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TABLE OF CONTENTS
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | ||
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended September 30, 2013 | ||
OR | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to |
Commission File Number: 1-15081
UnionBanCal Corporation
(Exact name of registrant as specified in its charter)
Delaware | 94-1234979 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
400 California Street, San Francisco, California | 94104-1302 | |
(Address of principal executive offices) | (Zip Code) | |
(Registrant's telephone number, including area code) (415) 765-2969 |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filero | Accelerated filero | ||
Non-accelerated filerþ(Do not check if a smaller reporting company) | Smaller reporting companyo |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Number of shares of Common Stock outstanding at October 31, 2013: 136,330,830
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H (1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.
UnionBanCal Corporation and Subsidiaries
Table of Contents
PART I. FINANCIAL INFORMATION | 40 | |
Item 1. Financial Statements | 40 | |
Consolidated Statements of Income (Unaudited) | 40 | |
Consolidated Statements of Comprehensive Income (Unaudited) | 41 | |
Consolidated Balance Sheets (Unaudited) | 42 | |
Consolidated Statements of Changes in Stockholder's Equity (Unaudited) | 43 | |
Consolidated Statements of Cash Flows (Unaudited) | 44 | |
Note 1—Summary of Significant Accounting Policies, Nature of Operations and Other Developments | 45 | |
Note 2—Correction of Prior Period Amounts | 47 | |
Note 3—Business Combinations | 48 | |
Note 4—Securities | 50 | |
Note 5—Loans and Allowance for Loan Losses | 55 | |
Note 6—Variable Interest Entities | 66 | |
Note 7—Employee Pension and Other Postretirement Benefits | 67 | |
Note 8—Commercial Paper and Other Short-Term Borrowings | 67 | |
Note 9—Long-Term Debt | 68 | |
Note 10—Fair Value Measurement and Fair Value of Financial Instruments | 70 | |
Note 11—Derivative Instruments and Other Financial Instruments | 76 | |
Note 12—Accumulated Other Comprehensive Loss | 81 | |
Note 13—Commitments, Contingencies and Guarantees | 84 | |
Note 14—Business Segments | 85 | |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | 6 | |
Consolidated Financial Highlights | 6 | |
Introduction | 8 | |
Executive Overview | 8 | |
Financial Performance | 10 | |
Balance Sheet Analysis | 15 | |
Quantitative and Qualitative Disclosures About Market Risk | 24 | |
Liquidity Risk | 27 | |
Business Segments | 29 | |
Critical Accounting Estimates | 37 | |
Item 3. Quantitative and Qualitative Disclosures About Market Risk | 38 | |
Item 4. Controls and Procedures | 38 | |
PART II. OTHER INFORMATION | 89 | |
Item 1. Legal Proceedings | 89 | |
Item 1A. Risk Factors | 89 | |
Item 6. Exhibits | 98 | |
SIGNATURES | 99 |
2
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report, along with other reports to the Securities and Exchange Commission (SEC) and other public documents, includes forward-looking statements, which include expectations for our operations and business and our assumptions for those expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly compared to our expectations. See Part I, Item 1A. "Risk Factors," in our 2012 Annual Report on Form 10-K, Part II, Item 1A. "Risk Factors" in this Form 10-Q, and the other risks described in this Form 10-Q and in our 2012 Annual Report on Form 10-K, for factors to be considered when reading any forward-looking statements in this filing.
This report includes forward-looking statements, which are subject to the "safe harbor" created by section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended. We may make forward-looking statements in our SEC filings, press releases, news articles and when we are speaking on behalf of UnionBanCal Corporation. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include the words "believe," "expect," "target," "anticipate," "intend," "plan," "seek," "estimate," "potential," "project," "forecast," "outlook," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," "might," or "may." These forward-looking statements are intended to provide investors with additional information with which they may assess our future potential. All of these forward-looking statements are based on assumptions about an uncertain future and are based on information known to our management at the date of these statements. We do not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date any forward-looking statements are made.
Examples of forward-looking statements in this report include, but are not limited to, statements about:
- •
- Our business objectives, our strategies and initiatives, our organizational structure, the growth of our business, our competitive position and prospects, and the effect of competition on our business and strategies
- •
- Our assessment of significant factors and developments that have affected or may affect our results
- •
- Our assessment of economic conditions and trends and economic and credit cycles, and their impact on our business
- •
- The economic outlook for the U.S. in general, for particular states in the U.S., including California, Oregon, Washington, Texas, New York and Illinois, and for global economies
- •
- The impact of changes in interest rates, our strategy to manage our interest rate risk profile and our outlook for short-term and long-term interest rates and their effect on our net interest margin, investment portfolio and our borrowers' ability to service their loans
- •
- Our sensitivity to and management of market risk, including changes in interest rates, and the economic outlook within specific industries, for the U.S. in general, for particular states in the U.S., including California, Oregon, Washington, Texas, New York and Illinois, and in foreign countries (including Japan and the Euro-zone)
- •
- Pending and recent legislative and regulatory actions, and future legislative and regulatory developments, including the effects of legislation and other governmental measures, including the monetary policies of the Federal Reserve Board, introduced in response to the 2008-2009 financial crises, the following recession affecting the banking system, financial markets and the U.S. economy, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), changes to the deposit insurance assessment policies of the Federal Deposit Insurance Corporation (FDIC), the effect on and application of foreign and other laws and regulations to our business and operations, and anticipated fees, costs or other impacts on our business and operations as a result of these developments
3
- •
- Our strategies and expectations regarding capital levels and liquidity, our funding base, core deposits, our expectations regarding the capital, liquidity and enhanced prudential standards adopted by the U.S. bank regulators as a result of or under the Dodd-Frank Act and the Basel Committee capital and liquidity standards and recently adopted and proposed regulations by the U.S. federal banking agencies and the effect of the foregoing on our business
- •
- Regulatory controls and processes and their impact on our business, including our operating costs and revenues
- •
- The costs and effects of legal actions, investigations, regulatory actions, criminal proceedings or similar matters, our anticipated litigation strategies, our assessment of the timing and ultimate outcome of legal actions, or adverse facts and developments related thereto
- •
- Our allowance for credit losses, including the conditions we consider in determining the unallocated allowance and our portfolio credit quality, risk grade and credit migration trends and loss factors
- •
- Loan portfolio composition and risk grade trends, residential loan delinquency rates compared to the industry average, portfolio credit quality, our strategy regarding troubled debt restructurings (TDRs), and our intent to sell or hold loans we originate
- •
- Our intent to sell or hold, and the likelihood that we would be required to sell, or expectations regarding recovery of the amortized cost basis of, various investment securities
- •
- Our hedging strategies and positions and expectations regarding reclassifications of gains or losses on hedging instruments into earnings and the sensitivity of our net income to various factors, including customer behavior relating to mortgage pre-payments and deposit repricing
- •
- Expected rates of return, maturities, yields, loss exposure, growth rates, pension plan strategies, contributions and benefit payments, and projected results
- •
- Tax rates and taxes, the possible effect of changes in taxable profits of the U.S. operations of Mitsubishi UFJ Financial Group, Inc. (MUFG) on our state tax obligations and of expected tax credits or benefits
- •
- Critical accounting policies and estimates, the impact or anticipated impact of recent accounting pronouncements, guidance or changes in accounting principles and future recognition of impairments for the fair value of assets, including goodwill, financial instruments, intangible assets and other assets acquired in our acquisitions of Pacific Capital Bancorp, PB Capital Corporation's institutional commercial real estate lending portfolio, and Smartstreet and our April 2010 FDIC-assisted acquisitions
- •
- Decisions to downsize, sell or close units, dissolve subsidiaries, expand our branch network, pursue acquisitions, purchase banking facilities and equipment, or otherwise restructure, reorganize or change our business mix, and their timing and impact on our business
- •
- Our expectations regarding the impact of acquisitions on our business and results of operations and amounts we expect to collect from the FDIC, or must pay to the FDIC, under loss share agreements
- •
- The impact of changes in our credit rating
- •
- Maintenance of casualty and liability insurance coverage appropriate for our operations
- •
- The relationship between our business and that of The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU) and MUFG, the impact of their credit ratings, operations or prospects on our credit ratings and actions that may or may not be taken by BTMU and MUFG
- •
- Threats to the banking sector and our business due to cybersecurity issues and attacks
- •
- The reorganization of our affiliated HighMark Funds into shares of unaffiliated mutual funds and the impact on our business and activities
4
- •
- Our understanding that BTMU will continue to limit its participation in transactions with Iranian entities and individuals to certain types of transactions
- •
- Descriptions of assumptions underlying or relating to any of the foregoing
Readers of this document should not rely unduly on any forward-looking statements, which reflect only our management's belief as of the date of this report. There are numerous risks and uncertainties that could cause actual outcomes and results to differ materially from those discussed in our forward-looking statements. Many of these factors are beyond our ability to control or predict and could have a material adverse effect on our financial condition, results of operations or prospects. Such risks and uncertainties include, but are not limited to, those described or referred to in Part I, Item 1 "Business" under the captions "Competition" and "Supervision and Regulation" of our Annual Report on Form 10-K and in Item 1A. "Risk Factors" of Part II and Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part I of this Form 10-Q, and in our other reports to the SEC.
Any factor described in this report could by itself, or together with one or more other factors, adversely affect our business, prospects, results of operations or financial condition.
5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
UnionBanCal Corporation and Subsidiaries
Consolidated Financial Highlights
| For the Three Months Ended | | For the Nine Months Ended | | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | September 30, 2013 | September 30, 2012(1) | Percent Change | September 30, 2013 | September 30, 2012(1) | Percent Change | |||||||||||||
Results of operations: | |||||||||||||||||||
Net interest income | $ | 685 | $ | 646 | 6 | % | $ | 2,010 | $ | 1,942 | 4 | % | |||||||
Noninterest income | 234 | 197 | 19 | 686 | 589 | 16 | |||||||||||||
Total revenue | 919 | 843 | 9 | 2,696 | 2,531 | 7 | |||||||||||||
Noninterest expense | 689 | 638 | 8 | 2,104 | 1,851 | 14 | |||||||||||||
Pre-tax, pre-provision income(2) | 230 | 205 | 12 | 592 | 680 | (13 | ) | ||||||||||||
(Reversal of) provision for loan losses | (16 | ) | 45 | (136 | ) | (22 | ) | 30 | (173 | ) | |||||||||
Income before income taxes and including noncontrolling interests | 246 | 160 | 54 | 614 | 650 | (6 | ) | ||||||||||||
Income tax expense | 55 | 42 | 31 | 140 | 160 | (13 | ) | ||||||||||||
Net income including noncontrolling interests | 191 | 118 | 62 | 474 | 490 | (3 | ) | ||||||||||||
Deduct: Net loss from noncontrolling interests | 7 | 6 | 17 | 14 | 15 | (7 | ) | ||||||||||||
Net income attributable to UnionBanCal Corporation (UNBC) | $ | 198 | $ | 124 | 60 | $ | 488 | $ | 505 | (3 | ) | ||||||||
Balance sheet (period average): | |||||||||||||||||||
Total assets | $ | 101,534 | $ | 87,881 | 16 | % | $ | 98,984 | $ | 88,933 | 11 | % | |||||||
Total securities | 22,909 | 22,496 | 2 | 22,643 | 23,657 | (4 | ) | ||||||||||||
Total loans held for investment | 66,608 | 55,285 | 20 | 63,633 | 54,792 | 16 | |||||||||||||
Earning assets | 92,035 | 79,137 | 16 | 89,479 | 80,085 | 12 | |||||||||||||
Total deposits | 77,434 | 64,420 | 20 | 75,692 | 64,448 | 17 | |||||||||||||
UNBC Stockholder's equity | 12,210 | 12,209 | — | 12,463 | 11,913 | 5 | |||||||||||||
Performance ratios: | |||||||||||||||||||
Return on average assets(3) | 0.78 | % | 0.56 | % | 0.66 | % | 0.76 | % | |||||||||||
Return on average UNBC stockholder's equity(3) | 6.50 | 4.06 | 5.23 | 5.65 | |||||||||||||||
Efficiency ratio(4) | 75.01 | 75.56 | 78.03 | 73.15 | |||||||||||||||
Adjusted efficiency ratio(5) | 67.21 | 68.33 | 68.10 | 67.81 | |||||||||||||||
Net interest margin(3)(6) | 2.99 | 3.28 | 3.02 | 3.25 | |||||||||||||||
Net loans charged off (recovered) to average total loans held for investment(3) | (0.01 | ) | 0.30 | 0.04 | 0.31 | ||||||||||||||
Net loans charged off to average total loans held for investment, excluding purchased credit-impaired loans and FDIC covered other real estate owned (OREO)(3)(13) | 0.01 | 0.29 | 0.05 | 0.30 |
| As of | | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | December 31, 2012(1) | | |||||||
Balance sheet (end of period): | ||||||||||
Total assets | $ | 105,484 | $ | 97,008 | 9 | % | ||||
Total securities | 22,318 | 22,455 | (1 | ) | ||||||
Total loans held for investment | 67,170 | 60,034 | 12 | |||||||
Nonperforming assets | 574 | 616 | (7 | ) | ||||||
Core deposits(7) | 68,334 | 63,769 | 7 | |||||||
Total deposits | 79,415 | 74,304 | 7 | |||||||
Long-term debt | 7,803 | 5,622 | 39 | |||||||
UNBC Stockholder's equity | 12,549 | 12,461 | 1 | |||||||
Capital ratios: | ||||||||||
Tier 1 risk-based capital ratio(8) | 11.17 | % | 12.44 | % | ||||||
Total risk-based capital ratio(8) | 13.11 | 13.93 | ||||||||
Leverage ratio | 10.22 | 11.18 | ||||||||
Tier 1 common capital ratio(8)(9) | 11.10 | 12.35 | ||||||||
Tangible common equity ratio(10) | 9.01 | 9.89 | ||||||||
Credit ratios: | ||||||||||
Allowance for loan losses to total loans held for investment(11) | 0.91 | % | 1.09 | % | ||||||
Allowance for loan losses to nonaccrual loans(11) | 119.04 | 129.47 | ||||||||
Allowance for credit losses to total loans held for investment(12) | 1.10 | 1.28 | ||||||||
Allowance for credit losses to nonaccrual loans(12) | 144.63 | 152.67 | ||||||||
Nonperforming assets to total loans held for investment and OREO | 0.85 | 1.02 | ||||||||
Nonperforming assets to total assets | 0.54 | 0.63 | ||||||||
Nonaccrual loans to total loans held for investment | 0.76 | 0.84 | ||||||||
Credit ratios, excluding purchased credit-impaired loans and FDIC covered OREO(13): | ||||||||||
Allowance for loan losses to total loans held for investment(11) | 0.92 | % | 1.11 | % | ||||||
Allowance for loan losses to nonaccrual loans(11) | 123.53 | 137.40 | ||||||||
Allowance for credit losses to total loans held for investment(12) | 1.12 | 1.31 | ||||||||
Allowance for credit losses to nonaccrual loans(12) | 150.14 | 162.05 | ||||||||
Nonperforming assets to total loans held for investment and OREO | 0.78 | 0.88 | ||||||||
Nonperforming assets to total assets | 0.49 | 0.54 | ||||||||
Nonaccrual loans to total loans held for investment | 0.75 | 0.81 |
6
- (1)
- During the third quarter of 2013, the Company corrected prior period errors related to the recognition of income and expense associated with market-linked certificates of deposits. The Company concluded that these errors were not material to the periods in which the corrections were made. For additional information, refer to Note 2 of Notes to Consolidated Financial Statements in this Form 10-Q.
- (2)
- Pre-tax, pre-provision income is total revenue less noninterest expense. Management believes that this is a useful financial measure because it enables investors and others to assess the Company's ability to generate capital to cover loan losses through a credit cycle.
- (3)
- Annualized.
- (4)
- The efficiency ratio is total noninterest expense as a percentage of total revenue (net interest income and noninterest income).
- (5)
- The adjusted efficiency ratio, a non-GAAP financial measure, is adjusted noninterest expense (noninterest expense excluding privatization-related expenses and fair value amortization/accretion, foreclosed asset expense and other credit costs, (reversal of) provision for losses on off-balance sheet commitments, low income housing credit (LIHC) investment amortization expense, expenses of the LIHC consolidated variable interest entities (VIEs), merger costs related to acquisitions, certain costs related to productivity initiatives, debt termination fees from balance sheet repositioning and intangible asset amortization) as a percentage of adjusted total revenue (net interest income (taxable-equivalent basis) and noninterest income), excluding the impact of privatization, gains from productivity initiatives related to the sale of certain business units in 2012 and 2013, and other credit costs. Management discloses the adjusted efficiency ratio as a measure of the efficiency of our operations, focusing on those costs most relevant to our business activities. Refer to "Noninterest Expense" in this Form 10-Q for further information.
- (6)
- Amounts are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
- (7)
- Core deposits exclude brokered deposits, foreign time deposits and domestic time deposits greater than $250,000.
- (8)
- Effective September 30, 2013, the Company updated the methodologies applied to the calculation of its regulatory capital ratios as the result of recent regulatory correspondence, which clarified the treatment of certain off-balance sheet credit exposures. If the Company had applied the new methodology on a retrospective basis as of December 31, 2012, the Tier 1 risk-based capital ratio would have been 11.87%; the Total risk-based capital ratio would have been 13.30%; and the Tier 1 common capital ratio would have been 11.79%.
- (9)
- The Tier 1 common capital ratio is the ratio of Tier 1 capital, less qualifying trust preferred securities, if any, to risk-weighted assets. The Tier 1 common capital ratio, a non-GAAP financial measure, facilitates the understanding of the Company's capital structure and is used to assess and compare the quality and composition of the Company's capital structure to other financial institutions. Refer to "Capital" in this Form 10-Q for further information.
- (10)
- The tangible common equity ratio, a non-GAAP financial measure, is calculated as tangible common equity divided by tangible assets. The methodology for determining tangible common equity may differ among companies. The tangible common equity ratio facilitates the understanding of the Company's capital structure and is used to assess and compare the quality and composition of UnionBanCal's capital structure to other financial institutions. Refer to "Capital" in this Form 10-Q for further information.
- (11)
- The allowance for loan losses ratios are calculated using the allowance for loan losses against end of period total loans held for investment or total nonaccrual loans, as appropriate.
- (12)
- The allowance for credit losses ratios include the allowances for loan losses and for losses on off-balance sheet commitments against end of period total loans held for investment or total nonaccrual loans, as appropriate.
- (13)
- These ratios exclude the impact of all purchased credit-impaired loans and FDIC covered OREO. Purchased credit-impaired loans and OREO related to the acquisitions of certain assets and assumption of certain liabilities of Frontier Bank and Tamalpais Bank in April 2010 are covered under loss share agreements between Union Bank, N.A. and the Federal Deposit Insurance Corporation. Management believes the exclusion of purchased credit-impaired loans and FDIC covered OREO from certain asset quality ratios that include nonperforming loans, nonperforming assets, net loans charged off, total loans held for investment and the allowance for loan losses or credit losses in the numerator or denominator provides a better perspective into underlying asset quality trends.
7
Please refer to our consolidated financial statements and the Notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012 (2012 Form 10-K) along with the following discussion and analysis of our consolidated financial condition and results of operations for the three and nine months ended September 30, 2013 in this Form 10-Q. Averages, as presented in the following tables, are substantially all based upon daily average balances.
As used in this Form 10-Q, the term "UnionBanCal" or "the Company" and terms such as "we," "us" and "our" refer to UnionBanCal Corporation, one or more of its consolidated subsidiaries, or to all of them together.
We are a California-based financial holding company and bank holding company whose principal subsidiary is Union Bank, N.A. (the Bank). We are a wholly-owned subsidiary of The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU) which is a wholly-owned subsidiary of Mitsubishi UFJ Financial Group, Inc. (MUFG). BTMU's global network includes the BTMU Headquarters for the Americas (BTMU HQA), which oversees the branches and certain subsidiaries of BTMU's operations in the Americas.
We provide a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, primarily in California, Oregon, Washington, Texas, New York and Illinois, as well as nationally and internationally. We had consolidated assets of $105.5 billion at September 30, 2013.
References to the privatization transaction in this report refer to the transaction on November 4, 2008, when we became a privately held company. All of our issued and outstanding shares of common stock are owned by BTMU.
We are providing you with an overview of what we believe are the most significant factors and developments that affected our third quarter 2013 results and that could influence our future results. Further detailed information can be found elsewhere in this Form 10-Q. In addition, we ask that you carefully read this entire document and any other reports that we refer to in this Form 10-Q for more detailed information that will assist your understanding of trends, events and uncertainties that impact us.
Our sources of income are net interest income and noninterest income (collectively "total revenue"). Net interest income is generated predominantly from interest earned from loans, investment securities and other interest-earning assets, less interest incurred on deposits and borrowings. The primary sources of noninterest income are revenues from service charges on deposit accounts, trust and investment management fees, trading account activities and merchant banking fees. In the third quarter of 2013, revenue was comprised of 75 percent net interest income and 25 percent noninterest income. Changes in interest rates, credit quality, economic regulatory trends and the capital markets are primary factors that affect our revenue sources. A summary of our financial results is discussed below.
Our primary sources of liquidity are core deposits, securities and wholesale funding. Core deposits exclude brokered deposits, foreign time deposits and domestic time deposits greater than $250,000. Wholesale funding includes unsecured funds raised from interbank and other sources, both domestic and international, and secured funds raised by selling securities under repurchase agreements and by borrowing from the Federal Home Loan Bank of San Francisco (FHLB). We evaluate and monitor the stability and reliability of our various funding sources to help ensure that we have sufficient liquidity when adverse situations arise.
In the second quarter of 2013, we completed the purchase of PB Capital Corporation's (PB Capital) $3.5 billion institutional commercial real estate (CRE) lending portfolio. The acquisition expanded our CRE presence in the U.S., and provided geographic and asset class diversification.
In December 2012, we completed the purchase of Pacific Capital Bancorp (PCBC), a bank holding company headquartered in Santa Barbara, California. The transaction enhanced our geographic footprint
8
within California's Central Coast region where PCBC's principal subsidiary, Santa Barbara Bank & Trust, N.A., conducted its banking activities. In the transaction, Union Bank acquired $3.8 billion in loans held for investment and $4.7 billion in deposits.
In October 2012, we completed the acquisition of Smartstreet, formerly a division of PNC Bank, N.A., which provides banking services nationwide to homeowners associations and community association management companies. In the transaction, we acquired approximately $1.0 billion in deposits.
Our results for the nine months ended September 30, 2013 reflect the impact of the aforementioned acquisitions.
BTMU and UnionBanCal Integrated Business Initiative
Recently, we announced the formation of BTMU Americas Holdings, which will preside over all BTMU operations in the Americas region, including the Company. An integrated executive committee for this management structure has been appointed and is being chaired by our Chief Executive Officer, who also serves as the BTMU Chief Executive Officer for the Americas. The committee also includes other senior officers of BTMU HQA and the Company. The Company has adopted a new internal management structure as a result of this integrated business initiative, and plans to revise the composition of its reportable segments in the fourth quarter of 2013 to reflect the new structure.
Performance Highlights
In the third quarter of 2013, net income attributable to UnionBanCal was $198 million, compared with $124 million in the third quarter of 2012. Net interest income was $685 million in the third quarter of 2013, compared with $646 million in the third quarter of 2012. The increase in net interest income was primarily due to loan growth. Partially offsetting the increase in net interest income was a lower net interest margin, reflecting lower yields on total loans held for investment and securities. We expect continued pressure on our net interest margin as our balance sheet continues to reprice downward in the current low interest rate environment. Noninterest income was $234 million in the third quarter of 2013, up $37 million, or 19 percent, from the third quarter of 2012. The primary components increasing noninterest income were the gain on the sale of certain affiliated HighMark Funds and higher net gains on the sale of securities. Partially offsetting this increase in total revenue was an increase in noninterest expense, which increased $51 million to $689 million for the third quarter of 2013 compared with the third quarter of 2012. The increase in noninterest expense was primarily due to higher salaries and employee benefits expense resulting from acquisition-related activity.
The provision for loan losses was a benefit of $16 million for the quarter ended September 30, 2013, compared with a provision of $45 million for the quarter ended September 30, 2012 reflecting continued credit quality improvement within our loan portfolio. The provision for loan losses for the quarter ended September 30, 2012 included $22 million related to the impact of implementing OCC regulatory accounting guidance requiring loans discharged under Chapter 7 bankruptcy and not reaffirmed by the borrower be charged off to their collateral value. Our ratio of nonaccrual loans to total loans held for investment was 0.76 percent at September 30, 2013 and 0.84 percent at December 31, 2012. Our ratio of allowance for loan losses to total loans held for investment decreased to 0.91 percent at September 30, 2013 from 1.09 percent at December 31, 2012.
Capital Ratios
At September 30, 2013, our regulatory Tier 1 and total risk-based capital ratios were 11.17 percent and 13.11 percent, respectively, both above the well-capitalized regulatory thresholds, compared with 12.44 percent and 13.93 percent, respectively, at December 31, 2012. Our tangible common equity ratio and Tier 1 common risk-based capital ratio decreased 88 basis points and 125 basis points to 9.01 percent and 11.10 percent, respectively, at September 30, 2013. The decline in the Company's capital ratios from December 31, 2012 primarily reflects the acquisition of PB Capital.
9
Net Interest Income
The following tables show the major components of net interest income and net interest margin:
| For the Three Months Ended | Increase (Decrease) | |||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | September 30, 2012 | | | Interest Income/ Expense(1) | ||||||||||||||||||||||||||
| Average Balance | ||||||||||||||||||||||||||||||
| Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | |||||||||||||||||||||||||
(Dollars in millions) | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||
Assets | |||||||||||||||||||||||||||||||
Loans held for investment:(3) | |||||||||||||||||||||||||||||||
Commercial and industrial | $ | 22,930 | $ | 192 | 3.32 | % | $ | 20,389 | $ | 179 | 3.50 | % | $ | 2,541 | 12 | % | $ | 13 | 7 | % | |||||||||||
Commercial mortgage | 12,936 | 117 | 3.62 | 8,064 | 81 | 4.01 | 4,872 | 60 | 36 | 44 | |||||||||||||||||||||
Construction | 827 | 7 | 3.30 | 650 | 6 | 3.76 | 177 | 27 | 1 | 17 | |||||||||||||||||||||
Lease financing | 973 | 12 | 4.92 | 982 | 10 | 4.10 | (9 | ) | (1 | ) | 2 | 20 | |||||||||||||||||||
Residential mortgage | 24,157 | 225 | 3.72 | 21,022 | 218 | 4.17 | 3,135 | 15 | 7 | 3 | |||||||||||||||||||||
Home equity and other consumer loans | 3,384 | 33 | 3.87 | 3,557 | 34 | 3.74 | (173 | ) | (5 | ) | (1 | ) | (3 | ) | |||||||||||||||||
Loans, before purchased credit-impaired loans | 65,207 | 586 | 3.58 | 54,664 | 528 | 3.86 | 10,543 | 19 | 58 | 11 | |||||||||||||||||||||
Purchased credit-impaired loans | 1,401 | 82 | 23.46 | 621 | 80 | 51.23 | 780 | 126 | 2 | 3 | |||||||||||||||||||||
Total loans held for investment | 66,608 | 668 | 4.00 | 55,285 | 608 | 4.39 | 11,323 | 20 | 60 | 10 | |||||||||||||||||||||
Securities | 22,909 | 122 | 2.12 | 22,496 | 132 | 2.34 | 413 | 2 | (10 | ) | (8 | ) | |||||||||||||||||||
Interest-bearing deposits in banks | 2,050 | 1 | 0.25 | 941 | — | 0.24 | 1,109 | 118 | 1 | nm | |||||||||||||||||||||
Federal funds sold and securities purchased under resale agreements | 101 | — | 0.13 | 62 | — | 0.19 | 39 | 63 | — | — | |||||||||||||||||||||
Trading account assets | 134 | 1 | 0.43 | 228 | 1 | 0.53 | (94 | ) | (41 | ) | — | — | |||||||||||||||||||
Other earning assets | 233 | — | 0.97 | 125 | — | 0.15 | 108 | 86 | — | — | |||||||||||||||||||||
Total earning assets | 92,035 | 792 | 3.43 | 79,137 | 741 | 3.74 | 12,898 | 16 | 51 | 7 | |||||||||||||||||||||
Allowance for loan losses | (633 | ) | (657 | ) | 24 | 4 | |||||||||||||||||||||||||
Cash and due from banks | 1,315 | 1,258 | 57 | 5 | |||||||||||||||||||||||||||
Premises and equipment, net | 694 | 646 | 48 | 7 | |||||||||||||||||||||||||||
Other assets | 8,123 | 7,497 | 626 | 8 | |||||||||||||||||||||||||||
Total assets | $ | 101,534 | $ | 87,881 | $ | 13,653 | 16 | % | |||||||||||||||||||||||
Liabilities | |||||||||||||||||||||||||||||||
Interest-bearing deposits: | |||||||||||||||||||||||||||||||
Transaction and money market accounts | $ | 34,912 | $ | 31 | 0.36 | $ | 26,517 | $ | 15 | 0.23 | $ | 8,395 | 32 | $ | 16 | 107 | |||||||||||||||
Savings | 5,633 | 2 | 0.13 | 5,222 | 2 | 0.16 | 411 | 8 | — | — | |||||||||||||||||||||
Time | 12,017 | 30 | 0.98 | 11,361 | 34 | 1.22 | 656 | 6 | (4 | ) | (12 | ) | |||||||||||||||||||
Total interest-bearing deposits | 52,562 | 63 | 0.47 | 43,100 | 51 | 0.48 | 9,462 | 22 | 12 | 24 | |||||||||||||||||||||
Commercial paper and other short-term borrowings(4) | 3,376 | 2 | 0.20 | 2,541 | 2 | 0.25 | 835 | 33 | — | — | |||||||||||||||||||||
Long-term debt | 6,135 | 38 | 2.47 | 5,963 | 39 | 2.57 | 172 | 3 | (1 | ) | (3 | ) | |||||||||||||||||||
Total borrowed funds | 9,511 | 40 | 1.66 | 8,504 | 41 | 1.88 | 1,007 | 12 | (1 | ) | (2 | ) | |||||||||||||||||||
Total interest-bearing liabilities | 62,073 | 103 | 0.66 | 51,604 | 92 | 0.71 | 10,469 | 20 | 11 | 12 | |||||||||||||||||||||
Noninterest-bearing deposits | 24,872 | 21,320 | 3,552 | 17 | |||||||||||||||||||||||||||
Other liabilities | 2,110 | 2,494 | (384 | ) | (15 | ) | |||||||||||||||||||||||||
Total liabilities | 89,055 | 75,418 | 13,637 | 18 | |||||||||||||||||||||||||||
Equity | |||||||||||||||||||||||||||||||
UNBC Stockholder's equity | 12,210 | 12,209 | 1 | — | |||||||||||||||||||||||||||
Noncontrolling interests | 269 | 254 | 15 | 6 | |||||||||||||||||||||||||||
Total equity | 12,479 | 12,463 | 16 | — | |||||||||||||||||||||||||||
Total liabilities and equity | $ | 101,534 | $ | 87,881 | $ | 13,653 | 16 | % | |||||||||||||||||||||||
Net interest income/spread (taxable-equivalent basis) | 689 | 2.77 | % | 649 | 3.03 | % | 40 | 6 | % | ||||||||||||||||||||||
Impact of noninterest-bearing deposits | 0.19 | 0.21 | |||||||||||||||||||||||||||||
Impact of other noninterest-bearing sources | 0.03 | 0.04 | |||||||||||||||||||||||||||||
Net interest margin | 2.99 | 3.28 | |||||||||||||||||||||||||||||
Less: taxable-equivalent adjustment | 4 | 3 | 1 | 33 | |||||||||||||||||||||||||||
Net interest income | $ | 685 | $ | 646 | $ | 39 | 6 | ||||||||||||||||||||||||
- (1)
- Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
- (2)
- Annualized.
- (3)
- Average balances on loans outstanding include all nonperforming loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield.
- (4)
- Includes interest-bearing trading liabilities.
nm = not meaningful
10
| For the Nine Months Ended | Increase (Decrease) | |||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | September 30, 2012 | | | Interest Income/ Expense(1) | ||||||||||||||||||||||||||
| Average Balance | ||||||||||||||||||||||||||||||
| Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate(1)(2) | |||||||||||||||||||||||||
(Dollars in millions) | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||
Assets | |||||||||||||||||||||||||||||||
Loans held for investment:(3) | |||||||||||||||||||||||||||||||
Commercial and industrial | $ | 21,996 | $ | 554 | 3.37 | % | $ | 20,066 | $ | 535 | 3.56 | % | $ | 1,930 | 10 | % | $ | 19 | 4 | % | |||||||||||
Commercial mortgage | 11,573 | 330 | 3.81 | 8,204 | 248 | 4.03 | 3,369 | 41 | 82 | 33 | |||||||||||||||||||||
Construction | 760 | 22 | 3.84 | 720 | 22 | 4.12 | 40 | 6 | — | — | |||||||||||||||||||||
Lease financing | 1,030 | 28 | 3.61 | 1,006 | 32 | 4.23 | 24 | 2 | (4 | ) | (13 | ) | |||||||||||||||||||
Residential mortgage | 23,485 | 667 | 3.79 | 20,396 | 654 | 4.28 | 3,089 | 15 | 13 | 2 | |||||||||||||||||||||
Home equity and other consumer loans | 3,495 | 100 | 3.85 | 3,627 | 105 | 3.85 | (132 | ) | (4 | ) | (5 | ) | (5 | ) | |||||||||||||||||
Loans, before purchased credit-impaired loans | 62,339 | 1,701 | 3.64 | 54,019 | 1,596 | 3.94 | 8,320 | 15 | 105 | 7 | |||||||||||||||||||||
Purchased credit-impaired loans | 1,294 | 245 | 25.30 | 773 | 219 | 37.88 | 521 | 67 | 26 | 12 | |||||||||||||||||||||
Total loans held for investment | 63,633 | 1,946 | 4.08 | 54,792 | 1,815 | 4.42 | 8,841 | 16 | 131 | 7 | |||||||||||||||||||||
Securities | 22,643 | 365 | 2.15 | 23,657 | 409 | 2.30 | (1,014 | ) | (4 | ) | (44 | ) | (11 | ) | |||||||||||||||||
Interest-bearing deposits in banks | 2,671 | 5 | 0.25 | 1,254 | 2 | 0.25 | 1,417 | 113 | 3 | 150 | |||||||||||||||||||||
Federal funds sold and securities purchased under resale agreements | 131 | — | 0.17 | 62 | — | 0.21 | 69 | 111 | — | — | |||||||||||||||||||||
Trading account assets | 149 | 1 | 0.36 | 185 | 1 | 0.57 | (36 | ) | (19 | ) | — | — | |||||||||||||||||||
Other earning assets | 252 | 1 | 0.62 | 135 | — | 0.15 | 117 | 87 | 1 | nm | |||||||||||||||||||||
Total earning assets | 89,479 | 2,318 | 3.46 | 80,085 | 2,227 | 3.71 | 9,394 | 12 | 91 | 4 | |||||||||||||||||||||
Allowance for loan losses | (642 | ) | (710 | ) | 68 | 10 | |||||||||||||||||||||||||
Cash and due from banks | 1,356 | 1,299 | 57 | 4 | |||||||||||||||||||||||||||
Premises and equipment, net | 701 | 659 | 42 | 6 | |||||||||||||||||||||||||||
Other assets | 8,090 | 7,600 | 490 | 6 | |||||||||||||||||||||||||||
Total assets | $ | 98,984 | $ | 88,933 | $ | 10,051 | 11 | % | |||||||||||||||||||||||
Liabilities | |||||||||||||||||||||||||||||||
Interest-bearing deposits: | |||||||||||||||||||||||||||||||
Transaction and money market accounts | $ | 32,983 | $ | 79 | 0.32 | $ | 25,926 | $ | 43 | 0.22 | $ | 7,057 | 27 | $ | 36 | 84 | |||||||||||||||
Savings | 5,717 | 6 | 0.13 | 5,271 | 6 | 0.16 | 446 | 8 | — | — | |||||||||||||||||||||
Time | 12,346 | 99 | 1.07 | 12,636 | 108 | 1.15 | (290 | ) | (2 | ) | (9 | ) | (8 | ) | |||||||||||||||||
Total interest-bearing deposits | 51,046 | 184 | 0.48 | 43,833 | 157 | 0.48 | 7,213 | 16 | 27 | 17 | |||||||||||||||||||||
Commercial paper and other short-term borrowings(4) | 2,814 | 4 | 0.19 | 3,851 | 8 | 0.27 | (1,037 | ) | (27 | ) | (4 | ) | (50 | ) | |||||||||||||||||
Long-term debt | 5,629 | 109 | 2.57 | 5,907 | 111 | 2.50 | (278 | ) | (5 | ) | (2 | ) | (2 | ) | |||||||||||||||||
Total borrowed funds | 8,443 | 113 | 1.78 | 9,758 | 119 | 1.62 | (1,315 | ) | (13 | ) | (6 | ) | (5 | ) | |||||||||||||||||
Total interest-bearing liabilities | 59,489 | 297 | 0.67 | 53,591 | 276 | 0.69 | 5,898 | 11 | 21 | 8 | |||||||||||||||||||||
Noninterest bearing deposits | 24,646 | 20,615 | 4,031 | 20 | |||||||||||||||||||||||||||
Other liabilities | 2,118 | 2,554 | (436 | ) | (17 | ) | |||||||||||||||||||||||||
Total liabilities | 86,253 | 76,760 | 9,493 | 12 | |||||||||||||||||||||||||||
Equity | |||||||||||||||||||||||||||||||
UNBC Stockholder's equity | 12,463 | 11,913 | 550 | 5 | �� | ||||||||||||||||||||||||||
Noncontrolling interests | 268 | 260 | 8 | 3 | |||||||||||||||||||||||||||
Total equity | 12,731 | 12,173 | 558 | 5 | |||||||||||||||||||||||||||
Total liabilities and equity | $ | 98,984 | $ | 88,933 | $ | 10,051 | 11 | % | |||||||||||||||||||||||
Net interest income/spread (taxable-equivalent basis) | 2,021 | 2.79 | % | 1,951 | 3.02 | % | 70 | 4 | % | ||||||||||||||||||||||
Impact of noninterest-bearing deposits | 0.20 | 0.19 | |||||||||||||||||||||||||||||
Impact of other noninterest-bearing sources | 0.03 | 0.04 | |||||||||||||||||||||||||||||
Net interest margin | 3.02 | 3.25 | |||||||||||||||||||||||||||||
Less: taxable-equivalent adjustment | 11 | 9 | 2 | 22 | |||||||||||||||||||||||||||
Net interest income | $ | 2,010 | $ | 1,942 | $ | 68 | 4 | ||||||||||||||||||||||||
- (1)
- Yields and interest income are presented on a taxable-equivalent basis using the federal statutory tax rate of 35 percent.
