Washington, D. C. 20549

 

 

FORM 10–Q

 

(Mark One)

 

ý  QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2004

 

or

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to                

 

Commission File Number 1-10521

 

 

CITY NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

City National Center
400 North Roxbury Drive, Beverly Hills, California    90210

(Address of principal executive offices)    (Zip Code)

 

Registrant’s telephone number, including area code    (310) 888–6000

 

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.

 

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

 

 

Number of shares of common stock outstanding at April 30, 2004:  48,729,779

 

 

PART 1 - FINANCIAL INFORMATON

ITEM 1. FINANCIAL STATEMENTS

 

CITY NATIONAL CORPORATION

CONSOLIDATED BALANCE SHEET

(Unaudited)

 

Dollars in thousands, except per share amounts		March 31, 2004			December 31, 2003			March 31, 2003
Assets
Cash and due from banks		$	472,541		$	461,443		$	448,152
Federal funds sold		519,000			240,000			615,000
Due from banks - interest bearing .		34,570			405,747			22,975
Securities available-for-sale - cost $3,563,508; $3,350,632 and $2,478,311 at March 31, 2004, December 31, 2003 and March 31, 2003, respectively		3,612,173			3,365,654			2,531,809
Trading account securities		39,549			91,535			53,288
Loans		7,967,639			7,882,742			7,832,823
Less allowance for credit losses		165,072			165,986			169,480
Net loans		7,802,567			7,716,756			7,663,343
Premises and equipment, net		60,175			62,719			62,630
Deferred tax asset		60,049			65,913			43,602
Goodwill		253,737			253,824			230,084
Intangibles		46,120			47,879			25,032
Bank owned life insurance		63,510			62,799			60,682
Affordable housing investments		65,831			66,480			67,326
Other assets		186,085			171,785			181,663
Customers’ acceptance liability		4,617			5,708			6,886
Total assets		$	13,220,524		$	13,018,242		$	12,012,472
Liabilities
Demand deposits		$	5,525,627		$	5,486,668		$	4,625,439
Interest checking deposits		833,003			840,659			660,448
Money market deposits		3,535,809			3,260,959			3,101,656
Savings deposits		196,153			208,701			206,724
Time deposits-under $100,000		195,053			199,875			213,492
Time deposits-$100,000 and over		849,032			940,201			1,056,087
Total deposits		11,134,677			10,937,063			9,863,846
Federal funds purchased and securities sold under repurchase agreements		88,063			111,713			156,002
Other short-term borrowings		50,125			65,135			140,125
Subordinated debt		300,758			295,723			302,573
Long-term debt		239,804			230,555			274,001
Other liabilities		135,370			127,045			120,838
Acceptances outstanding		4,617			5,708			6,886
Total liabilities		11,953,414			11,772,942			10,864,271
Minority interest in consolidated subsidiaries		27,180			26,044			26,512
Commitments and contingencies
Shareholders’ Equity
Preferred Stock authorized - 5,000,000 : none outstanding		—			—			—
Common Stock-par value-$1.00; authorized - 75,000,000; Issued - 50,583,124; 50,459,716 and 50,282,743 shares at March 31, 2004, December 31, 2003 and March 31, 2003, respectively		50,583			50,460			50,283
Additional paid-in capital		409,235			401,233			399,551
Accumulated other comprehensive income		32,237			12,903			37,631
Retained earnings		849,859			814,591			708,849
Deferred equity compensation		(14,343		)	(6,699		)	—
Treasury shares, at cost -  1,754,657; 1,255,569;  and 1,694,129 shares at March 31, 2004, December 31, 2003 and March 31, 2003, respectively		(87,641		)	(53,232		)	(74,625		)
Total shareholders’ equity		1,239,930			1,219,256			1,121,689
Total liabilities and shareholders’ equity		$	13,220,524		$	13,018,242		$	12,012,472

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

2

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

 

		For the three months ended March 31,
In thousands, except per share amounts		2004			2003
Interest  Income
Loans		$	105,986		$	115,736
Securities available-for-sale		37,201			29,431
Federal funds sold and securities purchased under resale agreements		432			411
Due from bank - interest bearing		140			49
Trading account		38			49
Total interest income		143,797			145,676
Interest  Expense
Deposits		9,752			13,474
Subordinated debt		1,217			1,414
Other long-term debt		1,439			1,352
Federal funds purchased and securities sold under repurchase agreements		244			625
Other short-term borrowings		173			594
Total interest expense		12,825			17,459
Net interest income		130,972			128,217
Provision for credit losses		—			17,500
Net interest income after provision for credit losses		130,972			110,717
Noninterest  Income
Trust and investment fees		15,588			6,538
Brokerage and mutual fund fees		8,726			8,942
Cash management and deposit transaction charges		10,826			10,917
International services		5,126			4,328
Bank owned life insurance		831			714
Gain on sale of loans and assets		—			102
Gain on sale of securities		629			1,230
Other		4,844			6,205
Total noninterest income		46,570			38,976
Noninterest  Expense
Salaries and employee benefits		59,676			51,805
Net occupancy of premises		7,308			6,969
Professional fees		6,106			6,436
Information services		4,522			4,253
Depreciation		3,228			3,119
Marketing and advertising		3,507			3,112
Office services		2,419			2,570
Amortization of intangibles		1,759			1,976
Equipment		765			666
Other operating		5,241			4,506
Total noninterest expense		94,531			85,412
Minority interest in net income of consolidated subsidiaries		1,600			475
Income before income taxes		81,411			63,806
Income taxes		30,513			20,151
Net income		50,898			43,655
Other comprehensive income (loss)
Unrealized gain (loss) on securities available-for-sale		31,091			(2,848		)
Unrealized gain on cash flow hedges		2,891			528
Less reclassification adjustment for gain included in net income		613			2,455
Income taxes (benefit)		14,035			(2,006		)
Other comprehensive income (loss)		19,334			(2,769		)
Comprehensive income		$	70,232		$	40,886
Net income per share, basic		$	1.04		$	0.89
Net income per share, diluted		$	1.00		$	0.87
Shares used to compute income per share, basic		48,732			48,779
Shares used to compute income per share, diluted		50,679			50,124
Dividends per share		$	0.320		$	0.205

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

3

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

 

