total commercial, financial and industrial loans. This portfolio has a high degree of geographic diversification based upon our customer's revenue bases, which lowers our vulnerability to changes in the economic outlook of any particular region of the U.S.
Our commercial market lending originates primarily through our banking office network. These offices, which rely extensively on relationship-oriented banking, provide many services including cash management services, lines of credit, accounts receivable and inventory financing. Separately, we originate or participate in a wide variety of financial services to major corporations. These services include traditional commercial banking and specialized financing tailored to the needs of each customer's specific industry. Presently, we are active in the communications, media and entertainment, energy capital services, technology, healthcare, agribusiness, retailing and financial services industries.
At December 31, 1999, the commercial, financial and industrial loan portfolio was $14.2 billion, or 55 percent of the total loan portfolio. The increase of $1.1 billion, or 8 percent, from the previous year-end was primarily attributable to loans extended to businesses with revenues exceeding $20 million. The growth continued to reflect the results of initiatives to increase participation in larger syndicated loan positions as lead manager and as agent, especially in the communications, media, and entertainment and energy capital services industries in which we have developed specialized lending expertise. The increase in the communications, media, and entertainment businesses over 1998 was $253 million, or 13 percent, and the increase over 1998 in the energy capital services units was $206 million, or 12 percent.
CONSTRUCTION AND COMMERCIAL MORTGAGE LOANS
We engage in non-residential real estate lending that includes commercial mortgage loans and construction loans secured by deeds of trust. Construction loans are made primarily to commercial property developers and to residential builders.
At December 31, 1999, construction loans were $648 million, or 3 percent of the total loan portfolio. The increase of $208 million, or 47 percent, from the previous year-end was primarily attributable to the favorable California real estate market coupled with the continuing improvement in the West Coast economy.
At December 31, 1999, the commercial real estate mortgage loan portfolio was $3.6 billion, or 14 percent of the total loan portfolio. Commercial mortgage loans increased by $597 million, or 20 percent, from December 31, 1998, reflecting both the favorable California real estate market and the continued improvement in the West Coast economy.
RESIDENTIAL MORTGAGE LOANS
We originate residential loans, secured by one-to-four family residential properties, through our branch network in California, Oregon and Washington, and periodically purchase loans in our market area.
At December 31, 1999, residential mortgage loans were $2.6 billion, or 10 percent of the total loan portfolio. The decrease of $47 million, or 2 percent, from December 31, 1998 was principally due to prepayments arising from the lower interest rate environment in the early part of 1999.
CONSUMER LOANS
Through our auto dealer relationships and our branch network, we originate consumer loans, such as indirect and direct vehicle-secured installment loans, and home equity lines where advances are generally secured by second deeds of trust on residential real estate.
At December 31, 1999, consumer loans were $2.7 billion, or 10 percent of the total loan portfolio. The decrease of $153 million, or 5 percent, from the previous year-end was attributable to a reduction in home equity loans as customers refinanced to take advantage of favorable long-term, fixed mortgage rates. In the second quarter of 1998, we sold our $253 million credit card portfolio.
LEASE FINANCING
We enter into direct financing and leveraged leases primarily through our Equipment Leasing Division, and also through an agreement with a subsidiary of The Bank of Tokyo-Mitsubishi, Ltd. In addition, we originate auto leases through our Consumer Asset Management division, a part of the Community Banking Group.
At December 31, 1999, lease financing outstandings were $1.1 billion, or 4 percent of the total loan portfolio. During 1998, management created new initiatives for lending, especially in the lease financing segment. This refocus on leasing has continued in 1999 and resulted in a $117 million, or 11 percent, increase in lease financing over the prior year.
LOANS ORIGINATED IN FOREIGN BRANCHES
Our loans originated in foreign branches consist primarily of short-term extensions of credit to financial institutions located primarily in Asia and to corporations in Japan, Korea and Taiwan.
At December 31, 1999, loans originated in foreign branches totaled $1.1 billion, or 4 percent of the total loan portfolio. The decrease of $162 million, or 12 percent, is primarily attributable to the contraction of our exposure to key Asian markets, as we continue to monitor the economic situation in those markets.
CROSS-BORDER OUTSTANDINGS
Our cross-border outstandings reflect certain additional economic and political risks that are not reflected in domestic outstandings. These risks include those arising from exchange rate fluctuations and restrictions on the transfer of funds. The following table sets forth our cross-border outstandings as of December 31, 1997, 1998 and 1999 for each country where such outstandings exceeded 1 percent of total assets. The cross-border outstandings were compiled based upon category and domicile of ultimate risk and are comprised of balances with banks, trading account assets, securities available for sale, securities purchased under resale agreements, loans, accrued interest receivable, acceptances outstanding and investments with foreign entities. The amounts outstanding for each country exclude local currency
outstandings. For those individual countries shown in the table below, we do not have significant local currency outstandings that are not hedged or are not funded by local currency borrowings.
The economic condition and the ability of some countries, to which we have cross-border exposure, to manage their external debt obligations has been impacted by the Asian economic crisis that began in the second half of 1997. The Asian economic crisis appears to have stabilized, though other global markets may continue to have difficulties. Our exposure in all affected countries continues to be primarily short-term in nature and substantially related to the finance of trade. For further discussion on the actions taken by management to reduce our credit exposure in Asia and Latin America, see "Allowance for Credit Losses" on the following page.
PROVISION FOR CREDIT LOSSES
We recorded no provision for credit losses in 1997, a $45 million provision for credit losses in 1998 and a $65 million provision for credit losses in 1999. Provisions for credit losses are charged to income to bring our allowance for credit losses to a level deemed appropriate by management based on the factors discussed under "Allowance for Credit Losses" on the following page. No provision for credit losses was recorded in 1997 because, based on our review of such factors, management believed that the allowance for credit losses was adequate to cover probable losses inherent in the loan portfolio and firm commitments at each quarter end, including December 31, 1997. We resumed recording provisions in 1998 in order to bring our allowance for credit losses to a level deemed appropriate by management based upon management's application of the allowance methodology.
ALLOWANCE FOR CREDIT LOSSES
The following table reflects the allowance allocated to each respective loan category at period end and as a percentage of the total period end balance of that loan category, as set forth in the "Loans" table on page.
ALLOWANCE POLICY AND METHODOLOGY
We maintain an allowance for credit losses to absorb losses inherent in the loan portfolio. The allowance is based on our regular, quarterly assessments of the probable estimated losses inherent in the loan portfolio, and to a lesser extent, unused commitments to provide financing. Our methodology for measuring the appropriate level of the allowance relies on several key elements, which include the formula allowance, specific allowances for identified problem loans and portfolio segments and the unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding loans and certain unused commitments, in each case based on the internal risk grade of such loans, pools of loans, leases and commitments. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and may be adjusted for significant factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. Loss factors are developed in the following ways:
- Problem graded loan loss factors are derived from a migration model that tracks historical loss experience over a period we believe is reflective of a business cycle,
- Pass graded loan loss factors are based on the average annual net charge-off rate over a period we believe is reflective of a business cycle,
- Pooled loan loss factors (not individually graded loans) are based on expected net charge-offs for one year. Pooled loans are loans that are homogeneous in nature, such as consumer installment and residential mortgage loans and automobile leases.
We believe that a business cycle is a period in which both upturns and downturns in the economy have been reflected. The current economic expansion has required us to extend our historical perspective to capture the highs and lows of a typical economic cycle.
Specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate the probability that a loss has been incurred. This amount may be determined either by a method prescribed by Statement of Financial
Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan", or by a method which identifies certain qualitative factors.
The unallocated allowance is composed of two elements. The first element consists of an amount between 20 percent to 25 percent of the total of the formula and specific allowances. This element recognizes the model and estimation risk associated with the formula and specific allowances. The second element is based upon management's evaluation of various conditions, the effects of which are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the unallocated allowance include the following, which existed at the balance sheet date:
- General economic and business conditions affecting our key lending areas,
- Credit quality trends (including trends in nonperforming loans expected to result from existing conditions),
- Collateral values,
- Loan volumes and concentrations,
- Seasoning of the loan portfolio,
- Specific industry conditions within portfolio segments,
- Recent loss experience in particular segments of the portfolio,
- Duration of the current business cycle,
- Bank regulatory examination results, and
- Findings of our internal credit examiners.
Executive management reviews these conditions quarterly in discussion with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's estimate of the effect of such condition may be reflected as a specific allowance, applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management's evaluation of the probable loss related to such condition is reflected in the unallocated allowance.
The allowance for credit losses is based upon estimates of probable losses inherent in the loan portfolio. The amount actually observed for these losses can vary significantly from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. The loss migration model that is used to establish the loan loss factors for problem graded loans is designed to be self-correcting by taking into account our recent loss experience. Similarly, by basing the pass graded loan loss factors over a period reflective of a business cycle, the methodology is designed to take our recent loss experience into account. Pooled loan loss factors are adjusted quarterly based upon the level of net charge-offs expected by management in the next twelve months. Furthermore, our methodology permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management's judgment, significant factors, which affect the collectibility of the portfolio as of the evaluation date, are not reflected in the loss factors. By assessing the probable estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon the most recent information that has become available.
COMPARISON OF THE TOTAL ALLOWANCE AND RELATED PROVISON FOR CREDIT LOSSES
At December 31, 1997, our total allowance for credit losses was $452 million, or 1.99 percent of the total loan portfolio and 413 percent of total nonaccrual loans. At December 31, 1998, our total allowance for credit losses was $459 million or 1.89 percent of the total loan portfolio and 586 percent of total nonaccrual loans. At December 31, 1999, our total allowance for credit losses was $470 million, or 1.82 percent of the total loan portfolio and 281 percent of total nonaccrual loans. In addition, the allowance incorporates the results of measuring impaired loans as provided in SFAS No. 114 and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures". These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. At December 31, 1997, total impaired loans were $108 million, and the associated impairment allowance was $9 million compared with $78 million and $11 million, respectively, at December 31, 1998 and $167 million and $42 million, respectively, at December 31, 1999.
During 1997, 1998 and 1999, there were no changes in estimation methods or assumptions that affected our methodology for assessing the appropriateness of the formula and specific allowances for credit losses, except that we adjusted the periods contained within, what we believe reflects, a business cycle as explained on page. The impact of these adjustments in the formula allowance for 1997, 1998 and 1999 increased the formula allowance by $13 million, $19 million and $28 million, respectively. Changes in estimates and assumptions regarding the effects of economic and business conditions on borrowers and other factors, which are described below, also affected the assessment of the unallocated allowance.
We recorded no provision in 1997, a $45 million provision in 1998 and a $65 million provision in 1999. Although the level of net charge-offs and the decline of nonperforming loans during 1998 favorably impacted our asset quality ratios, the total portfolio of commercial, financial and industrial loans and commercial mortgage loans has been increasing. Losses inherent in both of these types of credit are more difficult to assess because historically they have been more volatile than losses from other credits. During 1999, we experienced additional growth in these two areas as well as a moderate increase in nonaccrual loans, primarily in the commercial, financial and industrial category.
The following table sets forth the allowance for credit losses.
CHANGES IN THE FORMULA AND SPECIFIC ALLOWANCES
At December 31, 1998, the formula allowance decreased by $6 million from the prior year, primarily due to a decline in criticized credits, offset by the extension of the average annual net charge-off rate for pass graded loans. At December 31, 1999, the formula allowance increased by $51 million from the prior year, primarily due to increases in criticized credits and downward migration within the criticized range.
At December 31, 1998, the specific allowance decreased by $30 million from the prior year primarily due to the sale of real estate notes. At December 31, 1999, the specific allowance increased by $13 million from the prior year due to the increases in both the level of our impaired loans and the degree of the
impairment offset by the elimination of the $26 million allowance on Asian country exposures. This exposure has been captured in the formula allowance.
At December 31, 1997, the allocated portion of the allowance for credit losses included $108 million related to special mention and classified credits, compared to $76 million at December 31, 1998 and $145 million at December 31, 1999. Special mention and classified credits are those that are internally risk graded as "special mention", "substandard" or "doubtful". Special mention credits are potentially weak, as the borrower has begun to exhibit deteriorating trends which, if not corrected, could jeopardize repayment of the loan and result in further downgrade. Substandard credits have well-defined weaknesses which, if not corrected, could jeopardize the full satisfaction of the debt. A credit classified as "doubtful" has critical weaknesses that make full collection improbable.
CHANGES IN THE UNALLOCATED ALLOWANCE
At December 31, 1998, the unallocated allowance increased $43 million from the previous year-end, primarily the result of certain conditions that adversely impacted the technology, agriculture and oil and gas industries. At December 31, 1999, the unallocated allowance declined $53 million from the prior year because management believed that the inherent losses related to certain conditions, described on page, considered in its evaluation of the unallocated allowance at December 31, 1998 had been recognized through charge-offs, had been reflected in the formula or specific allowance or had declined.