- (2)
- Annualized.
- (3)
- Average balances on loans outstanding include all nonperforming loans. The amortized portion of net loan origination fees (costs) is included in interest income on loans, representing an adjustment to the yield.
- (4)
- Includes interest-bearing trading liabilities.
nm = not meaningful
Net interest income for the third quarter of 2013 increased $39 million, compared with the third quarter of 2012. The increase was primarily due to growth in total loans held for investment, reflecting the impact from both organic growth and the PCBC and PB Capital acquisitions. The increase in net interest income was largely offset by contraction in the net interest margin, reflecting declining yields on total loans held for investment and securities.
11
Average total loans held for investment increased $11.3 billion for the quarter ended September 30, 2013 compared with the quarter ended September 30, 2012, primarily due to organic growth in commercial mortgage loans, residential mortgage loans, commercial and industrial loans, and the PCBC and PB Capital acquisitions. Average interest-bearing deposits increased $9.5 billion, and average noninterest-bearing deposits increased $3.6 billion, in the third quarter of 2013 compared with the third quarter of 2012, primarily reflecting the PCBC and Smartstreet acquisitions.
Noninterest Income and Noninterest Expense
The following tables detail our noninterest income and noninterest expense for the three and nine months ended September 30, 2013 and 2012:
Noninterest Income
| For the Three Months Ended | For the Nine Months Ended | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Increase (Decrease) | | | Increase (Decrease) | |||||||||||||||||||
| September 30, 2013 | September 30, 2012 | September 30, 2013 | September 30, 2012 | |||||||||||||||||||||
(Dollars in millions) | Amount | Percent | Amount | Percent | |||||||||||||||||||||
Service charges on deposit accounts | $ | 53 | $ | 51 | $ | 2 | 4 | % | $ | 158 | $ | 158 | $ | — | — | % | |||||||||
Securities gains, net | 47 | 41 | 6 | 15 | 170 | 88 | 82 | 93 | |||||||||||||||||
Trust and investment management fees | 34 | 29 | 5 | 17 | 107 | 86 | 21 | 24 | |||||||||||||||||
Credit facility fees | 31 | 27 | 4 | 15 | 83 | 77 | 6 | 8 | |||||||||||||||||
Merchant banking fees | 29 | 24 | 5 | 21 | 68 | 66 | 2 | 3 | |||||||||||||||||
Brokerage commissions and fees | 12 | 9 | 3 | 33 | 34 | 28 | 6 | 21 | |||||||||||||||||
Trading account activities | 15 | 23 | (8 | ) | (35 | ) | 41 | 71 | (30 | ) | (42 | ) | |||||||||||||
Card processing fees, net | 8 | 8 | — | — | 26 | 24 | 2 | 8 | |||||||||||||||||
Other investment income | 7 | 3 | 4 | 133 | 19 | 7 | 12 | 171 | |||||||||||||||||
Other, net | (2 | ) | (18 | ) | 16 | 89 | (20 | ) | (16 | ) | (4 | ) | (25 | ) | |||||||||||
Total noninterest income | $ | 234 | $ | 197 | $ | 37 | 19 | % | $ | 686 | $ | 589 | $ | 97 | 16 | % | |||||||||
Noninterest income in the third quarter of 2013 was $234 million, compared with $197 million in the third quarter of 2012. The increase was primarily attributed to other noninterest income which increased by $16 million primarily due to the gain on the sale of certain affiliated HighMark Funds. The increase was also driven by a $6 million increase in gains on the sale of securities. Merchant banking fees increased $5 million primarily driven by an increase in syndication and referral fees, and trust and investment management fees increased $5 million primarily due to higher fees on assets under management. Noninterest income for the nine months ended September 30, 2013 increased to $686 million from $589 million in the same period in 2012. The increase was primarily due to gains from the sale of securities for the nine months ended September 30, 2013, which increased by $82 million compared with the nine months ended September 30, 2012 due to securities portfolio rebalancing activities, partially offset by a decrease in trading account activities, which decreased $30 million for the nine months ended September 30, 2013 compared with the same period in 2012. This decrease was due to lower fees received in the first quarter of 2013 due to decreased customer activity.
12
Noninterest Expense
| For the Three Months Ended | For the Nine Months Ended | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Increase (Decrease) | | | Increase (Decrease) | |||||||||||||||||||
| September 30, 2013 | September 30, 2012 | September 30, 2013 | September 30, 2012 | |||||||||||||||||||||
(Dollars in millions) | Amount | Percent | Amount | Percent | |||||||||||||||||||||
Salaries and other compensation | $ | 310 | $ | 279 | $ | 31 | 11 | % | $ | 946 | $ | 814 | $ | 132 | 16 | % | |||||||||
Employee benefits | 81 | 77 | 4 | 5 | 279 | 257 | 22 | 9 | |||||||||||||||||
Salaries and employee benefits | 391 | 356 | 35 | 10 | 1,225 | 1,071 | 154 | 14 | |||||||||||||||||
Net occupancy and equipment | 77 | 65 | 12 | 18 | 236 | 197 | 39 | 20 | |||||||||||||||||
Professional and outside services | 66 | 54 | 12 | 22 | 186 | 147 | 39 | 27 | |||||||||||||||||
Software | 20 | 16 | 4 | 25 | 60 | 51 | 9 | 18 | |||||||||||||||||
Regulatory assessments | 20 | 14 | 6 | 43 | 60 | 48 | 12 | 25 | |||||||||||||||||
Low income housing credit investment amortization | 17 | 16 | 1 | 6 | 52 | 47 | 5 | 11 | |||||||||||||||||
Intangible asset amortization | 16 | 20 | (4 | ) | (20 | ) | 49 | 62 | (13 | ) | (21 | ) | |||||||||||||
Advertising and public relations | 15 | 12 | 3 | 25 | 46 | 36 | 10 | 28 | |||||||||||||||||
Communications | 11 | 10 | 1 | 10 | 33 | 30 | 3 | 10 | |||||||||||||||||
Data processing | 8 | 9 | (1 | ) | (11 | ) | 29 | 27 | 2 | 7 | |||||||||||||||
(Reversal of) provision for losses on off-balance sheet commitments | 1 | (4 | ) | 5 | nm | 14 | (7 | ) | 21 | nm | |||||||||||||||
Other | 47 | 70 | (23 | ) | (33 | ) | 114 | 142 | (28 | ) | (20 | ) | |||||||||||||
Total noninterest expense | $ | 689 | $ | 638 | $ | 51 | 8 | % | $ | 2,104 | $ | 1,851 | $ | 253 | 14 | % | |||||||||
nm = not meaningful
Noninterest expense in the third quarter of 2013 was $689 million compared with $638 million in the third quarter of 2012. Salaries and employee benefits increased $35 million primarily due to increased staff expenses, while net occupancy and equipment expense increased $12 million, both reflecting the acquisition of PCBC. Professional and outside services increased due to various regulatory and compliance projects and acquisition-related costs.
The adjusted efficiency ratio is a non-GAAP financial measure used by management to measure the efficiency of our operations, focusing on those costs management believes to be most relevant to our business activities. Productivity initiative costs primarily consist of salaries and benefits associated with operational efficiency enhancements. Productivity initiative gains reflect the gain from the sale of certain business units in
13
the first quarter of 2012 and the third quarter of 2013. The following table shows the calculation of this ratio for the three and nine months ended September 30, 2013 and 2012:
| For the Three Months Ended | For the Nine Months Ended | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | September 30, 2013 | September 30, 2012 | September 30, 2013 | September 30, 2012 | |||||||||
Noninterest Expense | $ | 689 | $ | 638 | $ | 2,104 | $ | 1,851 | |||||
Less: Foreclosed asset expense and other credit costs | (2 | ) | — | (6 | ) | 2 | |||||||
Less: (Reversal of) provision for losses on off-balance sheet commitments | 1 | (4 | ) | 14 | (7 | ) | |||||||
Less: Productivity initiative costs | 14 | 10 | 31 | 18 | |||||||||
Less: LIHC investment amortization expense | 17 | 15 | 52 | 46 | |||||||||
Less: Expenses of the LIHC consolidated VIEs | 11 | 10 | 23 | 25 | |||||||||
Less: Merger costs related to acquisitions | 25 | 6 | 109 | 10 | |||||||||
Less: Net adjustments related to privatization transaction | 13 | 21 | 41 | 64 | |||||||||
Less: Debt termination fees from balance sheet repositioning | — | 30 | — | 30 | |||||||||
Less: Intangible asset amortization | 3 | — | 10 | — | |||||||||
Net noninterest expense, as adjusted (a) | $ | 607 | $ | 550 | $ | 1,830 | $ | 1,663 | |||||
Total Revenue | $ | 919 | $ | 843 | $ | 2,696 | $ | 2,531 | |||||
Add: Net interest income taxable-equivalent adjustment | 4 | 3 | 11 | 9 | |||||||||
Less: Productivity initiative gains | 11 | — | 11 | 23 | |||||||||
Less: Accretion related to privatization-related fair value adjustments | 8 | 42 | 16 | 63 | |||||||||
Less: Other credit costs | 1 | — | (6 | ) | — | ||||||||
Total revenue, as adjusted (b) | $ | 903 | $ | 804 | $ | 2,686 | $ | 2,454 | |||||
Adjusted efficiency ratio (a)/(b) | 67.21 | % | 68.33 | % | 68.10 | % | 67.81 | % |
Income Tax Expense
The effective income tax rate was 22 percent in the third quarter of 2013 compared with 26 percent in the third quarter of 2012. The effective income tax rate was 23 percent in the nine month period ended September 30, 2013 compared with 25 percent for the nine month period ended September 30, 2012. The overall decrease in the effective tax rate for the third quarter of 2013 was primarily driven by the proportionately larger impact of low-income housing and alternative energy income tax benefits on pre-tax income.
For further information regarding income tax expense, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Income Tax Expense" and "Changes in our tax rates could affect our future results" in "Risk Factors" in Part I, Item 1A and Note 11 to the consolidated financial statements in our 2012 Form 10-K.
14
Securities
Our securities portfolio is primarily used for liquidity and interest rate risk management purposes, to invest cash resulting from excess liquidity, and to a lesser extent, to support our business development objectives. We strive to maximize total return while managing this objective within appropriate risk parameters. Securities available for sale are principally comprised of residential and commercial mortgage-backed securities, collateralized loan obligations (CLOs) and direct bank purchase bonds. Direct bank purchase bonds are instruments that are issued in bond form, accounted for as securities, but underwritten as loans with features that are typically found in commercial loans. Securities held to maturity consist of U.S. government and government-sponsored agency residential and commercial mortgage-backed securities and cash flow CLOs. A cash flow CLO is a structured finance product that securitizes a diversified pool of loan assets into multiple classes of notes. Cash flow CLOs pay the note holders through the receipt of interest and principal repayments from the underlying loans, unlike other types of CLOs that pay note holders through the trading and sale of underlying collateral.
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of securities are detailed in Note 4 to our consolidated financial statements included in this Form 10-Q.
Loans Held for Investment
The following table shows loans held for investment outstanding by loan type at the end of each period presented:
| | | Increase (Decrease) | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | December 31, 2012 | |||||||||||
(Dollars in millions) | Amount | Percent | |||||||||||
Loans held for investment: | |||||||||||||
Commercial and industrial | $ | 23,125 | $ | 20,827 | $ | 2,298 | 11 | % | |||||
Commercial mortgage | 12,905 | 9,939 | 2,966 | 30 | |||||||||
Construction | 855 | 627 | 228 | 36 | |||||||||
Lease financing | 972 | 1,104 | (132 | ) | (12 | ) | |||||||
Total commercial portfolio | 37,857 | 32,497 | 5,360 | 16 | |||||||||
Residential mortgage | 24,714 | 22,705 | 2,009 | 9 | |||||||||
Home equity and other consumer loans | 3,336 | 3,647 | (311 | ) | (9 | ) | |||||||
Total consumer portfolio | 28,050 | 26,352 | 1,698 | 6 | |||||||||
Total loans held for investment, before purchased credit-impaired loans | 65,907 | 58,849 | 7,058 | 12 | |||||||||
Purchased credit-impaired loans | 1,263 | 1,185 | 78 | 7 | |||||||||
Total loans held for investment | $ | 67,170 | $ | 60,034 | $ | 7,136 | 12 | % | |||||
Loans held for investment increased from December 31, 2012 to September 30, 2013 primarily due to the acquisition of PB Capital's $3.5 billion institutional CRE lending portfolio and organic growth in the commercial and industrial and residential mortgage portfolios.
Cross-Border Outstandings
Our cross-border outstandings reflect certain additional economic and political risks that are not reflected in domestic outstandings. These risks include those arising from exchange rate fluctuations and restrictions on the transfer of funds. Our total cross-border outstandings for Canada, the only country where such outstandings exceeded one percent of total assets, were $1.5 billion at both September 30, 2013 and
15
December 31, 2012. The cross-border outstandings are based on category and domicile of ultimate risk and are comprised of balances with banks, trading account assets, securities available for sale, securities purchased under resale agreements, loans, accrued interest receivable, acceptances outstanding and investments with foreign entities.
As of September 30, 2013, our sovereign and non-sovereign debt exposure to European countries was not material.
Deposits
The table below presents our deposits as of September 30, 2013 and December 31, 2012.
| | | Increase (Decrease) | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | December 31, 2012 | |||||||||||
(Dollars in millions) | Amount | Percent | |||||||||||
Interest checking | $ | 5,102 | $ | 5,178 | $ | (76 | ) | (1 | )% | ||||
Money market | 30,919 | 25,169 | 5,750 | 23 | |||||||||
Total interest-bearing transaction and money market accounts | 36,021 | 30,347 | 5,674 | 19 | |||||||||
Savings | 5,589 | 5,853 | (264 | ) | (5 | ) | |||||||
Time | 11,679 | 12,626 | (947 | ) | (8 | ) | |||||||
Total interest-bearing deposits | 53,289 | 48,826 | 4,463 | 9 | |||||||||
Noninterest-bearing deposits | 26,126 | 25,478 | 648 | 3 | |||||||||
Total deposits | $ | 79,415 | $ | 74,304 | $ | 5,111 | 7 | % | |||||
Total interest-bearing deposits include the following brokered deposits: | |||||||||||||
Interest-bearing transaction and money market accounts | $ | 3,222 | $ | 2,474 | $ | 748 | 30 | % | |||||
Time | 3,367 | 3,008 | 359 | 12 | |||||||||
Total brokered deposits | $ | 6,589 | $ | 5,482 | $ | 1,107 | 20 | % | |||||
Core Deposits: | |||||||||||||
Total deposits | $ | 79,415 | $ | 74,304 | $ | 5,111 | 7 | % | |||||
Less: Total brokered deposits | 6,589 | 5,482 | 1,107 | 20 | |||||||||
Less: Total foreign deposits and nonbrokered domestic time deposits of over $250,000 | 4,492 | 5,053 | (561 | ) | (11 | ) | |||||||
Total core deposits | $ | 68,334 | $ | 63,769 | $ | 4,565 | 7 | % | |||||
Total deposits and core deposits increased $5.1 billion and $4.6 billion, respectively, from December 31, 2012 to September 30, 2013, primarily due to organic retail deposit growth. Core deposits as a percentage of total deposits were 86 percent at September 30, 2013 and December 31, 2012.
Allowance for Credit Losses
Allowance Policy and Methodology
We maintain an allowance for credit losses (defined as both the allowance for loan losses and the allowance for off-balance sheet commitment losses) to absorb losses inherent in the loan portfolio as well as for off-balance sheet commitments. Understanding our policies on the allowance for credit losses is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly, our significant accounting policies on the allowance for credit losses are discussed in detail in Note 1 to our consolidated financial statements and in the section "Allowance for Credit Losses" included in "Management's
16
Discussion and Analysis of Financial Condition and Results of Operations" in our 2012 Form 10-K. For additional information regarding our allowance for loan losses, refer to Note 5 of our consolidated financial statements in this Form 10-Q.
Allowance and Related Provision for Credit Losses
The allowance for loan losses decreased $45 million to $608 million as of September 30, 2013 compared with $653 million at December 31, 2012. This decrease is primarily due to improving credit quality in our commercial and consumer portfolios. The unallocated allowance was $84 million at September 30, 2013, compared with $110 million at December 31, 2012. The allowance for credit losses for the commercial portfolio was updated to reflect an extension of the loss emergence period, which previously had been estimated within the unallocated allowance for loan losses. However, the unallocated allowance increased by $46 million at September 30, 2013 from $38 million at June 30, 2013. The increase was largely due to various refinements in assumptions underlying the methodology used to measure credit risk ascribed to the commercial loan portfolio segment.
Our ratio of nonaccrual loans to total loans held for investment was 0.76 percent at September 30, 2013 and 0.84 percent at December 31, 2012. Our ratio of allowance for loan losses to total loans held for investment decreased to 0.91 percent at September 30, 2013 from 1.09 percent at December 31, 2012. Annualized net loans recovered to average total loans held for investment was 0.01 percent for the quarter ended September 30, 2013 compared with an annualized net loans charged off to average total loans held for investment of 0.30 percent for the quarter ended September 30, 2012. Criticized credits in the commercial segment were $1.3 billion at September 30, 2013 and December 31, 2012. Criticized credits are those that have regulatory risk grades of "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. Adversely classified credits are those that are internally risk graded as "substandard" or "doubtful." "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 on the basis of currently existing facts and conditions.
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Change in the Total Allowance for Loan Losses
The following table sets forth a reconciliation of changes in our allowance for loan losses:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | 2013 | 2012 | 2013 | 2012 | |||||||||
Balance, beginning of period | $ | 625 | $ | 656 | $ | 653 | $ | 764 | |||||
(Reversal of) provision for loan losses, excluding FDIC covered loans | (16 | ) | 43 | (22 | ) | 31 | |||||||
(Reversal of) provision for FDIC covered loan losses not subject to FDIC indemnification | — | 2 | — | (1 | ) | ||||||||
Increase/(Decrease) in allowance covered by FDIC indemnification | (2 | ) | 8 | (2 | ) | (1 | ) | ||||||
Other | — | 1 | — | 1 | |||||||||
Loans charged off: | |||||||||||||
Commercial and industrial | (6 | ) | (12 | ) | (18 | ) | (56 | ) | |||||
Commercial mortgage | (2 | ) | (1 | ) | (5 | ) | (12 | ) | |||||
Construction | (1 | ) | — | (1 | ) | (11 | ) | ||||||
Total commercial portfolio | (9 | ) | (13 | ) | (24 | ) | (79 | ) | |||||
Residential mortgage | (2 | ) | (22 | ) | (12 | ) | (43 | ) | |||||
Home equity and other consumer loans | (2 | ) | (19 | ) | (13 | ) | (37 | ) | |||||
Total consumer portfolio | (4 | ) | (41 | ) | (25 | ) | (80 | ) | |||||
FDIC covered loans | — | (3 | ) | (3 | ) | (5 | ) | ||||||
Total loans charged off | (13 | ) | (57 | ) | (52 | ) | (164 | ) | |||||
Recoveries of loans previously charged off: | |||||||||||||
Commercial and industrial | 5 | 7 | 15 | 19 | |||||||||
Commercial mortgage | 4 | 5 | 6 | 8 | |||||||||
Construction | 1 | 1 | 1 | 7 | |||||||||
Total commercial portfolio | 10 | 13 | 22 | 34 | |||||||||
Home equity and other consumer loans | 2 | 1 | 4 | 2 | |||||||||
Total consumer portfolio | 2 | 1 | 4 | 2 | |||||||||
FDIC covered loans | 2 | 1 | 5 | 2 | |||||||||
Total recoveries of loans previously charged off | 14 | 15 | 31 | 38 | |||||||||
Net loans recovered (charged off) | 1 | (42 | ) | (21 | ) | (126 | ) | ||||||
Ending balance of allowance for loan losses | $ | 608 | $ | 668 | $ | 608 | $ | 668 | |||||
Components of allowance for loan losses and credit losses: | |||||||||||||
Allowance for loan losses, excluding allowance on purchased credit-impaired loans | $ | 607 | $ | 656 | $ | 607 | $ | 656 | |||||
Allowance for loan losses on purchased credit-impaired loans | 1 | 12 | 1 | 12 | |||||||||
Total allowance for loan losses | 608 | 668 | 608 | 668 | |||||||||
Allowance for losses on off-balance sheet commitments | 131 | 126 | 131 | 126 | |||||||||
Total allowance for credit losses | $ | 739 | $ | 794 | $ | 739 | $ | 794 | |||||
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Nonperforming Assets
Nonperforming assets consist of nonaccrual loans and OREO. Nonaccrual loans are those for which management has discontinued accrual of interest because there exists significant uncertainty as to the full and timely collection of either principal or interest, or such loans have become contractually past due 90 days with respect to principal or interest. For a more detailed discussion of the accounting for nonaccrual loans, see Note 1 to our consolidated financial statements included in our 2012 Form 10-K. OREO includes property where the Bank acquired title through foreclosure or "deed in lieu" of foreclosure.
The following table sets forth an analysis of nonperforming assets:
| | | Increase (Decrease) | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | December 31, 2012 | |||||||||||
(Dollars in millions) | Amount | Percent | |||||||||||
Commercial and industrial | $ | 62 | $ | 48 | $ | 14 | 29 | % | |||||
Commercial mortgage | 88 | 65 | 23 | 35 | |||||||||
Total commercial portfolio | 150 | 113 | 37 | 33 | |||||||||
Residential mortgage | 293 | 306 | (13 | ) | (4 | ) | |||||||
Home equity and other consumer loans | 48 | 56 | (8 | ) | (14 | ) | |||||||
Total consumer portfolio | 341 | 362 | (21 | ) | (6 | ) | |||||||
Total nonaccrual loans, before purchased credit-impaired loans | 491 | 475 | 16 | 3 | |||||||||
Purchased credit-impaired loans | 20 | 30 | (10 | ) | (33 | ) | |||||||
Total nonaccrual loans | 511 | 505 | 6 | 1 | |||||||||
OREO, before FDIC covered OREO | 22 | 45 | (23 | ) | (51 | ) | |||||||
FDIC covered OREO | 41 | 66 | (25 | ) | (38 | ) | |||||||
Total nonperforming assets | $ | 574 | $ | 616 | $ | (42 | ) | (7 | )% | ||||
Total nonperforming assets, excluding purchased credit-impaired loans and FDIC covered OREO | $ | 513 | $ | 520 | $ | (7 | ) | (1 | )% | ||||
Troubled debt restructurings: | |||||||||||||
Accruing | $ | 373 | $ | 401 | $ | (28 | ) | (7 | )% | ||||
Nonaccruing (included in total nonaccrual loans above) | $ | 260 | $ | 209 | $ | 51 | 24 | % | |||||
Allowance for loan losses | $ | 608 | $ | 653 | $ | (45 | ) | (7 | )% | ||||
Allowance for credit losses | $ | 739 | $ | 770 | $ | (31 | ) | (4 | )% | ||||
Troubled Debt Restructurings
Troubled debt restructurings (TDRs) are loans where we have granted a concession to a borrower as a result of the borrower experiencing financial difficulty and, consequently, we receive less than the current market-based compensation for loans with similar risk characteristics. Such loans are classified as impaired and are reviewed for specific reserves either individually or in pools with similar risk characteristics. Our loss mitigation strategies are designed to minimize economic loss and, at times, may result in changes to original terms, including interest rate changes, maturity extensions, principal paydowns, covenant waivers and payment deferrals, or some combination thereof. We evaluate whether these changes to the terms and conditions of our loans meet the TDR criteria after considering the specific situation of the borrower and all relevant facts and circumstances related to the modification. For our consumer portfolio segment, TDRs are initially placed on nonaccrual and, typically, a minimum of six consecutive months of sustained performance is required before returning to accrual status. For our commercial portfolio segment, we generally determine
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accrual status for TDRs by performing an individual assessment of each loan, which may include, among other factors, the consideration of demonstrated performance by the borrower under the previous terms.
Modifications of purchased credit-impaired loans that are accounted for within loan pools do not result in the removal of these loans from the pool even if the modification would otherwise be considered a TDR. Each pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Accordingly, modifications of loans within such pools are not considered TDRs.
The following table provides a summary of TDRs by loan type as of September 30, 2013 and December 31, 2012. Refer to Note 5 to our consolidated financial statements in this Form 10-Q for more information.
| | | As a Percentage of Ending Loan Balances | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | September 30, 2013 | December 31, 2012 | September 30, 2013 | December 31, 2012 | |||||||||
Commercial and industrial | $ | 232 | $ | 215 | 1.00 | % | 1.03 | % | |||||
Commercial mortgage | 70 | 64 | 0.54 | 0.64 | |||||||||
Construction | 2 | 35 | 0.21 | 5.54 | |||||||||
Total commercial portfolio | 304 | 314 | 0.80 | 0.96 | |||||||||
Residential mortgage | 303 | 271 | 1.23 | 1.19 | |||||||||
Home equity and other consumer loans | 23 | 21 | 0.69 | 0.58 | |||||||||
Total consumer portfolio | 326 | 292 | 1.16 | 1.11 | |||||||||
Total restructured loans, excluding purchased credit-impaired loans(1) | $ | 630 | $ | 606 | 0.96 | % | 1.03 | % | |||||
- (1)
- Amounts exclude $3 million and $4 million of TDRs covered by FDIC loss share agreements at September 30, 2013 and December 31, 2012, respectively.
Loans 90 Days or More Past Due and Still Accruing
Loans held for investment 90 days or more past due and still accruing totaled $8 million and $1 million at September 30, 2013 and December 31, 2012, respectively. These amounts exclude purchased credit-impaired loans, which are generally accounted for within loan pools, of $203 million and $124 million at September 30, 2013 and December 31, 2012, respectively. The past due status of individual loans included within purchased credit-impaired loan pools is not a meaningful indicator of credit quality, as potential credit losses are measured at the loan pool level against prior expectations of cash flow performance.
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Capital
The following tables summarize our risk-based capital, risk-weighted assets, and risk-based capital ratios:
UnionBanCal Corporation
(Dollars in millions) | September 30, 2013 | | December 31, 2012 | | | | | | | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Capital Components | ||||||||||||||||||||||||||||
Tier 1 capital | $ | 10,153 | $ | 9,864 | ||||||||||||||||||||||||
Tier 2 capital | 1,766 | 1,184 | ||||||||||||||||||||||||||
Total risk-based capital | $ | 11,919 | $ | 11,048 | ||||||||||||||||||||||||
Risk-weighted assets | $ | 90,900 | $ | 79,321 | ||||||||||||||||||||||||
Average total assets for leverage capital purposes | $ | 99,377 | $ | 88,265 | ||||||||||||||||||||||||
| September 30, 2013 | December 31, 2012 | September 30, 2013 Minimum Regulatory Requirement | September 30, 2013 "Well-Capitalized" Regulatory Requirement | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||
Capital Ratios | |||||||||||||||||||||||||
Tier 1 capital (to risk-weighted assets) | $ | 10,153 | 11.17 | % | $ | 9,864 | 12.44 | % | ³$ | 3,636 | 4.0 | % | ³$ | 5,454 | 6.0 | % | |||||||||
Total capital (to risk-weighted assets) | 11,919 | 13.11 | 11,048 | 13.93 | ³ | 7,272 | 8.0 | ³ | 9,090 | 10.0 | |||||||||||||||
Tier 1 leverage(1) | 10,153 | 10.22 | 9,864 | 11.18 | ³ | 3,975 | 4.0 | ³ | na | na |
- (1)
- Tier 1 capital divided by average total assets for leverage capital purposes (excluding certain intangible assets).
na—not applicable
Union Bank, N.A.
(Dollars in millions) | September 30, 2013 | | December 31, 2012 | | | | | | | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Capital Components | ||||||||||||||||||||||||||||
Tier 1 capital | $ | 9,451 | $ | 9,192 | ||||||||||||||||||||||||
Tier 2 capital | 1,752 | 1,170 | ||||||||||||||||||||||||||
Total risk-based capital | $ | 11,203 | $ | 10,362 | ||||||||||||||||||||||||
Risk-weighted assets | $ | 86,212 | $ | 78,674 | ||||||||||||||||||||||||
Average total assets for leverage capital purposes | $ | 98,877 | $ | 87,456 | ||||||||||||||||||||||||
| September 30, 2013 | December 31, 2012 | September 30, 2013 Minimum Regulatory Requirement | September 30, 2013 "Well-Capitalized" Regulatory Requirement | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||
Capital Ratios | |||||||||||||||||||||||||
Tier 1 capital (to risk-weighted assets) | $ | 9,451 | 10.96 | % | $ | 9,192 | 11.68 | % | ³$ | 3,448 | 4.0 | % | ³$ | 5,173 | 6.0 | % | |||||||||
Total capital (to risk-weighted assets) | 11,203 | 13.00 | 10,362 | 13.17 | ³ | 6,897 | 8.0 | ³ | 8,621 | 10.0 | |||||||||||||||
Tier 1 leverage(1) | 9,451 | 9.56 | 9,192 | 10.51 | ³ | 3,955 | 4.0 | ³ | 4,944 | 5.0 |
- (1)
- Tier 1 capital divided by average total assets for leverage capital purposes (excluding certain intangible assets).
Both the Company and the Bank are subject to various regulations of the federal banking agencies, including requirements 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). The Company and the Bank interact with the federal banking agencies regarding matters that pertain to capital management and during the course of those discussions become aware, from time to time, of evolving regulatory interpretations of capital adequacy
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guidelines. As these interpretations are clarified, their resolution can result in changes to the methodologies applied to the computations of our capital ratios. Effective September 30, 2013, the Company updated the methodologies applied to the calculation of its regulatory capital ratios as the result of recent regulatory correspondence, which clarified the treatment of certain off-balance sheet credit exposures. If the Company had applied the new methodology on a retrospective basis, as of December 31, 2012, the Tier 1 risk-based capital ratio would have been 11.87 percent, the Total risk-based capital ratio would have been 13.30 percent, and the Tier 1 common capital ratio would have been 11.79 percent. As of September 30, 2013, management believes the capital ratios of the Company and the Bank met all regulatory requirements of "well-capitalized" institutions. During the second quarter of 2013, Union Bank issued $750 million of subordinated debt to BTMU. The subordinated debt qualifies as Tier 2 capital for Union Bank.
In January 2013, the Company timely filed its Capital Plan Review (CapPR) with the Federal Reserve. The CapPR is an assessment of the capital plans of bank holding companies in the U.S. with total assets exceeding $50 billion that were not included in the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) of the largest U.S. bank holding companies. In March 2013, the Company was notified by the Federal Reserve that it did not object to the Company's planned capital actions. The Federal Reserve's regulations provide that a bank holding company may be required to revise and re-submit its capital plan if certain material events occur after adoption of its plan.
Commencing in January 2014, the Company will file its annual capital plan under the provisions mandated by the Federal Reserve's CCAR program. The Company's 2014 CCAR submission will encompass a range of expected and stressed economic and financial market scenarios, and will include an assessment of expected sources and uses of capital over a prescribed planning horizon, a description of all capital actions within that timeframe, and a discussion of any proposed business plan changes that are likely to have a material impact on capital adequacy. As part of the 2014 CCAR process, the Federal Reserve will also generate a supervisory stress test using the information provided by the Company to estimate performance and advise us as to whether it objects to any of our proposed capital actions. The Federal Reserve will publish its supervisory stress test results and the related CCAR results taking into account the Company's proposed capital actions.
In addition to capital ratios determined in accordance with regulatory requirements, we consider the tangible common equity ratio and the Tier 1 common capital ratio when evaluating capital utilization and adequacy. These capital ratios are viewed by management, and presented below, to further facilitate the understanding of our capital structure and for use in assessing and comparing the quality and composition of UnionBanCal's capital structure to other financial institutions. These ratios are not defined by accounting principles generally accepted in the United States of America (U.S. GAAP) or federal banking regulations; therefore, they are considered non-GAAP financial measures. Our tangible common equity ratio calculation methods may differ from those used by other financial services companies.