		For the three months ended March 31,
Dollars in thousands		2004			2003
Cash Flows From Operating Activities
Net income		$	50,898		$	43,655
Adjustments to net income:
Provision for credit losses		—			17,500
Amortization of restricted stock awards		508			—
Amortization of intangibles		1,759			1,976
Depreciation		3,228			3,119
Deferred income tax benefit		(8,171		)	(5,018		)
Gain on sales of loans and assets		—			(102		)
Gain on sales of securities		(629		)	(1,230		)
Net decrease (increase) in other assets		6,800			(43,047		)
Net decrease in trading securities		51,986			118,923
Other, net		6,306			52,845
Net cash provided by operating activities		112,685			188,621
Cash Flows From Investing Activities
Purchase of securities		(455,043		)	(714,151		)
Sales of securities available-or-ale		46,799			49,475
Maturities and paydowns of securities		193,811			354,823
Loan principal collections (originations), net		(84,897		)	151,765
Purchase of premises and equipment		(1,649		)	(5,449		)
Other, net		—			(1		)
Net cash used by investing activities		(300,979		)	(163,538		)
Cash Flows From Financing Activities
Net increase in deposits		197,614			24,148
Net decrease in federal funds purchased and securities sold under repurchase agreements		(23,650		)	(110,725		)
Net decrease in short-term borrowings, net of transfers from long-term debt		(15,010		)	—
Repayment of long-term debt		—			(1,367		)
Net proceeds of issuance of senior debt		—			221,749
Proceeds from exercise of stock options		7,273			2,808
Stock repurchases		(43,382		)	(22,841		)
Cash dividends paid		(15,630		)	(10,001		)
Net cash provided by financing activities		107,215			103,771
Net  (decrease) increase in cash and cash equivalents		(81,079		)	128,854
Cash and cash equivalents at beginning of year		1,107,190			957,273
Cash and cash equivalents at end of period		$	1,026,111		$	1,086,127
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest		$	20,170		$	20,919
Income taxes		—			6,000
Non-cash investing activities:
Transfer from loans to foreclosed assets		$	—		$	—
Transfer from long-term debt to short-term borrowings		—			15,000

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

4

 

CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

		For the three months ended March 31,
Dollars in thousands		2004			2003
Common Stock
Balance, beginning of period		$	50,460		$	50,283
Restricted stock and units issued		123			—
Balance, end of period		50,583			50,283
Additional paid-in capital
Balance, beginning of period		401,233			400,866
Tax benefit from stock options		1,673			878
Stock options exercised		(1,700		)	(2,193		)
Restricted stock and units issued		8,029			—
Balance, end of period		409,235			399,551
Accumulated other comprehensive income
Balance, beginning of period		12,903			40,400
Other comprehensive income (loss) net of income taxes		19,334			(2,769		)
Balance, end of period		32,237			37,631
Retained earnings
Balance, beginning of period		814,591			675,195
Net income		50,898			43,655
Dividends paid		(15,630		)	(10,001		)
Balance, end of period		849,859			708,849
Deferred equity compensation
Balance, beginning of period		(6,699		)	—
Restricted stock and units issued		(8,152		)	—
Amortization of restricted stock awards		508
Balance, end of period		(14,343		)	—
Treasury shares
Balance, beginning of period		(53,232		)	(56,785		)
Purchase of shares		(43,382		)	(22,841		)
Issuance of shares for stock options		8,973			5,001
Balance, end of period		(87,641		)	(74,625		)
Total shareholders’ equity		$	1,239,930		$	1,121,689

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

5

 

CITY NATIONAL CORPORATION

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.               City National Corporation (the “Corporation”) is the holding company for City National Bank (the “Bank”).  In light of the fact that the Bank comprises substantially all of the business of the Corporation, references to the “Company” mean the Corporation and the Bank together.

 

2.               The results of operations reflect the interim adjustments, all of which are of a normal recurring nature and which, in the opinion of management, are necessary for a fair presentation of the results for the interim period presented.  These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003.  The results for the 2004 interim period are not necessarily indicative of the results expected for the full year.

 

3.               Trading account securities are stated at market value.  Investments not classified as trading securities are classified as securities available-for-sale and recorded at fair value.  Unrealized holding gains or losses for securities available-for-sale, net of taxes are excluded from net income and are reported as other comprehensive income included as a separate component of shareholders’ equity.

 

4.               Certain prior periods’ data have been reclassified to conform to current period presentation.

 

5.               Reserves established as a purchase price adjustment for the February 29, 2000 acquisition of The Pacific Bank N.A. of $0.7 million for exit costs relating to surplus space remain as of March 31, 2004.  Reserves established as a purchase price adjustment for the February 28, 2002 acquisition of Civic BanCorp of $0.2 million for exit costs relating to surplus space remain as of March 31, 2004.

 

6.               The following table provides information about purchases by the Company during the quarter ended March 31, 2004 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act.

 

 

Basic earnings per share is based on the weighted average shares of common stock outstanding less unvested restricted shares and units.  Diluted earnings per share gives effect to all dilutive potential common shares which consists of stock options and restricted shares and units that were outstanding during the period.  At March 31, 2004, 481,758 stock options were antidilutive compared with 689,051 antidilutive stock options at March 31, 2003.

 

7.               The Company applies APB Opinion No. 25 in accounting for stock option plans and, accordingly, no compensation cost has been recognized for its plans in the financial statements.  As a practice, the Corporation’s stock option grants are such that the exercise price equals the current market price of the common stock.  Had the

 

6

 

Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123 using the Black Scholes option-pricing model, the Company’s proforma net income would have been reduced to the proforma amounts indicated below:

 

		For the three months ended March 31,
Dollars in thousands, except for per share amounts		2004			2003
Net income, as reported		$	50,898		$	43,655
Proforma net income		50,175			42,188
Net income per share, basic, as reported		1.04			0.89
Proforma net income per share, basic		1.03			0.86
Net income per share, diluted, as reported		1.00			0.87
Proforma net income per share, diluted		0.99			0.84
Percentage reduction in net income per share, diluted		1.00		%	3.45		%

 

During the latter part of the second quarter of 2003, stock-based compensation performance awards for 2002 were granted to colleagues of the Company.  These performance awards for the first time included restricted stock grants with fewer stock options, which reduced the total number of shares awarded but better aligned the interests of shareholders and colleagues.  The number of shares awarded was further reduced in 2004 for stock-based compensation performance awards for 2003 when the Company took into consideration changes in the value of the Company’s stock price when determining share awards.  The 2004 percentage reduction in net income per share, diluted is lower because a fewer number of stock options have been awarded with a portion replaced by restricted stock awards, the cost of which is charged to noninterest expense.  The Company recorded $508,000 in expense for restricted stock awards in the first quarter of 2004.  There was no expense for restricted stock awards in the first quarter of 2003 since the first grant was not until June 2003. 