The following chart identifies the components of the attribution of the unallocated and the range of inherent loss.
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nm = not meaningful for this assessment.
In our assessment as of December 31, 1997, management focused, in particular, on the following factors:
- With respect to the adverse impact of the Asian financial turmoil, which could be in the range of $46 million to $94 million.
- With respect to cross-border loans and acceptances to Latin American countries, management considered the continued effects of the local financial turmoil, which could be in the range of $5 million to $8 million.
- With respect to the margin for model and estimation risk, which could be in the range of $56 million to $70 million.
In our assessment as of December 31, 1998, management focused, in particular, on the following factors:
- With respect to oil and gas, we considered the effects of the decline in oil prices on the cash flows of borrowers in the oil and gas industry, which could be in the range of $14 million to $22 million.
- With respect to the technology industry, management considered the effects of export market conditions and cyclical over-capacity on borrowers in the chip and semiconductor industries, which could be in the range of $18 million to $27 million.
- With respect to the agricultural industry, we considered the effects of abnormal weather conditions and export market conditions on agricultural borrowers, which could be in the range of $11 million to $16 million.
- With respect to cross-border loans and acceptances to certain Asia/Pacific countries, management considered the improving but continuing effects of the global financial turmoil, which changed the range to $55 million to $80 million.
- With respect to cross-border loans and acceptances to Latin American countries, management considered the continued effects of the global financial turmoil, which could be in the range of $10 million to $15 million.
- With respect to the margin for model and estimation risk, which could be in the range of $49 million to $61 million.
In our assessment as of December 31, 1999, management focused, in particular, on the following factors:
- With respect to the agriculture industry, we considered the reduction of the impact of previous years' abnormal weather conditions and improvement in export market conditions on agricultural borrowers, which has reduced the exposure to a range of $3 million to $6 million.
- With respect to the technology industry, management considered the improvements in export market conditions and the reduction in the cyclical over-capacity on borrowers in the chip and semiconductor industries, which has reduced the exposure to a range of $15 million to $22 million.
- With respect to cross-border loans and acceptances to certain Asia/Pacific countries, management considered the improving but continuing effects of the global financial turmoil, which has reduced the exposure to a range of $18 million to $39 million.
- With respect to cross-border loans and acceptances to Latin America, primarily Brazil, management considered the improving but continuing effects of the global financial turmoil, which has reduced the exposure to a range of $4 million to $7 million.
- With respect to oil and gas, management considered the effects of rising oil prices and the improvement in the cash flows of borrowers in the oil and gas industry, which no longer required an attribution of the unallocated allowance.
- With respect to the margin for model and estimation risk, which could be in the range of $62 million to $77 million.
There can be no assurance that the adverse impact of any of these conditions on us will not be in excess of the range set forth above. See paragraph on forward-looking statements on page.
Although in certain instances the downgrading of a loan resulting from these effects was reflected in the formula allowance, management believed that in most instances the impact of these events on the collectibility of the applicable loans was not reflected in the level of nonperforming loans or in the internal risk grading process with respect of such loans. Accordingly, our evaluation of the probable losses related to these factors was reflected in the unallocated allowance. The evaluations of the inherent losses with respect to these factors were subject to higher degrees of uncertainty because they were not identified with specific problem credits.
CHANGE IN THE TOTAL ALLOWANCE FOR CREDIT LOSSES
The following table sets forth a reconciliation of changes in our allowance for credit losses.
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(1) Foreign loans are those loans originated in foreign branches.
nm = not meaningful
Loans charged off in 1998 decreased by $46 million, primarily due to a $20 million decrease in commercial, financial and industrial loans charged off as portfolio quality improved, and a $26 million decrease in consumer loans charged off, primarily due to the sale of the credit card portfolio in the second quarter of 1998. Loans charged off in 1999 increased by $5 million over 1998, primarily due to a $10 million increase in commercial, financial and industrial loans and a $14 million increase in foreign loans charged off, partially offset by a $14 million decrease in consumer loans charged off and a $6 million decrease in mortgage loans charged off. The foreign loan charge-off consisted of a single Taiwanese credit. Charge-offs reflect the realization of losses in the portfolio that were recognized previously through
provisions for credit losses. Recoveries of loans previously charged off in 1998 decreased by $10 million from 1997, and the percentage of current year recoveries to loans charged off in the previous year decreased from 42.83 percent in 1997 to 33.51 percent in 1998. Recoveries of loans previously charged off in 1999 decreased by $14 million over 1998, and the percentage of current year recoveries to loans charged off in the previous year increased from 33.51 percent in 1998 to 35.86 percent in 1999. At December 31, 1999, the allowance for credit losses exceeded the net loans charged off during 1999, reflecting management's belief, based on the foregoing analysis, that there were additional losses inherent in the portfolio.
At December 31, 1997, our average annual net charge-offs for the past five years were $131 million, compared with $88 million at December 31, 1998 and $59 million at December 31, 1999. These net charge-offs represent 3.4 years, 5.2 years and 8.0 years of losses based on the level of the allowance for credit losses at December 31, 1997, 1998 and 1999, respectively. Historical net charge-offs are not necessarily indicative of the amount of net charge-offs that we will realize in the future.
NONPERFORMING ASSETS
Nonperforming assets consist of nonaccrual loans, renegotiated loans, and foreclosed assets. Nonaccrual loans are those for which management has discontinued accrual of interest because there exists significant uncertainty as to the full and timely collection of either principal or interest or such loans have become contractually past due 90 days with respect to principal or interest. For a more detailed discussion of the accounting for nonaccrual loans, see Note 1 to our Consolidated Financial Statements.
Renegotiated loans are those accruing loans for which, for reasons related to the borrower's financial difficulties, we have amended the terms of the original loan agreement and the borrower is performing according to the renegotiated terms.
Foreclosed assets include property where we acquired title through foreclosure or "deed in lieu" of foreclosure. On an ongoing basis, foreclosed asset values are reviewed and any decline in value is recognized as noninterest expense in the current period.
The following table sets forth an analysis of nonperforming assets.
The following table sets forth an analysis of loans contractually past due 90 days or more as to interest or principal, but not included in nonaccrual loans above.
At December 31, 1999, nonperforming assets totaled $170 million, an increase of $80 million, or 89 percent, from year-end 1998. The increase was concentrated among several large credits in different industry sectors. We do not believe that the magnitude of this increase is indicative of an on-going trend.
Nonaccrual and renegotiated loans as a percentage of total loans were 0.32 percent at December 31, 1998 compared with 0.65 percent at December 31, 1999. Nonperforming assets as a percentage of total loans and foreclosed assets increased to 0.66 percent at year-end 1999 from 0.37 percent at December 31, 1998. At December 31, 1999, approximately 95 percent of nonaccrual loans were related to commercial, financial and industrial.
Total loans 90 days or more past due and still accruing were $31 million at December 31, 1998 compared with $12 million at December 31, 1999.
INTEREST FOREGONE
Interest foregone during 1998 and 1999 for loans that were on nonaccrual status at December 31, 1998 and 1999 was $4 million and $8 million, respectively. We recognized less than $1 million in interest income during 1998 and 1999 for loans that were on nonaccrual status at December 31, 1998 and December 31, 1999, respectively.
SECURITIES
The following tables summarize the composition of the securities portfolio and the gross unrealized gains and losses within the portfolio.
SECURITIES AVAILABLE FOR SALE
SECURITIES HELD TO MATURITY
Management of the securities portfolio involves the maximization of return while maintaining prudent levels of quality and liquidity. At December 31, 1999, approximately 96 percent of total securities were investment grade.
ANALYSIS OF SECURITIES PORTFOLIO
The following tables show the remaining contractual maturities and expected yields of the securities portfolio at December 31, 1999.
SECURITIES AVAILABLE FOR SALE
SECURITIES HELD TO MATURITY
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(1) The remaining contractual maturities of mortgage-backed securities were allocated assuming no prepayments. The contractual maturity of these securities is not a reliable indicator of their expected life because borrowers have the right to repay their obligations at any time.
(2) Yields on tax-exempt municipal securities are presented on a taxable-equivalent basis using the current federal statutory rate of 35 percent.
(3) Equity securities do not have a stated maturity and are included in the total column only.
(4) For the purposes of the analysis of the securities portfolio, yields are based on amortized cost.
LOAN MATURITIES
The following table presents our loans by maturity.
CERTIFICATES OF DEPOSIT OF $100,000 AND OVER
The following table presents domestic certificates of deposit of $100,000 and over by maturity.
We offer certificates of deposit of $100,000 and over at market rates of interest. Many of these certificates are issued to customers, both public and private, who have done business with us for an extended period. Based on our historical experience, we expect that as these deposits come due, the majority will continue to be renewed at market rates of interest.
Substantially all of our deposits in foreign branches are certificates of deposit of $100,000 and over and mature in less than one year.
BORROWED FUNDS
The following table presents information on our borrowed funds.
CAPITAL ADEQUACY AND DIVIDENDS
Our principal capital objectives are to support future growth, to protect depositors, to absorb any unanticipated losses and to comply with various regulatory requirements. Management believes that we have retained our capital at a level that supports our risk structure, as well as providing for anticipated growth of current business activities and strategic expansion.
Total shareholders' equity was $3.0 billion at December 31, 1999, a decrease of $71 million from year-end 1998. This change was primarily a result of $442 million of net income for 1999, offset by dividends on common stock of $135 million, repurchases of our common stock of $329 million, and net unrealized losses on securities available for sale of $62 million. Of the $329 million repurchases of our common stock, $312 million related to repurchases from The Bank of Tokyo-Mitsubishi, Ltd. and Meiji Life Insurance Company and $17 million related to planned repurchases under the $100 million stock repurchase program announced in November 1999.
We offer a dividend reinvestment plan that allows shareholders to reinvest dividends in our common stock at 5 percent below the market price. During 1999, The Bank of Tokyo-Mitsubishi, Ltd. did not participate in the plan.
Capital adequacy depends on a variety of factors including asset quality and risk profile, liquidity, earnings stability, competitive and economic conditions, and management. We believe that the current
level of profitability, coupled with a prudent dividend policy, is adequate to support normal growth in operations while meeting regulatory capital guidelines.
The following table summarizes our risk-based capital, risk-weighted assets, and risk-based capital ratios.
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(1) Tier 1 capital divided by quarterly average assets (excluding certain intangible assets).
We and Union Bank of California, N.A. are subject to various regulations of the federal banking agencies, including minimum capital requirements. We and Union Bank of California, N.A. are required to maintain minimum ratios of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to quarterly average assets (the leverage ratio).
Compared with December 31, 1998, our Tier 1 risk-based capital ratio at December 31, 1999 increased 30 basis points to 9.94 percent, our total risk-based capital ratio increased 18 basis points to 11.79 percent, and our leverage ratio increased 72 basis points to 10.10 percent. The increase in our capital ratios was primarily attributable to retained earnings growing faster than both risk-weighted assets and average assets.
As of December 31, 1999, management believed the capital ratios of Union Bank of California, N.A. met all regulatory requirements of a "well-capitalized" institution.
COMPARISON OF FINANCIAL RESULTS OF 1997 TO 1998
Net income in 1997 was $411 million, compared to $466 million in 1998. Net income applicable to common stock was $404 million, or $2.30 per diluted common share, in 1997, compared with $466 million, or $2.65 per diluted common share, in 1998. This increase in diluted earnings per share of 15 percent over 1997 was due to a 7 percent increase in net interest income, a 15 percent increase in noninterest income, and a decline in the effective income tax rate of 6 percentage points, partially offset by a $45 million increase in the provision for credit losses and a 9 percent increase in noninterest expense. Other highlights for 1998 include:
- Net interest income, on a taxable-equivalent basis, was $1.3 billion in 1998, an increase of $86 million, or 7 percent, over 1997. Net interest margin in 1998 was 4.81 percent, an increase of 11 basis points over 1997.
- No provision for credit losses was recorded in 1997, compared with $45 million in 1998. This resulted from management's regular assessment of overall credit quality, loan growth and economic conditions in relation to the level of the allowance for credit losses. The allowance for credit losses was $452 million, or 413% of total nonaccrual loans, at December 31, 1997, compared with
$459 million, or 586% of total nonaccrual loans, at December 31, 1998. Net loans charged off for 1998 were $36 million.