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The following table summarizes the calculation of our tangible common equity ratio and Tier 1 common capital ratio as of September 30, 2013 and December 31, 2012:
| | | Increase (Decrease) | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | December 31, 2012 | |||||||||||
(Dollars in millions) | Amount | Percent | |||||||||||
Total UNBC stockholder's equity | $ | 12,549 | $ | 12,461 | $ | 88 | 1 | % | |||||
Goodwill | (3,168 | ) | (2,942 | ) | (226 | ) | (8 | ) | |||||
Intangible assets, except mortgage servicing rights (MSRs) | (287 | ) | (373 | ) | 86 | 23 | |||||||
Deferred tax liabilities related to goodwill and intangible assets | 110 | 129 | (19 | ) | (15 | ) | |||||||
Tangible common equity (a) | $ | 9,204 | $ | 9,275 | $ | (71 | ) | (1 | ) | ||||
Tier 1 capital, determined in accordance with regulatory requirements | $ | 10,153 | $ | 9,864 | $ | 289 | 3 | ||||||
Junior subordinated debt payable to trusts | (66 | ) | (66 | ) | — | — | |||||||
Tier 1 common equity (b) | $ | 10,087 | $ | 9,798 | $ | 289 | 3 | ||||||
Total assets | $ | 105,484 | $ | 97,008 | $ | 8,476 | 9 | ||||||
Goodwill | (3,168 | ) | (2,942 | ) | (226 | ) | (8 | ) | |||||
Intangible assets, except MSRs | (287 | ) | (373 | ) | 86 | 23 | |||||||
Deferred tax liabilities related to goodwill and intangible assets | 110 | 129 | (19 | ) | (15 | ) | |||||||
Tangible assets (c) | $ | 102,139 | $ | 93,822 | $ | 8,317 | 9 | ||||||
Risk-weighted assets, determined in accordance with regulatory requirements (d) | $ | 90,900 | $ | 79,321 | $ | 11,579 | 15 | % | |||||
Tangible common equity ratio (a)/(c) | 9.01 | % | 9.89 | % | |||||||||
Tier 1 common capital ratio (b)/(d) | 11.10 | 12.35 |
In July 2013, the Federal Reserve Board and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the Basel Committee's current international regulatory capital accord (Basel III). These rules, upon their effectiveness, will replace the federal banking agencies' general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules in accordance with certain transition provisions. Under the rules as adopted, banking organizations will be required to determine their regulatory capital requirements under either the advanced approaches or the standardized approach. Banking organizations may elect to use the advanced approaches (with regulatory approval), and certain banking organizations will be required to use the advanced approaches (e.g., those with total assets of $250 billion or more). For banking organizations whose regulatory capital requirements are determined under the advanced approaches, which we expect will include the Company, the effective date and the beginning of the transitional adjustments will be January 1, 2014, and for other banking organizations, January 1, 2015. The final rules establish more restrictive capital definitions, create additional categories and higher risk weightings for certain asset classes and off-balance sheet exposures, higher minimum capital and leverage ratios and capital conservation buffers that will be added to the minimum capital requirements and must be met for banking organizations to avoid being subject to certain limitations on dividends and discretionary bonus payments to executive officers. The final rules will provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of 4.5 percent; (b) a Tier 1 capital ratio of 6 percent; (c) a total capital ratio of 8 percent; and (d) a Tier 1 leverage ratio to average consolidated assets of 4 percent. The advanced approaches banking organizations will also be subject to a new and separate supplementary leverage ratio under which they will be required to maintain capital against not only on-balance sheet assets but also certain off-balance sheet assets and exposures, including derivative exposures. Banking organizations that are subject
23
to the advanced approaches must include most elements of their accumulated other comprehensive income (AOCI) in determining their regulatory capital; banking organizations using the standardized approach may make a one-time permanent opt-out election to exclude most AOCI elements from regulatory capital. Advanced approaches banking organizations must also determine their capital ratios with reference to the lower of the standardized or advanced approaches.
The Company is evaluating the impact that these recently adopted rules of the U.S. federal banking agencies will have on its capital position and capital management policy and expects that it will be able to satisfy the minimum capital requirements within the prescribed implementation timelines. For additional information, see Item 1A. Risk Factors—"The effects of changes or increases in, or supervisory enforcement of, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us" in this Form 10-Q and "Supervision and Regulation—Regulatory Capital Standards" in our 2012 Form 10-K.
Quantitative and Qualitative Disclosures About Market Risk
The objective of market risk management is to mitigate any adverse impact on earnings and capital arising from changes in interest rates and other market variables. Market risk management supports our broad objective of enhancing shareholder value, which encompasses the achievement of stable earnings growth while promoting capital stability over time. Market risk is defined as the risk of loss arising from an adverse change in the market value of financial instruments caused by fluctuations in market prices or rates. The primary market risk to which we are exposed is interest rate risk. Substantially all of our interest rate risk arises from instruments, positions and transactions entered into for purposes other than trading. These include loans, securities, deposits, borrowings and derivative financial instruments. To a much lesser degree, we are exposed to market risk in our trading portfolio.
Risk Governance
The Board of Directors (Board), directly or through its appropriate committee, approves our Asset Liability Management Policy (ALM Policy), which governs the management of market and liquidity risks and guides our investment, derivatives, trading and funding activities. The ALM Policy establishes the Company's risk tolerance by outlining standards for measuring market and liquidity risks, creates Board-level limits for specific market risks, establishes Asset Liability Management Committee (ALCO) responsibilities and requires independent review and oversight of market and liquidity risk activities.
The Risk & Capital Committee (RCC), composed of selected senior officers of the Company strives, among other things, to ensure that the Company has an effective process to identify, monitor, measure, and manage market risk as required by the ALM Policy. The RCC provides the broad and strategic guidance of market risk management by defining the risk and return direction for the Company, delegating to and reviewing market risk management activities of the ALCO and by approving the investment, derivatives and trading policies that govern the Company's activities. ALCO, as authorized by the RCC, is responsible for the management of market risk and approves specific risk management programs including those related to interest rate hedging, investment securities, wholesale funding and trading activities.
The Treasurer is primarily responsible for the implementation of risk management strategies approved by ALCO and for operational management of market risk through the funding, investment and derivatives hedging activities of Corporate Treasury. The manager of Global Capital Markets (GCM) is responsible for managing price risk through the trading activities conducted in GCM. The Market Risk Management (MRM) unit is responsible for the monitoring of market risk and functions independently of all operating and management units.
The Company has separate and distinct methods for managing the market risk associated with our asset and liability management activities and our trading activities, as described below.
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Interest Rate Risk Management (Other Than Trading)
ALCO monitors interest rate risk monthly through a variety of modeling techniques that are used to quantify the sensitivity of net interest income to changes in interest rates. Our net interest income policy measurement typically involves a simulation in which we estimate the net interest income impact of gradual parallel shifts in the yield curve of up and down 200 basis points over a 12-month horizon using a forecasted balance sheet. Due to the current and persistently low interest rate environment, the -200 basis point parallel scenario was replaced with a -100 basis point parallel scenario.
Net Interest Income Sensitivity
The table below presents the estimated increase (decrease) in net interest income given a gradual parallel shift in the yield curve up 200 basis points and down 100 basis points over a 12-month horizon.
(Dollars in millions) | September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
Effect on net interest income: | |||||||
Increase 200 basis points | $ | 137.5 | $ | 118.8 | |||
as a percentage of base case net interest income | 5.05 | % | 4.42 | % | |||
Decrease 100 basis points | $ | (52.1 | ) | $ | (49.1 | ) | |
as a percentage of base case net interest income | (1.91 | )% | (1.83 | )% |
An increase in rates increases net interest income. During the third quarter of 2013, the Company's asset sensitive profile increased slightly as changes were made to balance sheet composition and as a result of new activity forecasted to occur over the next twelve months. We believe that our simulation provides management with a comprehensive view of the sensitivity of net interest income to changes in interest rates over the measurement horizon. However, as with any financial model, the underlying assumptions are inherently uncertain and subject to refinement. In particular, two significant models used in interest rate risk measurement address residential mortgage prepayment speeds and non-maturity deposit rate and balance behaviors. The mortgage prepayment model is periodically calibrated to reflect changes in customer behavior, but in the current low-interest rate and credit environment, may be prone to lowered predictive capability when determining the borrower's propensity or ability to prepay their mortgage. The deposit model uses the Company's historical deposit pricing to forecast future deposit pricing in its scenarios. Management's response to future rate scenarios may deviate from historic responses as the 2008 financial crisis may have changed customer behaviors and future competitive responses with respect to deposit repricing. Actual results may differ from those derived in the simulation analysis due to extraordinary market events, unanticipated changes in customer behavior, market interest rates, product pricing, and investment, funding and hedging activities.
Investment Securities
Our ALM securities portfolio is composed of available for sale and held to maturity securities. As of September 30, 2013, this portfolio totaled $20.3 billion and was composed of $14.8 billion of available for sale securities and $5.4 billion of held to maturity securities. As of December 31, 2012, this portfolio totaled $20.9 billion and was composed of $19.7 billion of available for sale securities and $1.1 billion of held to maturity securities. The expected weighted average life of our ALM securities portfolio was 5.3 years at September 30, 2013. Based on current prepayment projections, the estimated ALM securities portfolio's effective duration was 4.1 at September 30, 2013, compared with 2.3 at December 31, 2012. Effective duration is a measure of price sensitivity of a bond portfolio to immediate parallel shifts in interest rates. An effective duration of 4.1 suggests an expected price decrease of approximately 4.1 percent for an immediate 1 percent parallel increase in interest rates. At September 30, 2013, approximately $6.1 billion of the portfolio was pledged to secure trust and public deposits and for other purposes as required or permitted by law.
25
In addition to our ALM securities, our securities available for sale portfolio includes approximately $1.9 billion of direct bank purchase bonds which are managed within our Corporate Banking operating segment. These instruments are accounted for as securities, but underwritten as loans with terms that are closely aligned with traditional commercial loan features, and are subject to national bank regulatory lending authority standards. These instruments typically are not issued in bearer form, nor are they registered with the SEC or the Depository Trust Company. Additionally, these instruments generally contain certain transferability restrictions and are not assigned external credit ratings.
ALM Derivatives
Since December 31, 2012, the notional amount of the ALM derivatives portfolio decreased by $4.9 billion. The Bank terminated $4.6 billion of receive fixed interest rate swap contracts previously used to hedge floating rate commercial loans and $2.0 billion of interest rate caps previously used to hedge interest-bearing deposits. In addition, $750 million of interest rate swaps and $1.0 billion of interest rate caps matured during the period. The interest rate swaps were partly replaced by $3.5 billion of new receive fixed interest rate swap contracts to hedge floating rate commercial loans.
The fair value of the ALM derivatives portfolio decreased as a result of the terminations noted above. For additional discussion of derivative instruments and our hedging strategies, see Note 11 to our consolidated financial statements in this Form 10-Q and Note 17 to our consolidated financial statements included in our 2012 Form 10-K.
(Dollars in millions) | September 30, 2013 | December 31, 2012 | Increase (Decrease) | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Total gross notional amount of positions held for purposes other than trading: | ||||||||||
Interest rate swap receive fixed contracts | $ | 3,550 | $ | 5,300 | $ | (1,750 | ) | |||
Interest rate cap purchased contracts | — | 3,100 | (3,100 | ) | ||||||
Other contracts | 165 | 109 | 56 | |||||||
Total interest rate contracts | $ | 3,715 | $ | 8,509 | $ | (4,794 | ) | |||
Fair value of positions held for purposes other than trading: | ||||||||||
Gross positive fair value | $ | 23 | $ | 29 | $ | (6 | ) | |||
Gross negative fair value | 7 | 3 | 4 | |||||||
Positive (negative) fair value of positions, net | $ | 16 | $ | 26 | $ | (10 | ) | |||
Trading Activities
We enter into trading account activities primarily as a financial intermediary for customers and, to a much lesser extent, for our own account. By acting as a financial intermediary, we are able to provide our customers with access to a range of products from the securities, foreign exchange and derivatives markets. In acting for our own account, we may take positions in certain securities, foreign exchange and interest rate instruments, subject to various limits in amount, tenor and other respects, with the objective of generating trading profits.
We believe that the risks associated with these positions are prudently managed. We utilize a combination of position limits, Value-at-Risk (VaR), and stop-loss limits, applied at an aggregated level and to various sub-components within those limits. Positions are controlled and reported both in notional and VaR terms. Our calculation of VaR estimates how high the loss in fair value might be, at a 99 percent confidence level, due to an adverse shift in market prices over a period of ten business days. VaR at the trading activity level is managed within the maximum limit of $14 million established by Board policy for total trading positions. The VaR model incorporates assumptions on key parameters, including holding period and historical volatility.
26
Consistent with our business strategy of focusing on meeting the needs of our customers through the sale of capital markets products, we manage our trading risk exposures at relatively low levels. Our foreign exchange business continues to derive the majority of its revenue from customer-related transactions. We take trading positions with other banks only on a limited basis and we do not take any large or long-term strategic positions in the market for our own portfolio. Similarly, we continue to generate most of our trading income from customer-related transactions.
As of September 30, 2013, we had notional amounts of $43.7 billion of interest rate derivative contracts, $3.4 billion of foreign exchange derivative contracts and $3.9 billion of commodity derivative contracts. We enter into these agreements for the principal purpose of accommodating the needs of our customers. We generally take offsetting positions in these transactions to mitigate our exposure to market risk. As of September 30, 2013, notional amounts of $1.1 billion, $2.0 billion and $3.9 billion of foreign exchange, commodity and equity contracts, respectively, represented our exposure to the embedded bifurcated derivatives and the related hedges contained in our market-linked certificates of deposit.
The following table provides the notional value and the fair value of our trading derivatives portfolio as of September 30, 2013 and December 31, 2012, and the change in fair value between September 30, 2013 and December 31, 2012:
(Dollars in millions) | September 30, 2013 | December 31, 2012 | Increase (Decrease) | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Total gross notional amount of positions held for trading purposes: | ||||||||||
Interest rate contracts | $ | 43,675 | $ | 37,790 | $ | 5,885 | ||||
Commodity contracts | 5,916 | 5,595 | 321 | |||||||
Foreign exchange contracts(1) | 4,477 | 4,050 | 427 | |||||||
Equity contracts | 3,910 | 3,631 | 279 | |||||||
Total | $ | 57,978 | $ | 51,066 | $ | 6,912 | ||||
Fair value of positions held for trading purposes: | ||||||||||
Gross positive fair value | $ | 1,098 | $ | 1,413 | $ | (315 | ) | |||
Gross negative fair value | 987 | 1,317 | (330 | ) | ||||||
Positive fair value of positions, net | $ | 111 | $ | 96 | $ | 15 | ||||
- (1)
- Excludes spot contracts with a notional amount of $0.6 billion and $0.5 billion at September 30, 2013 and December 31, 2012, respectively.
Liquidity risk is the risk that the Company's financial condition or overall safety and soundness is adversely affected by an inability, or perceived inability, to meet its contractual, including contingent, obligations. The objective of liquidity risk management is to maintain a sufficient amount of liquidity and diversity of funding sources to allow the Company to meet obligations in both stable and adverse conditions.
The management of liquidity risk is governed by the ALM Policy under the oversight of the RCC and the Audit & Finance Committee of the Board. ALCO oversees liquidity risk management activities. The Company's corporate treasury department (Corporate Treasury) formulates the Company's liquidity and contingency planning strategies and is responsible for identifying, managing and reporting on liquidity risk. Market Risk Management, which is part of the Enterprise Wide Risk Reporting and Analysis unit, partners with Corporate Treasury to establish sound policy and effective risk controls. Our Contingency Funding Plan identifies actions to be taken to help ensure adequate liquidity if an event should occur that disrupts or adversely affects the Company's normal funding activities.
27
Liquidity risk is managed using a total balance sheet perspective that analyzes all sources and uses of liquidity including loans, investments, deposits and borrowings, as well as off-balance sheet exposures. Management does not rely on any one source of liquidity and manages availability in response to changing balance sheet needs. Various tools are used to measure and monitor liquidity, including pro-forma forecasting of the sources and uses of cash flows over a 12-month time horizon, stress testing of the pro-forma forecast and assessment of the Bank's capacity to raise incremental unsecured and secured funding. Stress testing, which incorporates both bank-specific and systemic market scenarios that would adversely affect the Bank's liquidity position and profile, facilitates the identification of appropriate remedial measures to help ensure that the Bank maintains adequate liquidity in adverse conditions. Such measures may include extending the maturity profile of liabilities, optimizing liability levels through pricing strategies, adding new funding sources, altering dependency on certain funding sources or selling assets.
Our primary sources of liquidity are core deposits (described below), our securities portfolio and wholesale funding. Wholesale funding includes unsecured funds raised from interbank and other sources, both domestic and international, including both senior and subordinated debt. Also included are secured funds raised by selling securities under repurchase agreements and by borrowing from the FHLB. We evaluate and monitor the stability and reliability of our various funding sources to help ensure that we have sufficient liquidity in adverse circumstances. We generally view our core deposits to be relatively stable. Secured borrowings via repurchase agreements and advances from the FHLB are also recognized as highly reliable funding sources, and we, therefore, maintain access to these sources primarily to meet our contingency funding needs.
Wholesale funding increased to $13.8 billion at September 30, 2013, up $3.8 billion from $10.0 billion at December 31, 2012. The increase is primarily due to the issuance of $2.0 billion in senior notes by Union Bank during the third quarter of 2013. Total deposits increased $5.1 billion from $74.3 billion at December 31, 2012 to $79.4 billion at September 30, 2013, primarily reflecting organic retail deposit growth.
Core deposits, which exclude brokered deposits, foreign time deposits and domestic time deposits greater than $250,000, provide us with a sizable source of relatively stable and low-cost funds. At September 30, 2013, our core deposits totaled $68.3 billion and our total loan-to-total core deposit ratio was 98 percent.
The Bank maintains a variety of funding sources, secured and unsecured, which management believes will be adequate to meet the Bank's liquidity needs, including the following:
- •
- The Bank has secured borrowing facilities with the FHLB and the Federal Reserve Bank. As of September 30, 2013, the Bank had $1.6 billion of secured borrowings outstanding with the FHLB, and the Bank had a remaining combined unused borrowing capacity from the FHLB and the Federal Reserve Bank of $36.1 billion.
- •
- Our securities portfolio provides liquidity through either securities sales or repurchase agreements. Total unpledged securities increased by $1.0 billion from $12.9 billion at December 31, 2012 to $13.9 billion at September 30, 2013.
- •
- The Bank has an $8.0 billion unsecured Bank Note Program, of which $2.7 billion was available for issuance at September 30, 2013. We do not have any firm commitments in place to sell securities under the Bank Note Program.
- •
- In addition to the funding provided by the Bank, we raise funds at the holding company level. The Company has in place a shelf registration statement with the SEC permitting ready access to the public debt markets. As of September 30, 2013, $1.1 billion of debt or other securities were available for issuance under this shelf registration statement. We do not have any firm commitments in place to sell securities under this shelf registration statement.
We believe that these sources provide a stable funding base. As a result, we have not historically relied on BTMU for our funding needs.
28
Our costs and ability to raise funds in the capital markets are influenced by our credit ratings. Our credit ratings could be impacted by changes in the credit ratings of BTMU and MUFG. For further information, see "The Bank of Tokyo-Mitsubishi UFJ's and Mitsubishi UFJ Financial Group's credit ratings and financial or regulatory condition could adversely affect our operations" in Part II, Item 1A. "Risk Factors" in this Form 10-Q. The following table provides our credit ratings as of September 30, 2013:
| | Union Bank, N.A. | UnionBanCal Corporation | |||
---|---|---|---|---|---|---|
Standard & Poor's | Long-term | A+ | A | |||
Short-term | A-1 | A-1 | ||||
Moody's | Long-term | A2 | A3 | |||
Short-term | P-1 | — | ||||
Fitch | Long-term | A | A | |||
Short-term | F1 | F1 |
On October 24, 2013, the OCC, the Fed, and the FDIC jointly issued a proposed rule that would implement a standardized quantitative liquidity requirement generally consistent with the liquidity coverage ratio (LCR) standards established by the Basel Committee on Banking Supervision. The LCR would generally apply to banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure. The proposal also would apply a modified LCR to bank holding companies with total assets between $50 billion and $250 billion. Under the modified LCR, which is expected to apply to the Company, an institution would be required to hold minimum amounts of high-quality, liquid assets, such as central bank reserves and government and corporate debt that can be readily converted into cash in an amount equal to or greater than its projected net cash outflows during a short-term stress period. The proposed LCR (or the ratio of the institution's liquid assets to its projected net cash outflow) is more stringent than the Basel Committee's LCR standard in several respects, and the proposed transition period, which would begin on January 1, 2015 and require institutions to be fully compliant by January 1, 2017, is shorter than that included in the Basel agreement.
The Company is currently evaluating the proposal and its potential impact on its businesses; however, the Company expects to meet or exceed the final LCR requirement within the regulatory timelines. For information regarding this proposed rule, see"The effects of changes or increases in, or supervisory enforcement of, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us" in Part II, Item 1A, "Risk Factors" in this Form 10-Q.
We have three operating segments: Retail Banking Group, Corporate Banking Group and Pacific Rim Corporate Group. The Pacific Rim Corporate Group is included in "Other." We have two reportable business segments: Retail Banking and Corporate Banking.
Unlike financial accounting, there is no authoritative body of guidance for the management accounting equivalent to U.S. GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies, and they are not necessarily indicative of the results that would be reported by our business units if they were unique economic entities. The information, set forth in the tables that follow, is prepared using various management accounting methodologies to measure the performance of the individual segments. For a description of these methodologies, see Note 14 to our consolidated financial statements included in this Form 10-Q. Beginning with third quarter 2013, the operating segments' credit losses were revised to base the allocation on the Company's actual provision for credit losses. Credit losses were previously based on an expected credit loss allocation methodology, in which credit expense was charged to an operating
29
segment based upon expected losses arising from credit risk. Prior period segment results have been revised to reflect this change in methodology.
| Retail Banking | | | Corporate Banking | | | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | Increase (Decrease) | As of and for the Three Months Ended September 30, | Increase (Decrease) | |||||||||||||||||||||
(Dollars in millions) | 2013 | 2012 | Amount | Percent | 2013 | 2012 | Amount | Percent | |||||||||||||||||
Results of operations—Market View: | |||||||||||||||||||||||||
Net interest income (expense) | $ | 305 | $ | 269 | $ | 36 | 13 | % | $ | 378 | $ | 341 | $ | 37 | 11 | % | |||||||||
Noninterest income (expense) | 71 | 56 | 15 | 27 | 147 | 155 | (8 | ) | (5 | ) | |||||||||||||||
Total revenue | 376 | 325 | 51 | 16 | 525 | 496 | 29 | 6 | |||||||||||||||||
Noninterest expense (income) | 294 | 260 | 34 | 13 | 261 | 257 | 4 | 2 | |||||||||||||||||
(Reversal of) provision for loan losses | (16 | ) | 35 | (51 | ) | (146 | ) | 5 | 18 | (13 | ) | (72 | ) | ||||||||||||
Income (loss) before income taxes and including noncontrolling interests | 98 | 30 | 68 | 227 | 259 | 221 | 38 | 17 | |||||||||||||||||
Income tax expense (benefit) | 38 | 12 | 26 | 217 | 72 | 58 | 14 | 24 | |||||||||||||||||
Net income (loss) including noncontrolling interest | 60 | 18 | 42 | 233 | 187 | 163 | 24 | 15 | |||||||||||||||||
Deduct: Net loss from noncontrolling interests(1) | — | — | — | — | — | — | — | — | |||||||||||||||||
Net income (loss) attributable to UNBC | $ | 60 | $ | 18 | $ | 42 | 233 | $ | 187 | $ | 163 | $ | 24 | 15 | |||||||||||
Average balances—Market View: | |||||||||||||||||||||||||
Total loans held for investment | $ | 29,895 | $ | 25,628 | $ | 4,267 | 17 | $ | 38,587 | $ | 31,230 | $ | 7,357 | 24 | |||||||||||
Total assets | 31,269 | 26,598 | 4,671 | 18 | 45,724 | 37,555 | 8,169 | 22 | |||||||||||||||||
Total deposits | 34,400 | 25,617 | 8,783 | 34 | 41,496 | 36,802 | 4,694 | 13 |
| Other | | | Reconciling Items | | | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | Increase (Decrease) | As of and for the Three Months Ended September 30, | | | ||||||||||||||||||||
| 2013 | 2012 | Amount | Percent | 2013 | 2012 | | | |||||||||||||||||
Results of operations—Market View: | |||||||||||||||||||||||||
Net interest income (expense) | $ | 21 | $ | 56 | $ | (35 | ) | (63 | )% | $ | (19 | ) | $ | (20 | ) | ||||||||||
Noninterest income (expense) | 33 | 4 | 29 | nm | (17 | ) | (18 | ) | |||||||||||||||||
Total revenue | 54 | 60 | (6 | ) | (10 | ) | (36 | ) | (38 | ) | |||||||||||||||
Noninterest expense (income) | 150 | 139 | 11 | 8 | (16 | ) | (18 | ) | |||||||||||||||||
(Reversal of) provision for loan losses | (7 | ) | (3 | ) | (4 | ) | (133 | ) | 2 | (5 | ) | ||||||||||||||
Income (loss) before income taxes and including noncontrolling interests | (89 | ) | (76 | ) | (13 | ) | (17 | ) | (22 | ) | (15 | ) | |||||||||||||
Income tax expense (benefit) | (46 | ) | (21 | ) | (25 | ) | (119 | ) | (9 | ) | (7 | ) | |||||||||||||
Net income (loss) including noncontrolling interest | (43 | ) | (55 | ) | 12 | 22 | (13 | ) | (8 | ) | |||||||||||||||
Deduct: Net loss from noncontrolling interests(1) | 7 | 6 | 1 | 17 | — | — | |||||||||||||||||||
Net income (loss) attributable to UNBC | $ | (36 | ) | $ | (49 | ) | $ | 13 | 27 | $ | (13 | ) | $ | (8 | ) | ||||||||||
Average balances—Market View: | |||||||||||||||||||||||||
Total loans held for investment | $ | 291 | $ | 628 | $ | (337 | ) | (54 | ) | $ | (2,165 | ) | $ | (2,201 | ) | ||||||||||
Total assets | 26,768 | 25,977 | 791 | 3 | (2,227 | ) | (2,249 | ) | |||||||||||||||||
Total deposits | 4,583 | 4,460 | 123 | 3 | (3,045 | ) | (2,459 | ) |
30
| UnionBanCal Corporation | | | | | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | Increase (Decrease) | | | |||||||||||||||
| 2013 | 2012 | Amount | Percent | | | |||||||||||||
Results of operations—Market View: | |||||||||||||||||||
Net interest income (expense) | $ | 685 | $ | 646 | $ | 39 | 6 | % | |||||||||||
Noninterest income (expense) | 234 | 197 | 37 | 19 | |||||||||||||||
Total revenue | 919 | 843 | 76 | 9 | |||||||||||||||
Noninterest expense (income) | 689 | 638 | 51 | 8 | |||||||||||||||
(Reversal of) provision for loan losses | (16 | ) | 45 | (61 | ) | (136 | ) | ||||||||||||
Income (loss) before income taxes and including noncontrolling interests | 246 | 160 | 86 | 54 | |||||||||||||||
Income tax expense (benefit) | 55 | 42 | 13 | 31 | |||||||||||||||
Net income (loss) including noncontrolling interest | 191 | 118 | 73 | 62 | |||||||||||||||
Deduct: Net loss from noncontrolling interests(1) | 7 | 6 | 1 | 17 | |||||||||||||||
Net income (loss) attributable to UNBC | $ | 198 | $ | 124 | $ | 74 | 60 | ||||||||||||
Average balances—Market View: | |||||||||||||||||||
Total loans held for investment | $ | 66,608 | $ | 55,285 | $ | 11,323 | 20 | ||||||||||||
Total assets | 101,534 | 87,881 | 13,653 | 16 | |||||||||||||||
Total deposits | 77,434 | 64,420 | 13,014 | 20 |
- (1)
- Reflects net loss attributed to noncontrolling interest related to our consolidated VIEs.
nm = not meaningful
| Retail Banking | | | Corporate Banking | | | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | Increase (Decrease) | As of and for the Nine Months Ended September 30, | Increase (Decrease) | |||||||||||||||||||||
(Dollars in millions) | 2013 | 2012 | Amount | Percent | 2013 | 2012 | Amount | Percent | |||||||||||||||||
Results of operations—Market View: | |||||||||||||||||||||||||
Net interest income (expense) | $ | 917 | $ | 809 | $ | 108 | 13 | % | $ | 1,106 | $ | 1,000 | $ | 106 | 11 | % | |||||||||
Noninterest income (expense) | 191 | 170 | 21 | 12 | 461 | 444 | 17 | 4 | |||||||||||||||||
Total revenue | 1,108 | 979 | 129 | 13 | 1,567 | 1,444 | 123 | 9 | |||||||||||||||||
Noninterest expense (income) | 896 | 788 | 108 | 14 | 810 | 740 | 70 | 9 | |||||||||||||||||
(Reversal of) provision for loan losses | (28 | ) | 47 | (75 | ) | (160 | ) | 35 | 19 | 16 | 84 | ||||||||||||||
Income (loss) before income taxes and including noncontrolling interests | 240 | 144 | 96 | 67 | 722 | 685 | 37 | 5 | |||||||||||||||||
Income tax expense (benefit) | 94 | 57 | 37 | 65 | 193 | 191 | 2 | 1 | |||||||||||||||||
Net income (loss) including noncontrolling interest | 146 | 87 | 59 | 68 | 529 | 494 | 35 | 7 | |||||||||||||||||
Deduct: Net loss from noncontrolling interests(1) | — | — | — | — | — | — | — | — | |||||||||||||||||
Net income (loss) attributable to UNBC | $ | 146 | $ | 87 | $ | 59 | 68 | $ | 529 | $ | 494 | $ | 35 | 7 | |||||||||||
Average balances—Market View: | |||||||||||||||||||||||||
Total loans held for investment | $ | 29,363 | $ | 25,090 | $ | 4,273 | 17 | $ | 36,060 | $ | 31,168 | $ | 4,892 | 16 | |||||||||||
Total assets | 30,743 | 26,105 | 4,638 | 18 | 42,884 | 36,623 | 6,261 | 17 | |||||||||||||||||
Total deposits | 32,955 | 25,191 | 7,764 | 31 | 40,883 | 35,276 | 5,607 | 16 |
31
| Other | | | Reconciling Items | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | Increase (Decrease) | As of and for the Nine Months Ended September 30, | ||||||||||||||||
| 2013 | 2012 | Amount | Percent | 2013 | 2012 | |||||||||||||
Results of operations—Market View: | |||||||||||||||||||
Net interest income (expense) | $ | 45 | $ | 192 | $ | (147 | ) | (77 | )% | $ | (58 | ) | $ | (59 | ) | ||||
Noninterest income (expense) | 83 | 21 | 62 | 295 | (49 | ) | (46 | ) | |||||||||||
Total revenue | 128 | 213 | (85 | ) | (40 | ) | (107 | ) | (105 | ) | |||||||||
Noninterest expense (income) | 439 | 365 | 74 | 20 | (41 | ) | (42 | ) | |||||||||||
(Reversal of) provision for loan losses | (29 | ) | (29 | ) | — | — | — | (7 | ) | ||||||||||
Income (loss) before income taxes and including noncontrolling interests | (282 | ) | (123 | ) | (159 | ) | (129 | ) | (66 | ) | (56 | ) | |||||||
Income tax expense (benefit) | (121 | ) | (65 | ) | (56 | ) | (86 | ) | (26 | ) | (23 | ) | |||||||
Net income (loss) including noncontrolling interest | (161 | ) | (58 | ) | (103 | ) | (178 | ) | (40 | ) | (33 | ) | |||||||
Deduct: Net loss from noncontrolling interests(1) | 14 | 16 | (2 | ) | (13 | ) | — | (1 | ) | ||||||||||
Net income (loss) attributable to UNBC | $ | (147 | ) | $ | (42 | ) | $ | (105 | ) | (250 | ) | $ | (40 | ) | $ | (34 | ) | ||
Average balances—Market View: | |||||||||||||||||||
Total loans held for investment | $ | 388 | $ | 730 | $ | (342 | ) | (47 | ) | $ | (2,178 | ) | $ | (2,196 | ) | ||||
Total assets | 27,590 | 28,445 | (855 | ) | (3 | ) | (2,233 | ) | (2,240 | ) | |||||||||
Total deposits | 4,707 | 6,407 | (1,700 | ) | (27 | ) | (2,853 | ) | (2,426 | ) |
| UnionBanCal Corporation | | | | | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | Increase (Decrease) | | | |||||||||||||||
| 2013 | 2012 | Amount | Percent | | | |||||||||||||
Results of operations—Market View: | |||||||||||||||||||
Net interest income (expense) | $ | 2,010 | $ | 1,942 | $ | 68 | 4 | % | |||||||||||
Noninterest income (expense) | 686 | 589 | 97 | 16 | |||||||||||||||
Total revenue | 2,696 | 2,531 | 165 | 7 | |||||||||||||||
Noninterest expense (income) | 2,104 | 1,851 | 253 | 14 | |||||||||||||||
(Reversal of) provision for loan losses | (22 | ) | 30 | (52 | ) | (173 | ) | ||||||||||||
Income (loss) before income taxes and including noncontrolling interests | 614 | 650 | (36 | ) | (6 | ) | |||||||||||||
Income tax expense (benefit) | 140 | 160 | (20 | ) | (13 | ) | |||||||||||||
Net income (loss) including noncontrolling interest | 474 | 490 | (16 | ) | (3 | ) | |||||||||||||
Deduct: Net loss from noncontrolling interests(1) | 14 | 15 | (1 | ) | (7 | ) | |||||||||||||
Net income (loss) attributable to UNBC | $ | 488 | $ | 505 | $ | (17 | ) | (3 | ) | ||||||||||
Average balances—Market View: | |||||||||||||||||||
Total loans held for investment | $ | 63,633 | $ | 54,792 | $ | 8,841 | 16 | ||||||||||||
Total assets | 98,984 | 88,933 | 10,051 | 11 | |||||||||||||||
Total deposits | 75,692 | 64,448 | 11,244 | 17 |
- (1)
- Reflects net loss attributed to noncontrolling interest related to our consolidated VIEs.
Retail Banking
Retail Banking provides deposit and lending products delivered through our branches and relationship managers to individuals and small businesses. Retail Banking is focused on executing a strategy to identify targeted opportunities within the consumer and small business markets, and develop product, marketing and sales strategies to attract new customers in these identified target markets.
32
Retail Banking is comprised of two major divisions:
- •
- theCommunity Banking Division serves its customers through 357 full-service branches in California and 48 full-service branches in Washington and Oregon. Customers may also access our services 24 hours-a-day by telephone or through our website at www.unionbank.com. In addition, the branches offer automated teller and point-of-sale merchant services.
- —
- through banking branches and ATMs, which serve consumers and businesses with checking and deposit products and services, as well as various types of consumer and business financing and investment services;
- —
- through its call centers and internet banking services, which augment its physical delivery channels by providing an array of customer transaction, bill payment and loan payment services; and
- —
- through alliances with other financial institutions, the Community Banking Division offers additional products and services, such as credit cards and merchant services.
- •
- theConsumer Lending Division provides the centralized origination, underwriting, processing, servicing, collection and administration for consumer assets including residential mortgages.
The Community Banking Division is organized geographically and serves its customers in the following ways:
Residential mortgage loans are originated and secured by one-to-four family residential properties, through our multiple channel network (including branches, private bankers, mortgage brokers, and telephone centers) throughout California, Oregon and Washington. Additionally, we periodically purchase loans in our market area. We hold the majority of the loans we originate.
At September 30, 2013, 53 percent in principal amount of our residential mortgage loans had current payment terms in which the monthly payment covers the full amount of interest due, but does not reduce the principal balance. At origination, these interest-only loans had strong credit profiles and had weighted average loan-to-value (LTV) ratios of approximately 66 percent. The remainder of the portfolio consists of regularly amortizing loans and a small amount of balloon loans. Refer to Note 5 of our consolidated financial statements included in this Form 10-Q for additional information on refreshed Fair Isaac Corporation (FICO) scores and refreshed LTV ratios for our residential mortgage loans at September 30, 2013.
We do not have a program for originating or purchasing subprime loan products. The Bank's "no doc" and "low doc" loan origination programs were discontinued in 2008, except for a streamlined refinance process for existing Bank mortgages that was discontinued in 2011. At September 30, 2013, the outstanding balances of the "no doc" and "low doc" portfolios were approximately 28 percent of our residential mortgage loans. At September 30, 2013, the aggregate balance of "no doc" and "low doc" loans past due 30 days or more was $119 million, compared with $154 million at December 31, 2012. These loan delinquency rates remained below the industry average for California prime loans.
Home equity and other consumer loans are originated principally through our branch network and Private Banking offices. We had approximately 33 percent and 34 percent of these home equity loans and lines supported by first liens on residential properties at September 30, 2013 and December 31, 2012. To manage risk associated with lending commitments, we review all equity-secured lines annually for creditworthiness and reduce or freeze limits, to the extent permitted by laws and regulations.