 

The Black Scholes option-pricing model requires assumptions on expected life of the options that is based upon the pattern of exercise of options granted by the Corporation in the past; volatility based on changes in the price of the Corporation’s common stock during the past 10 years, measured monthly; dividend yield and risk-free investment rate.  Actual dividend payments will depend upon a number of factors, including future financial results, and may differ substantially from the assumption.  The risk-free investment rate is based on the yield on 10-year U.S. Treasury Notes on the grant date.

 

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

 

8.               On April 1, 2003, the Corporation acquired Convergent Capital Management LLC, a privately held Chicago-based company, and substantially all of its asset management holdings, including its majority ownership interests in eight asset management firms and minority interests in two additional firms.  Combined, these 10 firms manage assets of approximately $9.4 billion as of March 31, 2004.  The purchase price was $49.0 million, comprised of cash and the assumption of approximately $7.5 million of debt.  The acquisition resulted in $25.8 million in customer contract intangibles, which are being amortized over 20 years, and $21.5 million in goodwill.

 

9.     As previously reported, the California Franchise Tax Board (the “FTB”) announced that it is taking the position that certain tax deductions related to real estate investment trusts (“REITs”) and regulated investment companies (“RICs”) will be disallowed pursuant to California Senate Bill 614 and California Assembly Bill 1601, which were signed into law in the fourth quarter of 2003.  The Company created its REITs (one of which was previously formed as a RIC in 2000) to raise capital for the Bank.  While the Company’s management continues to believe that the tax benefits realized in previous years were appropriate and fully defensible under the existing tax codes at that time, the Company has deemed it prudent to participate in the statutory Voluntary Compliance Initiative (“VCI”)  requiring payment of all California taxes and interest on these disputed 2000 through 2002 tax benefits, and permitting the Company to claim a refund for these years while avoiding certain potential penalties should the FTB choose to litigate the Company’s position on the appropriate tax treatment of REITs and RICs.

 

On April 15, 2004, the Company made payment of taxes and interest to the FTB of $66.2 million for tax years 2000, 2001, and 2002.  We continue to believe that the tax deductions are appropriate and, as such, we have also filed refund claims for the amounts paid with the amended returns.  The refund claims for these years will be  reflected as assets in the Company’s consolidated financial statements.  As a result of these actions the Company retains  potential exposure for assertion of an accuracy-rated penalty should the FTB prevail in its position, in addition to the risk of not being successful in our refund claim for taxes and interest.  Management believes potential exposure to all other penalties has been eliminated.  On advice of our advisors, management intends to aggressively pursue its claims for refund for the 2000 through 2003 tax years.

 

7

 

CITY NATIONAL CORPORATION

FINANCIAL HIGHLIGHTS

(Unaudited)

 

		At or for the three months ended									Percentage change March 31, 2004 from
Dollars in thousands, except per share amount		March 31, 2004			December 31, 2003			March 31, 2003			December 31, 2003		March 31, 2003
For The Quarter
Net income		$	50,898		$	44,438		$	43,655		15	%	17	%
Net income per common share, basic		1.04			0.91			0.89			14		17
Net income per common share, diluted		1.00			0.87			0.87			15		15
At Quarter End
Assets		$	13,220,524		$	13,018,242		$	12,012,472		2		10
Deposits		11,134,677			10,937,063			9,863,846			2		13
Loans		7,967,639			7,882,742			7,832,823			1		2
Securities		3,612,173			3,365,654			2,531,809			7		43
Shareholders’ equity		1,239,930			1,219,256			1,121,689			2		11
Book value per share		25.54			24.85			23.09			3		11
Average Balances
Assets		$	12,606,754		$	12,756,557		$	11,480,626		(1	)	10
Deposits		10,533,471			10,693,959			9,373,839			(2	)	12
Loans		7,886,333			7,605,417			7,964,338			4		(1	)
Securities		3,462,547			3,424,291			2,414,970			1		43
Shareholders’ equity		1,222,017			1,200,390			1,117,573			2		9
Selected Ratios
Return on average assets		1.62		%	1.38		%	1.54		%	17		5
Return on average shareholders’ equity		16.75			14.69			15.84			14		6
Corporation’s tier 1 leverage		7.61			7.48			7.65			2		(1	)
Corporation’s tier 1 risk-based capital		10.67			10.81			10.30			(1	)	4
Corporation’s total risk-based capital		14.43			14.86			14.46			(3	)	(0	)
Dividend payout ratio, per share		30.71			30.94			22.91			(1	)	34
Net interest margin		4.66			4.52			5.07			3		(8	)
Efficiency ratio *		53.39			52.77			50.28			1		6
Asset Quality Ratios
Nonaccrual loans to total loans		0.54		%	0.54		%	1.27		%	0		(57	)
Nonaccrual loans and ORE to toal loans and ORE		0.54			0.54			1.28			0		(58	)
Allowance for credit losses  to total loans		2.07			2.11			2.16			(2	)	(4	)
Allowance for credit losses to nonaccrual loans		386.29			392.65			169.93			(2	)	127
Net charge-offs to average loans - annualized		(0.05		)	(0.01		)	(0.64		)	400		(92	)

 

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

 

8

 

ITEM 2.                                                     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

See “Cautionary Statement for Purposes of the ‘Safe Harbor’ Provisions of the Private Securities Litigation Reform Act of 1995,” below relating to “forward-looking” statements included in this report.

 

 

RESULTS OF OPERATIONS

 

Critical Accounting Policies

 

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition.  The Company has identified four policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions.  These policies relate to the accounting for securities, the allowance for credit losses, derivatives and hedging activities and stock-based performance plans.  The Company, in consultation with the Audit Committee, has reviewed and approved these critical accounting policies, which are further described in Management’s Discussion and Analysis and Note 1 (Summary of Significant Accounting Policies) to the Consolidated Financial Statements in the Company’s 2003 Form 10-K.  There have been no material changes to the Company’s accounting policies since the last reporting period.

 

 Overview

 

The Corporation recorded net income of $50.9 million, or $1.00 per common share, for the first quarter of 2004, compared with net income of $43.7 million, or $0.87 per share, for the first quarter of 2003.

 

 

Highlights

 

•                  Average deposits were up 12 percent and average core deposits were up 16 percent from the same period a year ago.  

 

•                  Average loans came to nearly $7.9 billion for the first quarter of 2004, $280.9 million higher than the fourth quarter 2003 total of $7.6 billion.  Period-end loan balances at March 31, 2004 of $8.0 billion increased $84.9 million from $7.9 billion at December 31, 2003.