- Noninterest income was $534 million in 1998, an increase of $71 million, or 15 percent, over 1997. This increase includes the $17 million gain from the sale of the credit card portfolio in the second quarter of 1998. Service charges on deposit accounts grew $24 million, or 21 percent; trust and investment management fees increased $14 million, or 13 percent; international commissions and fees increased $6 million, or 9 percent; merchant banking fees increased $6 million, or 26 percent; and securities gains, net, increased $3 million.
- Noninterest expense was $1.1 billion in 1998, an increase of $91 million, or 9 percent, over 1997. Personnel-related expense increased $46 million, or 8 percent; other noninterest expense increased $16 million, or 19 percent; and professional services increased $9 million, or 31 percent.
- The effective tax rate for 1997 was 37 percent, compared with 31 percent for 1998. The effective tax rate for 1997 was favorably affected by an after-tax refund of $25 million from the FTB for tax years 1975-1987. The primary reason for the lower 1998 effective tax rate was the filing of our 1997, and our intention to file our 1998, California franchise tax returns on a worldwide unitary basis, which incorporates the results of The Bank of Tokyo-Mitsubishi, Ltd. and its worldwide affiliates. Excluding the FTB refund in 1997 and the $60 million state tax reduction in 1998, the effective tax rates would have been 41 percent and 40 percent, respectively.
- The return on average assets for 1998 increased to 1.53 percent, compared to 1.39 percent for 1997. The return on average common equity for 1998 increased to 16.39 percent, compared to 16.05 percent for 1997.
- Total loans at December 31, 1998 were $24.3 billion, an increase of $1.6 billion, or 7 percent, over year-end 1997.
- At December 31, 1998, our Tier 1 risk-based capital ratio was 9.64 percent and our total risk-based capital ratio was 11.61 percent, exceeding the minimum regulatory guidelines for bank holding companies of 4 percent and 8 percent, respectively. The Tier 1 and total risk-based capital ratios for Union Bank of California, N.A. at December 31, 1998 exceeded the regulatory guidelines for "well-capitalized" banks. Our leverage ratio was 9.38 percent at December 31, 1998, exceeding the minimum regulatory guideline for bank holding companies.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
GENERAL
Market risk is the risk of loss to future earnings, to fair values, or to future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, foreign currency exchange rates, commodity prices, equity prices, and other market changes that affect market risk sensitive instruments. Market risk is attributed to all market risk sensitive financial instruments, including securities, loans, deposits, and borrowings, as well as derivative instruments. Our exposure to market risk is a function of our asset and liability management activities, our trading activities for our own account, and our role as a financial intermediary in customer-related transactions. The objective of market risk management is to avoid excessive exposure of our earnings and equity to loss and to reduce the volatility inherent in certain financial instruments.
The management of market risk is governed by policies reviewed and approved annually by our Board of Directors (Board). The Board delegates responsibility for market risk management to the Asset & Liability Management Committee (ALCO), which reports quarterly to the Finance and Capital Committee of the Board on activities related to the management of market risk. As part of the management of our market risk, ALCO may direct changes in the mix of assets and liabilities and the use of derivative
instruments such as interest rate swaps, caps and floors. ALCO also reviews and approves market risk-management programs and market risk limits. The ALCO Chairman is responsible for the company-wide management of market risk. The Treasurer is responsible for implementing funding, investment, and hedging strategies designed to manage this risk. On a day-to-day basis, the oversight of market risk management takes place at a centralized level within the Risk Monitoring Unit (RMU). The RMU is responsible for measuring risks to ensure compliance with all market risk limits and guidelines incorporated within the policies and procedures established by ALCO. The RMU reports monthly to ALCO on the effectiveness of our hedging activities, on trading risk exposures, and on compliance with policy limits. In addition, periodic reviews by internal audit, regulators and independent accountants provide further evaluation of controls over the risk management process.
We have separate and distinct methods for managing the market risk associated with our trading activities and our asset and liability management activities, as described below.
INTEREST RATE RISK MANAGEMENT (OTHER THAN TRADING)
We engage in asset and liability management activities with the objective of reducing adverse changes in earnings as a result of changes in interest rates. The management of interest rate risk relates to the timing and magnitude of the repricing of assets compared to liabilities and has, as its objective, the control of risks associated with movements in interest rates.
The Asset & Liability Management (ALM) Policy approved by the Board requires monthly monitoring of interest rate risk by ALCO. As part of the management of our interest rate risk, ALCO may direct changes in the composition of the balance sheet and the extent to which we utilize off-balance sheet derivative instruments such as interest rate swaps, floors, and caps.
Our unhedged balance sheet is inherently "asset-sensitive", which means that assets generally reprice more often than liabilities. Since an asset-sensitive balance sheet tends to reduce net interest income when interest rates decline and to increase net interest income when interest rates rise, off-balance sheet hedges and the securities portfolio are used to manage this interest rate risk.
One method of measuring interest rate risk is by measuring the interest rate sensitivity gap, which is the difference between earning assets and liabilities maturing or repricing within specified periods. The table on page presents such an analysis, which reflects certain assumptions as to the rate sensitivity of deposits without contractual maturities or repricing dates. These include demand deposits, money market demand accounts, and savings deposits. Additional assumptions such as prepayment estimates for residential mortgages and mortgage-backed securities are made to reflect the probable behavior of those assets. The section of the table on page entitled "Interest Rate Risk Management Positions" presents the effects of the securities portfolio and of derivatives used for hedging, such as interest rate swaps and floors, in reducing the interest rate sensitivity gap primarily for LIBOR-based loans.
Gap analysis has significant limitations as a method for measuring interest rate risk since changes in interest rates do not affect all categories of assets and liabilities in the same way. To address these limitations, we use a simulation model to quantify the impact of changing interest rates on net interest income (NII). A frequency distribution of simulated 12-month NII outcomes based on rate scenarios produced through a Monte Carlo rate generation process is prepared monthly to statistically determine the mean NII. The amount of Earnings at Risk (EaR), defined as the potential negative change in NII, is measured at a 97.5 percent confidence level and is managed within the limit established in the Board's
ALM Policy at 5 percent of mean NII. The following table summarizes our EaR and EaR as a percentage of NII.
During 1999, our EaR increased significantly from the previous year because we allowed our asset sensitivity to rise, thus increasing interest income during the rising rate environment. With an asset-sensitive balance sheet, EaR measures the potential risk to earnings during a falling rate environment.
An additional limit established by the Board's ALM Policy is that under single interest rate shock scenarios, up or down 200 basis points, the difference between the lower simulated NII and the mean NII must be no more than 8 percent of the mean NII. The following table sets forth the change in simulated NII for both an upward and downward shock scenario of 200 basis points.
During 1999, our mean NII increased significantly from the previous year, largely due to the fact that we allowed our asset sensitivity to rise, thereby increasing net interest income. In addition, mean NII increased as a result of the $1.5 billion increase in average earning assets.
TRADING ACTIVITIES
We enter into trading account activities primarily as a financial intermediary for customers, and, to a lesser extent, for our own account. By acting as a financial intermediary, we are able to provide our customers with access to a wide range of products from the securities, foreign exchange, and derivatives markets. In acting for our own account, we may take positions in some of these instruments with the objective of generating trading profits. These activities expose us to two primary types of market risk: interest rate and foreign currency exchange risk.
In order to manage interest rate and foreign currency exchange risk associated with our trading activities, we utilize a variety of non-statistical methods including: position limits for each trading activity, daily marking of all positions to market, daily profit and loss statements, position reports, and independent verification of all inventory pricing. Additionally, the RMU reports positions and profits and losses daily to the Treasurer and trading managers and weekly to the ALCO Chairman. ALCO is provided reports on a monthly basis. We believe that these procedures, which stress timely communication between the RMU and senior management, are the most important elements of the risk management process.
We use a form of Value at Risk (VaR) methodology to measure the overall market risk inherent in our trading account activities. Under this methodology, management statistically calculates, with 97.5 percent confidence, the potential loss in fair value that we might experience if an adverse shift in market prices were to occur within a period of 5 business days. The amount of VaR is managed within limits well below the maximum limit established by Board policy at 0.5 percent of shareholders' equity. The VaR model incorporates a number of key assumptions, including assumed holding period and historical volatility based
on 3 years of historical market data updated quarterly. The following table sets forth the average, high and low VaR during the year for our trading activities.
The VaRs for foreign exchange trading increased during 1999 due to higher volumes of foreign exchange activities as well as higher approved trading limits. While the VaRs are significantly greater that the previous year, they are well within the limits established by our trading policy. The VaRs for securities trading declined significantly during 1999, reflecting the decision we made earlier this year to exit the municipal underwriting and certain other capital markets businesses.
Our interest rate derivative contracts include $2.9 billion of derivative contracts entered into as an accommodation for customers. We act as an intermediary and match these contracts at a profit with contracts with The Bank of Tokyo-Mitsubishi, Ltd. or other dealers, thus neutralizing the related market risk. We maintain responsibility for the credit risk associated with these contracts.
LIQUIDITY RISK
Liquidity risk represents the potential for loss as a result of limitations on our ability to adjust our future cash flows to meet the needs of depositors and borrowers and to fund operations on a timely and cost-effective basis. The ALM Policy approved by the Board requires quarterly reviews of our liquidity by the ALCO, which is composed of bank senior executives. Our liquidity management draws upon the strengths of our extensive retail and commercial market business franchise, coupled with the ability to obtain funds for various terms in a variety of domestic and international money markets. Liquidity is managed through the funding and investment functions of the Global Markets Group.
Core deposits provide us with a sizable source of relatively stable and low-cost funds. Our average core deposits, which include demand deposits, money market demand accounts, and savings and consumer time deposits, combined with average common shareholders' equity, funded 66 percent of average total assets of $32.1 billion for the year ended December 31, 1999. Most of the remaining funding was provided by short-term borrowings in the form of negotiable certificates of deposit, foreign deposits, federal funds purchased and securities sold under repurchase agreements, commercial paper and other borrowings. In 1999, we issued $350 million in trust preferred securities the proceeds of which were utilized to repurchase our common stock.
Liquidity may also be provided by the sale or maturity of assets. Such assets include interest bearing deposits in banks, federal funds sold and securities purchased under resale agreements, and trading account securities. The aggregate of these assets averaged $0.6 billion during 1999. Additional liquidity may be provided by investment securities available for sale that amounted to $3.2 billion at December 31, 1999, and by loan maturities. At December 31, 1999, $8.7 billion of loans were scheduled to mature within one year.
The following table summarizes our interest rate sensitivity based on expected repricings in the time frames indicated for the balance sheet and interest rate derivatives as of December 31, 1999. This table shows that assets that are rate sensitive within one year exceeded liabilities within that same period by $5.6 billion at December 31, 1999. Adjusted for the effects of the securities portfolio and derivatives used for hedging, this cumulative gap was $5.7 billion. At December 31, 1998, our assets that were rate sensitive within one year exceeded liabilities within that same period by $5.0 billion. Adjusted for the effects of the securities portfolio and derivatives used for hedging, this cumulative gap was reduced to $3.7 billion.
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(1) Certain balance sheet classifications used for interest rate sensitivity analysis do not conform to the Consolidated Balance Sheets on.
(2) Items that neither reprice nor mature are included in the "After 5 years" column.
(3) Interest rate sensitivity of non-maturity deposit accounts are based on assumptions for a declining interest rate scenario since our balance sheet is asset-sensitive.
(4) 70 percent of the demand deposit account balance is assumed to be "core" deposits, which are not sensitive to interest rate changes.
(5) Floors purchased affect interest rate sensitivity in a declining interest rate scenario.
(6) Floors and swaps that mature within the same period are excluded.
YEAR 2000
The Year 2000 problem exists because many computer programs use only the last two digits to refer to a year. This convention could affect date-sensitive calculations that treat "00" as the year 1900, rather than as the year 2000. Another issue is that the year 2000 is a leap year and some programs may not properly provide for February 29, 2000.
We achieved a successful transition to the Year 2000. Considering the complexity of our operations and the breadth of our technology, few problems occurred. None were more serious than the occasional problems that occur from time to time in normal ongoing banking operations, and all were dealt with satisfactorily. In addition, no problems with vendors or customers have yet been identified or experienced.
We have largely completed the extensive Year 2000 Program that made the successful transition possible. The principal tasks remaining are to perform tests of quarter-end processing and monitoring ongoing operations for problems that may occur in the months ahead. See page for information on the cost of the Year 2000 Program.
CERTAIN BUSINESS RISK FACTORS
ADVERSE CALIFORNIA ECONOMIC CONDITIONS COULD ADVERSELY AFFECT OUR BUSINESS
A substantial majority of our assets and deposits are generated in California. As a result, poor economic conditions in California may cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio. In the early 1990's, the California economy experienced an economic recession that resulted in increases in the level of delinquencies and losses for us and many of the state's other financial institutions. If California were to experience another recession, it is expected that our level of problem assets would increase accordingly. The current economic crisis in Asia is expected to continue to negatively impact the economic conditions in California, which could adversely affect our business.