During the first nine months of 2013, net income for Retail Banking increased 68 percent compared with the same period in 2012. The increase resulted from a 13 percent increase in net interest income and a 12 percent increase in noninterest income, partially offset by a 14 percent increase in noninterest expense. The increases in net interest income and noninterest expense were primarily related to our PCBC acquisition. Average asset growth in the first nine months of 2013 compared with the same period in 2012 was primarily
33
driven by a 17 percent increase in average loans held for investment, mainly in residential mortgages, reflecting both our PCBC acquisition and organic loan growth. Average deposits increased 31 percent during the first nine months of 2013 compared with the same period in 2012, driven by both the PCBC acquisition and organic deposit generation. Retail Banking continues to focus on marketing activities to attract new consumer and small business deposits, customer cross-sell, and relationship management.
Corporate Banking
Corporate Banking offers a range of financial products to U.S.-based middle-market and corporate businesses. Corporate Banking focuses its activities on certain specialized industries, such as power and utilities, oil and gas, real estate, healthcare, equipment leasing and commercial finance, as well as lending in U.S. regional markets. Corporate Banking relationship managers provide credit services including commercial loans, accounts receivable and inventory financing, project financing, trade financing and real estate financing. In addition to credit services, Corporate Banking offers its customers a range of noncredit services, which include global treasury management solutions, capital market, foreign exchange and various interest rate risk and commodity risk management products. These products are delivered through treasury relationship managers and product specialists with expertise in the industry segments described above.
One of the primary strategies of our Corporate Banking business units is to target industries and companies for which we can reasonably expect to be one of our customers' preferred banks. Consistent with this strategy, Corporate Banking attempts to serve a large part of the targeted customers' credit and depository needs. Corporate Banking competes with other banks primarily on the basis of the quality of our relationship managers, the level of industry expertise, the delivery of quality customer service, and our reputation as a commercial lending institution. We also compete with a variety of other financial services companies as well as non-bank companies. Competitors include other major California banks, as well as regional, national and international banks. In addition, we compete with investment banks, commercial finance companies, leasing companies and insurance companies.
Corporate Banking initiatives continue to expand commercial and loan relationship strategies that include originating, underwriting and syndicating loans in core competency markets, such as in our West Coast commercial lending markets, as well as our national specialty markets, including real estate, energy, equipment leasing and commercial finance.
Corporate Banking is comprised of the following main divisions:
- •
- theCommercial Banking Division, which includes the following operating units:
- —
- Commercial Banking, which provides commercial lending products and treasury management services to middle-market and corporate companies primarily in California, Oregon and Washington;
- —
- Power and Utilities, which provides treasury management products and commercial lending products, including commercial lines of credit and project financing, to independent power producers as well as regulated utility companies;
- —
- Petroleum, which provides commercial lending products, including reserve-based lines of credit, commercial lines of credit as well as treasury management products, to oil and gas companies;
- —
- National Banking, which provides commercial lending and treasury management products to corporate clients on a national basis, in states outside of California, Oregon, and Washington. National Banking also targets certain defined industries, such as entertainment and technology; and
34
- —
- Specialized Industries, which provides commercial lending and treasury products to middle-market and corporate clients in specific industries on a national basis, including commercial finance, funds finance, environmental services, non-profits, healthcare, aerospace and defense.
- •
- theReal Estate Industries Division serves professional real estate investors and developers with products such as construction loans, commercial mortgages and bridge financing. Additionally, through our Community Development Finance unit, we make tax credit investments in affordable housing projects, as well as provide construction and permanent financing;
- •
- theGlobal Capital Markets Division helps to serve our customers with their foreign exchange, interest rate and energy risk management needs in addition to facilitating merchant and investment banking related transactions. The division takes market risk when buying and selling securities, interest rate derivatives and foreign exchange contracts for its own account and accepts limited market risk when providing commodity and equity derivative contracts, since a significant portion of the market risk for these products is offset with third parties. Additionally, the division's leasing arm provides lease and other financing services to corporate customers;
- •
- theGlobal Treasury Management Division targets numerous industry relationship markets with deep industry and product expertise. The Global Treasury Management Division provides working capital solutions to meet deposit, investment and global treasury management services to businesses of all sizes. This division manages Union Bank's web strategies for retail, small business, wealth management and commercial clients, as well as commercial product development. The client base of Global Trust Services consists of financial institutions, corporations, government agencies, insurance companies, mutual funds, investment managers and non-profit organizations. Institutional custody provides both domestic and international asset portfolio safekeeping and settlement services in addition to money markets and liquidity management products. Corporate Trust acts as agent or trustee for corporate and municipal debt issues, and provides escrow and project finance agent services; and
- •
- theWealth Markets Division consists of the following operating units:
- —
- The Private Bank focuses primarily on delivering financial services to high net worth individuals with sophisticated financial needs as well as to professional service firms, foundations and endowments. Specific products and services include trust and estate services, financial planning, investment account management services, and deposit and credit products;
- —
- UnionBanc Investment Services LLC (UBIS) is a subsidiary of Union Bank and is our registered broker-dealer and registered investment advisor. UBIS provides services to retail and institutional clients in several core products areas, including annuities, mutual funds, and fixed income products. Retail services are delivered through dedicated investment specialists located throughout the Bank's geographical footprint. Institutional services are delivered through a dedicated trading desk and sales force specializing in fixed income products; and
- —
- Asset Management includes HighMark Capital Management, Inc., a subsidiary of Union Bank and a registered investment advisor, which provides investment management and advisory services to institutional clients as well as investment advisory services to the affiliated HighMark Funds. During the third quarter of 2013, the reorganization of the affiliated HighMark Funds into shares of unaffiliated mutual funds was completed. Following this reorganization, HighMark Capital Management, Inc. provides investment management sub-advisory services to these unaffiliated mutual funds. HighMark Capital Management, Inc. also provides investment management services to Union Bank with respect to most of its trust and agency clients, including corporations, pension funds and individuals.
Commercial and industrial loans are extended principally to corporations, middle-market businesses and small businesses and are originated primarily through our commercial banking offices. These offices, which rely extensively on relationship-oriented banking, provide a variety of services including cash management,
35
lines of credit, accounts receivable and inventory financing. Separately, we originate or participate in a variety of financial services to major corporations. These services include traditional commercial banking and specialized financing tailored to the needs of each customer's specific industry. We are active in, among other sectors, power and utilities, oil and gas, manufacturing, finance and insurance services, wholesale trade, real estate and leasing, and communications. These industries comprise the majority of our commercial and industrial portfolio. While loans extended within these sectors comprise the majority of our commercial and industrial portfolio, no individual industry sector exceeded 10 percent of our total loans held for investment at either September 30, 2013 or December 31, 2012.
Construction and commercial mortgage loans are secured by deeds of trust or mortgages. Construction loans are extended primarily to commercial property developers and to residential builders. Geographically, 58 percent of the construction loan portfolio was domiciled in California as of September 30, 2013. The commercial mortgage loan portfolio consists of loans secured by commercial income properties, 63 percent of which were to borrowers located in California, 8 percent in New York, 6 percent in Washington, and the remaining 23 percent in various other states as of September 30, 2013.
Lease financing includes either direct financing leases, where the assets leased are acquired without additional financing from other sources, or leveraged leases, where a substantial portion of the financing is provided by debt with no recourse to us. At September 30, 2013, we had leveraged leases of $585 million, which were net of non-recourse debt of approximately $1.0 billion. In accordance with accounting guidance for leveraged leases, the gross lease receivable is offset by the qualifying non-recourse debt. In leveraged lease transactions, the third-party lender may only look to the collateral value of the leased assets for repayment in the event of lessee default.
During the first nine months of 2013, net income for Corporate Banking increased 7 percent compared with the same period in 2012, primarily resulting from an 11 percent increase in net interest income and a 4 percent increase in noninterest income. The increase in net interest income was the result of strong asset growth, as well as our PCBC and PB Capital acquisitions. The increase in noninterest income included gains on the sale of lease financings, partially offset by lower trading income. During the first nine months of 2013, average deposits increased 16 percent compared with the same period in 2012, primarily due to a 20 percent increase in noninterest-bearing deposits and a 13 percent increase in interest-bearing deposits, partially reflecting the impact of our PCBC and Smartstreet acquisitions.
Other
"Other" includes the following:
- •
- The Pacific Rim Corporate Group, which offers a range of credit, deposit, and investment management products and services to companies located primarily in the U.S. that are affiliated with companies headquartered in Japan and other Asian countries;
- •
- the funds transfer pricing results for our entire company, which allocates to the business segments their cost of funds on all asset categories and credit for funds on all liability categories;
- •
- Corporate Treasury, which is responsible for our ALM, wholesale funding and the ALM investment and derivatives hedging portfolios. These Treasury management activities are carried out to manage the net interest rate and liquidity risks of our balance sheet and to manage those risks within the guidelines established by ALCO. For additional discussion regarding these risk management activities, see "Quantitative and Qualitative Disclosures About Market Risk" in Part I, Item 2 of this Form 10-Q;
- •
- the residual costs of support groups;
- •
- corporate activities that are not directly attributable to the business segments. Included in this category are certain other items such as the results of operations of certain subsidiaries of UnionBanCal, and the elimination of the fully taxable-equivalent basis amount;
36
- •
- goodwill, intangible assets, and related amortization/accretion associated with our privatization transaction;
- •
- the FDIC covered assets; and
- •
- the adjustment between the tax expense calculated using the adjusted statutory tax rate of 39.29 percent and our consolidated effective tax rate.
During the nine months ended September 30, 2013, net income decreased by $105 million compared with the same period in 2012, resulting from a $147 million decrease in net interest income and a $74 million increase in noninterest expense, partially offset by a $62 million increase in noninterest income. The decrease in net interest income was primarily the result of decreased income from securities that were sold as part of the Company's portfolio rebalancing activities. The increase in noninterest expense was primarily due to an increase in salaries and employee benefits. The increase in noninterest income was primarily due to an $87 million increase in gains on the sale of securities. The increase was partially offset by a $9 million decrease in trading income and an $8 million decrease in indemnification asset accretion, driven by better than expected FDIC covered loans performance, in the nine months ended September 30, 2013.
UnionBanCal Corporation's consolidated financial statements are prepared in accordance with U.S. GAAP, which include management estimates and judgments. The financial information contained within our statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. For example, we use discount factors and other assumptions to measure certain assets and liabilities. A change in the discount factor or other important assumptions could significantly increase or decrease the reported amounts of those assets and liabilities and result in either a beneficial or an adverse impact to our financial results. We use historical loss factors, adjusted for current conditions, to estimate the credit loss inherent in our loan and lease portfolios held for investment and certain off-balance sheet commitments on the balance sheet date. Actual losses could differ significantly from the loss factors that we use. Other significant estimates that we use include the valuation of certain derivatives and securities, the expected cash flows related to our acquired loans and FDIC indemnification asset, the assumptions used in measuring our pension obligations, and assumptions regarding our effective tax rates.
For each financial reporting period, our most significant estimates are presented to and discussed with the Audit & Finance Committee of our Board of Directors.
Understanding our accounting policies is fundamental to understanding our consolidated financial condition and consolidated results of operations. Accordingly, both our critical accounting estimates and our significant accounting policies are discussed in detail in our 2012 Form 10-K. There have been no material changes to these critical accounting estimates during the third quarter of 2013.
Disclosure of Iranian Activities under Section 13(r) of the Securities Exchange Act of 1934
We are disclosing the following information pursuant to Section 13(r) of the U.S. Securities Exchange Act of 1934 (Exchange Act), which requires an issuer to disclose whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with natural persons or entities designated by the U.S. government under specified Executive Orders. The scope of activities that must be reported includes activities not prohibited by U.S. law and conducted outside the United States in compliance with applicable local law. Because we are indirectly wholly-owned by MUFG, a Japanese corporation, our disclosure includes activities, transactions or dealings conducted outside the United States by non-U.S.
37
affiliates of MUFG which are not controlled by us. We have requested that MUFG provide us a description of reportable activity under Section 13(r) and have received the following information:
During the quarter ended September 30, 2013, a non-U.S. affiliate of MUFG engaged in business activities with entities in or affiliated with Iran, including counterparties owned or controlled by the Iranian government. These activities were consistent with rules and regulations applicable to MUFG's non-U.S. affiliate. Specifically, MUFG's non-U.S. banking subsidiary, BTMU, issued letters of credit and guarantees and provided remittance and other settlement services mainly in connection with customer transactions related to the purchase and exportation of Iranian crude oil to Japan, and in some cases, in connection with other petroleum-related transactions with Iran by its customers. These transactions did not involve U.S. dollars nor clearing services of U.S. banks for the settlement of payments, and were reviewed for compliance with applicable U.S. and non-U.S. laws and regulations. For the quarter ended September 30, 2013, the aggregate interest and fee income relating to these transactions was less than ¥35 million, representing less than 0.005 percent of MUFG's total interest and fee income. Some of these transactions were conducted through the use of non-U.S. dollar correspondent accounts and other similar settlement accounts maintained with BTMU outside the United States by Iranian financial institutions and other entities in or affiliated with Iran. In addition to such accounts, BTMU receives deposits in Japan from and provides settlement services in Japan to fewer than ten Iranian government-related entities and fewer than 100 Iranian government-related individuals such as Iranian diplomats, and maintains settlement accounts outside the United States for certain other financial institutions specified in Executive Order 13382, which settlement accounts were frozen in accordance with applicable laws and regulations. For the quarter ended September 30, 2013, the average aggregate balance of deposits held in these accounts represented less than 0.01 percent of the average balance of MUFG's total deposits. The fee income from the transactions attributable to these account holders was less than ¥1 million, representing less than 0.001 percent of MUFG's total fee income. BTMU also holds loans that were arranged prior to changes in applicable laws and regulations to borrowers in or affiliated with Iran, including entities owned by the Iranian government, the outstanding balance of which was less than ¥500 million, representing less than 0.001 percent of MUFG's total loans, as of September 30, 2013. For the quarter ended September 30, 2013, the aggregate gross interest and fee income relating to these loan transactions was less than ¥25 million, representing less than 0.005 percent of MUFG's total interest and fee income.
We understand that BTMU will continue to limit its participation in these types of transactions mainly to arrange financing transactions relating to customer imports of Iranian crude oil into Japan, maintain accounts in Japan of Iranian entities and individuals, and obtain interest and fee income and repayment of principal in connection with existing loans to borrowers in or affiliated with Iran, in each case to the extent permitted by applicable laws and regulations.
As of the date of this report, to our knowledge, there are no other activities, transactions or dealings by us during the quarter ended September 30, 2013 that require disclosure in this Form 10-Q under Section 13(r) of the Exchange Act. For affiliates that we do not control and that are or may be our affiliates solely due to their possible common control by our parent MUFG, we have relied upon MUFG for information regarding their activities, transactions and dealings.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
A discussion of our market risk exposure is incorporated by reference to Part I, Item 2 of this Form 10-Q under the caption "Quantitative and Qualitative Disclosures About Market Risk" and to Part II, Item 1A of this Form 10-Q under the caption "Risk Factors."
Item 4. Controls and Procedures
Disclosure Controls and Procedures. Our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) have concluded that the design and operation of our disclosure
38
controls and procedures are effective as of September 30, 2013. This conclusion is based on an evaluation conducted under the supervision, and with the participation, of management. Disclosure controls and procedures are those controls and procedures that are designed to ensure that information required to be disclosed in this filing is recorded, processed, summarized and reported in a timely manner and in accordance with the SEC's rules and regulations and to ensure that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting. During the third quarter of 2013, there were no changes in our internal control over financial reporting that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.
39
UnionBanCal Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
| For the Three Months Ended | For the Nine Months Ended | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | September 30, 2013 | September 30, 2012 | September 30, 2013 | September 30, 2012 | |||||||||
Interest Income | |||||||||||||
Loans | $ | 668 | $ | 608 | $ | 1,946 | $ | 1,810 | |||||
Securities | 118 | 129 | 354 | 405 | |||||||||
Other | 2 | 1 | 7 | 3 | |||||||||
Total interest income | 788 | 738 | 2,307 | 2,218 | |||||||||
Interest Expense | |||||||||||||
Deposits | 63 | 51 | 184 | 157 | |||||||||
Commercial paper and other short-term borrowings | 2 | 2 | 4 | 8 | |||||||||
Long-term debt | 38 | 39 | 109 | 111 | |||||||||
Total interest expense | 103 | 92 | 297 | 276 | |||||||||
Net Interest Income | 685 | 646 | 2,010 | 1,942 | |||||||||
(Reversal of) provision for loan losses | (16 | ) | 45 | (22 | ) | 30 | |||||||
Net interest income after (reversal of) provision for loan losses | 701 | 601 | 2,032 | 1,912 | |||||||||
Noninterest Income | |||||||||||||
Service charges on deposit accounts | 53 | 51 | 158 | 158 | |||||||||
Trust and investment management fees | 34 | 29 | 107 | 86 | |||||||||
Trading account activities | 15 | 23 | 41 | 71 | |||||||||
Securities gains, net | 47 | 41 | 170 | 88 | |||||||||
Credit facility fees | 31 | 27 | 83 | 77 | |||||||||
Merchant banking fees | 29 | 24 | 68 | 66 | |||||||||
Brokerage commissions and fees | 12 | 9 | 34 | 28 | |||||||||
Card processing fees, net | 8 | 8 | 26 | 24 | |||||||||
Other, net | 5 | (15 | ) | (1 | ) | (9 | ) | ||||||
Total noninterest income | 234 | 197 | 686 | 589 | |||||||||
Noninterest Expense | |||||||||||||
Salaries and employee benefits | 391 | 356 | 1,225 | 1,071 | |||||||||
Net occupancy and equipment | 77 | 65 | 236 | 197 | |||||||||
Professional and outside services | 66 | 54 | 186 | 147 | |||||||||
Intangible asset amortization | 16 | 20 | 49 | 62 | |||||||||
Regulatory assessments | 20 | 14 | 60 | 48 | |||||||||
(Reversal of) provision for losses on off-balance sheet commitments | 1 | (4 | ) | 14 | (7 | ) | |||||||
Other | 118 | 133 | 334 | 333 | |||||||||
Total noninterest expense | 689 | 638 | 2,104 | 1,851 | |||||||||
Income before income taxes and including noncontrolling interests | 246 | 160 | 614 | 650 | |||||||||
Income tax expense | 55 | 42 | 140 | 160 | |||||||||
Net Income including Noncontrolling Interests | 191 | 118 | 474 | 490 | |||||||||
Deduct: Net loss from noncontrolling interests | 7 | 6 | 14 | 15 | |||||||||
Net Income attributable to UNBC | $ | 198 | $ | 124 | $ | 488 | $ | 505 | |||||
See accompanying notes to consolidated financial statements.
40
UnionBanCal Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | 2013 | 2012 | 2013 | 2012 | |||||||||
Net Income Attributable to UNBC | $ | 198 | $ | 124 | $ | 488 | $ | 505 | |||||
Other Comprehensive Income (Loss), Net of Tax: | |||||||||||||
Net change in unrealized gains (losses) on cash flow hedges | 11 | 21 | 8 | 41 | |||||||||
Net change in unrealized gains (losses) on investment securities | (55 | ) | 195 | (449 | ) | 281 | |||||||
Foreign currency translation adjustment | — | 1 | (3 | ) | 1 | ||||||||
Net change in gains (losses) on pension and other postretirement benefits | 18 | 16 | 53 | 46 | |||||||||
Total other comprehensive income (loss) | (26 | ) | 233 | (391 | ) | 369 | |||||||
Comprehensive Income (Loss) Attributable to UNBC | 172 | 357 | 97 | 874 | |||||||||
Comprehensive loss from noncontrolling interests | (7 | ) | (6 | ) | (14 | ) | (15 | ) | |||||
Total Comprehensive Income (Loss) | $ | 165 | $ | 351 | $ | 83 | $ | 859 | |||||
See accompanying notes to consolidated financial statements.
41
UnionBanCal Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
(Dollars in millions except for per share amount) | September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
Assets | |||||||
Cash and due from banks | $ | 1,719 | $ | 1,845 | |||
Interest bearing deposits in banks | 5,471 | 3,477 | |||||
Federal funds sold and securities purchased under resale agreements | 122 | 169 | |||||
Total cash and cash equivalents | 7,312 | 5,491 | |||||
Trading account assets (includes $13 at September 30, 2013 and $1 at December 31, 2012 of assets pledged as collateral) | 776 | 1,208 | |||||
Securities available for sale | 16,872 | 21,352 | |||||
Securities held to maturity (Fair value: September 30, 2013, $5,450; December 31, 2012, $1,135) | 5,446 | 1,103 | |||||
Loans held for investment | 67,170 | 60,034 | |||||
Allowance for loan losses | (608 | ) | (653 | ) | |||
Loans held for investment, net | 66,562 | 59,381 | |||||
Premises and equipment, net | 685 | 710 | |||||
Intangible assets | 288 | 376 | |||||
Goodwill | 3,168 | 2,942 | |||||
FDIC indemnification asset | 191 | 338 | |||||
Other assets | 4,184 | 4,107 | |||||
Total assets | $ | 105,484 | $ | 97,008 | |||
Liabilities | |||||||
Deposits: | |||||||
Noninterest bearing | $ | 26,126 | $ | 25,478 | |||
Interest bearing | 53,289 | 48,826 | |||||
Total deposits | 79,415 | 74,304 | |||||
Commercial paper and other short-term borrowings | 3,078 | 1,363 | |||||
Long-term debt | 7,803 | 5,622 | |||||
Trading account liabilities | 614 | 895 | |||||
Other liabilities | 1,767 | 2,099 | |||||
Total liabilities | 92,677 | 84,283 | |||||
Commitments, contingencies and guarantees—See Note 13 | |||||||
Equity | |||||||
UNBC stockholder's equity: | |||||||
Preferred stock: | |||||||
Authorized 5,000,000 shares; no shares issued or outstanding | — | — | |||||
Common stock, par value $1 per share: | |||||||
Authorized 300,000,000 shares, 136,330,830 shares issued and outstanding as of September 30, 2013 and December 31, 2012 | 136 | 136 | |||||
Additional paid-in capital | 5,985 | 5,994 | |||||
Retained earnings | 7,333 | 6,845 | |||||
Accumulated other comprehensive loss | (905 | ) | (514 | ) | |||
Total UNBC stockholder's equity | 12,549 | 12,461 | |||||
Noncontrolling interests | 258 | 264 | |||||
Total equity | 12,807 | 12,725 | |||||
Total liabilities and equity | $ | 105,484 | $ | 97,008 | |||
See accompanying notes to consolidated financial statements.
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UnionBanCal Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholder's Equity
(Unaudited)
| UNBC Stockholder's Equity | | | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(in millions, except shares) | Common stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive income (loss) | Noncontrolling interests | Total equity | |||||||||||||
BALANCE DECEMBER 31, 2011 | $ | 136 | $ | 5,989 | $ | 6,217 | $ | (809 | ) | $ | 268 | $ | 11,801 | ||||||
Net income (loss) | 505 | (15 | ) | 490 | |||||||||||||||
Other comprehensive income (loss), net of tax | 369 | 369 | |||||||||||||||||
Other | 6 | 6 | |||||||||||||||||
Net change | — | — | 505 | 369 | (9 | ) | 865 | ||||||||||||
BALANCE SEPTEMBER 30, 2012 | $ | 136 | $ | 5,989 | $ | 6,722 | $ | (440 | ) | $ | 259 | $ | 12,666 | ||||||
BALANCE DECEMBER 31, 2012 | $ | 136 | $ | 5,994 | $ | 6,845 | $ | (514 | ) | $ | 264 | $ | 12,725 | ||||||
Net income (loss) | 488 | (14 | ) | 474 | |||||||||||||||
Other comprehensive income (loss), net of tax | (391 | ) | (391 | ) | |||||||||||||||
Compensation—restricted stock units | (9 | ) | (9 | ) | |||||||||||||||
Other | 8 | 8 | |||||||||||||||||
Net change | — | (9 | ) | 488 | (391 | ) | (6 | ) | 82 | ||||||||||
BALANCE SEPTEMBER 30, 2013 | $ | 136 | $ | 5,985 | $ | 7,333 | $ | (905 | ) | $ | 258 | $ | 12,807 | ||||||
See accompanying notes to consolidated financial statements.
43
UnionBanCal Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
| For the Nine Months Ended September 30, | ||||||
---|---|---|---|---|---|---|---|
(Dollars in millions) | 2013 | 2012 | |||||
Cash Flows from Operating Activities: | |||||||
Net income including noncontrolling interests | $ | 474 | $ | 490 | |||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |||||||
(Reversal of) provision for loan losses | (22 | ) | 30 | ||||
(Reversal of) provision for losses on off-balance sheet commitments | 14 | (7 | ) | ||||
Depreciation, amortization and accretion, net | 381 | 351 | |||||
Stock-based compensation—restricted stock units | 15 | — | |||||
Deferred income taxes | 38 | 3 | |||||
Net gains on sales of securities | (170 | ) | (88 | ) | |||
Net decrease (increase) in trading account assets | 432 | (101 | ) | ||||
Net decrease (increase) in other assets | (348 | ) | 170 | ||||
Net increase (decrease) in trading account liabilities | (281 | ) | (88 | ) | |||
Net increase (decrease) in other liabilities | 50 | (591 | ) | ||||
Loans originated for sale | (183 | ) | (8 | ) | |||
Net proceeds from sale of loans originated for sale | 155 | 6 | |||||
Other, net | 33 | (85 | ) | ||||
Total adjustments | 114 | (408 | ) | ||||
Net cash provided by (used in) operating activities | 588 | 82 | |||||
Cash Flows from Investing Activities: | |||||||
Proceeds from sales of securities available for sale | 8,109 | 6,109 | |||||
Proceeds from paydowns and maturities of securities available for sale | 2,925 | 5,185 | |||||
Purchases of securities available for sale and held to maturity | (11,666 | ) | (7,751 | ) | |||
Proceeds from paydowns and maturities of securities held to maturity | 344 | 155 | |||||
Purchases of premises and equipment | (84 | ) | (50 | ) | |||
Proceeds from sales of loans | 365 | 227 | |||||
Net decrease (increase) in loans | (4,132 | ) | (3,256 | ) | |||
Proceeds from FDIC loss share agreements | 6 | 64 | |||||
Net cash paid for acquisitions | (3,688 | ) | — | ||||
Other, net | 47 | 12 | |||||
Net cash provided by (used in) investing activities | (7,774 | ) | 695 | ||||
Cash Flows from Financing Activities: | |||||||
Net increase (decrease) in deposits | 5,111 | 715 | |||||
Net increase (decrease) in commercial paper and other short-term borrowings | 1,715 | (1,592 | ) | ||||
Proceeds from issuance of subordinated debt due to BTMU | 750 | — | |||||
Proceeds from issuance of long-term debt | 1,999 | 895 | |||||
Repayment of long-term debt | (550 | ) | (2,025 | ) | |||
Other, net | (26 | ) | 2 | ||||
Change in noncontrolling interests | 8 | 6 | |||||
Net cash provided by (used in) financing activities | 9,007 | (1,999 | ) | ||||
Net change in cash and cash equivalents | 1,821 | (1,222 | ) | ||||
Cash and cash equivalents at beginning of period | 5,491 | 4,195 | |||||
Cash and cash equivalents at end of period | $ | 7,312 | $ | 2,973 | |||
Cash Paid During the Period For: | |||||||
Interest | $ | 266 | $ | 276 | |||
Income taxes, net | 25 | 184 | |||||
Supplemental Schedule of Noncash Investing and Financing Activities: | |||||||
Securities available for sale transferred to securities held to maturity | 3,860 | 155 | |||||
Net transfer of loans held for investment to loans held for sale | 381 | 200 | |||||
Transfer of loans held for investment to other real estate owned assets (OREO) | 30 | 83 | |||||
Carrying amount of securities held to maturity immediately prior to transfer to securities available for sale | — | 1,112 |
See accompanying notes to consolidated financial statements.
44
Note 1—Summary of Significant Accounting Policies, Nature of Operations and Other Developments
The unaudited consolidated financial statements of UnionBanCal Corporation, its subsidiaries, and its consolidated variable interest entities (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Rules and Regulations of the Securities and Exchange Commission (SEC). However, they do not include all of the disclosures necessary for annual financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. The results of operations for the third quarter of 2013 are not necessarily indicative of the operating results anticipated for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in UnionBanCal Corporation's Annual Report on Form 10-K for the year ended December 31, 2012 (2012 Form 10-K).
The preparation of financial statements in conformity with U.S. GAAP also requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Although such estimates contemplate current conditions and management's expectations of how they may change in the future, it is reasonably possible that actual results could differ significantly from those estimates. This could materially affect the Company's results of operations and financial condition in the near term. Significant estimates made by management in the preparation of the Company's financial statements include, but are not limited to, the evaluation of other-than-temporary impairment on investment securities (Note 4), allowance for credit losses (Note 5), purchased credit-impaired loans (Note 5), goodwill impairment analysis, pension accounting (Note 7), fair value of financial instruments (Note 10), and income taxes.
UnionBanCal Corporation is a financial holding company and bank holding company whose principal subsidiary is Union Bank, N.A. (the Bank). The Company provides a wide range of financial services to consumers, small businesses, middle-market companies and major corporations, primarily in California, Oregon, Washington, Texas, New York, and Illinois, as well as nationally and internationally.
Beginning in 2013, fees associated with certain unused commitment balances are classified within credit facility fees in noninterest income. Such fees were previously recorded in loan interest income and totaled $13 million for the three months ended September 30, 2012 and $38 million for the nine months ended September 30, 2012. The Company has corrected the prior period presentation to conform to the presentation adopted at the beginning of 2013.
During 2012, we concluded our trial in the U.S. Court of Federal Claims related to tax refund claims for leveraged lease transactions that we entered into in 1998 and 1999. On October 4, 2013, the court rendered its opinion denying our refund claim and, as a result, the $97 million tax receivable associated with the refund claim has been derecognized and the liability for unrecognized tax positions has been reduced by a corresponding amount.
Recently Issued Accounting Pronouncements That Are Not Yet Effective
Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date
In February 2013, the FASB issued ASU 2013-04,Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date, which provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. Examples of obligations within the scope of this guidance include debt arrangements, other contractual obligations, and
45
Note 1—Summary of Significant Accounting Policies, Nature of Operations and Other Developments (Continued)
settled litigation and judicial rulings. This guidance is effective for interim and annual periods beginning on January 1, 2014 and must be retroactively applied to prior periods presented. Early adoption is permitted. Management does not expect the adoption of this guidance to significantly impact the Company's financial position or results of operations.
Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity
In March 2013, the FASB issued ASU 2013-05,Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity, which provides guidance on releasing cumulative translation adjustments out of accumulated comprehensive income when a parent deconsolidates or derecognizes a subsidiary or group of assets that is a not for profit activity or a businesswithin a foreign entity or deconsolidates or derecognizes investmentsin a foreign entity. This guidance is effective prospectively for interim and annual periods beginning on January 1, 2014. Early adoption is permitted. Management does not expect the adoption of this guidance to significantly impact the Company's financial position or results of operations.
Investment Companies—Amendments to the Scope, Measurement, and Disclosure Requirements
In June 2013, the FASB issued ASU 2013-08,Financial Services—Investment Companies (Topic 946)—Amendments to the Scope, Measurement, and Disclosure Requirements, which changes the criteria for determining whether an entity meets the definition of an investment company, requires investment companies to measure noncontrolling ownership interests in other investment companies at fair value (rather than using the equity method of accounting), and requires additional disclosures for investment companies. This guidance is effective for interim and annual periods beginning on January 1, 2014. The revised investment company accounting must be applied to all entities that meet the new investment company definition on the effective date, with a cumulative effect adjustment to beginning retained earnings. Management is currently assessing the impact of this guidance on the Company's financial position and results of operations.
Inclusion of the Fed Funds Effective Swap Rate as a Benchmark Interest Rate for Hedge Accounting Purposes
In July 2013, the FASB issued ASU 2013-10,Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes, which will now permit the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes. The guidance also removes the existing restriction on using different benchmark rates for similar hedge accounting relationships. This guidance is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. Management does not expect the adoption of this guidance to significantly impact the Company's financial position or results of operations.
Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists
In July 2013, the FASB issued ASU 2013-11,Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which specifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. However,
46
Note 1—Summary of Significant Accounting Policies, Nature of Operations and Other Developments (Continued)
to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented as a liability and should not be combined with deferred tax assets. This guidance is applied prospectively beginning on January 1, 2014 to all unrecognized tax benefits that exist on that date, with retrospective application permitted. Early adoption is also permitted. Management does not expect the adoption of this guidance to significantly impact the Company's financial position or results of operations.
Note 2—Correction of Prior Period Amounts
During the third quarter of 2013, the Company corrected prior period errors related to the recognition of income and expense associated with market-linked certificates of deposit. These errors affected historical periods beginning in 2009 through June 30, 2013. The Company recognized certain noninterest income amounts in the period in which the market-linked certificates of deposit originated. These amounts should have been deferred and recognized as a reduction of interest expense over the contractual term of the related certificates of deposit. These errors were not material to any of the Company's previously issued financial statements. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), the consolidated balance sheet as of December 31, 2012 and the consolidated statements of income and comprehensive income for the three and nine months ended September 30, 2012 and changes in stockholder's equity for the nine months ended September 30, 2012 and 2013 have been adjusted to reflect the correction of these errors.
The following tables show the affected line items within the consolidated financial statements:
Consolidated Statements of Income:
| For the Three Months Ended September 30, 2012 | For the Nine Months Ended September 30, 2012 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | As previously reported | Adjustment | As corrected | As previously reported | Adjustment | As corrected | |||||||||||||
Net interest income | |||||||||||||||||||
Interest expense—deposits | $ | 56 | $ | (5 | ) | $ | 51 | $ | 171 | $ | (14 | ) | $ | 157 | |||||
Noninterest income | |||||||||||||||||||
Trading account activities | 26 | (3 | ) | 23 | 82 | (11 | ) | 71 | |||||||||||
Brokerage commissions and fees | 11 | (2 | ) | 9 | 32 | (4 | ) | 28 | |||||||||||
Income before income taxes and including noncontrolling interests | 160 | — | 160 | 651 | (1 | ) | 650 | ||||||||||||
Net Income Attributable to UnionBanCal Corporation | 124 | — | 124 | 506 | (1 | ) | 505 |
47
Note 2—Correction of Prior Period Amounts (Continued)
Consolidated Balance Sheet and Statements of Changes in Stockholder's Equity:
| December 31, 2012 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | As previously reported | Adjustment | As corrected | |||||||
Other assets | $ | 4,091 | $ | 16 | $ | 4,107 | ||||
Interest bearing deposits | 48,777 | 49 | 48,826 | |||||||
Other liabilities | 2,102 | (3 | ) | 2,099 | ||||||
Retained earnings | 6,875 | (30 | ) | 6,845 |
| December 31, 2011 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | As previously reported | Adjustment | As corrected | |||||||
Retained earnings | $ | 6,246 | $ | (29 | ) | $ | 6,217 |
On December 1, 2012, the Company completed its acquisition of Pacific Capital Bancorp (PCBC), a bank holding company headquartered in Santa Barbara, California, for $1.5 billion in cash.
The assets acquired and liabilities assumed from PCBC were recorded at their estimated fair values on the acquisition date. These fair value estimates are considered provisional, as additional analysis will be performed on certain assets and liabilities in which fair values were primarily determined through the use of inputs that were not observable from market-based information. During the nine months ended September 30, 2013, management reviewed and, where necessary, adjusted the acquisition date fair values for circumstances that existed as of the acquisition date. Management may further adjust the provisional fair values for a period of up to one year from the date of acquisition. The assets and liabilities that continue to be provisional include loans, intangible assets, OREO, and the residual effects the adjustments would have on goodwill.
48
Note 3—Business Combinations (Continued)
The following table presents the net assets acquired from PCBC and the estimated purchase accounting adjustments as of the acquisition date. During the first nine months of 2013, measurement period adjustments were applied to the acquisition date fair values, which increased goodwill by $21 million.
(Dollars in millions) | December 1, 2012 | |||
---|---|---|---|---|
Purchase price | $ | 1,516 | ||
Net assets acquired | 859 | |||
Purchase accounting adjustments: | ||||
Securities available for sale | 8 | |||
Loans held for investment | 141 | |||
Intangible assets | 18 | |||
Other assets | 128 | |||
Deposits | (12 | ) | ||
Other short-term borrowings | (36 | ) | ||
Long-term debt | (14 | ) | ||
Other liabilities | 11 | |||
Total purchase accounting adjustments | 244 | |||
Fair value of net assets acquired | 1,103 | |||
Goodwill | $ | 413 | ||
For further information related to the PCBC acquisition, see Note 2 to the consolidated financial statements in the Company's 2012 Form 10-K. For further information related to goodwill, see Note 5 to the consolidated financial statements in the Company's 2012 Form 10-K.