 

•                  No provision for credit losses was recorded for the first quarter of 2004, a result of continued strong credit quality and an appropriate allowance for credit losses.  Net loan charge-offs were $0.9 million for the quarter.  Nonaccrual loans were $42.7 million, down 57 percent from March 31, 2003, and up 1 percent from December 31, 2003.

 

•                  Average securities for the first quarter of 2004 were up 43 percent from the prior-year quarter due to higher deposit balances, and were up 1 percent from the fourth quarter of 2003.  The average duration of the total available-for-sale securities portfolio at March 31, 2004 was 3.1 years.

 

•                  First-quarter noninterest income rose 19 percent over the same period a year ago.  Assets under management and administration surpassed $30 billion for the first time.  First-quarter 2004 results include the operations of Convergent Capital Management LLC (“CCM”) while first-quarter 2003 results do not include any CCM results since the acquisition was not completed until April 1, 2003.

 

9

 

 

Dollars in millions, except per share		For the three months ended March 31,						% Change		For the three months ended December 31, 2003
		2004			2003
Earnings Per Share		$	1.00		$	0.87		15		$	0.87
Net Income		50.9			43.7			17		44.4
Average Assets		12,606.8			11,480.6			10		12,756.6
Return on Average Assets		1.62		%	1.54		%	5		1.38		%
Return on Average Equity		16.75			15.84			6		14.69

 

As previously disclosed, in 2004 the Company is continuing its practice, adopted in the fourth quarter of 2003, of not recognizing tax benefits associated with its real estate investment trusts (“REITS”) in its financial statements.  First-quarter 2003 results included $2.8 million in net income, or $0.06 per share, from tax benefits of the Company’s two REITS.  Fourth-quarter 2003 results included a net charge of $8.1 million, or $0.16 per share, from the reversal of the REIT tax benefits recognized in the first three quarters of 2003.

 

Return on average assets and the return on average shareholders’ equity for the first quarter of 2004 increased from the same period a year ago due to higher net income.

 

Outlook

 

Consistent with its April 14, 2004 first-quarter earnings release, management continues to expect net income per diluted common share for 2004 to be approximately 7 to 9 percent higher than net income per diluted common share for 2003, based on current economic conditions and the business indicators below:

 

•		Average loan growth		6 to 9 percent
•		Average deposit growth		6 to 9 percent
•		Net interest margin		4.50 to 4.70 percent
•		Provision for credit losses		$10 million to $20 million
•		Noninterest income growth		6 to 8 percent
•		Noninterest expense growth		8 to 10 percent
•		Effective tax rate		36 to 38 percent

 

The Company considers that it is premature to modify its net income per share guidance in light of modest commercial loan demand to date.  Our outlook for 2004 is still built on the assumption that short-term interest rates will stay where they are until later this year.  An increase in interest rates sooner will increase net interest income since the Company is naturally asset-sensitive.

 

Revenues

 

First-quarter revenues (net interest income plus noninterest income) increased 6 percent to $177.5 million, compared with $167.2 million for the same period in 2003 due to higher net interest income, and noninterest income from the acquisition of CCM.  Revenues were down 1 percent from the fourth quarter of 2003 due to the absence of participating mortgage loan (“PML”) fees in the first quarter of 2004.  (These are fees earned upon completion of certain real estate construction projects and repayment of debt where the Company participates in the profits of the project by funding a portion of the equity requirement for the project.)

 

Net Interest Income

 

Fully taxable-equivalent net interest income for the first quarter of 2004 was $134.3 million, compared with $131.9 million for the first quarter of 2003 and $134.0 for the fourth quarter of 2003.

 

10

 

Dollars in millions		For the three months ended March 31,						% Change		For the three months ended December 31, 2003
		2004			2003
Average Loans		$	7,886.3		$	7,964.3		(1	)	$	7,605.4
Average Securities		3,462.5			2,415.0			43		3,424.3
Average Deposits		10,533.5			9,373.8			12		10,694.0
Average Core Deposits		9,621.2			8,326.5			16		9,737.3
Fully Taxable-Equivalent Net Interest Income		134.3			131.9			2		134.0
Net Interest Margin		4.66		%	5.07		%	(8	)	4.52		%

 

Average loans for the first quarter of 2004 were slightly lower than they were in the first quarter of 2003, but increased 4 percent from the fourth quarter of 2003.  Compared with the prior-year first-quarter averages, residential first mortgage loans rose 11 percent; real estate mortgage loans rose 5 percent; real estate construction loans rose 2 percent; and commercial loans decreased 11 percent.  Compared with the fourth quarter of 2003, average loans increased in all categories except installment loans.

 

Period-end March 31, 2004 loans increased $84.9 million from December 31, 2003, reflecting growth in residential first mortgage, real estate mortgage, and real estate construction loans.

 

Average securities increased 43 percent for the first quarter of 2004 compared with the same period for 2003 primarily due to higher deposit balances.  Average securities were slightly higher than the fourth quarter of 2003.  As of March 31, 2004, unrealized gains on securities available-for-sale were $48.7 million.  The average duration of total available-for-sale securities at March 31, 2004 was 3.1 years compared with 3.4 years at December 31, 2003 and 2.3 years at March 31, 2003.

 

Average deposits during the first quarter of 2004 increased 12 percent over the same period last year and were down 2 percent from the fourth quarter of 2003, the latter change reflecting historical seasonal trends.  Average core deposits represented 91 percent, 89 percent, and 91 percent of the total average deposit base for the first quarters of 2004 and 2003, and the fourth quarter of 2003, respectively.  New clients and higher client balances maintained as deposits to pay for services contributed to the year-over-year growth of deposits.  

 

The net interest margin was slightly higher than the fourth quarter of 2003 due to higher yielding interest-earning assets.

 

As part of the Company’s long-standing asset/liability management strategy, its “plain vanilla” interest rate swaps hedging loans, deposits and borrowings, with a notional value of  $1.1 billion, added $8.3 million to net interest income in the first quarter of 2004, compared with $7.5 million in the first quarter of 2003 and $8.3 million in the fourth quarter of 2003.  These amounts included $6.0 million, $4.5 million, and $6.1 million, respectively, for interest rate swaps qualifying as fair value hedges.  Income from swaps qualifying as cash-flow hedges was $2.3 million for the first quarter of 2004, compared with $3.0 million for the first quarter of 2003, and $2.2 million for the fourth quarter of 2003.  Income from existing swaps qualifying as cash-flow hedges of loans expected to be recorded in net interest income within the next 12 months is $6.5 million.