ADVERSE ECONOMIC FACTORS AFFECTING CERTAIN INDUSTRIES COULD HAVE AN ADVERSE EFFECT ON OUR CUSTOMERS AND THEIR ABILITY TO MAKE PAYMENTS TO US
We are also subject to certain industry-specific economic factors. For example, a portion of our total loan portfolio is related to real estate obligations, and a portion of our recent growth has been fueled by the general real estate recovery in California. Accordingly, a downturn in the real estate industry in California could have an adverse effect on our operations. Similarly, a portion of our total loan portfolio is to borrowers in the agricultural industry. Adverse weather conditions, combined with low commodity prices, may adversely affect the agricultural industry and, consequently, may impact our business negatively.
FLUCTUATIONS IN INTEREST RATES COULD ADVERSELY AFFECT OUR BUSINESS
Significant increases in market interest rates, or the perception that an increase may occur, could adversely affect both our ability to originate new loans and our ability to grow. Conversely, a decrease in interest rates could result in an acceleration in the prepayment of loans. In addition, changes in market interest rates, or changes in the relationships between short-term and long-term market interest rates, or changes in the relationships between different interest rate indices, could affect the interest rates charged on interest earning assets differently than the interest rates paid on interest bearing liabilities. This difference could result in an increase in interest expense relative to interest income. An increase in market interest rates also could adversely affect the ability of our floating-rate borrowers to meet their higher payment obligations. If this occurred, it could cause an increase in nonperforming assets and charge-offs, which could adversely affect our business.
SHAREHOLDER VOTES ARE CONTROLLED BY THE BANK OF TOKYO-MITSUBISHI, LTD.
A majority of our directors are not officers or employees of UnionBanCal Corporation or any of our affiliates, including The Bank of Tokyo-Mitsubishi. However, because of The Bank of Tokyo-Mitsubishi's control over the election of our directors, The Bank of Tokyo-Mitsubishi could change the composition of our Board of Directors so that the Board would not have a majority of outside directors. The Bank of Tokyo-Mitsubishi, Ltd. owns a majority of the outstanding shares of our common stock. As a result, The Bank of Tokyo-Mitsubishi can elect all of our directors and, as a result, can control the vote on all matters, including determinations such as: approval of mergers or other business combinations; sales of all or substantially all of our assets; any matters submitted to a vote of our shareholders; issuance of any additional common stock or other equity securities; incurrence of debt other than in the ordinary course of business; the selection and tenure of our Chief Executive Officer; payment of dividends with respect to common stock or other equity securities; and matters that might be favorable to The Bank of Tokyo-Mitsubishi. The Bank of Tokyo-Mitsubishi's ability to prevent an unsolicited bid for us or any other change in control could have an adverse effect on the market price for our common stock.
THE BANK OF TOKYO-MITSUBISHI'S FINANCIAL CONDITION COULD ADVERSELY AFFECT OUR OPERATIONS
Although we fund our operations independently of The Bank of Tokyo-Mitsubishi and believe our business is not necessarily closely related to The Bank of Tokyo-Mitsubishi's business or outlook, The Bank of Tokyo-Mitsubishi's credit ratings may affect our credit ratings. The Bank of Tokyo-Mitsubishi's credit ratings were downgraded in October 1998 by Standard and Poor's Corporation and are currently on Moody's Investors Service, Inc.'s credit watch with negative implications. Any future downgrading of The Bank of Tokyo-Mitsubishi's credit rating could adversely affect our credit ratings. Therefore, as long as The Bank of Tokyo-Mitsubishi maintains a majority interest in us, deterioration in The Bank of Tokyo-Mitsubishi's financial condition could result in an increase in our borrowing costs and could impair our access to the public and private capital markets. The Bank of Tokyo-Mitsubishi is also subject to regulatory oversight and review. Our business operations and expansion plans could be negatively affected by regulatory concerns related to the Japanese financial system and The Bank of Tokyo-Mitsubishi.
POTENTIAL CONFLICTS OF INTEREST WITH THE BANK OF TOKYO-MITSUBISHI, LTD. COULD ADVERSELY AFFECT US
As part of The Bank of Tokyo-Mitsubishi's normal risk management processes, The Bank of Tokyo-Mitsubishi manages global credit exposures and concentrations on an aggregate basis, including us. Therefore, at certain levels, our ability to approve certain credits and categories of customers is subject to concurrence by The Bank of Tokyo-Mitsubishi. We may wish to extend credit to the same customer as The Bank of Tokyo-Mitsubishi. Our ability to do so may be limited for various reasons, including The Bank of Tokyo-Mitsubishi's aggregate credit exposure and marketing policies. Certain directors' and officers' ownership interests in The Bank of Tokyo-Mitsubishi's common stock or service as a director or officer or other employee of both us and The Bank of Tokyo-Mitsubishi could create or appear to create potential conflicts of interest, especially since both of us compete in the United States banking industry.
SUBSTANTIAL COMPETITION IN THE CALIFORNIA BANKING MARKET COULD ADVERSELY AFFECT US
Banking is a highly competitive business. We compete actively for loan, deposit, and other financial services business in California, as well as nationally and internationally. Our competitors include a large number of state and national banks, thrift institutions and major foreign-affiliated or foreign banks, as well as many financial and non-financial firms that offer services similar to those offered by us. Some of our competitors are community banks that have strong local market positions. Other competitors include large financial institutions (such as Bank of America, California Federal, Washington Mutual, and Wells Fargo) that have substantial capital, technology and marketing resources. Such large financial institutions may have greater access to capital at a lower cost than us, which may adversely affect our ability to compete effectively. In addition, there have been a number of recent mergers involving financial institutions located
in California. Some of the merged banks, such as Norwest/Wells Fargo, employ a strong community-based banking model of doing business that may increase competition with our distinctive combination of traditional community bank service coupled with a large branch network.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS COULD LIMIT AMOUNTS PAYABLE TO US
A substantial portion of our cash flow typically comes from dividends our bank and nonbank subsidiaries pay to us. Various statutory provisions restrict the amount of dividends our subsidiaries can pay to us without regulatory approval. In addition, if any of our subsidiaries liquidates, that subsidiary's creditors will be entitled to receive distributions from the assets of that subsidiary to satisfy their claims against it before we, as a holder of an equity interest in the subsidiary, will be entitled to receive any of the assets of the subsidiary. If, however, we are a creditor of the subsidiary with recognized claims against it, we would be in the same position.
ADVERSE EFFECTS OF BANKING REGULATIONS OR CHANGES IN BANKING REGULATIONS COULD ADVERSELY AFFECT US
We are subject to significant federal and state regulation and supervision, which is primarily for the benefit and protection of our customers and not for the benefit of investors. In the past, our business has been materially affected by these regulations. This trend is likely to continue in the future. Laws, regulations or policies currently affecting us and our subsidiaries may change at any time. Regulatory authorities may also change their interpretation of these statutes and regulations. Therefore, our business may be adversely affected by any future changes in laws, regulations, policies or interpretations. Additionally, our international activities may be subject to the laws and regulations of the jurisdiction where business is being conducted. International laws, regulations and policies affecting us and our subsidiaries may change at any time and affect our business opportunities and competitiveness in these jurisdictions. Due to The Bank of Tokyo-Mitsubishi's controlling ownership of us, laws, regulations and policies adopted or enforced by the Government of Japan may adversely affect our activities and investments and those of our subsidiaries in the future. Under long-standing policy of the Board of Governors of the Federal Reserve System, a bank holding company is expected to act as a source of financial strength for its subsidiary banks. As a result of that policy, we may be required to commit financial and other resources to our subsidiary bank in circumstances where we might not otherwise do so.
POSSIBLE FUTURE SALES OF SHARES BY THE BANK OF TOKYO-MITSUBISHI, LTD. COULD ADVERSELY AFFECT THE MARKET FOR OUR STOCK
Although The Bank of Tokyo-Mitsubishi has announced its intention to maintain its majority ownership in us, The Bank of Tokyo-Mitsubishi may sell shares of our common stock in compliance with the federal securities laws. By virtue of The Bank of Tokyo-Mitsubishi's current control of us, The Bank of Tokyo-Mitsubishi could sell large amounts of shares of our common stock by causing us to file a registration statement that would allow them to sell shares more easily. In addition, The Bank of Tokyo-Mitsubishi could sell shares of our common stock without registration pursuant to Rule 144 under the Securities Act. Although we can make no prediction as to the effect, if any, that such sales would have on the market price of our common stock, sales of substantial amounts of our common stock, or the perception that such sales could occur, could adversely affect our market price. If The Bank of Tokyo-Mitsubishi sells or transfers shares of our common stock as a block, another person or entity could become our controlling shareholder.
STRATEGIES
In connection with our strategic repositioning, we have developed long-term financial performance goals, which we expect to result from successful implementation of our operating strategies. We cannot assure you that we will be successful in achieving these long-term goals or that our operating strategies will
be successful. Achieving success in these areas is dependent on a number of factors, many of which are beyond our direct control.
Factors that may adversely affect our ability to attain our long-term financial performance goals include:
- deterioration of our asset quality,
- our inability to reduce noninterest expenses,
- our inability to increase noninterest income,
- our inability to decrease reliance on asset revenues,
- our ability to sustain loan growth,
- regulatory and other impediments associated with making acquisitions,
- deterioration in general economic conditions, especially in our core markets,
- decreases in net interest margins,
- increases in competition,
- adverse regulatory developments,
- unexpected increases in costs related to potential acquisitions, and
- unexpected increased costs associated with implementation of our efficiency improvement project.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS OR DIVESTITURES OR RESTRUCTURING
We may acquire or invest in companies, technologies, services or products that complement our business. In addition, we continue to evaluate performance of all of our businesses and business lines and may sell a business or business lines. Any acquisitions, divestitures or restructuring may result in potentially dilutive issuance of equity securities, significant write-offs, the amortization of expenses related to goodwill and other intangible assets and/or the incurrence of debt, any of which could have a material adverse effect on our business, financial condition and results of operations. Acquisitions, divestitures or restructuring could involve numerous additional risks including difficulties in the assimilation or separation of operations, services, products and personnel, the diversion of management's attention from other business concerns, the disruption of our business and the potential loss of key employees. There can be no assurance that we would be successful in overcoming these or any other significant risks encountered.
UNIONBANCAL CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
UNIONBANCAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
UNIONBANCAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
UNIONBANCAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
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(1) Includes dividends applicable to preferred shareholders of $7.6 million in 1997.
(2) Dividends per share were $0.51 in 1997, $0.61 in 1998, and $0.82 in 1999.
See accompanying notes to consolidated financial statements.
UNIONBANCAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1998, AND 1999
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
INTRODUCTION
UnionBanCal Corporation, a commercial bank holding company, and subsidiaries (the Company) was created on April 1, 1996 by the combination of Union Bank with BanCal Tri-State Corporation and its banking subsidiary, The Bank of California, N.A. (the Bank). The combination was accounted for as a reorganization of entities under common control (similar to a business combination under the pooling of interests method). Information pertaining to merger and integration expense is presented in Note 8.
On March 3, 1999, the Company completed a secondary offering of 28.75 million shares of its Common Stock owned by The Bank of Tokyo-Mitsubishi, Ltd. (BTM). The Company received no proceeds from this transaction. Concurrent with the secondary offering, the Company repurchased 8.6 million shares of its outstanding Common Stock from BTM and 2.1 million shares owned by Meiji Life Insurance Company with $312 million of the net proceeds from the issuance of $350 million of 7 3/8 percent trust preferred securities that occurred on February 19, 1999. After the secondary offering and the repurchase, BTM owns 64 percent of the Company, or 105.6 million shares, compared with 82 percent prior to the transaction.
The Company provides a wide range of financial services to consumers, small businesses, middle market companies and major corporations, primarily in California, Oregon, and Washington, but also nationally and internationally.
BASIS OF FINANCIAL STATEMENT PRESENTATION
The accounting and reporting policies of the Company conform to generally accepted accounting principles (GAAP) and general practice within the banking industry. Those policies that materially affect the determination of financial position, results of operations, and cash flows are summarized below.
The Consolidated Financial Statements include the accounts of the Company. All material intercompany transactions and balances have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts for prior periods have been reclassified to conform with current financial statement presentation.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest bearing deposits in banks, and federal funds sold and securities purchased under resale agreements, substantially all of which have maturities less than 90 days.