Acquisition of PB Capital
During the second quarter of 2013, the Company acquired PB Capital Corporation's (PB Capital) institutional commercial real estate (CRE) lending division for $3.7 billion in cash. The acquisition expands the Company's CRE presence in the U.S., and provides geographic and asset class diversification. Excluding the effects of purchase accounting adjustments, the Company acquired approximately $3.5 billion in loans. The assets acquired were recorded at acquisition date fair values of $3.4 billion, resulting in goodwill as of the acquisition date of $227 million, which was allocated to the Company's Corporate Banking reportable business segment. The fair value estimates of the loans acquired are considered provisional and are subject to change for up to one year after the closing date of the acquisition as additional information relative to closing date fair values becomes available. During the quarter ended September 30, 2013, measurement period adjustments were applied to the acquisition date fair values, which decreased goodwill by $18 million.
49
Securities Available for Sale
At September 30, 2013 and December 31, 2012, the amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities are presented below.
| September 30, 2013 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||
U.S. government sponsored agencies | $ | 138 | $ | 1 | $ | — | $ | 139 | |||||
Residential mortgage-backed securities: | |||||||||||||
U.S. government agency and government sponsored agencies | 10,035 | 3 | 256 | 9,782 | |||||||||
Privately issued | 238 | 5 | 2 | 241 | |||||||||
Commercial mortgage-backed securities | 2,047 | 9 | 80 | 1,976 | |||||||||
Collateralized loan obligations (CLOs) | 2,605 | 20 | 12 | 2,613 | |||||||||
Asset-backed and other | 58 | 1 | — | 59 | |||||||||
Asset Liability Management securities | 15,121 | 39 | 350 | 14,810 | |||||||||
Other debt securities: | |||||||||||||
Direct bank purchase bonds | 1,916 | 34 | 42 | 1,908 | |||||||||
Other | 148 | 4 | 5 | 147 | |||||||||
Equity securities | 6 | 1 | — | 7 | |||||||||
Total securities available for sale | $ | 17,191 | $ | 78 | $ | 397 | $ | 16,872 | |||||
| December 31, 2012 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||
U.S. government-sponsored agencies | $ | 866 | $ | 19 | $ | — | $ | 885 | |||||
Residential mortgage-backed securities: | |||||||||||||
U.S. government agency and government-sponsored agencies | 13,104 | 232 | 3 | 13,333 | |||||||||
Privately issued | 445 | 8 | 10 | 443 | |||||||||
Commercial mortgage-backed securities | 2,863 | 114 | 6 | 2,971 | |||||||||
CLOs | 1,996 | 7 | 44 | 1,959 | |||||||||
Asset-backed and other | 145 | 1 | — | 146 | |||||||||
Asset Liability Management securities | 19,419 | 381 | 63 | 19,737 | |||||||||
Other debt securities: | |||||||||||||
Direct bank purchase bonds | 1,482 | 27 | 71 | 1,438 | |||||||||
Other | 156 | 6 | 4 | 158 | |||||||||
Equity securities | 19 | — | — | 19 | |||||||||
Total securities available for sale | $ | 21,076 | $ | 414 | $ | 138 | $ | 21,352 | |||||
50
Note 4—Securities (Continued)
The Company's securities available for sale with a continuous unrealized loss position at September 30, 2013 and December 31, 2012 are shown below, identified for periods less than 12 months and 12 months or more.
| September 30, 2013 | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Less than 12 months | 12 months or more | Total | ||||||||||||||||
(Dollars in millions) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||
Residential mortgage-backed securities: | |||||||||||||||||||
U.S. government agency and government sponsored agencies | $ | 9,295 | $ | 254 | $ | 90 | $ | 2 | $ | 9,385 | $ | 256 | |||||||
Privately issued | 72 | 2 | 19 | — | 91 | 2 | |||||||||||||
Commercial mortgage-backed securities | 1,428 | 80 | — | — | 1,428 | 80 | |||||||||||||
CLOs | 1,373 | 11 | 10 | 1 | 1,383 | 12 | |||||||||||||
Asset-backed and other | 4 | — | 1 | — | 5 | — | |||||||||||||
Asset Liability Management securities | 12,172 | 347 | 120 | 3 | 12,292 | 350 | |||||||||||||
Other debt securities: | |||||||||||||||||||
Direct bank purchase bonds | 591 | 21 | 756 | 21 | 1,347 | 42 | |||||||||||||
Other | 10 | 1 | 35 | 4 | 45 | 5 | |||||||||||||
Total securities available for sale | $ | 12,773 | $ | 369 | $ | 911 | $ | 28 | $ | 13,684 | $ | 397 | |||||||
| December 31, 2012 | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Less than 12 months | 12 months or more | Total | ||||||||||||||||
(Dollars in millions) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||
Residential mortgage-backed securities: | |||||||||||||||||||
U.S. government agency and government sponsored agencies | $ | 1,152 | $ | 3 | $ | 13 | $ | — | $ | 1,165 | $ | 3 | |||||||
Privately issued | 32 | — | 137 | 10 | 169 | 10 | |||||||||||||
Commercial mortgage-backed securities | 675 | 6 | — | — | 675 | 6 | |||||||||||||
CLOs | 168 | 1 | 980 | 43 | 1,148 | 44 | |||||||||||||
Asset-backed and other | 32 | — | 3 | — | 35 | — | |||||||||||||
Asset Liability Management securities | 2,059 | 10 | 1,133 | 53 | 3,192 | 63 | |||||||||||||
Other debt securities: | |||||||||||||||||||
Direct bank purchase bonds | 1,019 | 71 | — | — | 1,019 | 71 | |||||||||||||
Other | 34 | 3 | 13 | 1 | 47 | 4 | |||||||||||||
Total securities available for sale | $ | 3,112 | $ | 84 | $ | 1,146 | $ | 54 | $ | 4,258 | $ | 138 | |||||||
At September 30, 2013, the Company did not have the intent to sell any securities in an unrealized loss position before a recovery of the amortized cost, which may be at maturity. The Company also believes that it is more likely than not that it will not be required to sell the securities prior to recovery of amortized cost.
Agency residential mortgage-backed securities consist of securities guaranteed by a U.S. government corporation or a government-sponsored enterprise (GSE) such as Fannie Mae, Freddie Mac, and Ginnie Mae. These securities are collateralized by residential mortgage loans and may be prepaid at par prior to maturity. The unrealized losses on agency residential mortgage-backed securities resulted from changes in interest rates
51
Note 4—Securities (Continued)
and not credit quality. At September 30, 2013, the Company expects to recover the entire amortized cost basis of these securities because the Company determined that the strength of the issuers' guarantees through direct obligations or support from the U.S. government is sufficient to protect the Company from losses.
Commercial mortgage-backed securities are collateralized by commercial mortgage loans and are generally subject to prepayment penalties. The unrealized losses on commercial mortgage-backed securities resulted from higher market yields since purchase. The Company estimated loss projections for each security by assessing the loans collateralizing each security. The Company estimates the portion of loss attributable to credit based on the expected cash flows of the underlying collateral using estimates of current key assumptions, such as default rates, loss severity and prepayment rates. Based on the analysis performed as of September 30, 2013, the Company expects to recover the entire amortized cost basis of these securities.
Other debt securities primarily consist of direct bank purchase bonds, which are not rated by external credit rating agencies. The unrealized losses on these bonds resulted from a higher return on capital expected by the secondary market compared with the return on capital required at the time of origination when the bonds were purchased. The Company estimated loss projections for each security by assessing the underlying collateral of each security. The Company estimates the portion of loss attributable to credit based on the expected cash flows of the underlying collateral using estimates of current key assumptions, such as probability of default and loss severity. Cash flow analysis of the underlying collateral provides an estimate of other-than-temporary impairment, which is performed quarterly when the fair value of a security is lower than its amortized cost and potential impairment is identified. Based on the analysis performed as of September 30, 2013, the Company expects to recover the entire amortized cost basis of these securities.
The fair value of debt securities available for sale by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
| September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | One Year or Less | Over One Year Through Five Years | Over Five Years Through Ten Years | Over Ten Years | Total Fair Value | |||||||||||
U.S. government sponsored agencies | $ | 139 | $ | — | $ | — | $ | — | $ | 139 | ||||||
Residential mortgage-backed securities: | ||||||||||||||||
U.S. government agency and government sponsored agencies | 3 | 51 | 637 | 9,091 | 9,782 | |||||||||||
Privately issued | — | — | 6 | 235 | 241 | |||||||||||
Commercial mortgage-backed securities | — | — | 34 | 1,942 | 1,976 | |||||||||||
CLOs | — | 365 | 496 | 1,752 | 2,613 | |||||||||||
Asset-backed and other | — | 51 | 8 | — | 59 | |||||||||||
Asset Liability Management securities | 142 | 467 | 1,181 | 13,020 | 14,810 | |||||||||||
Other debt securities | ||||||||||||||||
Direct bank purchase bonds | 155 | 297 | 953 | 503 | 1,908 | |||||||||||
Other | — | 34 | 16 | 97 | 147 | |||||||||||
Total debt securities available for sale | $ | 297 | $ | 798 | $ | 2,150 | $ | 13,620 | $ | 16,865 | ||||||
52
Note 4—Securities (Continued)
The proceeds from sales of securities available for sale and gross realized gains and losses are shown below. The specific identification method is used to calculate realized gains and losses on sales.
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | 2013 | 2012 | 2013 | 2012 | |||||||||
Proceeds from sales | $ | 2,524 | $ | 1,985 | $ | 8,109 | $ | 6,109 | |||||
Gross realized gains | 55 | 43 | 181 | 92 | |||||||||
Gross realized losses | 3 | 1 | 3 | 2 |
Securities Held to Maturity
The securities held to maturity consist of CLOs, Commercial mortgage-backed securities and U.S. government and government sponsored agencies residential mortgage-backed securities. Management has asserted the positive intent and ability to hold these securities to maturity. At September 30, 2013 and December 31, 2012, the amortized cost, gross unrealized gains and losses recognized in other comprehensive income (OCI), carrying amount, gross unrealized gains and losses not recognized in OCI, and fair values of securities held to maturity are presented below.
| September 30, 2013 | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Recognized in OCI | | Not Recognized in OCI | | |||||||||||||||||
(Dollars in millions) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Carrying Amount | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||
U.S. government agency and government sponsored agencies—residential mortgage backed securities | $ | 3,983 | $ | 8 | $ | 68 | $ | 3,923 | $ | 13 | $ | 21 | $ | 3,915 | ||||||||
Commercial mortgage-backed securities | 1,609 | — | 94 | $ | 1,515 | 11 | 1 | $ | 1,525 | |||||||||||||
CLOs | 9 | — | 1 | 8 | 2 | — | 10 | |||||||||||||||
Total securities held to maturity | $ | 5,601 | $ | 8 | $ | 163 | $ | 5,446 | $ | 26 | $ | 22 | $ | 5,450 | ||||||||
| December 31, 2012 | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Recognized in OCI | | Not Recognized in OCI | | |||||||||||||||||
(Dollars in millions) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Carrying Amount | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||
U.S. government agency and government sponsored agencies—residential mortgage backed securities | $ | 997 | $ | 5 | $ | — | $ | 1,002 | $ | 12 | $ | — | $ | 1,014 | ||||||||
CLOs | 118 | — | 17 | 101 | 20 | — | 121 | |||||||||||||||
Total securities held to maturity | $ | 1,115 | $ | 5 | $ | 17 | $ | 1,103 | $ | 32 | $ | — | $ | 1,135 | ||||||||
For securities held to maturity, the amount recognized in OCI primarily reflects the unrealized gain or loss at date of transfer to the held to maturity classification, net of amortization. Amortized cost is defined as the original purchase cost, adjusted for any accretion or amortization of a purchase discount or premium, less principal payments and any impairment previously recognized in earnings.
53
Note 4—Securities (Continued)
The Company's securities held to maturity with a continuous unrealized loss position at September 30, 2013 and December 31, 2012 are shown below, separately for periods less than 12 months and 12 months or more.
| September 30, 2013 | |||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Less than 12 months | 12 months or more | Total | |||||||||||||||||||||||||
| | Unrealized Losses | | Unrealized Losses | | Unrealized Losses | ||||||||||||||||||||||
(Dollars in millions) | Fair Value | Recognized in OCI | Not Recognized in OCI | Fair Value | Recognized in OCI | Not Recognized in OCI | Fair Value | Recognized in OCI | Not Recognized in OCI | |||||||||||||||||||
U.S. government agency and government sponsored agencies—residential mortgage backed securities | $ | 2,739 | $ | 68 | $ | 21 | $ | 1 | $ | — | $ | — | $ | 2,740 | $ | 68 | $ | 21 | ||||||||||
Commercial mortgage-backed securities | 1,525 | 94 | 1 | — | — | — | 1,525 | 94 | 1 | |||||||||||||||||||
CLOs | — | — | — | 10 | 1 | — | 10 | 1 | — | |||||||||||||||||||
Total securities held to maturity | $ | 4,264 | $ | 162 | $ | 22 | $ | 11 | $ | 1 | $ | — | $ | 4,275 | $ | 163 | $ | 22 | ||||||||||
| December 31, 2012 | |||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Less than 12 months | 12 months or more | Total | |||||||||||||||||||||||||
| | Unrealized Losses | | Unrealized Losses | | Unrealized Losses | ||||||||||||||||||||||
(Dollars in millions) | Fair Value | Recognized in OCI | Not Recognized in OCI | Fair Value | Recognized in OCI | Not Recognized in OCI | Fair Value | Recognized in OCI | Not Recognized in OCI | |||||||||||||||||||
CLOs | $ | — | $ | — | $ | — | $ | 121 | $ | 17 | $ | — | $ | 121 | $ | 17 | $ | — | ||||||||||
The carrying amount and fair value of securities held to maturity by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
| September 30, 2013 | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Over One Year Through Five Years | Over Five Years Through Ten Years | Over Ten Years | Total | |||||||||||||||||||||
(Dollars in millions) | Carrying Amount | Fair Value | Carrying Amount | Fair Value | Carrying Amount | Fair Value | Carrying Amount | Fair Value | |||||||||||||||||
U.S. government agency and government sponsored agencies—residential mortgage backed securities | $ | 4 | $ | 4 | $ | 1 | $ | 1 | $ | 3,918 | $ | 3,910 | $ | 3,923 | $ | 3,915 | |||||||||
Commercial mortgage-backed securities | — | — | 833 | 841 | 682 | 684 | 1,515 | 1,525 | |||||||||||||||||
CLOs | 8 | 10 | — | — | — | — | 8 | 10 | |||||||||||||||||
Total securities held to maturity | $ | 12 | $ | 14 | $ | 834 | $ | 842 | $ | 4,600 | $ | 4,594 | $ | 5,446 | $ | 5,450 | |||||||||
Securities Pledged as Collateral
Transactions involving purchases of securities under agreements to resell (reverse repurchase agreements or reverse repos) or sales of securities under agreements to repurchase (repurchase agreements or repos) are accounted for as collateralized financings except where the Company does not have an agreement to sell (or purchase) the same or substantially the same securities before maturity at a fixed or determinable price. The
54
Note 4—Securities (Continued)
Company's policy is to obtain possession of collateral with a market value equal to or in excess of the principal amount loaned under resale agreements. Collateral is valued daily, and the Company may require counterparties to deposit additional collateral or return collateral pledged, when appropriate.
The Company separately identifies in the consolidated balance sheets, securities pledged as collateral in secured borrowings and other arrangements when the secured party can sell or repledge the securities. If the secured party cannot resell or repledge the securities that have been placed as collateral, those securities are not separately identified. At September 30, 2013, the Company had $6.1 billion of securities available for sale pledged as collateral where the secured party cannot resell or repledge such securities. These available for sale securities have been pledged to secure borrowings ($0.7 billion), to support unrealized losses on derivative transactions reported in trading liabilities ($0.3 billion) and to secure public and trust deposits ($5.1 billion).
At September 30, 2013 and December 31, 2012, the Company accepted securities as collateral that it is permitted by contract to sell or repledge of $121 million ($25 million of which has been repledged) and $19 million (none of which has been repledged), respectively. These securities were received as collateral for secured lending.
Note 5—Loans and Allowance for Loan Losses
The following table provides the outstanding balances of loans at September 30, 2013 and December 31, 2012:
(Dollars in millions) | September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
Loans held for investment: | |||||||
Commercial and industrial | $ | 23,125 | $ | 20,827 | |||
Commercial mortgage | 12,905 | 9,939 | |||||
Construction | 855 | 627 | |||||
Lease financing | 972 | 1,104 | |||||
Total commercial portfolio | 37,857 | 32,497 | |||||
Residential mortgage | 24,714 | 22,705 | |||||
Home equity and other consumer loans | 3,336 | 3,647 | |||||
Total consumer portfolio | 28,050 | 26,352 | |||||
Total loans held for investment, before purchased credit-impaired loans | 65,907 | 58,849 | |||||
Purchased credit-impaired loans(1) | 1,263 | 1,185 | |||||
Total loans held for investment(2) | 67,170 | 60,034 | |||||
Allowance for loan losses | (608 | ) | (653 | ) | |||
Loans held for investment, net | $ | 66,562 | $ | 59,381 | |||
- (1)
- Includes $303 million and $421 million as of September 30, 2013 and December 31, 2012, respectively, of loans for which the Company will be reimbursed a substantial portion of any future losses under the terms of the FDIC loss share agreements. Of these FDIC covered loans, $20 million and $24 million as of September 30, 2013 and December 31, 2012, respectively, were not accounted for under accounting guidance for loans acquired with deteriorated credit quality.
- (2)
- Includes $70 million and $5 million at September 30, 2013 and December 31, 2012, respectively, for net unamortized discounts and premiums and deferred fees and costs.
55
Note 5—Loans and Allowance for Loan Losses (Continued)
Allowance for Loan Losses
The following tables provide a reconciliation of changes in the allowance for loan losses by portfolio segment:
| For the Three Months Ended September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Commercial | Consumer | Purchased Credit- Impaired | Unallocated | Total | |||||||||||
Allowance for loan losses, beginning of period | $ | 480 | $ | 106 | $ | 1 | $ | 38 | $ | 625 | ||||||
(Reversal of) provision for loan losses | (27 | ) | (35 | ) | — | 46 | (16 | ) | ||||||||
Decrease in allowance covered by FDIC indemnification | — | — | (2 | ) | — | (2 | ) | |||||||||
Loans charged off | (9 | ) | (4 | ) | — | — | (13 | ) | ||||||||
Recoveries of loans previously charged off | 10 | 2 | 2 | — | 14 | |||||||||||
Allowance for loan losses, end of period | $ | 454 | $ | 69 | $ | 1 | $ | 84 | $ | 608 | ||||||
| For the Three Months Ended September 30, 2012 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Commercial | Consumer | Purchased Credit- Impaired | Unallocated | Total | |||||||||||
Allowance for loan losses, beginning of period | $ | 388 | $ | 126 | $ | 4 | $ | 138 | $ | 656 | ||||||
(Reversal of) provision for loan losses | (17 | ) | 30 | — | 30 | 43 | ||||||||||
(Reversal of) provision for FDIC covered loan losses not subject to FDIC indemnification | — | — | 2 | — | 2 | |||||||||||
Decrease in allowance covered by FDIC indemnification | — | — | 8 | — | 8 | |||||||||||
Other | 1 | — | — | — | 1 | |||||||||||
Loans charged off | (13 | ) | (41 | ) | (3 | ) | — | (57 | ) | |||||||
Recoveries of loans previously charged off | 13 | 1 | 1 | — | 15 | |||||||||||
Allowance for loan losses, end of period | $ | 372 | $ | 116 | $ | 12 | $ | 168 | $ | 668 | ||||||
| For the Nine Months Ended September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Commercial | Consumer | Purchased Credit- Impaired | Unallocated | Total | |||||||||||
Allowance for loan losses, beginning of period | $ | 418 | $ | 124 | $ | 1 | $ | 110 | $ | 653 | ||||||
(Reversal of) provision for loan losses | 38 | (34 | ) | — | (26 | ) | (22 | ) | ||||||||
Decrease in allowance covered by FDIC indemnification | — | — | (2 | ) | — | (2 | ) | |||||||||
Other | — | |||||||||||||||
Loans charged off | (24 | ) | (25 | ) | (3 | ) | — | (52 | ) | |||||||
Recoveries of loans previously charged off | 22 | 4 | 5 | — | 31 | |||||||||||
Allowance for loan losses, end of period | $ | 454 | $ | 69 | $ | 1 | $ | 84 | $ | 608 | ||||||
56
Note 5—Loans and Allowance for Loan Losses (Continued)
| For the Nine Months Ended September 30, 2012 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Commercial | Consumer | Purchased Credit- Impaired | Unallocated | Total | |||||||||||
Allowance for loan losses, beginning of period | $ | 474 | $ | 138 | $ | 17 | $ | 135 | $ | 764 | ||||||
(Reversal of) provision for loan losses | (58 | ) | 56 | — | 33 | 31 | ||||||||||
(Reversal of) provision for FDIC covered loan losses not subject to FDIC indemnification | — | — | (1 | ) | — | (1 | ) | |||||||||
Decrease in allowance covered by FDIC indemnification | — | — | (1 | ) | — | (1 | ) | |||||||||
Other | 1 | — | — | — | 1 | |||||||||||
Loans charged off | (79 | ) | (80 | ) | (5 | ) | — | (164 | ) | |||||||
Recoveries of loans previously charged off | 34 | 2 | 2 | — | 38 | |||||||||||
Allowance for loan losses, end of period | $ | 372 | $ | 116 | $ | 12 | $ | 168 | $ | 668 | ||||||
The following tables show the allowance for loan losses and related loan balances by portfolio segment as of September 30, 2013 and December 31, 2012:
| September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Commercial | Consumer | Purchased Credit- Impaired | Unallocated | Total | |||||||||||
Allowance for loan losses: | ||||||||||||||||
Individually evaluated for impairment | $ | 32 | $ | 18 | $ | — | $ | — | $ | 50 | ||||||
Collectively evaluated for impairment | 422 | 51 | — | 84 | 557 | |||||||||||
Purchased credit-impaired loans | — | — | 1 | — | 1 | |||||||||||
Total allowance for loan losses | $ | 454 | $ | 69 | $ | 1 | $ | 84 | $ | 608 | ||||||
Loans held for investment: | ||||||||||||||||
Individually evaluated for impairment | $ | 290 | $ | 326 | $ | 4 | $ | — | $ | 620 | ||||||
Collectively evaluated for impairment | 37,567 | 27,724 | — | — | 65,291 | |||||||||||
Purchased credit-impaired loans | — | — | 1,259 | — | 1,259 | |||||||||||
Total loans held for investment | $ | 37,857 | $ | 28,050 | $ | 1,263 | $ | — | $ | 67,170 | ||||||
| December 31, 2012 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Commercial | Consumer | Purchased Credit- Impaired | Unallocated | Total | |||||||||||
Allowance for loan losses: | ||||||||||||||||
Individually evaluated for impairment | $ | 24 | $ | 18 | $ | — | $ | — | $ | 42 | ||||||
Collectively evaluated for impairment | 394 | 106 | — | 110 | 610 | |||||||||||
Purchased credit-impaired loans | — | — | 1 | — | 1 | |||||||||||
Total allowance for loan losses | $ | 418 | $ | 124 | $ | 1 | $ | 110 | $ | 653 | ||||||
Loans held for investment: | ||||||||||||||||
Individually evaluated for impairment | $ | 330 | $ | 292 | $ | 5 | $ | — | $ | 627 | ||||||
Collectively evaluated for impairment | 32,167 | 26,060 | — | — | 58,227 | |||||||||||
Purchased credit-impaired loans | — | — | 1,180 | — | 1,180 | |||||||||||
Total loans held for investment | $ | 32,497 | $ | 26,352 | $ | 1,185 | $ | — | $ | 60,034 | ||||||
57
Note 5—Loans and Allowance for Loan Losses (Continued)
Nonaccrual and Past Due Loans
The following table presents nonaccrual loans as of September 30, 2013 and December 31, 2012:
(Dollars in millions) | September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
Commercial and industrial | $ | 62 | $ | 48 | |||
Commercial mortgage | 88 | 65 | |||||
Total commercial portfolio | 150 | 113 | |||||
Residential mortgage | 293 | 306 | |||||
Home equity and other consumer loans | 48 | 56 | |||||
Total consumer portfolio | 341 | 362 | |||||
Total nonaccrual loans, before purchased credit-impaired loans | 491 | 475 | |||||
Purchased credit-impaired loans | 20 | 30 | |||||
Total nonaccrual loans | $ | 511 | $ | 505 | |||
Troubled debt restructured loans that continue to accrue interest | $ | 373 | $ | 401 | |||
Troubled debt restructured nonaccrual loans (included in the total nonaccrual loans above) | $ | 260 | $ | 209 | |||
The following table shows an aging of the balance of loans held for investment, excluding purchased credit-impaired loans, by class as of September 30, 2013 and December 31, 2012:
| September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Aging Analysis of Loans | |||||||||||||||
(Dollars in millions) | Current | 30 to 89 Days Past Due | 90 Days or More Past Due | Total Past Due | Total | |||||||||||
Commercial and industrial | $ | 24,061 | $ | 25 | $ | 11 | $ | 36 | $ | 24,097 | ||||||
Commercial mortgage | 12,804 | 76 | 25 | 101 | 12,905 | |||||||||||
Construction | 853 | 2 | — | 2 | 855 | |||||||||||
Total commercial portfolio | 37,718 | 103 | 36 | 139 | 37,857 | |||||||||||
Residential mortgage | 24,461 | 141 | 112 | 253 | 24,714 | |||||||||||
Home equity and other consumer loans | 3,300 | 22 | 14 | 36 | 3,336 | |||||||||||
Total consumer portfolio | 27,761 | 163 | 126 | 289 | 28,050 | |||||||||||
Total loans held for investment, excluding purchased credit-impaired loans | $ | 65,479 | $ | 266 | $ | 162 | $ | 428 | $ | 65,907 | ||||||
58
Note 5—Loans and Allowance for Loan Losses (Continued)
| December 31, 2012 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Aging Analysis of Loans | |||||||||||||||
(Dollars in millions) | Current | 30 to 89 Days Past Due | 90 Days or More Past Due | Total Past Due | Total | |||||||||||
Commercial and industrial | $ | 21,861 | $ | 68 | $ | 2 | $ | 70 | $ | 21,931 | ||||||
Commercial mortgage | 9,869 | 57 | 13 | 70 | 9,939 | |||||||||||
Construction | 622 | 5 | — | 5 | 627 | |||||||||||
Total commercial portfolio | 32,352 | 130 | 15 | 145 | 32,497 | |||||||||||
Residential mortgage | 22,351 | 181 | 173 | 354 | 22,705 | |||||||||||
Home equity and other consumer loans | 3,584 | 44 | 19 | 63 | 3,647 | |||||||||||
Total consumer portfolio | 25,935 | 225 | 192 | 417 | 26,352 | |||||||||||
Total loans held for investment, excluding purchased credit-impaired loans | $ | 58,287 | $ | 355 | $ | 207 | $ | 562 | $ | 58,849 | ||||||
Loans 90 days or more past due and still accruing totaled $8 million and $1 million at September 30, 2013 and December 31, 2012, respectively. Purchased credit-impaired loans that were 90 days or more past due and still accruing totaled $203 million and $124 million at September 30, 2013 and December 31, 2012, respectively.
Credit Quality Indicators
Management analyzes the Company's loan portfolios by applying specific monitoring policies and procedures that vary according to the relative risk profile and other characteristics within the various loan portfolios. For further information related to the credit quality indicators the Company uses to monitor the portfolio, see Note 4 to the consolidated financial statements in the Company's 2012 Form 10-K.
The following tables summarize the loans in the commercial portfolio segment and commercial loans within the purchased credit-impaired loans segment monitored for credit quality based on internal ratings, excluding $261 million and $365 million covered by Federal Deposit Insurance Corporation (FDIC) loss share agreements, at September 30, 2013 and December 31, 2012, respectively. The amounts presented reflect unpaid principal balances less charge-offs. The amounts presented for purchased credit-impaired loans also reflect purchase price adjustments as of the acquisition date.
| September 30, 2013 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Pass | Special Mention | Classified | Total | |||||||||
Commercial and industrial | $ | 23,295 | $ | 500 | $ | 361 | $ | 24,156 | |||||
Construction | 819 | 14 | — | 833 | |||||||||
Commercial mortgage | 12,343 | 135 | 261 | 12,739 | |||||||||
Total commercial portfolio | 36,457 | 649 | 622 | 37,728 | |||||||||
Purchased credit-impaired loans | 30 | 237 | 438 | 705 | |||||||||
Total | $ | 36,487 | $ | 886 | $ | 1,060 | $ | 38,433 | |||||
59
Note 5—Loans and Allowance for Loan Losses (Continued)
| December 31, 2012 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Pass | Special Mention | Classified | Total | |||||||||
Commercial and industrial | $ | 20,961 | $ | 438 | $ | 380 | $ | 21,779 | |||||
Construction | 610 | 17 | — | 627 | |||||||||
Commercial mortgage | 9,298 | 194 | 248 | 9,740 | |||||||||
Total commercial portfolio | 30,869 | 649 | 628 | 32,146 | |||||||||
Purchased credit-impaired loans | 21 | 153 | 301 | 475 | |||||||||
Total | $ | 30,890 | $ | 802 | $ | 929 | $ | 32,621 | |||||
The Company monitors the credit quality of its consumer portfolio segment and consumer loans within the purchased credit-impaired loans segment based primarily on payment status. The following tables summarize the loans in the consumer portfolio segment and purchased credit-impaired loans segment, which excludes $42 million and $57 million of loans covered by FDIC loss share agreements, at September 30, 2013 and December 31, 2012, respectively:
| September 30, 2013 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Accrual | Nonaccrual | Total | |||||||
Residential mortgage | $ | 24,421 | $ | 293 | $ | 24,714 | ||||
Home equity and other consumer loans | 3,288 | 48 | 3,336 | |||||||
Total consumer portfolio | 27,709 | 341 | 28,050 | |||||||
Purchased credit-impaired loans | 253 | 1 | 254 | |||||||
Total | $ | 27,962 | $ | 342 | $ | 28,304 | ||||
| December 31, 2012 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Accrual | Nonaccrual | Total | |||||||
Residential mortgage | $ | 22,399 | $ | 306 | $ | 22,705 | ||||
Home equity and other consumer loans | 3,591 | 56 | 3,647 | |||||||
Total consumer portfolio | 25,990 | 362 | 26,352 | |||||||
Purchased credit-impaired loans | 288 | — | 288 | |||||||
Total | $ | 26,278 | $ | 362 | $ | 26,640 | ||||
The Company also monitors the credit quality for substantially all of its consumer portfolio segment using credit scores provided by Fair Isaac Corporation (FICO) and refreshed weighted average loan-to-value (LTV) ratios. FICO credit scores are refreshed at least quarterly to monitor the quality of the portfolio. Refreshed LTV measures the principal balance of the loan as a percentage of the estimated current value of the property securing the loan. Home equity loans are evaluated using combined LTV, which measures the principal balance of the combined loans that have liens against the property (including unused amounts for home equity line products) as a percentage of the estimated current value of the property securing the loans. The LTV ratios are refreshed on a quarterly basis, using the most recent home pricing index (HPI) data available for the property location.
The following tables summarize the loans in the consumer portfolio segment and consumer loans within the purchased credit-impaired loans segment monitored for credit quality based on refreshed FICO scores and refreshed LTV ratios at September 30, 2013 and December 31, 2012. These tables exclude loans serviced by
60
Note 5—Loans and Allowance for Loan Losses (Continued)
third-parties and loans covered by FDIC loss share agreements, as discussed above. The amounts presented reflect unpaid principal balances less partial charge-offs.
| September 30, 2013 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| FICO scores | ||||||||||||
(Dollars in millions) | 720 and above | Below 720 | No FICO available(1) | Total | |||||||||
Residential mortgage | $ | 18,380 | $ | 4,947 | $ | 326 | $ | 23,653 | |||||
Home equity and other consumer loans | 2,311 | 875 | 76 | 3,262 | |||||||||
Total consumer portfolio | 20,691 | 5,822 | 402 | 26,915 | |||||||||
Purchased credit-impaired loans | 90 | 147 | 16 | 253 | |||||||||
Total | $ | 20,781 | $ | 5,969 | $ | 418 | $ | 27,168 | |||||
Percentage of total | 76 | % | 22 | % | 2 | % | 100 | % |
| December 31, 2012 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| FICO scores | ||||||||||||
(Dollars in millions) | 720 and above | Below 720 | No FICO available(1) | Total | |||||||||
Residential mortgage | $ | 17,103 | $ | 4,666 | $ | 395 | $ | 22,164 | |||||
Home equity and other consumer loans | 2,464 | 986 | 122 | 3,572 | |||||||||
Total consumer portfolio | 19,567 | 5,652 | 517 | 25,736 | |||||||||
Purchased credit-impaired loans | 106 | 172 | 10 | 288 | |||||||||
Total | $ | 19,673 | $ | 5,824 | $ | 527 | $ | 26,024 | |||||
Percentage of total | 76 | % | 22 | % | 2 | % | 100 | % |
- (1)
- Represents loans for which management was not able to obtain an updated FICO score (e.g., due to recent profile changes).
| September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| LTV ratios | |||||||||||||||
(Dollars in millions) | Less than 80 percent | 80-100 percent | Greater than 100 percent | No LTV available(1) | Total | |||||||||||
Residential mortgage | $ | 21,471 | $ | 1,903 | $ | 274 | $ | 5 | $ | 23,653 | ||||||
Home equity loans | 2,484 | 377 | 237 | 60 | 3,158 | |||||||||||
Total consumer portfolio | 23,955 | 2,280 | 511 | 65 | 26,811 | |||||||||||
Purchased credit-impaired loans | 158 | 53 | 38 | — | 249 | |||||||||||
Total | $ | 24,113 | $ | 2,333 | $ | 549 | $ | 65 | $ | 27,060 | ||||||
Percentage of total | 89 | % | 9 | % | 2 | % | — | % | 100 | % |
61
Note 5—Loans and Allowance for Loan Losses (Continued)
| December 31, 2012 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| LTV ratios | |||||||||||||||
(Dollars in millions) | Less than 80 percent | 80-100 percent | Greater than 100 percent | No LTV available(1) | Total | |||||||||||
Residential mortgage | $ | 17,771 | $ | 3,031 | $ | 1,232 | $ | 130 | $ | 22,164 | ||||||
Home equity loans | 2,216 | 618 | 540 | 113 | 3,487 | |||||||||||
Total consumer portfolio | 19,987 | 3,649 | 1,772 | 243 | 25,651 | |||||||||||
Purchased credit-impaired loans | 72 | 50 | 153 | 13 | 288 | |||||||||||
Total | $ | 20,059 | $ | 3,699 | $ | 1,925 | $ | 256 | $ | 25,939 | ||||||
Percentage of total | 77 | % | 14 | % | 8 | % | 1 | % | 100 | % |
- (1)
- Represents loans for which management was not able to obtain refreshed property values.
Troubled Debt Restructurings
The following table provides a summary of the Company's recorded investment in troubled debt restructurings (TDRs) as of September 30, 2013 and December 31, 2012. The summary includes those TDRs that are on nonaccrual status and those that continue to accrue interest. The Company had $40 million in commitments to lend additional funds to borrowers with loan modifications classified as TDRs as of September 30, 2013.
(Dollars in millions) | September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
Commercial and industrial | $ | 232 | $ | 215 | |||
Commercial mortgage | �� | 70 | 64 | ||||
Construction | 2 | 35 | |||||
Total commercial portfolio | 304 | 314 | |||||
Residential mortgage | 303 | 271 | |||||
Home equity and other consumer loans | 23 | 21 | |||||
Total consumer portfolio | 326 | 292 | |||||
Total restructured loans, excluding | $ | 630 | $ | 606 | |||
- (1)
- Amounts exclude $3 million and $4 million of TDRs covered by FDIC loss share agreements at September 30, 2013 and December 31, 2012, respectively.