 

Interest recovered on nonaccrual and charged-off loans included in net interest income for the first quarter of 2004 was $0.7 million, compared with $0.6 million for the first quarter of 2003, and $0.3 million for the fourth quarter of 2003.

 

The Bank’s prime rate was 4.00 percent as of March 31, 2004, compared with 4.25 percent a year earlier.

 

The following table presents the components of net interest income on a fully taxable-equivalent basis for the three months ended March 31, 2004 and 2003.  To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pre-tax equivalents based on the marginal corporate federal tax rate of 35 percent.

 

11

 

Net Interest Income Summary

 

		For the three months ended March 31, 2004								For the three months ended March 31, 2003
Dollars in thousands		Average Balance			Interest income/ expense (2)			Average interest rate		Average Balance			Interest income/ expense (2)			Average interest rate
Assets
Interest-earning assets
Loans
Commercial		$	3,172,149		$	40,142		5.09	%	$	3,560,411		$	47,190		5.38
Real estate mortgages		2,001,733			30,214			6.07		1,908,554			31,652			6.73
Residential first mortgages		1,952,305			26,801			5.52		1,756,838			28,164			6.50
Real estate construction		678,479			8,571			5.08		663,956			8,840			5.40
Installment		81,667			1,432			7.05		74,579			1,500			8.16
Total loans (1)		7,886,333			107,160			5.47		7,964,338			117,346			5.98
Due from banks - interest bearing		78,348			140			0.72		26,826			49			0.74
Securities available-for-sale		3,432,391			39,390			4.62		2,385,584			31,460			5.35
Federal funds sold and securities purchased under resale agreements		174,649			432			0.99		132,989			411			1.25
Trading account securities		30,156			39			0.52		29,386			52			0.72
Total interest-earning assets		11,601,877			147,161			5.10		10,539,123			149,318			5.75
Allowance for credit losses		(166,660		)						(169,424		)
Cash and due from banks		447,220								441,078
Other nonearning assets		724,317								669,849
Total assets		$	12,606,754							$	11,480,626
Liabilities and Shareholders' Equity
Interest-bearing deposits
Interest checking accounts		$	802,578		166			0.08		$	674,809		337			0.20
Money market accounts		3,421,000			5,819			0.68		2,988,825			7,573			1.03
Savings deposits		204,741			133			0.26		198,295			262			0.54
Time deposits - under $100,000		197,660			711			1.45		215,691			1,010			1.90
Time deposits - $100,000 and over		912,315			2,923			1.29		1,047,354			4,292			1.66
Total interest - bearing deposits		5,538,294			9,752			0.71		5,124,974			13,474			1.07
Federal funds purchased and securities sold under repurchase agreements		111,763			244			0.88		219,518			625			1.15
Other borrowings		578,988			2,829			1.97		615,443			3,360			2.21
Total interest - bearing liabilities		6,229,045			12,825			0.83		5,959,935			17,459			1.19
Noninterest - bearing deposits		4,995,177								4,248,865
Other liabilities		160,515								154,253
Shareholders’ equity		1,222,017								1,117,573
Total liabilities and shareholders’ equity		$	12,606,754							$	11,480,626
Net interest spread								4.27	%							4.56	%
Fully taxable-equivalent net interest income					$	134,336							$	131,859
Net interest margin								4.66	%							5.07	%

 

(1)           Includes average nonaccrual loans of $41,279 and $83,037 for 2004 and 2003, respectively.

(2)           Loan income includes loan fees of $5,328 and $5,428 for 2004 and 2003, respectively.

 

12

 

Net interest income is impacted by the volume, mix, and rate of interest-earning assets and interest-bearing liabilities.  The following table shows changes in net interest income on a fully taxable-equivalent basis between the first quarter of 2004 and the first quarter of 2003, as well as between the first quarter of 2003 and the first quarter of 2002.

 

Changes In Net Interest Income

 

Dollars in thousands		For the three months ended March 31, 2004 vs 2003									For the three months ended March 31, 2003 vs 2002
		Increase (decrease) due to						Net increase			Increase (decrease) due to						Net increase
		Volume			Rate			(decrease)			Volume			Rate			(decrease)
Interest earned on:
Loans		$	(1,057	)	$	(9,129	)	$	(10,186	)	$	7,823		$	(12,663	)	$	(4,840	)
Due from banks - interest bearing		92			(1		)	91			6			(35		)	(29		)
Securities available-for-sale		12,625			(4,695		)	7,930			7,323			(5,017		)	2,306
Federal funds sold and securities purchased under resale agreements		115			(94		)	21			13			(109		)	(96		)
Trading account securities		1			(14		)	(13		)	(21		)	(57		)	(78		)
Total interest-earning assets		11,776			(13,933		)	(2,157		)	15,144			(17,881		)	(2,737		)
Interest paid on:
Interest checking deposits		56			(227		)	(171		)	61			(77		)	(16		)
Money market deposits		1,022			(2,776		)	(1,754		)	2,551			(2,725		)	(174		)
Savings deposits		9			(138		)	(129		)	(116		)	(349		)	(465		)
Other time deposits		(590		)	(1,078		)	(1,668		)	(1,713		)	(3,101		)	(4,814		)
Other borrowings		(632		)	(280		)	(912		)	(2,638		)	(1,097		)	(3,735		)
Total interest-bearing liabilities		(135		)	(4,499		)	(4,634		)	(1,855		)	(7,349		)	(9,204		)
		$	11,911		$	(9,434	)	$	2,477		$	16,999		$	(10,532	)	$	6,467

 

The impact of interest rate swaps, which increases loan interest income and reduces deposit and borrowing interest expense, is included in rate changes.

 

Provision for Credit Losses

 

The Company made no provision for credit losses in the first quarter of 2004.  This was attributable to the continued strong credit quality of its portfolio; a low level of net charged-off and nonaccrual loans; management’s ongoing assessment of the credit quality of the portfolio, modest loan growth and an improving economic environment.  Management believes the allowance for credit losses is adequate to cover risks in the portfolio at March 31, 2004.  See “¾ Allowance for Credit Losses.”

 

Noninterest Income

 

In the first quarter of 2004, noninterest income increased to $46.6 million, up 19 percent from $39.0 million in the first quarter of 2003.  This growth was mainly attributable to the CCM acquisition which was completed on April 1, 2003.  Noninterest income was 3 percent lower than the fourth quarter of 2003 due to the absence of PML fees in the first quarter of 2004.  This more than offset an increase in trust and investment fees.