TRADING ACCOUNT ASSETS
Trading account assets are those financial instruments that management acquires with the intent to hold for short periods of time in order to take advantage of anticipated changes in market values. Substantially all of these assets are securities with a high degree of liquidity and a readily determinable market value. Interest earned, paid, or accrued on trading account assets is included in interest income using a method that generally produces a level yield. Realized gains and losses from the close out of
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED) trading account positions and unrealized market value adjustments are recognized in noninterest income. The reserve for derivative and foreign exchange contracts is presented as an offset to trading account assets. Changes in the reserve as a result of changes in the positive replacement cost of those contracts are provided as an offset to trading gains and losses.
SECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITY
The Company's securities portfolios consist of debt and equity securities that are classified either as securities available for sale or securities held to maturity.
Debt securities for which the Company has the positive intent and ability to hold until maturity are classified as securities held to maturity and carried at amortized cost.
Debt securities and equity securities with readily determinable market values that are not classified as either securities held to maturity or trading account assets are classified as securities available for sale and carried at fair value, with the unrealized gains or losses reported net of taxes as a component of accumulated other comprehensive income (loss) in shareholders' equity until realized.
Realized gains and losses arising from the sale of securities are based upon the specific identification method and included in noninterest income as securities gains (losses), net.
Interest income on debt securities includes the amortization of premiums and the accretion of discounts using the effective interest method and is included in interest income on securities. Dividend income on equity securities is included in noninterest income.
LOANS
Loans are reported at the principal amounts outstanding, net of unamortized nonrefundable loan fees and related direct loan origination costs. Deferred net fees and costs are recognized in interest income over the loan term using a method that generally produces a level yield on the unpaid loan balance. Nonrefundable fees and direct loan origination costs related to loans held for sale are deferred and recognized as a component of the gain or loss on sale. Interest income is accrued principally on a simple interest basis.
Nonaccrual loans are those for which management has discontinued accrual of interest because there exists significant uncertainty as to the full and timely collection of either principal or interest or such loans have become contractually past due 90 days with respect to principal or interest.
Interest accruals are continued for certain small business loans that are processed centrally, consumer loans, and one-to-four family residential mortgage loans. These loans are charged off or written down to their net realizable value based on delinquency time frames that range from 120 to 270 days, depending on the type of credit that has been extended. Interest accruals are also continued for loans that are both well-secured and in the process of collection. For this purpose, loans are considered well-secured if they are collateralized by property having a net realizable value in excess of the amount of principal and accrued interest outstanding or are guaranteed by a financially responsible and willing party. Loans are considered "in the process of collection" if collection is proceeding in due course either through legal action or other actions that are reasonably expected to result in the prompt repayment of the debt or in its restoration to current status.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED) When a loan is placed on nonaccrual, all previously accrued but uncollected interest is reversed against current period operating results. All subsequent payments received are first applied to unpaid principal and then to uncollected interest. Interest income is accrued at such time as the loan is brought fully current as to both principal and interest, and, in management's judgment, such loans are considered to be fully collectible. However, Company policy also allows management to continue the recognition of interest income on certain loans designated as nonaccrual. This portion of the nonaccrual portfolio is referred to as "Cash Basis Nonaccrual" loans. This policy only applies to loans that are well secured and in management's judgment are considered to be fully collectible. Although the accrual of interest is suspended, any payments received may be applied to the loan according to its contractual terms and interest income recognized when cash is received.
Loans are considered impaired when, based on current information, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including interest payments. Impaired loans are carried at the lower of the recorded investment in the loan, the estimated present value of total expected future cash flows, discounted at the loan's effective rate, or the fair value of the collateral, if the loan is collateral dependent. Additionally, some impaired loans with commitments of less than $1 million are aggregated for the purpose of measuring impairment using historical loss factors as a means of measurement. Excluded from the impairment analysis are large groups of smaller balance homogeneous loans such as consumer, installment, residential mortgage loans, and automobile leases.
Renegotiated loans are those in which the Company has formally restructured a significant portion of the loan. The remaining portion is normally charged off, with a concession either in the form of below market rate financing, or debt forgiveness on the charged off portion. Loans that have been renegotiated and have not met specific performance standards for payment are classified as renegotiated loans within the classification of nonperforming assets. Upon payment performance, such loans may be transferred from nonperforming status to accrual status.
The Company offers primarily two types of leases to customers: 1) direct financing leases where the assets leased are acquired without additional financing from other sources, and 2) leveraged leases where a substantial portion of the financing is provided by debt with no recourse to the Company. Direct financing leases are carried net of unearned income, unamortized nonrefundable fees and related direct costs associated with the origination or purchase of leases. Leveraged leases are carried net of nonrecourse debt.
ALLOWANCE FOR CREDIT LOSSES
The Company maintains an allowance for credit losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable estimated losses inherent in the loan portfolio, and to a lesser extent, unused commitments to provide financing. The allowance is increased by the provision for credit losses, which is charged against current period operating results and decreased by the amount of charge-offs, net of recoveries. The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowances and the unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding loans and certain unused commitments. Loss factors are based on the Company's historical loss experience and may be adjusted for significant factors that, in management's judgement, affect the collectibility of the portfolio as of the
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED) evaluation date. The Company derives the loss factors for problem graded loans from a loss migration model, for pass graded loans by using historical average net charge-offs during a business cycle, and for pooled loans by using expected net charge-offs for one year. Pooled loans are homogeneous in nature and include consumer installment, residential mortgage, automobile leases and other loans and leases.
Specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate the probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance.
The unallocated allowance is composed of two elements. The first element recognizes the model and estimation risk associated with the formula and specific allowances. The second element is based upon management's evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The conditions evaluated in connection with the unallocated allowance may include existing general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in particular segments of the portfolio, duration of the current business cycle, bank regulatory examination results and findings of the Company's internal credit examiners.
The allowance also incorporates the results of measuring impaired loans as provided in Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures". These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. A loan is considered impaired when management determines that it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan agreement. Impairment is measured by the difference between the recorded investment in the loan (including accrued interest, net deferred loan fees or costs and unamortized premium or discount) and the estimated present value of total expected future cash flows, discounted at the loan's effective rate, or the fair value of the collateral, if the loan is collateral dependent. In addition, the impairment allowance may include amounts related to certain qualitative factors that have yet to manifest themselves in the other measurements. Impairment is recognized by adjusting an allocation of the existing allowance for credit losses.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line method over the estimated useful life of each asset. Lives of premises range from ten to forty years; lives of furniture, fixtures and equipment range from three to eight years. Leasehold improvements are amortized over the term of the respective lease or 10 years, whichever is shorter.
OTHER ASSETS
Goodwill represents the excess of purchase price over the fair value of identifiable net assets of acquired companies and is reported as intangible assets. Goodwill is amortized using the straight-line method, generally over 15 years.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED) Other real estate owned (OREO) represents the collateral acquired through foreclosure in full or partial satisfaction of the related loan. OREO is recorded at the lower of the loan's unpaid principal balance or its fair value as established by a current appraisal, adjusted for disposition costs. Any write-down at the date of transfer is charged to the allowance for credit losses. OREO values, recorded in other assets, are reviewed on an ongoing basis and any decline in value is recognized as foreclosed asset expense in the current period. The net operating results from these assets are included in the current period in noninterest expense as foreclosed asset expense (income).
DERIVATIVE INSTRUMENTS HELD FOR TRADING OR CUSTOMER ACCOMMODATION
The Company enters into a variety of interest rate derivative contracts, primarily swaps, options and foreign exchange contracts, either for trading purposes, based on management's intent at inception, or as an accommodation to customers.
Derivatives held or issued for trading or customer accommodation are carried at fair value, with realized and unrealized changes in fair values on contracts included in noninterest income in the period in which the changes occur. Unrealized gains and losses are reported gross and included in trading account assets and other liabilities, respectively. Cash flows are reported net as operating activities.
DERIVATIVE INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING
The Company enters into a variety of derivative contracts as a means of reducing the Company's interest rate and foreign exchange exposures. At inception these contracts are evaluated in order to determine if they qualify for hedge accounting treatment and are accounted for either on a deferral, accrual or market value basis, depending on the nature of the Company's hedge strategy and the method used to account for the hedged item. Hedge criteria include demonstrating the manner in which the hedge will reduce risk, identifying the specific asset, liability or firm commitment being hedged, and citing the time horizon being hedged. A monthly evaluation is performed to ensure that continuing correlation exists between the hedge and the item being hedged.
Net interest settlements on interest rate swap, cap and floor agreements are recognized on an accrual basis as interest income or interest expense of the related asset or liability over the lives of the agreements. Premiums paid or received for interest rate caps and floors are amortized either to interest income or to interest expense of the related asset or liability over the lives of the agreements. If an agreement is terminated early, any resulting gain or loss is deferred and amortized as interest income or interest expense of the related asset or liability over the remaining life of the original agreement. Net settlement amounts are reported gross as other assets and other liabilities. Cash flows are reported net as operating activities.
FOREIGN CURRENCY TRANSLATION
Assets, liabilities and results of operations for foreign branches are recorded based on the functional currency of each branch. Since the functional currency of the branches is the local currency, the net assets are remeasured into U.S. dollars using a combination of current and historical exchange rates. The resulting gains or losses are included in shareholders' equity, as a component of accumulated other comprehensive income (loss), on a net of tax basis.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED) INCOME TAXES
The Company files consolidated federal and combined state income tax returns. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred taxes, which arise principally from temporary differences between the period in which certain income and expenses are recognized for financial accounting purposes and the period in which they affect taxable income, are included in the amounts provided for income taxes. Under this method, the computation of the net deferred tax liability or asset gives current recognition to changes in the tax laws.
NET INCOME PER COMMON SHARE
Basic earnings per share (EPS) is computed by dividing net income after preferred dividends by the weighted average number of common shares outstanding during the period. Diluted EPS incorporates the dilutive effect of common stock equivalents outstanding on an average basis during the period. Stock options (see Note 14) are a common stock equivalent. Also see Note 19.
EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
The Company provides a variety of benefit and incentive compensation plans for eligible employees and retirees. Provisions for the costs of these employee benefit and incentive plans and postretirement benefit plans are accrued and charged to expense when the benefit is earned.
STOCK-BASED COMPENSATION
As allowed under the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", the Company has chosen to continue to recognize compensation expense using the intrinsic value-based method of valuing stock options prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations. Under the intrinsic value-based method, compensation cost is measured as the amount by which the quoted market price of the Company's stock at the date of grant exceeds the stock option exercise price.
Compensation cost associated with the Company's unvested restricted stock issued under the management stock plan is measured based on the market price of the stock at the grant date and is expensed over the vesting period.
SEGMENT REPORTING
Business unit results are based on an internal management reporting system used by management to measure the performance of the units and the Company as a whole. The management reporting system identifies balance sheet and income statement items to each business unit based on internal management accounting policies. Net interest income is determined using the Company's internal funds transfer pricing system, which assigns a cost of funds to assets or a credit for funds to liabilities and capital based on their type, maturity or repricing characteristics. Noninterest income and expense directly or indirectly attributable to a business unit are assigned to that business. Economic capital is attributed to each business units using a Risk Adjusted Return on Capital (RAROC) methodology, which seeks to allocate capital to each business unit consistent with the level of risk they assume. These risks are primarily credit risk, market risk
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (CONTINUED) and operational risk. Credit risk is the potential loss in economic value due to the likelihood that the obligor will not perform as agreed. Market risk is the potential loss in fair value due to changes in interest rates, currency rates and volatilities. Operational risk is the potential loss due to failures in internal controls, system failures, or external events.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY GRANTOR TRUST
Company-obligated mandatorily redeemable preferred securities of subsidiary grantor trust (trust preferred securities) are accounted for as a liability on the balance sheet. Dividends (or distributions) on trust preferred securities are treated as interest expense on an accrual basis.
PENDING ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. SFAS No. 133 requires that derivative instruments used to hedge be identified specifically to assets, liabilities, firm commitments or anticipated transactions and measured as to effectiveness and ineffectiveness when hedging changes in fair value or cash flows. Derivative instruments that do not qualify as either a fair value or cash flow hedge will be valued at fair value with the resultant gain or loss recognized in current earnings. Changes in the effective portion of fair value hedges will be recognized in current earnings along with the change in fair value of the hedged item. Changes in the effective portion of the fair value of cash flow hedges will be recognized in other comprehensive income (loss) until realization of the cash flows of the hedged item through current earnings. Any ineffective portion of hedges will be recognized in current earnings. In June 1999, the FASB issued SFAS No. 137, "Deferral of the Effective Date of FASB Statement No. 133", to defer for one year the effective date of implementation of SFAS No. 133. SFAS No. 133, as amended by SFAS No. 137, is effective for fiscal years beginning after June 15, 2000, with earlier application encouraged. Management believes that, depending upon the accumulated net gain or loss of the effective portion of cash flow hedges at the date of adoption, the impact of SFAS No. 133 could have a material impact on other comprehensive income (loss). However, management believes that any ineffective portion of cash flow hedges or any other hedges will not have a material impact on the Company's financial position or results of operations. The Company expects to adopt SFAS No. 133 as of January 1, 2001.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 2--SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities are presented below.