For the third quarter of 2013, TDR modifications in the commercial portfolio segment were primarily composed of interest rate changes, maturity extensions, principal paydowns, covenant waivers and payment deferrals, or some combination thereof. In the consumer portfolio segment, primarily all of the modifications were composed of interest rate reductions and maturity extensions. There were no charge-offs related to TDR modifications in the third quarter of 2013. For the commercial and consumer portfolio segments, the allowance for loan losses for TDRs is measured on an individual loan basis or in pools with similar risk characteristics.
62
Note 5—Loans and Allowance for Loan Losses (Continued)
The following tables provide the pre- and post-modification outstanding recorded investment amounts of TDRs as of the date of the restructuring that occurred during the three and nine months ended September 30, 2013:
| For the Three Months Ended September 30, 2013 | For the Nine Months Ended September 30, 2013 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Pre-Modification Outstanding Recorded Investment(1) | Post-Modification Outstanding Recorded Investment(2) | Pre-Modification Outstanding Recorded Investment(1) | Post-Modification Outstanding Recorded Investment(2) | |||||||||
Commercial and industrial | $ | 2 | $ | 2 | $ | 127 | $ | 124 | |||||
Commercial mortgage | 45 | 45 | 60 | 60 | |||||||||
Total commercial portfolio | 47 | 47 | 187 | 184 | |||||||||
Residential mortgage | 20 | 20 | 75 | 74 | |||||||||
Home equity and other consumer loans | 2 | 2 | 6 | 5 | |||||||||
Total consumer portfolio | 22 | 22 | 81 | 79 | |||||||||
Total | $ | 69 | $ | 69 | $ | 268 | $ | 263 | |||||
- (1)
- Represents the recorded investment in the loan immediately prior to the restructuring event.
- (2)
- Represents the recorded investment in the loan immediately following the restructuring event. It includes the effect of paydowns that were required as part of the restructuring terms.
The following table provides the recorded investment amounts of TDRs at the date of default, for which there was a payment default during the third quarter of 2013, and where the default occurred within the twelve months after modification into a TDR. A payment default is defined as the loan being 60 days or more past due.
(Dollars in millions) | For the Three Months Ended September 30, 2013 | For the Nine Months Ended September 30, 2013 | |||||
---|---|---|---|---|---|---|---|
Commercial and industrial | $ | 2 | $ | 10 | |||
Residential mortgage | 3 | 12 | |||||
Home equity and other consumer loans | — | 1 | |||||
Total consumer portfolio | 3 | 13 | |||||
Total | $ | 5 | $ | 23 | |||
For the consumer portfolio, historical payment defaults and the propensity to redefault are some of the factors considered when determining the allowance for loan losses for situations where impairment is measured using the present value of expected future cash flows discounted at the loan's effective interest rate.
Loan Impairment
Loans that are individually evaluated for impairment include larger commercial and industrial, construction, commercial mortgage loans, and loans modified in a TDR. When the value of an impaired loan is less than the recorded investment in the loan, the Company records an impairment allowance.
63
Note 5—Loans and Allowance for Loan Losses (Continued)
The following tables show information about impaired loans by class as of September 30, 2013 and December 31, 2012:
| September 30, 2013 | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Recorded Investment | | Unpaid Principal Balance | ||||||||||||||||
(Dollars in millions) | With an Allowance | Without an Allowance | Total | Allowance for Impaired Loans | With an Allowance | Without an Allowance | |||||||||||||
Commercial and industrial | $ | 202 | $ | 45 | $ | 247 | $ | 29 | $ | 242 | $ | 11 | |||||||
Commercial mortgage | 27 | 14 | 41 | 3 | 46 | — | |||||||||||||
Construction | 2 | — | 2 | — | 3 | — | |||||||||||||
Total commercial portfolio | 231 | 59 | 290 | 32 | 291 | 11 | |||||||||||||
Residential mortgage | 203 | 100 | 303 | 18 | 217 | 114 | |||||||||||||
Home equity and other consumer loans | 3 | 20 | 23 | — | 3 | 34 | |||||||||||||
Total consumer portfolio | 206 | 120 | 326 | 18 | 220 | 148 | |||||||||||||
Total, excluding purchased credit-impaired loans | 437 | 179 | 616 | 50 | 511 | 159 | |||||||||||||
Purchased credit-impaired loans | 2 | 2 | 4 | — | 2 | 7 | |||||||||||||
Total | $ | 439 | $ | 181 | $ | 620 | $ | 50 | $ | 513 | $ | 166 | |||||||
| December 31, 2012 | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Recorded Investment | | Unpaid Principal Balance | ||||||||||||||||
(Dollars in millions) | With an Allowance | Without an Allowance | Total | Allowance for Impaired Loans | With an Allowance | Without an Allowance | |||||||||||||
Commercial and industrial | $ | 156 | $ | 64 | $ | 220 | $ | 24 | $ | 167 | $ | 64 | |||||||
Commercial mortgage | 15 | 60 | 75 | — | 18 | 70 | |||||||||||||
Construction | — | 35 | 35 | — | — | 38 | |||||||||||||
Total commercial portfolio | 171 | 159 | 330 | 24 | 185 | 172 | |||||||||||||
Residential mortgage | 186 | 85 | 271 | 18 | 199 | 97 | |||||||||||||
Home equity and other consumer loans | 3 | 18 | 21 | — | 3 | 31 | |||||||||||||
Total consumer portfolio | 189 | 103 | 292 | 18 | 202 | 128 | |||||||||||||
Total, excluding purchased credit-impaired loans | 360 | 262 | 622 | 42 | 387 | 300 | |||||||||||||
Purchased credit-impaired loans | — | 4 | 4 | — | 1 | 14 | |||||||||||||
Total | $ | 360 | $ | 266 | $ | 626 | $ | 42 | $ | 388 | $ | 314 | |||||||
64
Note 5—Loans and Allowance for Loan Losses (Continued)
The following tables present the average recorded investment in impaired loans and the amount of interest income recognized for impaired loans during the three and nine months ended September 30, 2013 and 2012 for the commercial, consumer and purchased credit-impaired loans portfolio segments.
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012 | 2013 | 2012 | |||||||||||||||||||||
(Dollars in millions) | Average Recorded Investment | Recognized Interest Income | Average Recorded Investment | Recognized Interest Income | Average Recorded Investment | Recognized Interest Income | Average Recorded Investment | Recognized Interest Income | |||||||||||||||||
Commercial and industrial | $ | 257 | $ | 2 | $ | 204 | $ | 5 | $ | 249 | $ | 8 | $ | 201 | $ | 7 | |||||||||
Commercial mortgage | 48 | — | 119 | 1 | 56 | 1 | 121 | 1 | |||||||||||||||||
Construction | 2 | — | 39 | — | 10 | — | 52 | 2 | |||||||||||||||||
Total commercial portfolio | 307 | 2 | 362 | 6 | 315 | 9 | 374 | 10 | |||||||||||||||||
Residential mortgage | 300 | 3 | 223 | 5 | 287 | 8 | 189 | 8 | |||||||||||||||||
Home equity and other consumer loans | 23 | — | 2 | — | 22 | 1 | 2 | — | |||||||||||||||||
Total consumer portfolio | 323 | 3 | 225 | 5 | 309 | 9 | 191 | 8 | |||||||||||||||||
Total, excluding purchased credit-impaired loans | 630 | 5 | 587 | 11 | 624 | 18 | 565 | 18 | |||||||||||||||||
Purchased credit-impaired loans | 4 | — | 8 | — | 4 | — | 10 | 1 | |||||||||||||||||
Total | $ | 634 | $ | 5 | $ | 595 | $ | 11 | $ | 628 | $ | 18 | $ | 575 | $ | 19 | |||||||||
The Company transferred a net $293 million of loans from held for investment to held for sale and sold $167 million in loans during the third quarter of 2013.
Loans Acquired in Business Combinations
The Company accounts for certain loans acquired in business combinations in accordance with accounting guidance related to loans acquired with deteriorated credit quality (purchased credit-impaired loans). The following table presents the outstanding balances and carrying amounts of the Company's purchased credit-impaired loans as of September 30, 2013 and December 31, 2012.
(Dollars in millions) | September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
Total outstanding balance | $ | 2,013 | $ | 2,155 | |||
Carrying amount | $ | 1,243 | $ | 1,161 | |||
The accretable yield for purchased credit-impaired loans for the three and nine months ended September 30, 2013 and 2012 was as follows:
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | 2013 | 2012 | 2013 | 2012 | |||||||||
Accretable yield, beginning of period | $ | 479 | $ | 441 | $ | 590 | $ | 424 | |||||
Additions | — | — | 31 | — | |||||||||
Accretion | (81 | ) | (72 | ) | (241 | ) | (135 | ) | |||||
Reclassifications from nonaccretable difference during the period | 17 | 105 | 35 | 185 | |||||||||
Accretable yield, end of period | $ | 415 | $ | 474 | $ | 415 | $ | 474 | |||||
65
Note 6—Variable Interest Entities
The Company has interests in various entities that are considered to be variable interest entities (VIEs). Generally, a VIE is a corporation, partnership, trust or any other legal structure where the equity investors do not have sufficient equity at risk in the entity to allow the entity to independently finance its activities, lack the power to direct the significant activities of the entity through voting or similar rights, or do not have an obligation to absorb the entity's losses or the right to receive the entity's returns. The Company's investments in VIEs primarily consist of equity investments in low income housing credit (LIHC) structures, renewable energy projects and leasing trusts involved in railcar leasing, which are designed to generate returns principally through the realization of federal tax credits and deductions. For further information related to the Company's consolidated VIEs and those that were not consolidated, see Note 7 to the consolidated financial statements in the Company's 2012 Form 10-K.
Consolidated VIEs
At September 30, 2013, assets of $280 million and liabilities of $7 million were consolidated by the Company on its consolidated balance sheet related to two LIHC investment fund structures because the Company sponsors, manages and syndicates the funds. The assets are included in other assets as well as interest-bearing deposits in banks, the liabilities are primarily included in long-term debt, and third-party investor interests are included in stockholder's equity as noncontrolling interests. Neither creditors nor equity investors in the LIHC investments have any recourse to the general credit of the Company, and the Company's creditors do not have any recourse to the assets of the consolidated LIHC investments.
At September 30, 2013, the Company consolidated $155 million of assets related to trusts that own and lease renewable energy facilities because the Company directs the significant activities of these trusts. The assets are included in loans held for investment on the Company's consolidated balance sheets. At September 30, 2013, the Company also consolidated $96 million in assets related to trusts that own and lease railcars because the Company directs the significant activities of these trusts. The assets are primarily included in other assets on the Company's consolidated balance sheets.
For the three and nine months ended September 30, 2013, the Company recorded $6 million and $17 million, respectively, of revenue related to its consolidated VIEs in other noninterest income and interest income on loans on the Company's consolidated statements of income. For the three and nine months ended September 30, 2013, the Company recorded $11 million and $26 million, respectively, of expenses related to its consolidated VIEs. For the three and nine months ended September 30, 2012, the Company recorded $11 million and $26 million, respectively, of expenses related to its consolidated VIEs. These expenses are included in other noninterest expense on the Company's consolidated statements of income.
Unconsolidated VIEs in which the Company has a Variable Interest
The following table presents the Company's carrying amounts and maximum exposure to loss related to its involvement with the unconsolidated VIEs at September 30, 2013. The maximum exposure to loss represents the carrying amount of the Company's involvement plus any legally binding unfunded commitments in the unlikely event that all of the assets in the VIEs become worthless.
| September 30, 2013 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Total Assets | Total Liabilities | Maximum Exposure to Loss | |||||||
LIHC investments | $ | 1,224 | $ | 405 | $ | 1,224 | ||||
Renewable energy investments | 493 | — | 493 | |||||||
Private capital investments | 15 | — | 15 | |||||||
Total unconsolidated VIEs | $ | 1,732 | $ | 405 | $ | 1,732 | ||||
66
Note 7—Employee Pension and Other Postretirement Benefits
The following tables summarize the components of net periodic benefit cost for the three and nine months ended September 30, 2013 and 2012:
| Pension Benefits | Other Benefits | Superannuation, SERP(1) and ESBP(2) | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Three Months Ended September 30, | For the Three Months Ended September 30, | For the Three Months Ended September 30, | ||||||||||||||||
(Dollars in millions) | 2013 | 2012 | 2013 | 2012 | 2013 | 2012 | |||||||||||||
Components of net periodic benefit cost: | |||||||||||||||||||
Service cost | $ | 23 | $ | 19 | $ | 4 | $ | 4 | $ | — | $ | 1 | |||||||
Interest cost | 25 | 25 | 2 | 3 | 1 | — | |||||||||||||
Expected return on plan assets | (42 | ) | (37 | ) | (4 | ) | (4 | ) | — | — | |||||||||
Amortization of transition amount | — | — | — | 1 | — | — | |||||||||||||
Recognized net actuarial loss | 26 | 23 | 2 | 2 | 1 | — | |||||||||||||
Total net periodic benefit cost | $ | 32 | $ | 30 | $ | 4 | $ | 6 | $ | 2 | $ | 1 | |||||||
| Pension Benefits | Other Benefits | Superannuation, SERP(1) and ESBP(2) | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Nine Months Ended September 30, | For the Nine Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||
(Dollars in millions) | 2013 | 2012 | 2013 | 2012 | 2013 | 2012 | |||||||||||||
Components of net periodic benefit cost: | |||||||||||||||||||
Service cost | $ | 66 | $ | 58 | $ | 11 | $ | 10 | $ | — | $ | 1 | |||||||
Interest cost | 74 | 75 | 8 | 9 | 3 | 2 | |||||||||||||
Expected return on plan assets | (125 | ) | (110 | ) | (12 | ) | (10 | ) | — | — | |||||||||
Amortization of transition amount | — | — | — | 1 | — | — | |||||||||||||
Recognized net actuarial loss | 80 | 67 | 5 | 6 | 2 | 1 | |||||||||||||
Total net periodic benefit cost | $ | 95 | $ | 90 | $ | 12 | $ | 16 | $ | 5 | $ | 4 | |||||||
- (1)
- Supplemental Executives Retirement Plan (SERP).
- (2)
- Executive Supplemental Benefit Plans (ESBP).
Note 8—Commercial Paper and Other Short-Term Borrowings
The following table is a summary of the Company's commercial paper and other short-term borrowings:
(Dollars in millions) | September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
Federal funds purchased and securities sold under repurchase agreements with weighted average interest rates of 0.12% and 0.96% at September 30, 2013 and December 31, 2012, respectively | $ | 124 | $ | 123 | |||
Commercial paper, with weighted average interest rates of 0.17% and 0.20% at September 30, 2013 and December 31, 2012, respectively | 2,954 | 1,240 | |||||
Total commercial paper and other short-term borrowings | $ | 3,078 | $ | 1,363 | |||
67
The following is a summary of the Company's long-term debt:
(Dollars in millions) | September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
Debt issued by UnionBanCal Corporation | |||||||
Senior debt: | |||||||
Fixed rate 3.50% notes due June 2022 | $ | 397 | $ | 397 | |||
Subordinated debt: | |||||||
Fixed rate 5.25% notes due December 2013 | 401 | 406 | |||||
Junior subordinated debt payable to trusts(1): | |||||||
Floating rate notes with maturities ranging from March 2033 to September 2036. These notes bear a combined weighted-average rate of 2.61% at September 30, 2013 and 2.66% at December 31, 2012 | 66 | 66 | |||||
Total debt issued by UnionBanCal Corporation | 864 | 869 | |||||
Debt issued by Union Bank, N.A. and other subsidiaries | |||||||
Senior debt: | |||||||
Fixed and floating rate Federal Home Loan Bank advances with maturities ranging from October 2013 to February 2016. These notes bear a combined weighted-average rate of 1.47% at September 30, 2013 and 1.39% at December 31, 2011 at December 31, 2012 | 1,550 | 2,100 | |||||
Fixed rate 2.125% notes due December 2013 | 400 | 399 | |||||
Floating rate notes due June 2014. These notes, which bear interest at 0.95% above 3-month LIBOR, had a rate of 1.21% at September 30, 2013 and 1.26% December 31, 2011 at December 31, 2012 | 300 | 300 | |||||
Fixed rate 3.00% notes due June 2016 | 699 | 699 | |||||
Fixed rate 1.50% notes due September 2016 | 499 | — | |||||
Floating rate notes due September 2016. These notes, which bear interest at 0.75% above 3-month LIBOR, had a rate of 1.00% at September 30, 2013 | 500 | — | |||||
Fixed rate 2.125% notes due June 2017 | 499 | 499 | |||||
Fixed rate 2.625% notes due September 2018 | 1,000 | — | |||||
Note payable: | |||||||
Fixed rate 6.03% notes due July 2014 (related to consolidated VIE) | 6 | 6 | |||||
Subordinated debt: | |||||||
Fixed rate 5.95% notes due May 2016 | 721 | 729 | |||||
Subordinated debt due to BTMU: | |||||||
Floating rate subordinated debt due June 2023. This note, which bears interest at 1.2% above 3-month LIBOR, had a rate of 1.45% at September 30, 2013 | 750 | — | |||||
Capital lease obligations with a combined weighted average interest rate of 4.88% at September 30, 2013 and 4.72% at December 31, 2012(1) | 15 | 21 | |||||
Total debt issued by Union Bank, N.A. and other subsidiaries | 6,939 | 4,753 | |||||
Total long-term debt | $ | 7,803 | $ | 5,622 | |||
- (1)
- Long-term debt assumed through PCBC acquisition
68
Note 9—Long-Term Debt (Continued)
Senior Debt
On September 26, 2013, Union Bank issued $500 million in aggregate principal amount of Floating Rate Senior Bank Notes due 2016 (2016 Floating Rate Notes), $500 million in aggregate principal amount of 1.50 percent Senior Bank Notes due 2016 (2016 Fixed Rate Notes), and $1 billion in aggregate principal amount of 2.625 percent Senior Bank Notes due 2018 (2018 Fixed Rate Notes) and, together with the 2016 Floating Rate Notes and the 2016 Fixed Rate Notes (Senior Notes). The 2016 Floating Rate Notes were issued to purchasers at a price of 100 percent of their principal amount. The 2016 Fixed Rate Notes were issued to purchasers at a price of 99.746 percent of their principal amount. The 2018 Fixed Rate Notes were issued to purchasers at a price of 99.977 percent of their principal amount.
The 2016 Floating Rate Notes will bear interest at a rate equal to three-month U.S. Dollar LIBOR plus 0.75 percent per annum and will mature on September 26, 2016. The 2016 Fixed Rate Notes will bear interest at a rate of 1.50 percent per annum and will mature on September 26, 2016. The 2018 Fixed Rate Notes will bear interest at a rate of 2.625 percent per annum and will mature on September 26, 2018. Interest payments are due on the 2016 Floating Rate Notes on March 26, June 26, September 26 and December 26 of each year, commencing on December 26, 2013. Interest payments are due on the 2016 Fixed Rate Notes and the 2018 Fixed Rate Notes on March 26 and September 26 of each year, commencing on March 26, 2014.
The 2016 Floating Rate Notes are not redeemable at the option of the Bank prior to maturity. The Bank may redeem any of the 2016 Fixed Rate Notes, in whole or in part, on and after August 26, 2016 at a redemption price equal to 100 percent of the principal amount being redeemed plus interest accrued to, but excluding, the date of redemption upon not less than 30 nor more than 60 days' notice provided by the Bank to holders of the 2016 Fixed Rate Notes. The Bank may redeem any of the 2018 Fixed Rate Notes, in whole or in part, on and after August 26, 2018 at a redemption price equal to 100 percent of the principal amount being redeemed plus interest accrued to, but excluding, the date of redemption upon not less than 30 nor more than 60 days' notice provided by the Bank to holders of the 2018 Fixed Rate Notes. None of the Senior Notes are subject to repayment at the option of the holders prior to maturity.
The net proceeds from the sale of the Senior Notes will be used by the Bank for general corporate purposes in the ordinary course of its banking business.
The Senior Notes were issued as part of the Bank's $8 billion bank note program under which the Bank may issue, from time to time, senior unsecured debt obligations with maturities of more than one year from their respective dates of issue and subordinated debt obligations with maturities of five years or more from their respective dates of issue. After issuing the Senior Notes, there is $2.7 billion available for issuance under the program.
Subordinated Debt due to BTMU
On June 28, 2013, the Bank borrowed $750 million from The Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU) under a subordinated debt agreement. The subordinated debt bears interest at a rate of three-month LIBOR plus 1.2 percent, payable quarterly, and will mature on June 28, 2023. The terms and conditions of the agreement are equivalent to those which would apply in a similar transaction with a non-related party. The subordinated debt due to BTMU is a junior obligation to the Bank's existing and future outstanding senior indebtedness, and qualifies as Tier 2 capital under the federal banking agency risk-based capital guidelines.
69
Note 10—Fair Value Measurement and Fair Value of Financial Instruments
Valuation Methodologies
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., an exit price) in an orderly transaction between willing market participants at the measurement date. The Company has an established and documented process for determining fair value for financial assets and financial liabilities that are measured at fair value on either a recurring or nonrecurring basis. When available, quoted market prices are used to determine fair value. If quoted market prices are not available, fair value is based upon valuation techniques that use, where possible, current market-based or independently sourced parameters, such as yield curves, foreign exchange rates, credit spreads, commodity prices, and implied volatilities. Valuation adjustments may be made to ensure the financial instruments are recorded at fair value. These adjustments include amounts that reflect counterparty credit quality and that consider the Company's creditworthiness in determining the fair value of its trading liabilities. For further information related to the valuation methodologies used for certain financial assets and financial liabilities measured at fair value, see Note 16 to the consolidated financial statements in the Company's 2012 Form 10-K.
Fair Value Hierarchy
In determining fair value, the Company maximizes the use of observable market inputs and minimizes the use of unobservable inputs. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect the Company's estimate about market data. Based on the observability of the significant inputs used, the Company classifies its fair value measurements in accordance with the three-level hierarchy as defined by U.S. GAAP. This hierarchy is based on the quality, observability, and reliability of the information used to determine fair value. For further information related to the fair value hierarchy, see Note 16 to the consolidated financial statements in the Company's 2012 Form 10-K.
Valuation Processes
The Company has established a Valuation Committee (VC) to oversee its valuation framework for measuring fair value and to establish valuation policies and procedures. The VC's responsibilities include reviewing and approving all fair value measurements and categorizations within the fair value hierarchy and monitoring the use of pricing sources, mark-to-model valuations, dealer quotes, and other valuation processes. The VC reports to the Company's Risk & Capital Committee and meets at least quarterly.
Independent price verification (IPV) is performed periodically by the Company to test the market data and valuations of substantially all instruments measured at fair value on a recurring basis. As part of its IPV procedures, the Company utilizes third party valuations and both internal and external models to compare pricing sources and perform analysis. Results are formally reported on a quarterly basis to the VC. For further information related to valuation processes, see Note 16 to the consolidated financial statements in the Company's 2012 Form 10-K.
70
Note 10—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
Fair Value Measurements on a Recurring Basis
The following tables present financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012, by major category and by valuation hierarchy level:
| September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Level 1 | Level 2 | Level 3 | Netting Adjustment(1) | Fair Value | |||||||||||
Assets | ||||||||||||||||
Trading account assets: | ||||||||||||||||
U.S. Treasury | $ | — | $ | 82 | $ | — | $ | — | $ | 82 | ||||||
U.S. government sponsored agencies | — | 54 | — | — | 54 | |||||||||||
State and municipal | — | 2 | — | — | 2 | |||||||||||
Interest rate derivative contracts | 1 | 754 | 8 | (189 | ) | 574 | ||||||||||
Commodity derivative contracts | — | 93 | 14 | (93 | ) | 14 | ||||||||||
Foreign exchange derivative contracts | 1 | 23 | 2 | (11 | ) | 15 | ||||||||||
Equity derivative contracts | — | — | 202 | (167 | ) | 35 | ||||||||||
Total trading account assets | 2 | 1,008 | 226 | (460 | ) | 776 | ||||||||||
Securities available for sale: | ||||||||||||||||
U.S. government sponsored agencies | — | 139 | — | — | 139 | |||||||||||
Residential mortgage-backed securities: | ||||||||||||||||
U.S. government and government sponsored agencies | — | 9,782 | — | — | 9,782 | |||||||||||
Privately issued | — | 241 | — | — | 241 | |||||||||||
Commercial mortgage-backed securities | — | 1,976 | — | — | 1,976 | |||||||||||
CLOs | — | 2,613 | — | — | 2,613 | |||||||||||
Asset-backed and other | — | 59 | — | — | 59 | |||||||||||
Other debt securities: | ||||||||||||||||
Direct bank purchase bonds | — | — | 1,908 | — | 1,908 | |||||||||||
Other | — | 92 | 55 | — | 147 | |||||||||||
Equity securities | 7 | — | — | — | 7 | |||||||||||
Total securities available for sale | 7 | 14,902 | 1,963 | — | 16,872 | |||||||||||
Other assets: | ||||||||||||||||
Interest rate hedging contracts | — | 21 | — | — | 21 | |||||||||||
Other derivative contracts | — | — | 2 | — | 2 | |||||||||||
Total other assets | — | 21 | 2 | — | 23 | |||||||||||
Total assets | $ | 9 | $ | 15,931 | $ | 2,191 | $ | (460 | ) | $ | 17,671 | |||||
Percentage of Total | — | % | 90 | % | 13 | % | (3 | )% | 100 | % | ||||||
Percentage of Total Company Assets | — | % | 15 | % | 2 | % | — | % | 17 | % | ||||||
Liabilities | ||||||||||||||||
Trading account liabilities: | ||||||||||||||||
Interest rate derivative contracts | $ | 4 | $ | 650 | $ | — | $ | (397 | ) | $ | 257 | |||||
Commodity derivative contracts | — | 80 | 14 | (54 | ) | 40 | ||||||||||
Foreign exchange derivative contracts | 1 | 34 | 2 | (17 | ) | 20 | ||||||||||
Equity derivative contracts | — | — | 202 | — | 202 | |||||||||||
Securities sold, not yet purchased | — | 95 | — | — | 95 | |||||||||||
Total trading account liabilities | 5 | 859 | 218 | (468 | ) | 614 | ||||||||||
Other liabilities: | ||||||||||||||||
FDIC clawback liability | — | — | 94 | — | 94 | |||||||||||
Interest rate hedging contracts | — | 3 | — | — | 3 | |||||||||||
Other derivative contracts | — | 1 | 3 | — | 4 | |||||||||||
Total other liabilities | — | 4 | 97 | — | 101 | |||||||||||
Total liabilities | $ | 5 | $ | 863 | $ | 315 | $ | (468 | ) | $ | 715 | |||||
Percentage of Total | — | % | 121 | % | 44 | % | (65 | )% | 100 | % | ||||||
Percentage of Total Company Liabilities | — | % | 1 | % | 1 | % | (1 | )% | 1 | % |
- (1)
- Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.
71
Note 10—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
| December 31, 2012 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Level 1 | Level 2 | Level 3 | Netting Adjustment(1) | Fair Value | |||||||||||
Assets | ||||||||||||||||
Trading account assets: | ||||||||||||||||
U.S. Treasury | $ | — | $ | 1 | $ | — | $ | — | $ | 1 | ||||||
U.S. government sponsored agencies | — | 113 | — | — | 113 | |||||||||||
State and municipal | — | 15 | — | — | 15 | |||||||||||
Commercial paper | — | 10 | — | — | 10 | |||||||||||
Interest rate derivative contracts | — | 1,075 | — | (87 | ) | 988 | ||||||||||
Commodity derivative contracts | — | 137 | 30 | (127 | ) | 40 | ||||||||||
Foreign exchange derivative contracts | 1 | 65 | 3 | (28 | ) | 41 | ||||||||||
Equity derivative contracts | — | — | 103 | (103 | ) | — | ||||||||||
Total trading account assets | 1 | 1,416 | 136 | (345 | ) | 1,208 | ||||||||||
Securities available for sale: | ||||||||||||||||
U.S. government sponsored agencies | — | 885 | — | — | 885 | |||||||||||
Residential mortgage-backed securities: | ||||||||||||||||
U.S government and government sponsored agencies | — | 13,333 | — | — | 13,333 | |||||||||||
Privately issued | — | 443 | — | — | 443 | |||||||||||
Commercial mortgage-backed securities | — | 2,971 | — | — | 2,971 | |||||||||||
CLOs | — | 1,959 | — | — | 1,959 | |||||||||||
Asset-backed and other | — | 146 | — | — | 146 | |||||||||||
Other debt securities: | ||||||||||||||||
Direct bank purchase bonds | — | — | 1,438 | — | 1,438 | |||||||||||
Other | — | 97 | 61 | — | 158 | |||||||||||
Equity securities | 19 | — | — | — | 19 | |||||||||||
Total securities available for sale | 19 | 19,834 | 1,499 | — | 21,352 | |||||||||||
Other assets: | ||||||||||||||||
Interest rate hedging contracts | — | 28 | — | (24 | ) | 4 | ||||||||||
Other derivative contracts | — | 1 | — | (1 | ) | — | ||||||||||
Total other assets | — | 29 | — | (25 | ) | 4 | ||||||||||
Total assets | $ | 20 | $ | 21,279 | $ | 1,635 | $ | (370 | ) | $ | 22,564 | |||||
Percentage of Total | — | % | 94 | % | 7 | % | (1 | )% | 100 | % | ||||||
Percentage of Total Company Assets | — | % | 22 | % | 1 | % | — | % | 23 | % | ||||||
Liabilities | ||||||||||||||||
Trading account liabilities: | ||||||||||||||||
Interest rate derivative contracts | $ | 5 | $ | 1,004 | $ | — | $ | (407 | ) | $ | 602 | |||||
Commodity derivative contracts | — | 110 | 30 | (42 | ) | 98 | ||||||||||
Foreign exchange derivative contracts | 1 | 61 | 3 | — | 65 | |||||||||||
Equity derivative contracts | — | — | 103 | — | 103 | |||||||||||
Securities sold, not yet purchased | — | 27 | — | — | 27 | |||||||||||
Total trading account liabilities | 6 | 1,202 | 136 | (449 | ) | 895 | ||||||||||
Other liabilities: | ||||||||||||||||
FDIC clawback liability | — | — | 92 | — | 92 | |||||||||||
Other derivative contracts | — | — | 3 | — | 3 | |||||||||||
Total other liabilities | — | — | 95 | — | 95 | |||||||||||
Total liabilities | $ | 6 | $ | 1,202 | $ | 231 | $ | (449 | ) | $ | 990 | |||||
Percentage of Total | 1 | % | 121 | % | 23 | % | (45 | )% | 100 | % | ||||||
Percentage of Total Company Liabilities | — | % | 2 | % | — | % | (1 | )% | 1 | % |
- (1)
- Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.
72
Note 10—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
The following tables present a reconciliation of the assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2013 and 2012. Level 3 available for sale securities at September 30, 2013 and 2012 primarily consisted of direct bank purchase bonds. The Company's policy is to recognize transfers in and out of Level 1, 2 and 3 as of the end of a reporting period.
| For the Three Months Ended | |||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | September 30, 2012 | ||||||||||||||||||||||||||
(Dollars in millions) | Trading Assets | Securities Available for Sale | Other Assets | Trading Liabilities | Other Liabilities | Trading Assets | Securities Available for Sale | Trading Liabilities | Other Liabilities | |||||||||||||||||||
Asset (liability) balance, beginning of period | $ | 182 | $ | 1,762 | $ | 2 | $ | (183 | ) | $ | (94 | ) | $ | 118 | $ | 1,134 | $ | (118 | ) | $ | (72 | ) | ||||||
Total gains (losses) (realized/unrealized): | ||||||||||||||||||||||||||||
Included in income before taxes | 39 | — | — | (38 | ) | (3 | ) | 37 | — | (37 | ) | (5 | ) | |||||||||||||||
Included in other comprehensive income | — | (7 | ) | — | — | — | — | (43 | ) | — | — | |||||||||||||||||
Purchases/additions | 13 | 237 | — | — | — | 3 | 383 | (3 | ) | — | ||||||||||||||||||
Sales | — | — | — | (5 | ) | — | (3 | ) | — | 3 | — | |||||||||||||||||
Settlements | (8 | ) | (29 | ) | — | 8 | — | — | (48 | ) | — | — | ||||||||||||||||
Asset (liability) balance, end of period | $ | 226 | $ | 1,963 | $ | 2 | $ | (218 | ) | $ | (97 | ) | $ | 155 | $ | 1,426 | $ | (155 | ) | $ | (77 | ) | ||||||
Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period | $ | 39 | $ | — | $ | — | $ | (38 | ) | $ | (3 | ) | $ | 37 | $ | — | $ | (37 | ) | $ | (5 | ) |
| For the Nine Months Ended | |||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2013 | September 30, 2012 | ||||||||||||||||||||||||||
(Dollars in millions) | Trading Assets | Securities Available for Sale | Other Assets | Trading Liabilities | Other Liabilities | Trading Assets | Securities Available for Sale | Trading Liabilities | Other Liabilities | |||||||||||||||||||
Asset (liability) balance, beginning of period | $ | 136 | $ | 1,499 | $ | — | $ | (136 | ) | $ | (95 | ) | $ | — | $ | 48 | $ | — | $ | (51 | ) | |||||||
Total gains (losses) (realized/unrealized): | ||||||||||||||||||||||||||||
Included in income before taxes | 81 | — | 1 | (81 | ) | (2 | ) | 3 | — | (3 | ) | (26 | ) | |||||||||||||||
Included in other comprehensive income | — | 30 | — | — | — | — | (47 | ) | — | — | ||||||||||||||||||
Purchases/additions | 17 | 566 | 1 | — | — | 5 | 1,473 | (5 | ) | — | ||||||||||||||||||
Sales | — | (14 | ) | — | (9 | ) | — | (6 | ) | — | 6 | — | ||||||||||||||||
Settlements | (8 | ) | (118 | ) | — | 8 | — | — | (48 | ) | — | — | ||||||||||||||||
Transfers into Level 3 | — | — | — | — | — | 153 | — | (153 | ) | — | ||||||||||||||||||
Asset (liability) balance, end of period | $ | 226 | $ | 1,963 | $ | 2 | $ | (218 | ) | $ | (97 | ) | $ | 155 | $ | 1,426 | $ | (155 | ) | $ | (77 | ) | ||||||
Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period | $ | 81 | $ | — | $ | 1 | $ | (81 | ) | $ | (2 | ) | $ | 3 | $ | — | $ | (3 | ) | $ | (26 | ) |
73
Note 10—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
The following table presents information about significant unobservable inputs related to the Company's significant Level 3 assets and liabilities at September 30, 2013.
| September 30, 2013 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Level 3 Fair Value | Valuation Technique(s) | Significant Unobservable Input(s) | Range of Inputs | Weighted Average | |||||||||
Securities available for sale: | ||||||||||||||
Direct bank purchase bonds | $ | 1,908 | Return on equity | Market-required return on capital | 8.0 - 10.0 | % | 10.0 | % | ||||||
Probability of default | 0.0 - 25.0 | % | 0.6 | % | ||||||||||
Loss severity | 10.0 - 75.0 | % | 32.6 | % | ||||||||||
Other liabilities: | ||||||||||||||
FDIC clawback liability | $ | 94 | Discounted cash flow | Probability of default | 0.2 - 100.0 | % | 58.6 | % | ||||||
Loss severity | 20.0 - 100.0 | % | 41.3 | % |
The direct bank purchase bonds use a return on equity valuation technique. This technique uses significant unobservable inputs such as market-required return on capital, probability of default, and loss severity. Increases (decreases) in any of these inputs in isolation would result in a lower (higher) fair value measurement.
The FDIC clawback liability uses a discounted cash flow valuation technique. This technique uses significant unobservable inputs such as probability of default and loss severity. Increases (decreases) in probability of default and loss severity would result in a lower (higher) liability.