 

As a percentage of total revenues, noninterest income was 26 percent for the first quarter of 2004 compared with 23 percent and 27 percent for the first quarter of 2003 and the fourth quarter of 2003, respectively.

 

13

 

Wealth Management  

 

Dollars in millions		At or for the three months ended March 31,						% Change		At or for the three months ended December 31, 2003
		2004			2003
Trust and Investment Fees		$	15.6		$	6.5		138		$	14.2
Brokerage and Mutual Fund Fees		8.7			8.9			(2	)	9.1
Assets Under Administration		30,532.3			19,840.8			54		28,835.3
Assets Under Management (1)(2)		14,339.3			6,978.0			105		13,610.8

 

(1)          Included above in assets under administration

(2)          Excludes $3,591 million and $2,858 million of assets under management for the CCM minority-owned asset managers as of March 31, 2004 and December 31, 2003, respectively

 

Assets under management at March 31, 2004 increased from the same period last year primarily due to the CCM acquisition.  New business, aided by strong relative investment performance and higher market values, also contributed to the increase during the first quarter of 2004.  The trust and investment fee revenue increase over both the first and fourth quarters of 2003 was driven by higher balances under management or administration.  Increases in market values are reflected in fee income primarily on a trailing-quarter basis.  Brokerage and mutual fund fees are down primarily due to a decline in money-market balances.

 

Other Noninterest Income

 

Cash management and deposit transaction fees for the first quarter of 2004 decreased 1 percent from the first quarter of 2003.  Cash management and deposit transaction fees increased 4 percent from the fourth quarter of 2003 due to the recognition in arrears of annual fees.

 

International services fees for the first quarter of 2004 were up 18 percent over the same period last year primarily due to higher foreign exchange and trade finance income.  These fees were essentially the same compared with the fourth quarter of 2003.

 

Other income in the first quarter of 2004 declined $1.4 million and $2.9 million from the first quarter and fourth quarter of 2003, respectively.  The decline from one year ago was primarily attributable to the absence of $1.2 million of fees received from the sale of certain merchant credit card business and $0.2 million of interest on loans available for sale.  The decline from the fourth quarter last year was due primarily to the absence of $2.6 million in PML fees.

 

The Company realized $0.6 million in gains on the sale of loans, assets and debt repurchase, and gains on the sale of securities for the first quarter of 2004, compared with $1.3 million in gains for the first quarter of 2003 and $0.5 million in gains for the fourth quarter of 2003.

 

Noninterest Expense

 

Noninterest expense was $94.5 million in the first quarter of 2004, up 11 percent from $85.4 million for the first quarter of 2003 and down 1 percent from $95.1 million for the fourth quarter of 2003.  Compared with the first quarter of 2003, expenses grew primarily because of the acquisition of CCM.  In addition, first-quarter 2004 noninterest expense included the cost of restricted stock awards made in the second quarter of 2003 and the first quarter of 2004.  These restricted stock awards continue to replace a portion of the stock option grants that are part of the Company’s equity compensation program.

 

The efficiency ratio for the first quarter of 2004 was 53.39 percent, compared with 50.28 percent for the first quarter of 2003 and 52.77 percent for the fourth quarter of 2003.  The increase in the efficiency ratio over the year ago period is primarily attributable to the acquisition of CCM. 

 

14

 

Minority Interest

 

Minority interest consists of preferred stock dividends on the Bank’s real estate investment trust subsidiaries and the minority ownership share of earnings of the Corporation’s majority owned asset management firms.

 

Income Taxes

 

The first-quarter 2004 effective tax rate was 37.5 percent, compared with 36.6 percent for all of 2003.  The effective tax rate reflects changes in the mix of tax rates applicable to income before tax.  Quarterly comparisons with the first three quarters of 2003 will be impacted by the real estate investment trust (“REIT”) state tax benefits which were added to net income in the first three quarters of 2003 and were reversed in the fourth quarter of 2003.

 

The effective tax rates differ from the applicable statutory federal tax rate due to various factors, including state taxes, tax-exempt income including interest on bank-owned life insurance, and affordable housing investments.

 

The Company’s tax returns are being audited by the Internal Revenue Service back to 1998 and by the Franchise Tax Board of the State of California back to 1996.  From time to time, there may be differences in opinions with respect to the tax treatment accorded transactions.  When, and if, such differences occur and become probable and estimable, such amounts will be recognized.

 

As previously reported, the California Franchise Tax Board (the “FTB”) announced that it is taking the position that certain tax deductions related to real estate investment trusts (“REITs”) and regulated investment companies (“RICs”) will be disallowed pursuant to California Senate Bill 614 and California Assembly Bill 1601, which were signed into law in the fourth quarter of 2003.  The Company created its REITs (one of which was previously formed as a RIC in 2000) to raise capital for the Bank.  While the Company’s management continues to believe that the tax benefits realized in previous years were appropriate and fully defensible under the existing tax codes at that time, the Company has deemed it prudent to participate in the statutory Voluntary Compliance Initiative (“VCI”)  requiring payment of all California taxes and interest on these disputed 2000 through 2002 tax benefits, and permitting the Company to claim a refund for these years while avoiding certain potential penalties should the FTB choose to litigate the Company’s position on the appropriate tax treatment of REITs and RICs.

 

On April 15, 2004, the Company made payment of taxes and interest to the FTB of $66.2 million for tax years 2000, 2001, and 2002.  We continue to believe that the tax deductions are appropriate and, as such, we have also filed refund claims for the amounts paid with the amended returns.  The refund claims for these years will be  reflected as assets in the Company’s consolidated financial statements.  As a result of these actions the Company retains potential exposure for assertion of an accuracy-rated penalty should the FTB prevail in its position, in addition to the risk of not being successful in our refund claim for taxes and interest.  Management believes potential exposure to all other penalties has been eliminated.  On advice of our advisors, management intends to aggressively pursue its claims for refund for the 2000 through 2003 tax years.

 

BALANCE SHEET ANALYSIS

 

Average assets of $12.6 billion were 10 percent higher than the first quarter of 2003, primarily due to an increase in deposits, which were invested in securities and, to a lesser extent, federal funds sold.  Total assets at March 31, 2004 increased 10 percent to $13.2 billion from $12.0 billion at March 31, 2003 and increased 2 percent from $13.0 billion at December 31, 2003.

 

Total average interest-earning assets for the first quarter of 2004 were $11.6 billion, an increase of 10 percent over the $10.5 billion in total average interest-earning assets for the first quarter of 2003 and were 1 percent lower than the $11.7 billion in average interest-earning assets for the fourth quarter of 2003.