SECURITIES AVAILABLE FOR SALE
SECURITIES HELD TO MATURITY
The amortized cost and fair value of securities, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 2--SECURITIES (CONTINUED) MATURITY SCHEDULE OF SECURITIES
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(1) The remaining contractual maturities of mortgage-backed securities are classified without regard to prepayments. The contractual maturity of these securities is not a reliable indicator of their expected life since borrowers have the right to repay their obligations at any time.
During the years ended 1997, 1998 and 1999, there were no sales or transfers from the securities held to maturity portfolio.
In 1997, proceeds from sales of securities available for sale were $172 million with gross realized gains of $3 million and no gross realized losses. In 1998, proceeds from sales of securities available for sale were $418 million with gross realized gains of $6 million and no gross realized losses. In 1999, proceeds from sales of securities available for sale were $210 million with gross realized gains of $8 million and no gross realized losses.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 3--LOANS AND ALLOWANCE FOR CREDIT LOSSES
A summary of loans, net of unearned interest and fees of $126 million and $120 million, at December 31, 1998 and 1999, respectively, is as follows:
Changes in the allowance for credit losses were as follows:
In 1998, the Company reclassified a $1.9 million previously established reserve for credit losses related to interest rate derivatives and foreign exchange contracts from the unallocated portion of the allowance for credit losses. The reserve for derivative and foreign exchange contracts is presented as an offset to trading account assets.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 3--LOANS AND ALLOWANCE FOR CREDIT LOSSES (CONTINUED) Nonaccrual loans totaled $78 million and $167 million at December 31, 1998 and 1999, respectively. There were no renegotiated loans at December 31, 1998 and 1999. Interest foregone on loans designated as nonaccrual at December 31, 1997, 1998 and 1999 was $6 million, $4 million and $8 million, respectively.
LOAN IMPAIRMENT
Impaired loans of the Company include commercial, financial and industrial, construction and commercial mortgage loans designated as nonaccrual. When the value of an impaired loan is less than the recorded investment in the loan, a portion of the Company's allowance for credit losses is allocated as an impairment allowance.
The Company's policy for recognition of interest income, charge-offs of loans, and application of payments on impaired loans is the same as the policy applied to nonaccrual loans.
The following table sets forth information about the Company's impaired loans.
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(1) These loans do not require an allowance for credit losses since the fair values of the impaired loans equal or exceed the recorded investments in the loans
(2) This amount was evaluated for impairment using three measurement methods as follows: $27 million, $53 million, and $141 million was evaluated using the present value of the expected future cash flows at December 31, 1997, 1998 and 1999, respectively; $53 million, $8 million, and $6 million was evaluated using the fair value of the collateral at December 31, 1997, 1998 and 1999, respectively; and $28 million, $17 million, and $21 million was evaluated using historical loss factors at December 31, 1997, 1998 and 1999, respectively.
RELATED PARTY LOANS
In some cases, the Company makes loans to related parties including its directors, executive officers, and their affiliated companies. At December 31, 1998, related party loans outstanding to individuals who served as directors or executive officers at anytime during the year totaled $138 million, as compared to $133 million at December 31, 1999. In the opinion of management, these related party loans were made on substantially the same terms, including interest rates and collateral requirements, as those terms prevailing at the date these loans were made. During 1998 and 1999, there were no loans to related parties which were charged off. Additionally, at December 31, 1998 and 1999, there were no loans to related parties which were nonperforming.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 4--PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation and amortization. As of December 31, 1998 and 1999, the amounts were:
Rental and depreciation and amortization expenses were as follows:
Future minimum lease payments are as follows:
Included in other liabilities in the accompanying December 31, 1999 Consolidated Balance Sheet is $13.5 million of future operating lease payments accrued in connection with the merger and the restructuring charge (also see Notes 7 and 8).
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 4--PREMISES AND EQUIPMENT (CONTINUED) A majority of the leases provide for the payment of taxes, maintenance, insurance, and certain other expenses applicable to the leased premises. Many of the leases contain extension provisions, escalation clauses, and purchase options. There are no restrictions on paying dividends, incurring additional debt or negotiating additional leases under the terms of the present lease agreements.
NOTE 5--DEPOSITS
At December 31, 1999, the Company had $417 million in domestic interest bearing time deposits with a remaining term of greater than one year, of which $137 million exceeded $100,000. Maturity information for all domestic interest bearing time deposits with a remaining term of greater than one year is summarized below.
Substantially all of the foreign interest bearing time deposits exceeding $100,000 mature in less than one year.
NOTE 6-- EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS
RETIREMENT PLANS
The Company maintains the Union Bank of California, N.A. Retirement Plan (the Plan), which is a noncontributory defined benefit plan covering substantially all of the employees of the Company. The Plan provides retirement benefits based on years of credited service and the final average compensation amount, as defined in the Plan. Employees become eligible for this plan after one year of service and become fully vested after five years of service. The Company's funding policy is to make contributions equal to the maximum deductible amount as allowed by the Internal Revenue Code. Contributions are intended to provide not only for benefits attributed to services to date, but also for those expected to be earned in the future. Plan assets are invested in U.S. government securities, corporate bonds, and commingled investment funds.
OTHER POSTRETIREMENT BENEFITS
The Company provides certain health care and life insurance benefits for its retired employees. The health care cost is shared between the Company and the retiree. The life insurance plan is noncontributory. The accounting for the health care plan anticipates future cost-sharing changes to the written plan that are consistent with the Company's intent to maintain a level of cost-sharing at approximately 25 percent. Assets set aside to cover such obligations are primarily invested in mutual funds.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 6-- EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) The following table sets forth the funded status of the Company's defined benefit pension plan and its other postretirement benefit plans.
The following table summarizes the assumptions used in computing the present value of the projected benefit obligation and the net pension expense.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 6-- EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) The following table sets forth the components of postretirement benefit expense.
For 1997, the Company assumed a 9 percent annual rate of increase in the per capita cost of postretirement medical benefits for the indemnity plan and a 4 percent annual rate of increase for the health maintenance organization (HMO) plan. For future periods, the assumed rate for the indemnity plan gradually decreased from 9 percent to 5.5 percent in 2007 and will remain level thereafter. The rate of change on the HMO plan was expected to increase after one year of being at a low rate and then gradually decrease to 5.5 percent in 2007 and thereafter.
For 1998, the Company assumed a 9 percent annual rate of increase in the per capita cost of postretirement medical benefits for the indemnity plan and a 7 percent annual rate of increase for the HMO plan. For future periods, the rate for the indemnity plan was expected to gradually decrease from 9 percent to 5.5 percent in 2007 and remain at that level thereafter. The rate for the HMO plan was expected to gradually decrease to 5.5 percent in 2007 and thereafter.
For 1999, the Company assumed an 11 percent annual rate of increase in the per capita cost of postretirement medical benefits for the indemnity plan and an 8.5 percent annual rate of increase for the HMO plan. For future periods, the rate for the indemnity plan was expected to gradually decrease from 11 percent to 5 percent in 2007 and will remain at that level thereafter. The rate for the HMO plan was expected to gradually decrease from 8.5 percent to 5.0 percent in 2007 and remain at that level thereafter.
The healthcare cost trend rate assumption has a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 6-- EMPLOYEE BENEFIT AND INCENTIVE PLANS AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) EXECUTIVE SUPPLEMENTAL BENEFIT PLANS
The Company has several Executive Supplemental Benefit Plans (ESBP) which provide eligible employees with supplemental retirement benefits. The plans are unfunded. The accrued liability for ESBP's included in other liabilities in the Consolidated Balance Sheets was $28 million at December 31, 1998 and $25 million at December 31, 1999. The Company's expense relating to the ESBP's was $3 million for each of the years ended December 31, 1997, 1998, and 1999.
SECTION 401(k) SAVINGS PLANS
The Company has a defined contribution plan authorized under Section 401(k) of the Internal Revenue Code. All benefits-eligible employees with at least one year of service are eligible to participate in the plan. Employees may contribute up to 16 percent of their pre-tax covered compensation or up to 10 percent of their after-tax covered compensation through salary deductions. The Company contributes 50 percent of every pre-tax dollar an employee contributes up to the first 6 percent of the employee's pre-tax covered compensation. Effective January 1, 1997, employees are fully vested in the employer's contributions immediately. In addition, the Company may make a discretionary annual profit-sharing contribution up to 2.5 percent of an employee's pay. This profit-sharing contribution is for all eligible employees, regardless of whether an employee is participating in the 401(k) plan, and depends on the Bank's annual financial performance. All employer contributions are tax deductible by the Company. The Company's combined matching contribution expense was $13 million, $12 million and $17 million for the years ended December 31, 1997, 1998 and 1999, respectively.
NOTE 7--RESTRUCTURING CHARGE
A restructuring charge of $85 million was recorded in the third quarter of 1999. The restructuring charge was incurred in connection with a company-wide project referred to as "Mission Excel". Mission Excel is an initiative to slow the rate of growth of expenses, increase sustainable growth in revenues, and increase productivity through elimination of unnecessary or duplicate functions. The restructuring charge includes only direct and incremental costs associated with the program.
The table, which follows, provides details of the restructuring related reserve.
Personnel expense consists of severance and related benefits to be paid under the Company's enhanced severance plans. At the completion of Mission Excel, the Company expects to have terminated approximately 1,400 employees. From August 16, 1999 to December 31, 1999, 450 employees were
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 7--RESTRUCTURING CHARGE (CONTINUED) terminated under the plan. Occupancy and other consists of lease termination costs and professional services costs incurred during the assessment phase of the project.
NOTE 8--OTHER EXPENSES
The detail of other expenses is as follows:
In connection with the merger, which occurred in 1996, the Company incurred merger and integration expense of $6 million in 1997, none for the year ended 1998, and $2 million in 1999 as summarized in the following table.
Total merger and integration expense of $126 million was recorded to cover $38 million of personnel expense for severance, retention, and other employee related costs, $56 million for facilities expense related to redundant banking facilities, and $32 million in professional services and other expense. At December 31, 1999, the liability balance included amounts primarily for operating lease payments related to banking facilities that have been vacated, that are continuing over the expected term of the leases. As of December 31, 1999, the merger and integration liability has been eliminated and future operating lease payments will be paid from other liabilities.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 9--INCOME TAXES
The components of income tax expense were as follows:
The components of the net deferred tax balances of the Company were as follows:
During 1998, a valuation allowance was established to offset deferred tax assets related to state income tax net operating loss carryforwards. The carryforwards expire on December 31, 2002, and are subject to various conditions and limitations. In the opinion of management, the Company may not meet the conditions necessary to realize the benefits of such carryforwards.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 9--INCOME TAXES (CONTINUED) The following table is an analysis of the effective tax rate:
During 1997, the Company received a refund from the State of California Franchise Tax Board of approximately $25 million, net of federal tax, in settlement of litigation, administration, and audit disputes covering the years 1975-1987. During 1999, the Company recognized tax benefits of $10.7 million from federal and California audit settlements covering the years 1986 to 1994.
The Company has filed its 1997 and 1998 and intends to file its 1999, California franchise tax returns on a worldwide unitary basis, incorporating the financial results of BTM and its worldwide affiliates. As a result, during 1998, the Company reduced its state income tax liabilities by $29 million, net of federal tax, for previously accrued 1997 state tax liabilities.
Federal and state tax returns for several years are under or subject to examination by the respective taxing authorities. Although the ultimate outcome of such examinations cannot be determined at this time, management believes that the resolution of issues that have been or may be raised will not have a material adverse effect on the Company's consolidated financial position or results of operations.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 10--BORROWED FUNDS
The following is a summary of the major categories of borrowed funds:
NOTE 11--SUBORDINATED CAPITAL NOTES AND PREFERRED STOCK
The following is a summary of capital notes that are subordinated to other obligations of the Company.
All of the above notes qualify as Tier 2 risk-based capital under the Federal Reserve guidelines for assessing regulatory capital. For the total risk-based capital ratio, the amount of notes that qualify as capital is reduced as the notes approach maturity. At December 31, 1998 and 1999, $220 million and $200 million, respectively, of the notes qualified as risk-based capital.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 11--SUBORDINATED CAPITAL NOTES AND PREFERRED STOCK (CONTINUED) Provisions of several of the notes restrict the use of the Company's property as security for borrowings, and place limitations on leases, indebtedness, distributions to shareholders, mergers, sales of certain assets, transactions with affiliates, and changes in majority stock ownership of the Company.