Fair Value Measurement on a Nonrecurring Basis
Certain assets may be measured at fair value on a nonrecurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis during the third quarters of 2013 and 2012 that were still held on the consolidated balance sheet as of the respective periods ended, the following tables present the fair value of such financial instruments by the level of valuation assumptions used to determine each fair value adjustment:
| September 30, 2013 | | | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Loss for the Three Months Ended September 30, | Loss for the Nine Months Ended September 30, | |||||||||||||||||
(Dollars in millions) | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||||
Loans: | |||||||||||||||||||
Impaired loans | $ | 85 | $ | — | $ | — | $ | 85 | $ | (12 | ) | $ | (35 | ) | |||||
Other assets: | |||||||||||||||||||
OREO | 21 | — | — | 21 | (1 | ) | (7 | ) | |||||||||||
Private equity investments | — | — | — | — | (5 | ) | (5 | ) | |||||||||||
Total | $ | 106 | $ | — | $ | — | $ | 106 | $ | (18 | ) | $ | (47 | ) | |||||
74
Note 10—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
| September 30, 2012 | | | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Loss for the Three Months Ended September 30, | Loss for the Nine Months Ended September 30, | |||||||||||||||||
(Dollars in millions) | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||||
Loans: | |||||||||||||||||||
Impaired loans | $ | 111 | $ | — | $ | — | $ | 111 | $ | (34 | ) | $ | (70 | ) | |||||
Other assets: | |||||||||||||||||||
OREO | 47 | — | — | 47 | (3 | ) | (20 | ) | |||||||||||
Private equity investments | — | — | — | — | — | (2 | ) | ||||||||||||
Total | $ | 158 | $ | — | $ | — | $ | 158 | $ | (37 | ) | $ | (92 | ) | |||||
Loans include individually impaired loans that are measured at fair value based on appraised values of the underlying collateral or market pricing for the loan, adjusted for management judgment, as of the measurement date. The fair value of OREO was primarily based on independent appraisals.
Fair Value of Financial Instruments Disclosures
The tables below present the carrying amount and estimated fair value of financial assets and liabilities not measured at fair value in the balance sheet but for which fair value is required to be disclosed by the level of valuation assumptions held by the Company as of September 30, 2013 and as of December 31, 2012:
| September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Carrying Amount | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||
Assets | ||||||||||||||||
Cash and cash equivalents | $ | 7,312 | $ | 7,312 | $ | 7,312 | $ | — | $ | — | ||||||
Securities held to maturity | 5,446 | 5,450 | — | 5,450 | — | |||||||||||
Loans held for investment, net of allowance for loan losses(1) | 65,599 | 67,052 | — | — | 67,052 | |||||||||||
FDIC indemnification asset | 191 | 108 | — | — | 108 | |||||||||||
Other assets | 2 | 3 | — | — | 3 | |||||||||||
Liabilities | ||||||||||||||||
Deposits | $ | 79,415 | $ | 79,618 | $ | — | $ | 79,618 | $ | — | ||||||
Commercial paper and other short-term borrowings | 3,078 | 3,078 | — | 3,078 | — | |||||||||||
Long-term debt | 7,803 | 7,942 | — | 7,942 | — | |||||||||||
Off-Balance Sheet Instruments | ||||||||||||||||
Commitments to extend credit and standby and commercial letters of credit | $ | 267 | $ | 267 | $ | — | $ | — | $ | 267 |
- (1)
- Excludes lease financing, net of related allowance.
75
Note 10—Fair Value Measurement and Fair Value of Financial Instruments (Continued)
| December 31, 2012 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) | Carrying Amount | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||
Assets | ||||||||||||||||
Cash and cash equivalents | $ | 5,491 | $ | 5,491 | $ | 5,491 | $ | — | $ | — | ||||||
Securities held to maturity | 1,103 | 1,135 | — | 1,135 | — | |||||||||||
Loans held for investment, net of allowance for loan losses(1) | 58,284 | 59,613 | — | — | 59,613 | |||||||||||
FDIC indemnification asset | 338 | 151 | — | — | 151 | |||||||||||
Other assets | 3 | 3 | — | — | 3 | |||||||||||
Liabilities | ||||||||||||||||
Deposits | $ | 74,304 | $ | 74,524 | $ | — | $ | 74,524 | $ | — | ||||||
Commercial paper and other short-term borrowings | 1,363 | 1,363 | — | 1,363 | — | |||||||||||
Long-term debt | 5,622 | 5,861 | — | 5,861 | — | |||||||||||
Off-Balance Sheet Instruments | ||||||||||||||||
Commitments to extend credit and standby and commercial letters of credit | $ | 262 | $ | 262 | $ | — | $ | — | $ | 262 |
- (1)
- Excludes lease financing, net of related allowance.
For further information on methodologies for approximating fair values, see Note 16 to the consolidated financial statements in the Company's 2012 Form 10-K.
Note 11—Derivative Instruments and Other Financial Instruments
The Company enters into certain derivative and other financial instruments for trading purposes, which includes customer accommodation derivative contracts, and for other-than-trading purposes, which are predominantly used for risk management.
Credit and market risks are inherent in derivative instruments. Credit risk is defined as the possibility that a loss may occur from the failure of another party to perform in accordance with the terms of the contract, which exceeds the value of the existing collateral, if any. The Company utilizes master netting and collateral support annex (CSA) agreements in order to reduce its exposure to credit risk. Additionally, the Company considers the potential loss in the event of counterparty default in estimating the fair value amount of the derivative instrument. Market risk is defined as the risk of loss arising from an adverse change in the market value of financial instruments caused by fluctuations in market prices or rates.
Derivatives are primarily used to manage exposure to interest rate, commodity, foreign currency and credit risk, and to assist customers with their risk management objectives. The Company designates derivative instruments as those used for trading or other-than-trading purposes. All derivative instruments are recognized as assets or liabilities on the consolidated balance sheet at fair value.
The tables below present the notional amounts, and the location and fair value amounts of the Company's derivative instruments reported on the consolidated balance sheet, segregated between derivative instruments designated and qualifying as hedging instruments and all other derivative instruments as of September 30,
76
Note 11—Derivative Instruments and Other Financial Instruments (Continued)
2013 and December 31, 2012. Asset and liability values are presented gross, excluding the impact of legally enforceable master netting and CSA agreements.
| September 30, 2013 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Asset Derivatives | Liability Derivatives | |||||||||||
(Dollars in millions) | Notional Amount | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | |||||||||
Derivatives designated as other than trading | ||||||||||||||
Designated as hedging instruments: | ||||||||||||||
Interest rate contracts | $ | 3,550 | Other assets | $ | 21 | Other liabilities | $ | 3 | ||||||
Not designated as hedging instruments: | ||||||||||||||
Other contracts | $ | 165 | Other assets | $ | 2 | Other liabilities | $ | 4 | ||||||
Total derivatives designated as other than trading | $ | 3,715 | $ | 23 | $ | 7 | ||||||||
Trading derivatives: | ||||||||||||||
Interest rate contracts | $ | 43,675 | Trading account assets | $ | 763 | Trading account liabilities | $ | 654 | ||||||
Commodity contracts | 5,916 | Trading account assets | 107 | Trading account liabilities | 94 | |||||||||
Foreign exchange contracts | 5,129 | Trading account assets | 26 | Trading account liabilities | 37 | |||||||||
Equity contracts | 3,910 | Trading account assets | 202 | Trading account liabilities | 202 | |||||||||
Total trading derivatives | $ | 58,630 | $ | 1,098 | $ | 987 | ||||||||
Total derivative instruments | $ | 62,345 | $ | 1,121 | $ | 994 | ||||||||
| December 31, 2012 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Asset Derivatives | Liability Derivatives | |||||||||||
(Dollars in millions) | Notional Amount | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | |||||||||
Derivatives designated as other than trading | ||||||||||||||
Designated as hedging instruments: | ||||||||||||||
Interest rate contracts | $ | 8,400 | Other assets | $ | 28 | Other liabilities | $ | — | ||||||
Not designated as hedging instruments: | ||||||||||||||
Other contracts | $ | 109 | Other assets | $ | 1 | Other liabilities | $ | 3 | ||||||
Total derivatives designated as other than trading | $ | 8,509 | $ | 29 | $ | 3 | ||||||||
Trading derivatives: | ||||||||||||||
Interest rate contracts | $ | 37,790 | Trading account assets | $ | 1,075 | Trading account liabilities | $ | 1,009 | ||||||
Commodity contracts | 5,595 | Trading account assets | 167 | Trading account liabilities | 140 | |||||||||
Foreign exchange contracts | 4,593 | Trading account assets | 69 | Trading account liabilities | 65 | |||||||||
Equity contracts | 3,631 | Trading account assets | 103 | Trading account liabilities | 103 | |||||||||
Total trading derivatives | $ | 51,609 | $ | 1,414 | $ | 1,317 | ||||||||
Total derivative instruments | $ | 60,118 | $ | 1,443 | $ | 1,320 | ||||||||
Derivatives Used for Other-Than-Trading Purposes
The Company uses interest rate derivatives to manage the financial impact on the Company from changes in market interest rates. These instruments are used to manage interest rate risk relating to specified groups of assets and liabilities, primarily LIBOR-based commercial loans, certificates of deposit (CDs), borrowings, and future debt issuances. Derivatives that qualify for hedge accounting are designated as either fair value or cash flow hedges. For the nine months ended September 2013 and 2012, the Company did not have fair value
77
Note 11—Derivative Instruments and Other Financial Instruments (Continued)
hedges. For further information related to the Company's hedging strategy, see Note 17 to the consolidated financial statements in the Company's 2012 Form 10-K.
Cash Flow Hedges
The Company used interest rate swaps with a notional amount of $3.6 billion at September 30, 2013 to hedge the risk of changes in cash flows attributable to changes in the designated benchmark interest rate on LIBOR indexed loans. To the extent effective, payments received (or paid) under the swap contract offset fluctuations in interest income on loans caused by changes in the relevant LIBOR index. At September 30, 2013, the weighted average remaining life of the active cash flow hedges was approximately 4.04 years.
For cash flow hedges, the effective portion of the gain or loss on the hedging instruments is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged cash flows are recognized in net interest income. Gains and losses representing hedge ineffectiveness are recognized in earnings in the period in which they arise. At September 30, 2013, the Company expects to reclassify approximately $58 million of income from accumulated other comprehensive income to net interest income during the twelve months ending September 30, 2014. This amount could differ from amounts actually realized due to changes in interest rates, hedge terminations and the addition of other hedges subsequent to September 30, 2013.
The following tables present the amount and location of the net gains and losses recorded in the Company's consolidated statements of income and changes in stockholder's equity for derivatives designated as cash flow hedges for the three and nine months ended September 30, 2013 and 2012:
| Amount of Gain or (Loss) Recognized in OCI on Derivative Instruments (Effective Portion) | Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | Gain or (Loss) Recognized in Income on Derivative Instruments (Ineffective Portion and Amount Excluded from Effectiveness Testing) | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Three Months Ended September 30, | | For the Three Months Ended September 30, | | For the Three Months Ended September 30, | ||||||||||||||||||
(Dollars in millions) | 2013 | 2012 | Location | 2013 | 2012 | Location | 2013 | 2012 | |||||||||||||||
Derivatives in cash flow hedging relationships | |||||||||||||||||||||||
Interest income | $ | 13 | $ | 5 | |||||||||||||||||||
Interest rate contracts | $ | 30 | $ | 39 | Interest expense | (1 | ) | — | Noninterest expense(1) | $ | — | $ | — | ||||||||||
Total | $ | 30 | $ | 39 | $ | 12 | $ | 5 | $ | — | $ | — | |||||||||||
| Amount of Gain or (Loss) Recognized in OCI on Derivative Instruments (Effective Portion) | Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | Gain or (Loss) Recognized in Income on Derivative Instruments (Ineffective Portion and Amount Excluded from Effectiveness Testing) | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Nine Months Ended September 30, | | For the Nine Months Ended September 30, | | For the Nine Months Ended September 30, | ||||||||||||||||||
(Dollars in millions) | 2013 | 2012 | Location | 2013 | 2012 | Location | 2013 | 2012 | |||||||||||||||
Derivatives in cash flow hedging relationships | |||||||||||||||||||||||
Interest income | $ | 28 | $ | 11 | |||||||||||||||||||
Interest rate contracts | $ | 39 | $ | 77 | Interest expense | (1 | ) | (1 | ) | Noninterest expense(1) | $ | — | $ | — | |||||||||
Total | $ | 39 | $ | 77 | $ | 27 | $ | 10 | $ | — | $ | — | |||||||||||
- (1)
- Amount recognized was less than $1 million.
78
Note 11—Derivative Instruments and Other Financial Instruments (Continued)
Trading Derivatives
Derivative instruments classified as trading include both derivatives entered into for the Company's own account and as an accommodation for customers. Trading derivatives are included in trading assets or trading liabilities with changes in fair value reflected in income from trading account activities. The majority of the Company's derivative transactions for customers were essentially offset by contracts with third parties that reduce or eliminate market risk exposures.
The Company offers market-linked CDs, which allow the client to earn the higher of either a minimum fixed rate of interest or a return tied to either equity, commodity or currency indices. The Company hedges its exposure to the embedded derivative contained in market-linked CDs with a matched over-the-counter option. Both the embedded derivative and hedge options are recorded at fair value with the realized and unrealized changes in fair value recorded in noninterest income within trading account activities.
The following table presents the amount of the net gains and losses reported in the consolidated statement of income under the heading trading account activities for derivative instruments classified as trading for the three and nine months ended September 30, 2013 and 2012:
| Gain or (Loss) Recognized in Income on Derivative Instruments | Gain or (Loss) Recognized in Income on Derivative Instruments | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| For the Three Months Ended | For the Nine Months Ended | |||||||||||
(Dollars in million) | September 30, 2013 | September 30, 2012 | September 30, 2013 | September 30, 2012 | |||||||||
Trading derivatives: | |||||||||||||
Interest rate contracts | $ | 12 | $ | 17 | $ | 21 | $ | 39 | |||||
Equity contracts | (10 | ) | 3 | (4 | ) | 11 | |||||||
Foreign exchange contracts | 5 | 4 | 13 | 17 | |||||||||
Commodity contracts | 1 | (1 | ) | 1 | 3 | ||||||||
Other contracts | 1 | (2 | ) | 2 | (2 | ) | |||||||
Total | $ | 9 | $ | 21 | $ | 33 | $ | 68 | |||||
Offsetting Assets and Liabilities
During the first quarter of 2013, the Company adopted ASU 2011-11,Disclosures about Offsetting Assets and Liabilities, which establishes new disclosures about an entity's rights of setoff and arrangements associated with its financial instruments and derivative instruments. The Company primarily enters into derivative contracts and repurchase agreements with counterparties utilizing a standard International Swaps and Derivatives Association master netting agreement (ISDA MNA) or master repurchase agreements, which generally establish the terms and conditions of the transactions, including a legal right to set-off amounts payable and receivable between the Company and a counterparty, regardless of whether or not such amounts have matured or have contingency features.
79
Note 11—Derivative Instruments and Other Financial Instruments (Continued)
The following tables present the offsetting of financial assets and liabilities as of September 30, 2013 and December 31, 2012:
| September 30, 2013 | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | Gross Amounts Not Offset in Balance Sheet | | ||||||||||||||
(Dollars in millions) | Gross Amounts of Recognized Assets/Liabilities | Gross Amounts Offset in Balance Sheet | Net Amounts Presented in Balance Sheet | Financial Instruments | Cash Collateral Received/Pledged | Net Amount | |||||||||||||
Financial Assets: | |||||||||||||||||||
Derivative Assets | $ | 1,121 | $ | 460 | $ | 661 | $ | 47 | $ | — | $ | 614 | |||||||
Securities purchased under resale agreements | 122 | — | 122 | 121 | — | 1 | |||||||||||||
Total | $ | 1,243 | $ | 460 | $ | 783 | $ | 168 | $ | — | $ | 615 | |||||||
Financial Liabilities: | |||||||||||||||||||
Derivative Liabilities | $ | 994 | $ | 468 | $ | 526 | $ | 207 | $ | 2 | $ | 317 | |||||||
Securities sold under repurchase agreements | 38 | — | 38 | 38 | — | — | |||||||||||||
Total | $ | 1,032 | $ | 468 | $ | 564 | $ | 245 | $ | 2 | $ | 317 | |||||||
| December 31, 2012 | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | Gross Amounts Not Offset in Balance Sheet | | ||||||||||||||
(Dollars in millions) | Gross Amounts of Recognized Assets/Liabilities | Gross Amounts Offset in Balance Sheet | Net Amounts Presented in Balance Sheet | Financial Instruments | Cash Collateral Received/Pledged | Net Amount | |||||||||||||
Financial Assets: | |||||||||||||||||||
Derivative Assets | $ | 1,443 | $ | 370 | $ | 1,073 | $ | 21 | $ | 2 | $ | 1,050 | |||||||
Securities purchased under resale agreements | 19 | — | 19 | 19 | — | — | |||||||||||||
Total | $ | 1,462 | $ | 370 | $ | 1,092 | $ | 40 | $ | 2 | $ | 1,050 | |||||||
Financial Liabilities: | |||||||||||||||||||
Derivative Liabilities | $ | 1,320 | $ | 449 | $ | 871 | $ | 491 | $ | 121 | $ | 259 | |||||||
Securities sold under repurchase agreements | 5 | — | 5 | 5 | — | — | |||||||||||||
Total | $ | 1,325 | $ | 449 | $ | 876 | $ | 496 | $ | 121 | $ | 259 | |||||||
80
Note 12—Accumulated Other Comprehensive Loss
The following table presents the change in each of the components of accumulated other comprehensive loss and the related tax effect of the change allocated to each component for the three months ended September 30, 2012 and 2013:
(Dollars in millions) | Before Tax Amount | Tax Effect | Net of Tax | |||||||
---|---|---|---|---|---|---|---|---|---|---|
For the Three Months Ended September 30, 2012: | ||||||||||
Cash flow hedge activities: | ||||||||||
Unrealized net gains on hedges arising during the period | $ | 39 | $ | (15 | ) | $ | 24 | |||
Less: Reclassification adjustment for net losses on hedges included in net income | (5 | ) | 2 | (3 | ) | |||||
Net change in unrealized losses on hedges | 34 | (13 | ) | 21 | ||||||
Securities: | ||||||||||
Unrealized holding gains arising during the period on securities available for sale | 42 | (16 | ) | 26 | ||||||
Reclassification adjustment for net gains on securities available for sale included in net income | (41 | ) | 17 | (24 | ) | |||||
Reclassification of unrealized loss on held to maturity securities transferred to securities available for sale | 301 | (118 | ) | 183 | ||||||
Less: accretion of fair value adjustment on securities available for sale | (1 | ) | — | (1 | ) | |||||
Less: accretion of fair value adjustment on held to maturity securities | (9 | ) | 3 | (6 | ) | |||||
Less: amortization of net unrealized losses on held to maturity securities | 28 | (11 | ) | 17 | ||||||
Net change in unrealized losses on securities | 320 | (125 | ) | 195 | ||||||
Foreign currency translation adjustment | 3 | (2 | ) | 1 | ||||||
Reclassification adjustment for pension and other benefits included in net income: | ||||||||||
Amortization of transition amount | 1 | — | 1 | |||||||
Recognized net actuarial loss(1) | 25 | (10 | ) | 15 | ||||||
Net change in pension and other benefits(1) | 26 | (10 | ) | 16 | ||||||
Net change in accumulated other comprehensive loss | $ | 383 | $ | (150 | ) | $ | 233 | |||
For the Three Months Ended September 30, 2013: | ||||||||||
Cash flow hedge activities: | ||||||||||
Unrealized net gains on hedges arising during the period | $ | 30 | $ | (12 | ) | $ | 18 | |||
Less: Reclassification adjustment for net losses on hedges included in interest income for loans and interest expense on long-term debt | (13 | ) | 6 | (7 | ) | |||||
Net change in unrealized gains on hedges | 17 | (6 | ) | 11 | ||||||
Securities: | ||||||||||
Unrealized holding gains arising during the period on securities available for sale | 145 | (56 | ) | 89 | ||||||
Reclassification adjustment for net gains on securities available for sale included in securities gains, net | (47 | ) | 18 | (29 | ) | |||||
Less: accretion of fair value adjustment on securities available for sale | (31 | ) | 11 | (20 | ) | |||||
Less: accretion of fair value adjustment on held to maturity securities | (1 | ) | 1 | — | ||||||
Less: amortization of net unrealized losses on held to maturity securities | (156 | ) | 61 | (95 | ) | |||||
Net change in unrealized gains on securities | (90 | ) | 35 | (55 | ) | |||||
Foreign currency translation adjustment | 1 | (1 | ) | — | ||||||
Reclassification adjustment for pension and other benefits included in net income: | ||||||||||
Recognized net actuarial loss(1) | 29 | (11 | ) | 18 | ||||||
Net change in pension and other benefits(1) | 29 | (11 | ) | 18 | ||||||
Net change in accumulated other comprehensive loss | $ | (43 | ) | $ | 17 | $ | (26 | ) | ||
- (1)
- These amounts are included in the computation of net periodic pension cost. For further information, see Note 6 to these consolidated financial statements.
81
Note 12—Accumulated Other Comprehensive Loss (Continued)
The following table presents the change in each of the components of accumulated other comprehensive loss and the related tax effect of the change allocated to each component for the nine months ended September 30, 2012 and 2013:
(Dollars in millions) | Before Tax Amount | Tax Effect | Net of Tax | |||||||
---|---|---|---|---|---|---|---|---|---|---|
For the Nine Months Ended September 30, 2012: | ||||||||||
Cash flow hedge activities: | ||||||||||
Unrealized net gains on hedges arising during the period | $ | 77 | $ | (30 | ) | $ | 47 | |||
Less: Reclassification adjustment for net losses on hedges included in net income | (10 | ) | 4 | (6 | ) | |||||
Net change in unrealized losses on hedges | 67 | (26 | ) | 41 | ||||||
Securities: | ||||||||||
Unrealized holding gains arising during the period on securities available for sale | 189 | (74 | ) | 115 | ||||||
Reclassification adjustment for net gains on securities available for sale included in net income | (88 | ) | 35 | (53 | ) | |||||
Reclassification of unrealized loss on held to maturity securities transferred to securities available for sale | 301 | (118 | ) | 183 | ||||||
Less: accretion of fair value adjustment on securities available for sale | (2 | ) | 1 | (1 | ) | |||||
Less: accretion of fair value adjustment on held to maturity securities | (23 | ) | 9 | (14 | ) | |||||
Less: amortization of net unrealized losses on held to maturity securities | 84 | (33 | ) | 51 | ||||||
Net change in unrealized losses on securities | 461 | (180 | ) | 281 | ||||||
Foreign currency translation adjustment | 2 | (1 | ) | 1 | ||||||
Reclassification adjustment for pension and other benefits included in net income: | ||||||||||
Amortization of transition amount | 1 | — | 1 | |||||||
Recognized net actuarial loss(1) | 74 | (29 | ) | 45 | ||||||
Net change in pension and other benefits(1) | 75 | (29 | ) | 46 | ||||||
Net change in accumulated other comprehensive loss | $ | 605 | $ | (236 | ) | $ | 369 | |||
For the Nine Months Ended September 30, 2013: | ||||||||||
Cash flow hedge activities: | ||||||||||
Unrealized net gains on hedges arising during the period | $ | 39 | $ | (15 | ) | $ | 24 | |||
Less: Reclassification adjustment for net losses on hedges included in interest income for loans and interest expense on long-term debt | (27 | ) | 11 | (16 | ) | |||||
Net change in unrealized gains on hedges | 12 | (4 | ) | 8 | ||||||
Securities: | ||||||||||
Unrealized holding gains arising during the period on securities available for sale | (358 | ) | 141 | (217 | ) | |||||
Reclassification adjustment for net gains on securities available for sale included in securities gains, net | (170 | ) | 67 | (103 | ) | |||||
Less: accretion of fair value adjustment on securities available for sale | (69 | ) | 27 | (42 | ) | |||||
Less: accretion of fair value adjustment on held to maturity securities | (12 | ) | 5 | (7 | ) | |||||
Less: amortization of net unrealized losses on held to maturity securities | (131 | ) | 51 | (80 | ) | |||||
Net change in unrealized gains on securities | (740 | ) | 291 | (449 | ) | |||||
Foreign currency translation adjustment | (4 | ) | 1 | (3 | ) | |||||
Reclassification adjustment for pension and other benefits included in net income: | ||||||||||
Recognized net actuarial loss(1) | 87 | (34 | ) | 53 | ||||||
Net change in pension and other benefits(1) | 87 | (34 | ) | 53 | ||||||
Net change in accumulated other comprehensive loss | $ | (645 | ) | $ | 254 | $ | (391 | ) | ||
- (1)
- These amounts are included in the computation of net periodic pension cost. For further information, see Note 6 to these consolidated financial statements.
82
Note 12—Accumulated Other Comprehensive Loss (Continued)
The following tables present the change in accumulated other comprehensive loss balances:
For the Three Months Ended September 30, 2012 and 2013: (Dollars in millions) | Net Unrealized Gains (Losses) on Cash Flow Hedges | Net Unrealized Gains (Losses) on Securities | Foreign Currency Translation Adjustment | Pension and Other Benefits Adjustment | Accumulated Other Comprehensive Loss | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance, June 30, 2012 | $ | 3 | $ | (21 | ) | $ | — | $ | (655 | ) | $ | (673 | ) | |||
Other comprehensive income before reclassifications | 24 | 36 | 1 | — | 61 | |||||||||||
Amounts reclassified from accumulated other comprehensive loss | (3 | ) | 159 | — | 16 | 172 | ||||||||||
Balance, September 30, 2012 | $ | 24 | $ | 174 | $ | 1 | $ | (639 | ) | $ | (440 | ) | ||||
Balance, June 30, 2013 | $ | 21 | $ | (235 | ) | $ | (2 | ) | $ | (663 | ) | $ | (879 | ) | ||
Other comprehensive income before reclassifications | 18 | (26 | ) | — | — | (8 | ) | |||||||||
Amounts reclassified from accumulated other comprehensive loss | (7 | ) | (29 | ) | — | 18 | (18 | ) | ||||||||
Balance, September 30, 2013 | $ | 32 | $ | (290 | ) | $ | (2 | ) | $ | (645 | ) | $ | (905 | ) | ||
For the Nine Months Ended September 30, 2012 and 2013: (Dollars in millions) | Net Unrealized Gains (Losses) on Cash Flow Hedges | Net Unrealized Gains (Losses) on Securities | Foreign Currency Translation Adjustment | Pension and Other Benefits Adjustment | Accumulated Other Comprehensive Loss | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance, December 31, 2011 | $ | (17 | ) | $ | (107 | ) | $ | — | $ | (685 | ) | $ | (809 | ) | ||
Other comprehensive income before reclassifications | 47 | 151 | 1 | — | 199 | |||||||||||
Amounts reclassified from accumulated other comprehensive loss | (6 | ) | 130 | — | 46 | 170 | ||||||||||
Balance, September 30, 2012 | $ | 24 | $ | 174 | $ | 1 | $ | (639 | ) | $ | (440 | ) | ||||
Balance, December 31, 2012 | $ | 24 | $ | 159 | $ | 1 | $ | (698 | ) | $ | (514 | ) | ||||
Other comprehensive income before reclassifications | 24 | (346 | ) | (3 | ) | — | (325 | ) | ||||||||
Amounts reclassified from accumulated other comprehensive loss | (16 | ) | (103 | ) | — | 53 | (66 | ) | ||||||||
Balance, September 30, 2013 | $ | 32 | $ | (290 | ) | $ | (2 | ) | $ | (645 | ) | $ | (905 | ) | ||
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Note 13—Commitments, Contingencies and Guarantees
The following table summarizes the Company's commitments:
(Dollars in millions) | September 30, 2013 | |||
---|---|---|---|---|
Commitments to extend credit | $ | 31,968 | ||
Issued standby and commercial letters of credit | 5,886 | |||
Other commitments | 211 |
Commitments to extend credit are legally binding agreements to lend to a customer provided there are no violations of any condition established in the contract. Commitments have fixed expiration dates or other termination clauses and may require maintenance of compensatory balances. Since many of the commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements.
Standby and commercial letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party, while commercial letters of credit are issued specifically to facilitate foreign or domestic trade transactions. Additionally, the Company enters into risk participations in bankers' acceptances wherein a fee is received to guarantee a portion of the credit risk on an acceptance of another bank. The majority of these types of commitments have terms of one year or less. At September 30, 2013, the carrying amount of the Company's risk participations in bankers' acceptances and standby and commercial letters of credit totaled $3.8 million. Estimated exposure to loss related to these commitments is covered by the allowance for losses on off-balance sheet commitments. The carrying amounts of the standby and commercial letters of credit and the allowance for losses on off-balance sheet commitments are included in other liabilities on the consolidated balance sheet.
The credit risk involved in issuing loan commitments and standby and commercial letters of credit is essentially the same as that involved in extending loans to customers and is represented by the contractual amount of these instruments. Collateral may be obtained based on management's credit assessment of the customer.
Other commitments include commitments to fund principal investments and other securities.
Principal investments include direct investments in private and public companies. The Company issues commitments to provide equity and mezzanine capital financing to private and public companies through direct investments. The timing of future cash requirements to fund such commitments is generally dependent on the investment cycle. This cycle, the period over which privately held companies are funded by private equity investors and ultimately sold, merged, or taken public through an initial offering, can vary based on overall market conditions as well as the nature and type of industry in which the companies operate.
The Company occasionally enters into financial guarantee contracts where a premium is received from another financial institution counterparty to guarantee a portion of the credit risk on interest rate swap contracts entered into between the financial institution and its customer. The Company becomes liable to pay the financial institution only if the financial institution is unable to collect amounts owed to them by their customer. As of September 30, 2013, the current exposure to loss under these contracts totaled $25 million, and the maximum potential exposure to loss in the future was estimated at $47 million.
The Company is subject to various pending and threatened legal actions that arise in the normal course of business. The Company maintains liabilities for losses from legal actions that are recorded when they are determined to be both probable in their occurrence and can be reasonably estimated. Management believes the disposition of all claims currently pending, including potential losses from claims that may exceed the liabilities recorded, and claims for loss contingencies that are considered reasonably possible to occur, will not have a material effect, either individually or in the aggregate, on the Company's consolidated financial condition, results of operations or liquidity.
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The Company has three operating segments: Retail Banking Group, Corporate Banking Group and Pacific Rim Corporate Group. The Pacific Rim Corporate Group is included in "Other." The Company has two reportable business segments: Retail Banking and Corporate Banking.
- •
- Retail Banking offers a range of banking products and services, primarily to individuals and small businesses, delivered generally through a network of branches and ATMs and telephone and internet access 24-hours-a-day. These products offered include mortgages, home equity lines of credit, consumer and commercial loans, and deposit accounts.
- •
- Corporate Banking provides credit, depository and cash management services, investment and risk management products to businesses, individuals and target specialty niches. Services include commercial and project finance loans, real estate financing, asset-based financing, trade finance and letters of credit, lease financing, customized cash management services and capital markets products, as well as trust, private banking, investment and asset management services for individuals and institutions.
"Other" is comprised of certain subsidiaries of UnionBanCal Corporation; the transfer pricing center; the residual costs of support groups; goodwill, intangible assets, and the related amortization/accretion associated with the Company's privatization transaction; the elimination of the fully taxable-equivalent basis amount; and the difference between the marginal tax rate and the consolidated effective tax rate. In addition, "Other" includes the Pacific Rim Corporate Group, which offers a range of credit, deposit, and investment management products and services to companies located primarily in the U.S. that are affiliated with companies headquartered in Japan and other Asian countries, Corporate Treasury, which is responsible for Asset-Liability Management (ALM), wholesale funding, the ALM investment securities and derivatives hedging portfolios, and the FDIC covered assets.
The information, set forth in the tables that follow, is prepared using various management accounting methodologies to measure the performance of the individual segments. Unlike financial accounting, there is no authoritative body of guidance for management accounting equivalent to U.S. GAAP. Consequently, reported results are not necessarily comparable with those presented by other companies, and they are not necessarily indicative of the results that would be reported by our business units if they were unique economic entities. The management reporting accounting methodologies, which are enhanced from time to time, measure segment profitability by assigning balance sheet and income statement items to each operating segment. Methodologies that are applied to the measurement of segment profitability include:
- •
- A funds transfer pricing system, which assigns a cost of funds or a credit for funds to assets or liabilities based on their type, maturity or repricing characteristics.
- •
- An activity-based costing methodology, in which certain indirect costs, such as operations and technology expense, are allocated to the segments based on studies of billable unit costs for product or data processing. Other indirect costs, such as corporate overhead, are allocated to the segments based on internal surveys and metrics that serve as proxies for estimated usage.
- •
- A methodology to allocate the provision for credit losses. Beginning with third quarter 2013, allocated credit losses to the operating segments were revised to base the allocation on the Company's actual provision for credit losses. The allocation of credit losses was previously based on an expected credit loss allocation methodology, in which credit expense was charged to an operating segment based upon expected losses arising from credit risk. Prior period segment results have been revised to reflect this change in methodology.
The Company reflects a "market view" perspective in measuring the business segments. The market view is a measurement of customer markets aggregated to show all revenues generated and expenses incurred from
85
Note 14—Business Segments (Continued)
all products and services sold to those customers regardless of where product areas organizationally report. Therefore, revenues and expenses are included in both the business segment that provides the service and the business segment that manages the customer relationship. The duplicative results from this internal management accounting view are eliminated in "Reconciling Items."