 

Securities

 

Comparative period-end security portfolio balances are presented below:

 

Securities Available-for-Sale

 

		March 31, 2004						December 31, 2003						March 31, 2003
Dollars in thousands		Cost			Fair Value			Cost			Fair Value			Cost			Fair Value
U.S. Government and federal agency		$	349,978		$	354,096		$	345,725		$	348,468		$	287,444		$	292,055
Mortgage-backed		2,758,964			2,787,267			2,561,976			2,561,997			1,763,370			1,801,838
State and Municipal		266,329			279,075			255,355			268,041			228,619			241,479
Other		—			—			—			—			5,449			4,620
Total debt securities		3,375,271			3,420,438			3,163,056			3,178,506			2,284,882			2,339,992
Marketable equity securities		188,237			191,735			187,576			187,148			193,429			191,817
Total securities		$	3,563,508		$	3,612,173		$	3,350,632		$	3,365,654		$	2,478,311		$	2,531,809

 

Average securities available-for-sale continued to increase primarily due to strong deposit growth.  At March 31, 2004, securities available-for-sale totaled $3.6 billion, an increase of $1.1 billion compared with holdings at March 31, 2003 and an increase of $0.2 billion from December 31, 2003.  At March 31, 2004 the portfolio had an unrealized net gain of $48.7 million compared with $15.0 million and $53.5 million at December 31, 2003 and March 31, 2003, respectively.  The average duration of total available-for-sale securities at March 31, 2004 was 3.1 years.    The 3.1 duration compares with 3.4 at December 31, 2003 and 2.3 at March 31, 2003.  Duration provides a measure of fair value sensitivity to changes in interest rates.  This is within the investment guidelines set by the Company’s

 

15

 

Asset/Liability Committee and the interest rate risk guidelines set by the Board of Directors.  See “¾ Asset /Liability Management” for a discussion of the Company’s interest rate position. 

 

The following table provides the contractual remaining maturities and yields (taxable-equivalent basis) of debt securities within the securities portfolio as of March 31, 2004.  Contractual maturities of mortgage-backed securities are substantially longer than their expected maturities due to scheduled and unscheduled principal payments.  To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pre-tax equivalents based on the marginal corporate federal tax rate of 35 percent.

 

Debt Securities Available-for-Sale

 

		One year or less					Over 1 year thru 5 years					Over 5 years thru 10 years					Over 10 years					Total
Dollars in thousands		Amount			Yield (%)		Amount			Yield (%)		Amount			Yield (%)		Amount			Yield (%)		Amount			Yield (%)
U.S. Government and federal agency		$	25,933		4.07		$	327,096		3.28		$	1,067		6.17		$	—		—		$	354,096		3.35
Mortgage—backed		171,436			4.21		—			—		290,061			3.99		2,325,770			4.54		2,787,267			4.46
State and Municipal		6,003			6.93		117,066			6.66		98,118			6.29		57,888			6.10		279,075			6.42
Total debt securities		$	203,372		4.27		$	444,162		4.17		$	389,246		4.58		$	2,383,658		4.58		$	3,420,438		4.51
Amortized cost		$	199,641				$	433,287				$	381,509				$	2,360,834				$	3,375,271

 

Dividend income included in interest income on securities in the Unaudited Consolidated Statement of Income and Comprehensive Income for the first quarter of both 2004 and 2003 was $1.9 million.

 

Loan Portfolio

 

A comparative period-end loan table is presented below:

 

Loans

 

Dollars in thousands		March 31, 2004			December 31, 2003			March 31, 2003
Commercial		$	3,163,312		$	3,222,444		$	3,401,610
Real estate mortgages		2,004,860			2,002,229			1,920,209
Residential first mortgages		1,977,952			1,937,979			1,762,629
Real estate construction		741,637			637,595			676,618
Installment		79,878			82,495			71,757
Total loans, gross		7,967,639			7,882,742			7,832,823
Less allowance for credit losses		165,072			165,986			169,480
Total loans, net		$	7,802,567		$	7,716,756		$	7,663,343

 

Total loans at March 31, 2004 were 2 percent and 1 percent higher than total loans at March 31, 2003 and December 31, 2003, respectively.  At March 31, 2004, the Company’s loan portfolio included approximately $478.7 million of loans managed in Northern California offices.  In addition, the portfolio included approximately $138.3 million in outstanding dairy loans, an industry which the Company expects to exit over the next 21 months.

 

The following table presents information concerning nonaccrual loans, ORE, and restructured loans.  Bank policy requires that a loan be placed on nonaccrual status if (1) either principal or interest payments are 90 days past due, unless the loan is both well secured and in process of collection, (2) full collection of interest or principal becomes uncertain, regardless of the time period involved or (3) regulators’ ratings of credits suggest that the loan be placed on nonaccrual.

 

16

 

Nonaccrual Loans, ORE and Restructured Loans

 

Dollars in thousands		March 31, 2004			December 31, 2003			March 31, 2003
Nonaccrual loans:
Commercial		$	37,457		$	37,418		$	85,075
Real estate		4,847			4,510			14,663
Installment		429			345			—
Total		42,733			42,273			99,738
ORE		—			—			210
Total nonaccrual loans and ORE		$	42,733		$	42,273		$	99,948
Total nonaccrual loans as a percentage of total loans		0.54		%	0.54		%	1.27
Total nonaccrual loans and ORE as a percentage of total loans and ORE		0.54			0.54			1.28
Allowance for credit losses to total loans		2.07			2.11			2.16
Allowance for credit  losses to nonaccrual loans		386.29			392.65			169.93
Loans past due 90 days or more on accrual status:
Commercial		$	5,057		$	235		$	907
Real estate		—			1,808			—
Installment		—			—			964
Total		$	5,057		$	2,043		$	1,871

 

Nonaccrual loans increased slightly this quarter.  Approximately 40 percent of the nonperforming assets were loans to Northern California clients, and 26 percent were 3 dairy credits.  The remaining 34 percent were loans to other borrowers with no major industry concentrations

 

At March 31, 2004, there were $41.9 million of impaired loans included in nonaccrual loans, that had an allowance of $5.9 million allocated to them.  On a comparable basis, at December 31, 2003, there were $40.7 million of impaired loans, which had an allowance of $5.0 million allocated to them.  The assessment for impairment occurs when and while such loans are on nonaccrual, or the loan has been restructured.  When a loan with unique risk characteristics has been identified as being impaired, the amount of impairment will be measured by the Company using discounted cash flows, except when it is determined that the primary (remaining) source of repayment for the loan is the operation or liquidation of the underlying collateral.  In such cases, the current fair value of the collateral, reduced by costs to sell, will be used in place of discounted cash flows.  As a final alternative, the observable market price of the debt may be used to assess impairment.  Additionally, some impaired loans with commitments of less than $500,000 are aggregated for the purpose of measuring impairment using historical loss factors as a means of measurement.