The following table presents the maturities of subordinated capital notes.
On September 3, 1997, the Company redeemed all 1.35 million outstanding shares of its 8 3/8 percent Noncumulative Preferred Stock, Series A, (Preferred Stock) reducing shareholders' equity by $135 million. The redemption price was equal to the stated value of $100 per share of Preferred Stock (equivalent to $25 per depositary share), plus $2 million in accrued and unpaid dividends to the redemption date. The redemption was funded by proceeds from the issuance of $200 million in subordinated capital notes in June 1997.
NOTE 12-- UNIONBANCAL CORPORATION--OBLIGATED MANDITORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY GRANTOR TRUST
In February 1999, UnionBanCal Finance Trust I issued $350 million preferred securities to the public and $10,824,750 common securities to the Company. The proceeds of such issuances were invested by UnionBanCal Finance Trust I in $360,824,750 aggregate principal amount of the Company's 7 3/8percent debt securities due May 15, 2029 (the Trust Notes). The Trust Notes represent the sole asset of UnionBanCal Finance Trust I. The Trust Notes mature on May 15, 2029, bear interest at the rate of 7 3/8 percent, payable quarterly, and are redeemable by the Company beginning on or after February 19, 2004 at 100 percent of the principal amount thereof, plus any accrued and unpaid interest to the redemption date.
Holders of the preferred securities and common securities are entitled to cumulative cash distributions at an annual rate of 7 3/8 percent of the liquidation amount of $25 per security. The preferred securities are subject to mandatory redemption upon repayment of the Trust Notes and are callable by the Company at 100 percent of the liquidation amount beginning on or after February 19, 2004. The Trust exists for the sole purpose of issuing the preferred securities and investing the proceeds in the Trust Notes issued by the Company.
The Company has guaranteed, on a subordinated basis, distributions and other payments due on the preferred securities (the Guarantee). The Guarantee, when taken together with the Company's obligations under the Trust Notes and in the indenture pursuant to which the Trust Notes were issued and the Company's obligations under the Amended and Restated Declaration of Trust governing the subsidiary trust, provide a full and unconditional guarantee of amounts due on the Trust Preferred securities.
The grantor trust is a wholly owned subsidiary of UnionBanCal Corporation. The Trust Notes and related trust investment in the Trust Notes have been eliminated in consolidation and the preferred securities are reflected as outstanding in the accompanying financial statements.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 13--DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
The Company has a dividend reinvestment and stock purchase plan for shareholders. The plan allows shareholders to automatically reinvest all or part of their dividends in additional shares of the Company's common stock at a cost of 5 percent below the market price. Participating shareholders also have the option of purchasing additional shares at the full market price with cash payments of $25 to $3,000 per quarter. The Company obtains shares required for reinvestment through open market purchases or through the issuance of new shares from its authorized but unissued stock. During 1997, 1998, and 1999, 131,127, and 83,727 and 101,570 shares, respectively, were required for dividend reinvestment purposes, of which 3,687, 5,166 and 6,407 shares were considered new issuances during 1997, 1998, and 1999, respectively. BTM did not participate in the plan in 1997, 1998 or 1999.
NOTE 14--MANAGEMENT STOCK PLAN
The Company has a management stock plan (the Stock Plan) which has 6.6 million shares of the Company's common stock authorized to be awarded to key employees and outside directors of the Company at the discretion of the Executive Compensation and Benefits Committee of the Board of Directors (the Committee). Committee members and employees on rotational assignment from BTM are not eligible for stock awards.
The Committee determines the term of each stock option grant, up to a maximum of ten years from the date of grant. The exercise price of the options issued under the Stock Plan shall not be less than the fair market value on the date the option is granted. Unvested restricted stock issued under the Stock Plan is shown as a reduction to retained earnings. The value of the restricted shares at the date of grant is amortized to compensation expense over its vesting period. All cancelled or forfeited options and restricted stock become available for future grants.
In 1997, 1998 and 1999, the Company granted options to various key employees, including principal officers, under the Stock Plan. The stock options vest pro rata on each anniversary of the grant date and become fully exercisable three years from the grant date, provided that the employee has completed the specified continuous service requirement. They vest earlier if the employee dies, is permanently and totally disabled, or retires under certain grant, age, and service conditions.
The following is a summary of stock option transactions under the Stock Plan.
The weighted-average fair value of options granted was $6.94 during 1997, $11.99 during 1998, and $9.77 during 1999.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 14--MANAGEMENT STOCK PLAN (CONTINUED) The following table summarizes information about stock options outstanding.
In 1997, 1998 and 1999, the Company also granted 178,320, 184,935 and 1,050 shares, respectively, of restricted stock to key officers, including executive officers, under the Stock Plan. The awards of restricted stock vest pro rata on each anniversary of the grant date and become fully vested four years from the grant date, provided that the employee has completed the specified continuous service requirement. They vest earlier if the employee dies, is permanently and totally disabled, or retires under certain grant, age, and service conditions. Restricted shareholders have the right to vote their restricted shares and receive dividends.
The following is a summary of restricted stock transactions under the Stock Plan.
At December 31, 1997, 1998 and 1999, 3,365,586, 2,685,603, and 989,811 shares, respectively, were available for future grants as either stock options or restricted stock under the Stock Plan.
The Company follows the intrinsic value based method in accounting for its employee stock-based compensation plan. Accordingly, no compensation cost has been recognized for its stock option grants. Had compensation cost for the Company's stock-based plan been determined based on the fair value at the grant dates for awards under that plan consistent with the method of SFAS No. 123, "Accounting for Stock-
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 14--MANAGEMENT STOCK PLAN (CONTINUED) Based Compensation", the Company's net income and net income per share would have decreased to the pro forma amounts indicated in the following table.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants made in 1997, 1998 and 1999: risk-free interest rates of 6.6 percent in 1997, 5.8 percent in 1998, and 5.2 percent in 1999; expected volatility of 26 percent in 1997, 29 percent in 1998, and 30 percent in 1999; expected lives of 6, 6, and 5 years for 1997, 1998, and 1999, respectively; and expected dividend yields of 2.1 percent in 1997, 1.5 percent in 1998, and 2.2 percent in 1999.
Effective January 1, 1997, the Company established a Performance Share Plan. Eligible participants may earn performance share awards to be redeemed in cash three years after the date of grant. Performance shares are linked to shareholder value in two ways: (1) the market price of the Company's common stock, and (2) return on asset, in 1997 and 1998, and return on equity in 1999, performance measures closely linked to value creation. Eligible participants generally receive grants of performance shares annually. The total number of performance shares granted under the plan cannot exceed 600,000. The Company granted 14,400 shares in 1997, 24,900 shares in 1998 and 22,000 shares in 1999. In 1998, 2,400 performance shares were forfeited. No performance shares were forfeited in 1999. The value of a performance share is equal to the market price of the Company's common stock. All cancelled or forfeited performance shares become available for future grants.
NOTE 15--FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. All of the fair values presented below are as of their respective period ends and have been made under this definition of fair value unless otherwise disclosed.
It is management's belief that the fair values presented below are reasonable based on the valuation techniques and data available to the Company as of December 31, 1998 and 1999, as more fully described below. It should be noted that the operations of the Company are managed on a going concern basis and not on a liquidation basis. As a result, the ultimate value realized for the financial instruments presented could be substantially different when actually recognized over time through the normal course of operations. Additionally, a substantial portion of an institution's inherent value is its capitalization and
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 15--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) franchise value. Neither of these components has been given consideration in the presentation of fair values that follow.
The table below presents the carrying value and fair value of the specified assets and liabilities held by the Company.
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(1) Excludes lease financing.
The Company is also a party to financial instruments that are not reflected on the balance sheet but represent obligations of the Company in the normal course of business. For information regarding the fair value of off-balance sheet financial instruments, see Note 16.
The following methods and assumptions were used to estimate fair value of each class of financial instruments for which it is practicable to estimate that value.
CASH AND CASH EQUIVALENTS: The book value of cash and cash equivalents is considered a reasonable estimate of fair value.
TRADING ACCOUNT ASSETS: Trading account assets are short term in nature and valued at market based on quoted market prices or dealer quotes. If a quoted market price is not available, the recorded amounts are estimated using quoted market prices for similar securities. Thus, carrying value is considered a reasonable estimate of fair value for these financial instruments.
SECURITIES: The fair value of securities is based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 15--FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) Securities available for sale are carried at their aggregate fair value, while securities held to maturity are carried at amortized cost.
LOANS: The fair value for performing fixed and non-reference rate loans was estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for similar remaining maturities and, where available, discount rates were based on current market rates.
The fair value of performing loans tied to the Company's reference rate with normal credit risk is assumed to approximate their book value. The fair value for these floating rate loans with increasing credit risk was estimated by calculating their present value using a yield the Company would currently require for loans with similar terms to borrowers with similar credit quality.
Loans that are on nonaccrual status were not included in the loan valuation methods discussed previously. The fair value of these assets was estimated assuming these loans were sold at their carrying value less their impairment allowance.
The fair value of performing mortgage loans was based on quoted market prices for loans with similar credit and interest rate risk characteristics.
The fair value of credit lines is assumed to approximate their book value.
NONINTEREST BEARING DEPOSITS: The fair value of noninterest bearing deposits is the amount payable on demand at the reporting date. The fair value of the demand deposit intangible has not been estimated.
INTEREST BEARING DEPOSITS: The fair value of savings accounts and certain money market accounts is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit was estimated using rates currently being offered on certificates with similar maturities.
BORROWED FUNDS: The book values of federal funds purchased and securities sold under repurchase agreements and other short-term borrowed funds are assumed to approximate their fair value due to their limited duration characteristics. The fair value for commercial paper and term federal funds purchased was estimated using market quotes.
SUBORDINATED CAPITAL NOTES: The book values for variable-rate subordinated capital notes are assumed to approximate fair market value.
TRUST PREFERRED SECURITIES: The fair value of fixed-rate trust preferred securities was estimated using market quotes.
NOTE 16-- DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to certain derivative and other financial instruments that are not reflected on the balance sheet but represent obligations or assets of the Company in the normal course of business. These financial instruments are used for trading activities of the Company, to meet the needs of customers, and to reduce the impact on the Company's operating results due to market fluctuations in currency or interest rates.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 16-- DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED) These financial instruments involve, to varying degrees, elements of credit and market risk which are not recognized on the balance sheet. Credit risk is defined as the possibility that a loss may occur from the failure of another party to perform in accordance with the terms of the contract which exceeds the value of the existing collateral, if any. Market risk is the possibility that future changes in market conditions may make the financial instrument less valuable.
DERIVATIVE INSTRUMENTS
The fair value of the derivative financial instruments was calculated based on quoted market prices where available. If quoted market prices were not available, the Company used the estimated amount it would receive or pay to offset or terminate the agreements at December 31, 1998 and 1999 based upon the terms of such contracts relative to prevailing interest rates.
TRADING ACTIVITIES IN DERIVATIVE INSTRUMENTS
The following table reflects the Company's positions relating to trading activities in derivative instruments. Trading activities include both activities for the Company's own account and for customers. At December 31, 1998 and 1999, the majority of the Company's derivative transactions for customers are hedged with essentially offsetting contracts with other counterparties. The average fair value of derivatives held or written for trading purposes during the year is not significant. The notional amount of derivative instruments reflects the extent of the Company's involvement in these instruments. For interest rate swap, cap and floor agreements, notional amounts do not represent exposure to credit or market risk. Notional amounts are not exchanged, but serve as a point of reference for calculating payments.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 16-- DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED) The following is a summary of derivative instruments held or written for trading purposes.
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(1) Credit risk amounts reflect the replacement cost for those contracts in a gain position in the event of nonperformance by counterparties.
ASSET AND LIABILITY MANAGEMENT DERIVATIVE INSTRUMENTS
Derivative positions are integral components of the Company's designated asset and liability management activities. Therefore, the Company does not believe it is meaningful to separately analyze the derivative components of its risk management activities in isolation from related positions. The Company uses interest rate derivative instruments as part of its management of asset and liability positions. Derivatives are used to manage interest rate risk relating to specified groups of assets and liabilities, including LIBOR based commercial loans, deposit liabilities, certain subordinated capital notes and trust preferred securities. The Company uses foreign currency forward contracts as a means of managing foreign exchange rate risk associated with assets or liabilities denominated in foreign currencies.