The reportable business segment results for prior periods have been adjusted to reflect changes in the transfer pricing and overhead methodologies that have occurred.
| Retail Banking | Corporate Banking | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | As of and for the Three Months Ended September 30, | |||||||||||
(Dollars in millions) | 2013 | 2012 | 2013 | 2012 | |||||||||
Results of operations—Market View: | |||||||||||||
Net interest income (expense) | $ | 305 | $ | 269 | $ | 378 | $ | 341 | |||||
Noninterest income (expense) | 71 | 56 | 147 | 155 | |||||||||
Total revenue | 376 | 325 | 525 | 496 | |||||||||
Noninterest expense (income) | 294 | 260 | 261 | 257 | |||||||||
(Reversal of) provision for loan losses | (16 | ) | 35 | 5 | 18 | ||||||||
Income (loss) before income taxes and including noncontrolling interests | 98 | 30 | 259 | 221 | |||||||||
Income tax expense (benefit) | 38 | 12 | 72 | 58 | |||||||||
Net income (loss) including noncontrolling interest | 60 | 18 | 187 | 163 | |||||||||
Deduct: Net loss from noncontrolling interests | — | — | — | — | |||||||||
Net income (loss) attributable to UNBC | $ | 60 | $ | 18 | $ | 187 | $ | 163 | |||||
Total assets, end of period—Market View: | $ | 31,776 | $ | 26,906 | $ | 46,115 | $ | 37,876 | |||||
| Other | Reconciling Items | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | As of and for the Three Months Ended September 30, | |||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||
Results of operations—Market View: | |||||||||||||
Net interest income (expense) | $ | 21 | $ | 56 | $ | (19 | ) | $ | (20 | ) | |||
Noninterest income (expense) | 33 | 4 | (17 | ) | (18 | ) | |||||||
Total revenue | 54 | 60 | (36 | ) | (38 | ) | |||||||
Noninterest expense (income) | 150 | 139 | (16 | ) | (18 | ) | |||||||
(Reversal of) provision for loan losses | (7 | ) | (3 | ) | 2 | (5 | ) | ||||||
Income (loss) before income taxes and including noncontrolling interests | (89 | ) | (76 | ) | (22 | ) | (15 | ) | |||||
Income tax expense (benefit) | (46 | ) | (21 | ) | (9 | ) | (7 | ) | |||||
Net income (loss) including noncontrolling interest | (43 | ) | (55 | ) | (13 | ) | (8 | ) | |||||
Deduct: Net loss from noncontrolling interests | 7 | 6 | — | — | |||||||||
Net income (loss) attributable to UNBC | $ | (36 | ) | $ | (49 | ) | $ | (13 | ) | $ | (8 | ) | |
Total assets, end of period—Market View: | $ | 29,848 | $ | 25,636 | $ | (2,255 | ) | $ | (2,233 | ) | |||
86
Note 14—Business Segments (Continued)
| UnionBanCal Corporation | | | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Three Months Ended September 30, | | | ||||||||||
| 2013 | 2012 | | | |||||||||
Results of operations—Market View: | |||||||||||||
Net interest income (expense) | $ | 685 | $ | 646 | |||||||||
Noninterest income (expense) | 234 | 197 | |||||||||||
Total revenue | 919 | 843 | |||||||||||
Noninterest expense (income) | 689 | 638 | |||||||||||
(Reversal of) provision for loan losses | (16 | ) | 45 | ||||||||||
Income (loss) before income taxes and including noncontrolling interests | 246 | 160 | |||||||||||
Income tax expense (benefit) | 55 | 42 | |||||||||||
Net income (loss) including noncontrolling interest | 191 | 118 | |||||||||||
Deduct: Net loss from noncontrolling interests | 7 | 6 | |||||||||||
Net income (loss) attributable to UNBC | $ | 198 | $ | 124 | |||||||||
Total assets, end of period—Market View: | $ | 105,484 | $ | 88,185 | |||||||||
| Retail Banking | Corporate Banking | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | As of and for the Nine Months Ended September 30, | |||||||||||
(Dollars in millions) | 2013 | 2012 | 2013 | 2012 | |||||||||
Results of operations—Market View: | |||||||||||||
Net interest income (expense) | $ | 917 | $ | 809 | $ | 1,106 | $ | 1,000 | |||||
Noninterest income (expense) | 191 | 170 | 461 | 444 | |||||||||
Total revenue | 1,108 | 979 | 1,567 | 1,444 | |||||||||
Noninterest expense (income) | 896 | 788 | 810 | 740 | |||||||||
(Reversal of) provision for loan losses | (28 | ) | 47 | 35 | 19 | ||||||||
Income (loss) before income taxes and including noncontrolling interests | 240 | 144 | 722 | 685 | |||||||||
Income tax expense (benefit) | 94 | 57 | 193 | 191 | |||||||||
Net income (loss) including noncontrolling interest | 146 | 87 | 529 | 494 | |||||||||
Deduct: Net loss from noncontrolling interests | — | — | — | — | |||||||||
Net income (loss) attributable to UNBC | $ | 146 | $ | 87 | $ | 529 | $ | 494 | |||||
Total assets, end of period—Market View: | $ | 31,776 | $ | 26,906 | $ | 46,115 | $ | 37,876 | |||||
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Note 14—Business Segments (Continued)
| Other | Reconciling Items | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | As of and for the Nine Months Ended September 30, | |||||||||||
| 2013 | 2012 | 2013 | 2012 | |||||||||
Results of operations—Market View: | |||||||||||||
Net interest income (expense) | $ | 45 | $ | 192 | $ | (58 | ) | $ | (59 | ) | |||
Noninterest income (expense) | 83 | 21 | (49 | ) | (46 | ) | |||||||
Total revenue | 128 | 213 | (107 | ) | (105 | ) | |||||||
Noninterest expense (income) | 439 | 365 | (41 | ) | (42 | ) | |||||||
(Reversal of) provision for loan losses | (29 | ) | (29 | ) | — | (7 | ) | ||||||
Income (loss) before income taxes and including noncontrolling interests | (282 | ) | (123 | ) | (66 | ) | (56 | ) | |||||
Income tax expense (benefit) | (121 | ) | (65 | ) | (26 | ) | (23 | ) | |||||
Net income (loss) including noncontrolling interest | (161 | ) | (58 | ) | (40 | ) | (33 | ) | |||||
Deduct: Net loss from noncontrolling interests | 14 | 16 | — | (1 | ) | ||||||||
Net income (loss) attributable to UNBC | $ | (147 | ) | $ | (42 | ) | $ | (40 | ) | $ | (34 | ) | |
Total assets, end of period—Market View: | $ | 29,848 | $ | 25,636 | $ | (2,255 | ) | $ | (2,233 | ) | |||
| UnionBanCal Corporation | | | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As of and for the Nine Months Ended September 30, | | | ||||||||||
| 2013 | 2012 | | | |||||||||
Results of operations—Market View: | |||||||||||||
Net interest income (expense) | $ | 2,010 | $ | 1,942 | |||||||||
Noninterest income (expense) | 686 | 589 | |||||||||||
Total revenue | 2,696 | 2,531 | |||||||||||
Noninterest expense (income) | 2,104 | 1,851 | |||||||||||
(Reversal of) provision for loan losses | (22 | ) | 30 | ||||||||||
Income (loss) before income taxes and including noncontrolling interests | 614 | 650 | |||||||||||
Income tax expense (benefit) | 140 | 160 | |||||||||||
Net income (loss) including noncontrolling interest | 474 | 490 | |||||||||||
Deduct: Net loss from noncontrolling interests | 14 | 15 | |||||||||||
Net income (loss) attributable to UNBC | $ | 488 | $ | 505 | |||||||||
Total assets, end of period—Market View: | $ | 105,484 | $ | 88,185 | |||||||||
88
We are subject to various pending and threatened legal actions that arise in the normal course of business. We maintain liabilities for losses from legal actions that are recorded when they are determined to be both probable in their occurrence and can be reasonably estimated. We believe the disposition of all claims currently pending, including potential losses from claims that may exceed the liabilities recorded, and claims for loss contingencies that are considered reasonably possible to occur, will not have a material effect, either individually or in the aggregate, on our consolidated financial position, results of operations, or liquidity.
For a discussion of risk factors relating to our business, please refer to Item 1A of Part I of our 2012 Form 10-K, which is incorporated by reference herein, in addition to the following information.
Industry Factors
Starting in 2008, U.S. and global economies experienced a serious recession, unprecedented volatility in the financial markets, and significant deterioration in sectors of the U.S. and global consumer and business economies and a slow economic recovery, all of which have presented challenges for the banking and financial services industry and for UnionBanCal Corporation; the U.S. Government responded to these circumstances in the U.S. with a variety of measures; there can be no assurance that these measures ultimately will successfully address these circumstances; the U.S. Government continues to face significant fiscal and budgetary challenges which, if not resolved, may further exacerbate U.S. economic conditions.
Since 2008, adverse financial and economic developments have impacted the U.S. and global economies and financial markets and have presented challenges for the banking and financial services industry and for UnionBanCal Corporation. These developments included a general recession both globally and in the U.S. followed by a slow economic recovery and have contributed to substantial volatility in the financial markets.
In response, various significant economic and monetary stimulus measures were enacted by the U.S. Congress and the Federal Reserve Board has pursued a highly accommodative monetary policy aimed at keeping interest rates at historically low levels. Refer to "Supervision and Regulation" in Item 1 of our 2012 Form 10-K for discussion of certain of these measures.
It cannot be predicted whether U.S. Governmental actions will result in lasting improvement in financial and economic conditions affecting the U.S. banking industry and the U.S. economy. It also cannot be predicted whether and to what extent the efforts of the U.S. Government to combat the mixed economic conditions will continue. If, notwithstanding the government's fiscal and monetary measures, the U.S. economy were to deteriorate, or its recovery were too slow, this would present significant challenges for the U.S. banking and financial services industry and for our Company. In addition, as a wholly-owned subsidiary of a foreign bank, we have not been eligible to participate in some federal programs such as the U.S. Treasury's Capital Purchase Program and may not qualify for participation in future federal programs.
Since 2010, certain European sovereign borrowers have encountered difficulties in financing renewals of their indebtedness and continue to face serious economic and financial challenges. If this trend continues or worsens, including spreading to other countries in the Eurozone, it could have adverse impacts on costs in the global debt markets that could increase funding costs for banks generally and could generate further adverse financial and economic conditions for global and U.S. markets. Continued concerns regarding significant economic weaknesses in the European Union and, in particular, Cyprus, Greece, Italy, Ireland, Portugal and Spain continue to adversely affect confidence in the European financial markets and the ability of the Euro to continue as a currency. During 2011 and continuing into 2013, leaders of the major countries in the European Union have been pursuing a variety of measures to address the Eurozone debt crisis including support plans for Cyprus, Greece, Ireland, Portugal and Spain. There can be no assurance that measures that have been or may
89
be taken to address the Eurozone debt crisis will resolve the challenging economic and financial situation of these countries or prevent the spread of such difficulties or their having an adverse impact on the global and U.S. economies, with possible consequent adverse effects on the U.S. banking industry and our customers, business and prospects.
The challenges to the level of economic activity in the U.S., and therefore to the banking industry, have also been exacerbated by the extensive political disagreements regarding the statutory debt limit on U.S. federal government obligations and measures to address the substantial federal deficits. Following enactment of federal legislation in August 2011 which averted a default by the U.S. federal government on its sovereign obligations by raising the statutory debt limit and which established a process whereby cuts in federal spending may be accomplished, Standard & Poor's Ratings Services (Standard & Poor's) lowered its long-term sovereign credit rating on the U.S. to "AA+" from "AAA" while affirming its highest rating on short-term U.S. obligations. Standard & Poor's also stated at the time that its outlook on the long-term rating remained negative; however, in June 2013, Standard & Poor's revised its outlook on the U.S. credit rating to stable from negative. At the present time both Fitch Ratings and Moody's have reaffirmed the U.S.'s "AAA" credit rating; however, Fitch Ratings has stated that its outlook on the U.S. is negative, while in July 2013, Moody's revised its outlook on the U.S. credit rating to stable from negative. In October 2013, following continued disagreements between the Obama Administration and Congressional Republicans over government spending levels and the federal debt ceiling, which led to a temporary shutdown of portions of the federal government, Dagong, one of the top four Chinese rating agencies, downgraded its credit rating for the U.S. from "A" to "A-". Although it is not possible to predict the long-term impact of these developments on the U.S. economy in general and the banking industry in particular, the downgrade by Standard & Poor's and any further downgrades by it or other rating agencies could increase over time the U.S. federal government's cost of borrowing which may worsen its fiscal challenges, as well as generating upward pressure on interest rates generally in the U.S. which could, in turn, have adverse consequences for borrowers and the level of business activity.
In January 2013, the American Taxpayer Relief Act of 2012 was signed into law. The Act raised federal personal income and other tax rates and temporarily averted the effect of the 2011 federal legislation which would have mandated federal spending cuts of $1.2 trillion over nine years and more substantial increases in federal personal income and other tax rates, commonly referred to as the "fiscal cliff" due to its anticipated recessionary effects. It is presently expected that there will be continuing negotiations between the Administration and Congressional Republicans over the mandated federal spending cuts and federal spending levels in general, including entitlements and defense, as well as tax policy and the levels of the federal budget deficits and the debt ceiling. The outcome and impact of these developments cannot be predicted with any certainty, but could have further adverse consequences for the credit ratings of U.S. debt and also present additional challenges for the U.S. economy and for the U.S. banking industry in general and for our business prospects as well, including challenges for our credit customers who receive funding from the U.S. government, a material adverse effect on the market value of U.S. government securities we hold, the availability of such securities as collateral for borrowing, and our and other banks' ability to access the capital markets on favorable terms.
The effects of changes or increases in, or supervisory enforcement of, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us
We are subject to significant federal and state banking regulation and supervision, which is primarily for the benefit and protection of our customers and the Federal Deposit Insurance Fund and not for the benefit of investors in our securities. In the past, our business has been materially affected by these regulations. This will continue and likely intensify in the future. Laws, regulations or policies, including accounting standards and interpretations, currently affecting us and our subsidiaries may change at any time. Regulatory authorities may also change their interpretation of and intensify their examination of compliance with these statutes and regulations. Therefore, our business may be adversely affected by changes in laws, regulations, policies or
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interpretations or regulatory approaches to compliance and enforcement, as well as by supervisory action or criminal proceedings taken as a result of noncompliance, which could result in the imposition of significant civil money penalties or fines. Changes in laws and regulations may also increase our expenses by imposing additional supervision, fees, taxes or restrictions on our operations. Compliance with laws and regulations, especially new laws and regulations, increases our operating expenses and may divert management attention from our business operations.
On July 21, 2010, President Obama signed into law the Dodd-Frank Act. This important legislation has affected U.S. financial institutions, including UnionBanCal Corporation and Union Bank, in many ways, some of which have increased, or may increase in the future, the cost of doing business and present other challenges to the financial services industry. Due to our size of over $50 billion in assets, we are regarded as "systemically significant" to the financial health of the U.S. economy and, as a result, are subject to additional regulations as discussed further below. Many of the law's provisions are still in the process of being implemented by rules and regulations of the federal banking agencies, the scope and impact of which cannot yet be fully determined. The law contains many provisions that may have particular relevance to the business of UnionBanCal Corporation and Union Bank. The Dodd-Frank Act authorized the creation of the Consumer Financial Protection Bureau (CFPB), which has direct supervision and examination authority over banks with more than $10 billion in assets, including Union Bank. While the full effect of these provisions of the Dodd-Frank Act on Union Bank cannot be predicted at this time, they have resulted in adjustments to our FDIC deposit insurance premiums, and may result in increased capital and liquidity requirements, increased supervision, increased regulatory and compliance risks and costs and other operational costs and expenses, reduced fee-based revenues and restrictions on some aspects of our operations, and increased interest expense on our demand deposits, some or all of which may be material.
In July 2013, a Federal district court held that the Federal Reserve Board's regulation under the Dodd-Frank Act allowing banks to receive an interchange fee on debit card transactions of up to the sum of $0.21 per transaction and five basis points multiplied by the value of the transaction was not valid under the Act's standard that the fee be "reasonable and proportional" to the cost of processing the debit card transaction; the court held that the Federal Reserve Board's regulation improperly included certain categories of costs in applying the statutory standard. It also held that the regulation improperly failed to give merchants the ability to choose from among multiple networks to process debit card transactions. The Federal Reserve Board has appealed this decision, and the court has stayed its ruling until there has been a ruling on the appeal. This decision, upon its effectiveness, which would be after the resolution of the appeal, could further reduce the fee revenues that banks, including Union Bank, receive from the business of processing debit card transactions.
The Dodd-Frank Act will have a significant impact on our Global Capital Markets activities due to enhanced oversight of derivatives and swap activities by multiple regulatory agencies (the U.S. Commodities Futures Trading Commission, the SEC and bank regulators) and the potential need to "push out" of Union Bank certain non-conforming swap activity to a nonbank affiliate. The Dodd-Frank Act's Volcker Rule will require reporting of quantitative measures and the establishment of a compliance regime covering capital markets and principal risk-taking activities. The Federal Reserve Board has confirmed that financial institutions will have until at least July 21, 2014 to conform to the restrictions on proprietary trading activities and on hedge fund and private equity fund activities and investments set forth in the Volcker Rule. See "Supervision and Regulation" in Item 1 of our 2012 Form 10-K for additional information.
Proposals to reform the housing finance market in the U.S. could also significantly affect our business. These proposals, among other things, consider winding down the government sponsored entities Fannie Mae and Freddie Mac (GSEs) and reducing or eliminating over time the role of the GSEs in guaranteeing mortgages and providing funding for mortgage loans, as well as the implementation of reforms relating to borrowers, lenders, and investors in the mortgage market, including reducing the maximum size of a loan that the GSEs can guarantee, phasing in a minimum down payment requirement for borrowers, improving underwriting standards, and increasing accountability and transparency in the securitization process. While the specific
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nature of these reforms and their impact on the financial services industry in general, and on Union Bank in particular, is uncertain at this time, such reforms, if enacted, are likely to have a substantial impact on the mortgage market and could potentially reduce our income from mortgage originations by increasing mortgage costs or lowering originations. The GSE reforms could also reduce real estate prices, which could reduce the value of collateral securing outstanding mortgage loans. This reduction of collateral value could negatively impact the value or perceived collectability of these mortgage loans and may increase our allowance for loan losses. Such reforms may also include changes to the Federal Home Loan Bank System, which could adversely affect a significant source of term funding for lending activities by the banking industry, including Union Bank. These reforms may also result in higher interest rates on residential mortgage loans, thereby reducing demand, which could have an adverse impact on our residential mortgage lending business.
President Obama's proposed 2014 U.S. budget includes a "Financial Crisis Responsibility Fee" that would apply to banks with greater than $50 billion in assets. This fee would be effective January 1, 2015 and would be intended to recover taxpayer funds provided to U.S. financial institutions through the U.S. Treasury's Troubled Asset Relief Program (TARP). On May 21, 2012, the U.S. Treasury announced its final rule to establish an assessment fee on institutions with greater than $50 billion in assets to fund the Office of Financial Research. Although we did not receive, and were not eligible to receive, direct TARP investment from the U.S. Treasury, as we have greater than $50 billion in assets, under the final rule we are subject to this fee. In August 2013, the Federal Reserve issued a final rule to implement Section 318 of the Dodd-Frank Act which imposed a new supervisory assessment on institutions with greater than $50 billion in assets, which is being assessed at the MUFG level, and is based on an average of the total combined assets of MUFG from U.S. operations, net of U.S. intercompany balances and allowed transactions. Therefore, our operating costs over time can be expected to increase due to these assessments, which are based, among other things, on the projected operating expenses of this new office and the aggregate assessable assets of the subject banks.
Several cities in the United States (including, Los Angeles and San Diego) have adopted so-called "responsible banking acts", and other cities are considering the adoption of similar ordinances. These city ordinances generally require banks that hold city government deposits to provide detailed accounts of their lending practices in low-income communities, as well as their participation in foreclosure prevention and home loan principal reduction programs. Performance under these ordinances is used as a basis for awarding the city's financial services contracts. The adoption of these ordinances by municipalities for which Union Bank is a provider of cash management or other banking services could result in increased regulatory and compliance costs and other operational costs and expenses, making this business less desirable to the Bank and potentially resulting in reduced opportunities for the Bank to provide these services.
International laws, regulations and policies affecting us, our subsidiaries and the business we conduct may change at any time and affect our business opportunities and competitiveness in these jurisdictions. Due to our ownership by BTMU, laws, regulations, policies, fines and other supervisory actions adopted or enforced by the Government of Japan and the Federal Reserve Board may adversely affect our activities and investments and those of our subsidiaries in the future.
In July 2013, the Federal Reserve Board and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the Basel Committee's current international regulatory capital accord (Basel III). These rules, upon their effectiveness, will replace the federal banking agencies' general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules in accordance with certain transition provisions. Under the rules as adopted, banking organizations will be required to determine their regulatory capital requirements under either the advanced approaches or the standardized approach. Banking organizations may elect to use the advanced approaches (with regulatory approval), and certain banking organizations will be required to use the advanced approaches (e.g., those with total assets of $250 billion or more). For banking organizations whose regulatory capital requirements are determined under the advanced approaches, which we expect will include the Company, the effective date and the beginning of the transitional adjustments will be January 1, 2014, and for other banking organizations, January 1, 2015. The final rules
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establish more restrictive capital definitions, create additional categories and higher risk weightings for certain asset classes and off-balance sheet exposures, higher minimum capital and leverage ratios and capital conservation buffers that will be added to the minimum capital requirements and must be met for banking organizations to avoid being subject to certain limitations on dividends and discretionary bonus payments to executive officers. The final rules will provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of 4.5 percent; (b) a Tier 1 capital ratio of 6 percent; (c) a total capital ratio of 8 percent; and (d) a Tier 1 leverage ratio to average consolidated assets of 4 percent. The advanced approaches banking organizations will also be subject to a new and separate supplementary leverage ratio under which they will be required to maintain capital against not only on-balance sheet assets but also certain off-balance sheet assets and exposures, including derivative exposures. Banking organizations that are subject to the advanced approaches must include most elements of their accumulated other comprehensive income (AOCI) in determining their regulatory capital; banking organizations using the standardized approach may make a one-time permanent opt-out election to exclude most AOCI elements from regulatory capital. Advanced approaches banking organizations must also determine their capital ratios with reference to the lower of the standardized or advanced approaches.
In addition, on December 20, 2011, the Federal Reserve Board announced a proposed rule to implement the enhanced prudential standards required by the Dodd-Frank Act for larger bank holding companies. The proposed enhanced prudential standards, which will apply to us, include increased capital, liquidity and leverage standards as well as enhanced risk management and governance.
In December 2012, the Federal Reserve Board proposed enhanced prudential standards and early remediation rules for Foreign Banking Organizations (FBOs), operating in the U.S. such as our Company. This proposal could result in increased capital, liquidity and other financial and compliance costs for our Company and the other U.S. operations of MUFG and BTMU. Included is a proposed intermediate holding company (IHC) concept which would require that MUFG's and BTMU's and Mitsubishi UFJ Trust and Banking Corp.'s U.S. operations and businesses, including our Company, be held under a single IHC located in the U.S. (excluding, however, BTMU's U.S. branches which could be maintained separately). MUFG and BTMU are analyzing the potential impact of the FBO proposed rules on their U.S. operations (including UnionBanCal) and will make appropriate structural, operational and financial changes to comply with the FBO rules. Until the FBO rules are finalized, the significance of their impact on UnionBanCal, and MUFG's and BTMU's operations in the U.S. generally, cannot be determined.
On October 24, 2013, the OCC, the Fed, and the FDIC jointly issued a proposed rule that would implement a standardized quantitative liquidity requirement generally consistent with the liquidity coverage ratio (LCR) standards established by the Basel Committee on Banking Supervision. The LCR would generally apply to banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure. The proposal also would apply a modified LCR to bank holding companies with total assets between $50 billion and $250 billion. Under the modified LCR, which is expected to apply to the Company, an institution would be required to hold minimum amounts of high-quality, liquid assets, such as central bank reserves and government and corporate debt that can be readily converted into cash in an amount equal to or greater than its projected net cash outflows during a short-term stress period. The proposed LCR (or the ratio of the institution's liquid assets to its projected net cash outflow) is more stringent than the Basel Committee's LCR standard in several respects, and the proposed transition period, which would begin on January 1, 2015 and require institutions to be fully compliant by January 1, 2017, is shorter than that included in the Basel agreement.
The newly-adopted capital rules of the Federal banking agencies, as described above, as well as the various proposed regulations described above, if adopted, may restrict our ability to grow during favorable market conditions, require us to raise additional capital and sources of liquidity, generally increase our cost of doing business, lead us to stop or reduce our offerings of various credit products and curtail our flexibility in the operation of our investment portfolio.
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We maintain systems and procedures designed to comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of criminal or civil penalties (which can be substantial) for noncompliance. In some cases, liability may attach even if the noncompliance was inadvertent or unintentional and even if compliance systems and procedures were in place at the time. There may be other negative consequences from a finding of noncompliance, including restrictions on certain activities and damage to our reputation.
Additionally, our business is affected significantly by the fiscal and monetary policies of the U.S. federal government and its agencies. We are particularly affected by the policies of the Federal Reserve Board, which regulates the supply of money and credit in the U.S. Under the Dodd-Frank Act and a long-standing policy of the Federal Reserve Board, a bank holding company is expected to act as a source of financial and managerial strength for its subsidiary banks. As a result of that policy, we may be required to commit financial and other resources to our subsidiary bank in circumstances where we might not otherwise do so. Among the instruments of monetary policy available to the Federal Reserve Board are (a) conducting open market operations in U.S. Government securities, (b) changing the discount rates on borrowings by depository institutions and the federal funds rate, and (c) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the Federal Reserve Board can be expected to have a material effect on our business, prospects, results of operations and financial condition.
Refer to "Supervision and Regulation" in Item 1 of our 2012 Form 10-K for discussion of certain existing and proposed laws and regulations that may affect our business.
The increasing regulation of the financial services industry has required and can be expected to continue to require significant investments in technology, personnel or other resources. Our competitors may be subject to different or reduced degrees of regulation due to their asset size or types of products offered and may also be able to more efficiently utilize resources to comply with regulations and to more efficiently absorb increased regulatory compliance costs into their existing cost structure.
Legislative or regulatory actions responding to perceived financial and market problems could impair our rights against borrowers, decrease our revenue from other customers and make it more difficult to originate loans to individual borrowers
Under current bankruptcy laws, courts cannot force a modification of mortgage and home equity loans secured by primary residences. In response to the financial crisis, in 2009, legislation was proposed to allow mortgage loan "cram-downs," which would empower courts to modify the terms of mortgage and home equity loans including the ability to reduce the principal amounts to reflect lower underlying property values. Although this legislation has not moved forward at this time, legislation of this type could result in our writing down the value of our residential mortgage and home equity loans to reflect their lower loan values. There is also risk that home equity loans in a second lien position (i.e., behind a mortgage) could experience significantly higher losses to the extent they become unsecured as a result of a cram-down. The availability of principal reductions or other mortgage loan modifications could make bankruptcy a more attractive option for troubled borrowers, leading to increased bankruptcy filings and accelerated defaults.
Changes in federal rules have imposed new restrictions on banks' abilities to charge overdraft services and interchange fees on debit card transactions. Under the final rule, effective October 1, 2011, the maximum permissible interchange fee that a bank may receive is the sum of $0.21 per transaction and five basis points multiplied by the value of the transaction, with an additional upward adjustment of no more than $0.01 per transaction if a bank develops and implements policies and procedures reasonably designed to achieve fraud-prevention standards set by regulation. In July 2013, a Federal district court held that this rule was not valid under the Act's standard that the fee be "reasonable and proportional" to the cost of processing the debit card transactions and improperly included certain categories of costs in applying the statutory standard. The
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Federal Reserve Board appealed the decision, and the ruling has been stayed. This decision, upon its effectiveness, which would be after resolution of the appeal, could further reduce the fee revenues that banks, including Union Bank, can receive from the business of debit card transactions. These restrictions are resulting in decreased revenues and increased compliance costs for the banking industry and Union Bank, and there can be no assurance that alternative sources of revenues can be implemented to offset the impact of these developments. See "Supervision and Regulation—Overdraft and Interchange Fees; Interest on Demand Deposits" in Item 1 of our 2012 Form 10-K for additional information.
In April 2011, new federal rules went into effect regulating residential mortgage broker compensation. Generally, such compensation must now be based solely on the loan amount and not on any loan terms. In addition, mortgage brokers must offer the borrower the lowest possible interest rate and fees for which they qualify and may not collect fees from both the bank and the borrower. Although these amendments do not apply to banks directly, they regulate the compensation that banks may pay to mortgage brokers and the types of transactions they may refer to banks. In addition, in April 2011, the Federal Reserve Board proposed further rules to prohibit banks from making a residential mortgage loan without regard to a borrower's repayment ability. The Dodd-Frank Act transferred general rule-making authority in this subject matter area to the new CFPB which re-opened the comment period on this proposed rule to July 2012. In January 2013, the CFPB issued an Ability-to-Repay rule that all newly originated residential mortgages must meet, effective January 2014. In May 2013, the CFPB amended the rule to, among other things, create specific exemptions and modifications for small creditors, community development lenders, and housing stabilization programs. The Ability-to-Repay rule, as amended, establishes guidelines that the lender must follow when reviewing a borrower's credit and prohibits some mortgage features. Lenders will be presumed to have met the Ability-to-Repay rule by issuing Qualified Mortgages, a more stringent standard. The majority of the residential mortgages that Union Bank currently originates do not meet the Qualified Mortgage criteria but are believed to satisfy the Ability-to-Repay rule. The Ability-to-Repay rule could have an adverse impact on our residential mortgage lending business as the primary and secondary markets adapt. In addition, the CFPB is considering a number of amendments to the Ability-to-Repay rule which could also have an adverse impact on our residential mortgage lending business.
Fluctuations in interest rates on deposits or other funding sources could adversely affect our margin spread
Changes in market interest rates on deposits or other funding sources, including changes in the relationship between short-term and long-term market interest rates or between different interest rate indices, can impact, and has in past years impacted, our net interest margin (that is, the difference between the interest rates we charge on interest earning assets, such as loans, and the interest rates we pay on interest-bearing liabilities, such as deposits or other borrowings). This impact could result in a decrease in our interest income relative to interest expense. Increases in interest rates may also adversely impact the value of our investment securities portfolio and impact loan performance by making it more difficult for borrowers with adjustable rate loans to service their debts. For the past several years, the banking industry has operated in an extremely low interest rate environment relative to historical averages, and the Federal Reserve Board has pursued highly accommodative monetary policies (including a very low federal funds rate and substantial purchases of long-term U.S. Treasury and agency securities) in an effort to facilitate growth in the U.S. economy and a reduction in levels of unemployment. This environment has placed downward pressure on the net interest margins of U.S. banks, including Union Bank. We cannot predict with any certainty whether or to what extent these Federal Reserve policies will continue although various indications from the Federal Reserve Board suggest that aspects of its accommodative monetary policy may begin to taper down later in 2013 or into 2014.
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Company Factors
The Bank of Tokyo-Mitsubishi UFJ's and Mitsubishi UFJ Financial Group's credit ratings and financial or regulatory condition could adversely affect our operations
Adverse changes to our credit ratings, reputation or creditworthiness could have a negative effect on our operations. We fund our operations in substantial part independently of BTMU and MUFG and believe our business is not necessarily closely related to the business or outlook of BTMU or MUFG. However, if BTMU and MUFG's credit ratings or financial condition or prospects were to decline, this could adversely affect our credit rating or harm our reputation or perceived creditworthiness.
At this time, we cannot predict actions, if any, which the rating agencies may take regarding the Government of Japan, MUFG or BTMU, nor the ultimate effect of these developments on our credit rating.
BTMU and MUFG are also subject to regulatory oversight, review and supervisory action (which can include fines or penalties) by Japanese and U.S. regulatory authorities. Our business operations and expansion plans could be negatively affected by regulatory concerns or supervisory action in the U.S. and in Japan against BTMU or MUFG. In June 2013, BTMU entered into a consent agreement with the New York State Department of Financial Services under which it made a civil monetary payment of $250 million to resolve issues relating to certain U.S. dollar payments that were routed through New York from 2002 to 2007.
BTMU has received requests and subpoenas for information from government agencies in some jurisdictions, including the United States, Europe and Asia, which are conducting investigations into past submissions made by panel members, including BTMU, to the bodies that set various interbank offered rates. BTMU is cooperating with these investigations and has been conducting an internal investigation. Union Bank is not a member of any of these panels. In addition, BTMU and other panel members have been named as defendants in a number of civil lawsuits, including putative class actions, in the United States relating to similar matters. It is currently not possible for us to predict the scope and ultimate outcome of these investigations or lawsuits, including any possible effect on us as an affiliate of MUFG.
Significant legal or regulatory proceedings could subject us to substantial uninsured liabilities
We are from time to time subject to claims and proceedings related to our present or previous operations including claims by customers and our employees and our contractual counterparties. These claims, which could include supervisory or enforcement actions by bank regulatory authorities, or criminal proceedings by prosecutorial authorities, could involve demands for large monetary amounts, including civil money penalties or fines imposed by government authorities, and significant defense costs. To mitigate the cost of some of these claims, we maintain insurance coverage in amounts and with deductibles that we believe are appropriate for our operations. However, our insurance coverage does not cover any civil money penalties or fines imposed by government authorities and may not cover all other claims that have been or might be brought against us or continue to be available to us at a reasonable cost. As a result, we may be exposed to substantial uninsured liabilities, which could adversely affect our business, prospects, results of operations and financial condition. The federal bank regulators have announced regulatory enforcement actions against a number of large bank holding companies and banks arising from deficiencies in processes, procedures and controls involving anti-money laundering measures and compliance with the economic sanctions that affect transactions with designated foreign countries, nationals and others as provided for in the regulations of the Office of Foreign Assets Control of the U.S. Treasury Department. These actions evidence an intensification of the U.S. government's expectations for compliance with these regulatory regimes on the part of banks operating in the U.S., including Union Bank, and may result in increased compliance costs and increased risks of regulatory sanctions.
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We are subject to operational risks, including cybersecurity risks
We are subject to many types of operational risks throughout our organization. Operational risk is the potential loss from our operations due to factors, such as failures in internal control, systems failures, cybersecurity risks or external events, that do not fall into the market risk or credit risk categories described in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Business Segments." Operational risk includes execution risk related to operational initiatives, including implementation of our technology enhancement projects, increased reliance on internally developed models for risk and finance management, reputational risk, legal and compliance risk, the risk of fraud or theft by employees, customers or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems, and operational risks related to use of third party service providers. A discussion of risks associated with regulatory compliance appears above under the caption"The effects of changes or increases in, or supervisory enforcement of, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us."
Our operations rely on the secure processing, storage, transmission and reporting of personal, confidential and other sensitive information or data in our computer systems, networks and business applications. Although we take protective measures, our computer systems may be vulnerable to breaches, unauthorized access, misuse, computer viruses or other malicious code, and other events that could have significant negative consequences to us. Such events could result in interruptions or malfunctions in our or our customers' operations, interception, misuse or mishandling of personal, confidential or proprietary information and data, or processing of unauthorized transactions or loss of funds. These events could result in litigation and financial losses that are either not insured against or not fully covered by our insurance, regulatory consequences or reputational harm, any of which could harm our competitive position, operating results and financial condition. These types of incidents can remain undetected for extended periods of time, thereby increasing the associated risks. We may also be required to expend significant resources to modify our protective measures or to investigate and remediate vulnerabilities or exposures arising from cybersecurity risks.
We depend on the continued efficacy of our technical systems, operational infrastructure, relationships with third parties and our employees in our day-to-day and ongoing operations. Our dependence upon automated systems to record and process transactions may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect or data which is not reliable. With regard to the physical infrastructure that supports our operations, we have taken measures to implement backup systems and other safeguards, but our ability to conduct business may be adversely affected by any disruption to that infrastructure. Failures in our internal control or operational systems, security breaches or service interruptions could impair our ability to operate our business and result in potential liability to customers, reputational damage and regulatory intervention, any of which could harm our operating results and financial condition.
Union Bank and reportedly other financial institutions have been the target of various denial-of-service or other cyber attacks as part of what appears to be a coordinated effort to disrupt the operations of financial institutions and potentially test their cybersecurity in advance of future and more advanced cyber attacks. These denial-of-service attacks have not breached the Company's data security systems, but require substantial resources to defend, and may affect customer satisfaction and behavior. To date we have not experienced any material losses relating to cyber attacks or other information security breaches, but there can be no assurance that we will not suffer such losses or information security breaches in the future. While we have a variety of cybersecurity measures in place, the consequences to our business of such attacks cannot be predicted with any certainty.
In addition, there have been increasing efforts on the part of third parties to breach data security at financial institutions or with respect to financial transactions, including through the use of social engineering schemes such as "phishing." The ability of our customers to bank remotely, including online and through mobile devices, requires secure transmissions of confidential information and increases the risk of data
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security breaches which would expose us to financial claims by customers or others and which could adversely affect our reputation. Even if cyber attacks and similar tactics are not directed specifically at Union Bank, such attacks on other large financial institutions could disrupt the overall functioning of the financial system and undermine consumer confidence in banks generally, to the detriment of other financial institutions, including Union Bank.
We may also be subject to disruptions of our operating systems arising from other events that are wholly or partially beyond our control, such as electrical, internet or telecommunications outages or unexpected difficulties with the implementation of our technology enhancement projects, which may give rise to disruption of service to customers and to financial loss or liability. Our business recovery plan may not work as intended or may not prevent significant interruptions of our operations.
A list of exhibits to this Form 10-Q is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated herein by reference.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
UNIONBANCAL CORPORATION (Registrant) | ||||
Date: November 12, 2013 | By: | /s/ MASASHI OKA Masashi Oka President and Chief Executive Officer (Principal Executive Officer) | ||
Date: November 12, 2013 | By: | /s/ JOHN F. WOODS John F. Woods Vice Chairman and Chief Financial Officer (Principal Financial Officer) | ||
Date: November 12, 2013 | By: | /s/ ROLLAND D. JURGENS Rolland D. Jurgens Executive Vice President, Controller and Chief Accounting Officer (Principal Accounting Officer) |
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No. | Description | ||
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31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1) | ||
31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1) | ||
32.1 | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)(2) | ||
32.2 | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)(2) | ||
101 | Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2013, is formatted in XBRL interactive data files: (i) Consolidated Statements of Income; (ii) Consolidated Statements of Comprehensive Income; (iii) Consolidated Balance Sheets; (iv) Consolidated Statements of Changes in Stockholder's Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Financial Statements.(1) |
- (1)
- Filed herewith
- (2)
- In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed "filed" for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.
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