The following table reflects summary information on derivative contracts used to hedge or modify the Company's risk as of December 31, 1998 and 1999. Amounts included in the fair value column do not include gains or losses from changes in the value of the underlying asset or liability being hedged. Notional
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 16-- DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED) amounts are not exchanged, but serve as a point of reference for calculating payments. For interest rate swap, cap and floor agreements, notional amounts do not represent exposure to credit or market risk.
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(1) Credit risk amounts reflect the replacement cost for those contracts in a gain position in the event of nonperformance by counterparties.
OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Commitments to extend credit are legally binding agreements to lend to a customer provided there are no violations of any condition established in the contract. Commitments have fixed expiration dates or other termination clauses and may require payment of a fee or maintenance of compensatory balances. Such fees are deferred and, upon partial or full exercise of the commitment, amortized over the life of the loan or, if exercise is deemed remote, amortized over the commitment period. Since many of the commitments are expected to expire without being drawn upon, the contractual amounts do not necessarily represent future cash requirements. With respect to commitments to extend credit and letters of credit, the Company's exposure to credit risk in the event of nonperformance by customers is represented by the contractual amount of those instruments.
Standby letters of credit are provided to customers to assure their performance to a third party, generally in the production of goods and services or under contractual commitments in the financial markets. Commercial letters of credit are issued to customers to facilitate foreign or domestic trade transactions. The Company charges fees for the issuance of standby and commercial letters of credit. The majority of these types of commitments have terms of one year or less and any fees charged are recognized as noninterest income upon extension of the commitment. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers and is represented by
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 16-- DERIVATIVE INSTRUMENTS AND OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED) the contractual amount of those instruments. When deemed necessary, the Company holds appropriate collateral supporting those commitments.
The Company uses the same credit underwriting policies in granting or accepting such commitments or contingent obligations as it does for on-balance sheet instruments, by evaluating customers' credit worthiness. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's evaluation of the customer. The nature of the collateral varies but may include deposits held in financial institutions, marketable securities, accounts receivable, inventory, property and equipment, and real estate. The Company also provides for probable losses from either commitments to extend credit or standby letters of credit as a component of its evaluation in determining the adequacy of its allowance for credit losses and resulting level of provision charged against current period earnings.
The Company's pricing of these financial instruments is based on the credit quality and other covenants or requirements. Management believes that the current fees assessed on these off-balance sheet items represent market rates that would be charged for similar agreements. Based on this belief, the Company feels that the carrying amounts are reasonable estimates of the fair value of these financial instruments. At December 31, 1998 and 1999, fair value represents management's estimate of the unamortized fee income associated with these instruments. The following is a summary of other financial instruments with off-balance sheet risk.
The Company conducts securities lending transactions for institutional customers as a fully disclosed agent, and, at times, indemnifies its customers against counterparty default. All lending transactions are collateralized, primarily by cash. The amount of securities lent with indemnification was $1,259 million and $1,023 million at December 31, 1998 and 1999, respectively. The market value of the associated collateral was $1,284 million and $1,043 million at December 31, 1998 and 1999, respectively.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 17--RESTRICTIONS ON CASH AND DUE FROM BANKS, SECURITIES, LOANS AND DIVIDENDS
Federal Reserve Board regulations require the Bank to maintain reserve balances based on the types and amounts of deposits received. Average reserve balances were approximately $229 million and $202 million for the years ended December 31, 1998 and 1999, respectively.
As of December 31, 1998 and 1999, securities carried at $1.7 billion and $1.7 billion and loans of $2.5 billion and $6.9 billion, respectively, were pledged as collateral for borrowings, to secure public and trust department deposits, and for repurchase agreements as required by contract or law.
The Federal Reserve Act restricts the extension of credit by the Bank to BTM and affiliates and to the Company and its non-bank subsidiaries and requires that such loans be secured by certain types of collateral. At December 31, 1999, $129.0 million remained outstanding on six Bankers Commercial Corporation notes payable to the Bank. The respective notes were fully collateralized with equipment leases pledged by Bankers Commercial Corporation.
The payment of dividends by the Bank to the Company is subject to the approval of the Office of the Comptroller of the Currency (OCC) if the total of all dividends declared in any calendar year exceeds certain calculated amounts. The payment of dividends is also limited by minimum capital requirements imposed on national banks by the OCC. At December 31, 1999, the Bank could have declared dividends aggregating $597 million without prior regulatory approval.
NOTE 18--REGULATORY CAPITAL REQUIREMENTS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's Consolidated Financial Statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the Bank's prompt corrective action classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to Bank Holding Companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to quarterly average assets (as defined). Management believes, as of December 31, 1998 and 1999, that the Company and the Bank met all capital adequacy requirements to which they are subject.
On February 19, 1999, the Company issued $350 million of trust preferred securities, which qualify as Tier 1 capital. See Note 12 for a complete description of these securities.
As of December 31, 1998 and 1999, the most recent notification from the OCC categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized", the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank's category.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 18--REGULATORY CAPITAL REQUIREMENTS (CONTINUED) The Company's and the Bank's capital amounts and ratios are presented in the following tables.
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(1) Excludes certain intangible assets.
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(1) Excludes certain intangible assets.
NOTE 19--EARNINGS PER SHARE
Basic EPS is computed by dividing net income after preferred dividends by the weighted average number of common shares outstanding during the period. Diluted EPS is computed based on the weighted average number of common shares outstanding adjusted for common stock equivalents, which include
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 19--EARNINGS PER SHARE (CONTINUED) stock options. The following table presents a reconciliation of basic and diluted EPS for the years ended December 31, 1997, 1998 and 1999:
There were no anti-dilutive options in 1997. Options to 519,600 shares of common stock at $35 per share were outstanding but not included in the computation of diluted EPS in 1998. Options to purchase 1,500 shares of common stock at $39.25 per share and options to purchase 23,000 shares of common stock at $44.56 per share were outstanding but not included in the computation of diluted EPS in 1999.
NOTE 20--ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following is a summary of the components of accumulated other comprehensive income (loss):
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 21--CONTINGENCIES
The Company is subject to various pending and threatened legal actions that arise in the normal course of business. The Company maintains reserves for losses from legal actions that are both probable and estimable. In the opinion of management, the disposition of claims currently pending will not have a material adverse effect on the Company's financial position or results of operations.
NOTE 22--TRANSACTIONS WITH AFFILIATES
The Company had, and expects to have in the future, banking transactions and other transactions in the ordinary course of business with BTM and with its affiliates and associates. During 1997, 1998 and 1999, such transactions included, but were not limited to, origination, participation, servicing and remarketing of loans and leases, purchase and sale of acceptances, interest rate derivatives and foreign exchange transactions, funds transfers, custodianships, electronic data processing, investment advice and management, deposits and credit examination, and trust services. In the opinion of management, such transactions were made at prevailing rates, terms, and conditions and do not involve more than the normal risk of collectibility or present other unfavorable features. In addition, some compensation for services rendered to the Company is paid to the expatriate officers from BTM, and reimbursed by the Company to BTM under a services agreement.
NOTE 23--BUSINESS SEGMENTS
The Company is organized based on the products and services that it offers and operates in four principal areas:
- The Community Banking and Investment Services Group provides loan products and deposit services primarily to consumers and small businesses, as well as fiduciary, private banking, investment and asset management services for individuals and institutions.
- The Commercial Financial Services Group provides a wide variety of banking services, principally loans, to commercial customers.
- The International Banking Group provides trade-finance products to banks, and extends primarily short-term credit to corporations engaged in international business. The group's revenue predominately relates to foreign customers.
- The Global Markets Group manages the Company's securities portfolio, trading operations, wholesale funding needs, and interest rate and liquidity risk.
The information, set forth in the table on page, reflects the condensed income statements and a selected balance sheet item by business unit. The information presented does not necessarily represent the business units' financial condition and results of operations as if they were independent entities. Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to generally accepted accounting principles. Consequently, reported results are not necessarily comparable with those presented by other companies.
The information in this table is derived from the internal management reporting system used by management to measure the performance of the segments and the Company overall. The management reporting system assigns balance sheet and income statement items to each segment based on internal management accounting policies. Net interest income is determined by the Company's internal funds
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 23--BUSINESS SEGMENTS (CONTINUED) transfer pricing system, which assigns a cost of funds or a credit for funds to assets or liabilities based on their type, maturity or repricing characteristics. Noninterest income and expense directly attributable to a segment are assigned to that business, other than restructuring charges. Indirect costs, such as overhead, operations, and technology expense, are allocated to the segments based on studies of billable unit costs for product or data processing. With the Company's adoption of a risk-adjusted return on capital (RAROC) methodology, credit expense is charged to businesses based upon expected losses arising from credit risk. In addition, the attribution of economic capital is related to unexpected losses arising from credit, market and operational risks. Depreciation and capital expenditures are not used by management when measuring the performance of the segments.
"Other" is comprised of goodwill, merger and integration expense, restructuring charge, certain parent company non-bank subsidiaries, the elimination of the fully taxable-equivalent amounts, the unallocated allowance and related provision for credit losses, the net impact of transfer pricing, the earnings associated with the unallocated equity capital, and the residual costs of support groups. In addition, it includes two units, the Credit and Compliance Group, which manages nonperforming assets, and the Pacific Rim Group, which offers financial products to Asian-owned subsidiaries located in the U.S. On an individual basis, none of the items in "Other" are significant to the Company's business.
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 23--BUSINESS SEGMENTS (CONTINUED)
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(1) Performance center earnings (expense) represent the allocation of net interest income, noninterest income and noninterest expense between the business segments for products and services originated in one segment but managed by another.
(2) "Other" includes 3rd quarter 1999 restructuring charge of $85.0 million ($55.2 million, net of tax).
na = not applicable
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 24--CONDENSED UNIONBANCAL CORPORATION UNCONSOLIDATED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
UNIONBANCAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 24--CONDENSED UNIONBANCAL CORPORATION UNCONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONDENSED STATEMENTS OF INCOME
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(1) In 1998, the amount represents dividends distributed by nonbank subsidiaries in excess of their 1998 net income.
UNIONBANCAL CORPORATION SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 24--CONDENSED UNIONBANCAL CORPORATION UNCONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
UNIONBANCAL CORPORATION SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
NOTE 25--SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Certain amounts in the following unaudited quarterly financial information have been reclassified to conform with current presentation. In the opinion of management, all adjustments necessary to fairly present the results of operations have been made.
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(1) Dividends per share are based on the Company's common stock outstanding as of the declaration date.
UNIONBANCAL CORPORATION AND SUBSIDIARIES MANAGEMENT STATEMENT
The management of UnionBanCal Corporation is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in this annual report. The financial statements have been prepared in accordance with generally accepted accounting principles and, as such, include amounts based on informed judgments and estimates made by management.
We maintain a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with management's authorization and recorded properly to permit the preparation of financial statements in accordance with generally accepted accounting principles. Management recognizes that even a highly effective internal control system has inherent risks, including the possibility of human error and the circumvention or overriding of controls, and that the effectiveness of an internal control system can change with circumstances. However, management believes that the internal control system provides reasonable assurance that errors or irregularities that could be material to the financial statements would be prevented or detected on a timely basis and corrected through the normal course of business. As of December 31, 1999, management believes that the internal controls are in place and operating effectively.
The Audit and Examining Committee of the Board of Directors is comprised entirely of outside directors who are independent of our management; it includes members with banking or related financial management expertise and who are not large customers of Union Bank of California, N.A. The Audit and Examining Committee has access to outside counsel. The Audit and Examining Committee is responsible for recommending to the Board of Directors the selection of independent auditors. It meets periodically with management, the independent auditors, and the internal auditors to ensure that they are carrying out their responsibilities. The Audit and Examining Committee is also responsible for performing an oversight role by reviewing and monitoring our financial, accounting, and auditing procedures in addition to reviewing our financial reports. The independent auditors and internal auditors have full and free access to the Audit and Examining Committee, with or without the presence of management, to discuss the adequacy of the internal control structure for financial reporting and any other matters which they believe should be brought to the attention of the Audit and Examining Committee.
The financial statements have been audited by Deloitte & Touche LLP, independent auditors, who were given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the Board of Directors and committees of the Board. Management believes that all representations made to the independent auditors during their audit were valid and appropriate. The independent auditors' report is presented on page.
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Directors of UnionBanCal Corporation:
We have audited the accompanying consolidated balance sheets of UnionBanCal Corporation and subsidiaries (the "Company") as of December 31, 1998 and 1999, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of UnionBanCal Corporation and subsidiaries as of December 31, 1998 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP Deloitte & Touche LLP
San Francisco, California January 28, 2000
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, UnionBanCal Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of UnionBanCal Corporation and in the capacities and on the date indicated below.
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