 

If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net deferred loan fees or costs and unamortized premium or discount), an impairment is recognized by creating or adjusting an existing allocation of the allowance for credit losses.  The Company’s policy is to record cash receipts on impaired loans first as reductions in principal and then as interest income.

 

17

 

The following table summarizes the changes in nonaccrual loans for the three months ended March 31, 2004 and 2003.

 

Changes in Nonaccrual Loans

 

		For the three months ended March 31,
Dollars in thousands		2004			2003
Balance, beginning of period		$	42,273		$	71,357
Loans placed on nonaccrual		17,414			52,742
Charge-offs		(3,595		)	(10,517		)
Loans returned to accrual status		(5,975		)	—
Repayments (including interest applied to principal)		(7,384		)	(13,844		)
Balance, end of period		$	42,733		$	99,738

 

In addition to loans disclosed above as nonaccrual or restructured, management has also identified $13.0 million of credits to 14 borrowers, including one real estate-secured loan totaling $6.5 million, where the ability to comply with the present loan payment terms in the future is questionable.  However, the inability of the borrower to comply with repayment terms was not sufficiently probable to place the loan on nonaccrual status at March 31, 2004.  This amount was determined based on analysis of information known to management about the borrowers’ financial condition and current economic conditions.

 

Management’s classification of credits as nonaccrual, restructured or problems does not necessarily indicate that the principal is uncollectable in whole or in part.

 

Allowance for Credit Losses

 

The allowance for credit losses at March 31, 2004 totaled $165.1 million, or 2.07 percent of outstanding loans.  This compares with an allowance of $169.5 million, or 2.16 percent at March 31, 2003 and an allowance of $166.0 million, or 2.11 percent at December 31, 2003.  The allowance for credit losses as a percentage of nonaccrual loans was 386 percent at March 31, 2004, compared with 170 percent at March 31, 2003 and 393 percent at December 31, 2003. 

 

Net charge-offs for the first quarter of 2004 were $0.9 million, compared with $12.5 million and $0.2 million, respectively, for the first quarter of 2003 and the fourth quarter of 2003.  As an annualized percentage of average loans, net charge-offs were 0.05 percent, 0.64 percent and 0.01 percent for the first quarters of 2004 and 2003 and the fourth quarter of 2003, respectively.

 

The allowance for credit losses is maintained at a level that management deems appropriate based on a thorough analysis of numerous factors, including levels of net charge-offs and nonaccrual loans and changes in the loan portfolio.  Credit quality will be influenced by underlying trends in the economy, particularly in California, and other factors that may be beyond management’s control.  No assurances can be given that the Company will not sustain credit losses, in any particular period, that are sizable in relation to the allowance for credit losses.  Based on known information available to it at the date of this report, management believes the allowance for credit losses is adequate to cover risks inherent in the portfolio at March 31, 2004.  Subsequent evaluation of the loan portfolio, in light of factors then prevailing, will dictate the level of provisions required to maintain the adequacy of the allowance for credit losses.

 

18

 

The table below summarizes the changes in the allowance for credit losses for the three months ended March 31, 2004 and 2003.

 

Changes in Allowance for Credit Losses

 

		For the three months ended March 31,
Dollars in thousands		2004			2003
Loans outstanding		$	7,967,639		$	7,832,823
Average amount of loans outstanding		$	7,886,333		$	7,964,338
Balance of allowance for credit losses, beginning of period		$	165,986		$	164,502
Loans charged off:
Commercial		(3,256		)	(13,287		)
Real estate and other		(1,093		)	(1,595		)
Total loans charged off		(4,349		)	(14,882		)
Less recoveries of loans previously charged off:
Commercial		3,324			2,268
Real estate and other		111			92
Total recoveries		3,435			2,360
Net loans charged off		(914		)	(12,522		)
Additions to allowance charged to operating expense		—			17,500
Balance, end of period		$	165,072		$	169,480
Total net charge-offs to average loans (annualized)		(0.05		)%	(0.64		)%
Ratio of allowance for credit losses to total period end loans		2.07		%	2.16		%

 

 

Other Assets

 

Other assets included the following:

 

Other Assets

 

Dollars in thousands		March 31, 2004			December 31, 2003			March 31, 2003
Interest rate swap mark-to-market		$	54,188		$	42,133		$	57,538
Accrued interest receivable		44,600			43,980			43,724
Claim in receivership and other assets		12,151			12,151			23,214
Loans held-for-sale		—			—			10,412
Income tax refund		16,133			17,813			3,305
Other		59,013			55,708			43,470
Total other assets		$	186,085		$	171,785		$	181,663

 

The claim in receivership and other assets were acquired in the acquisition of Pacific Bank.  The reduction in 2003 was due to the claim in receivership being collected.

 

See “¾ Net Interest Income” for a discussion of interest rate swaps that result in the swap mark-to-market asset of $54.2 million.

 

19

 

Off Balance Sheet

 

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk.  These financial instruments include commitments to extend credit, letters of credit, and financial guarantees.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the consolidated balance sheet.  Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each client’s creditworthiness on a case-by-case basis.

 

The Company had outstanding and unfunded loan commitments aggregating $3,526.8 million at March 31, 2004.  In addition, the Company had $430.0 million outstanding in bankers’ acceptances and letters of credit of which $389.5 million relate to standby letters of credit at March 31, 2004.  Substantially all of the Company’s loan commitments are on a variable rate basis and are comprised of real estate and commercial loan commitments.  There have been no material changes to the information provided in the Company’s off balance sheet arrangements since the last reporting period.

 

Deposits

 

Deposits totaled $11.1 billion at March 31, 2004, an increase of 13 percent compared with $9.9 billion at March 31, 2003, and increased 2 percent over the $10.9 billion at December 31, 2003.  New clients, additional trust and escrow deposits and a lower earnings credit on analyzed deposit accounts resulting from lower interest rates, contributed to the growth of deposits.

 

Demand deposits accounted for 50 percent of total deposits at March 31, 2004.  Core deposits, which continued to provide substantial benefits to the Bank’s cost of funds, were 92 percent of total deposits at March 31, 2004.  See “¾ Net Interest Income.”

 

Other Borrowings

 

Other borrowings have declined by $24.4 million from December 31, 2003 and $194.0 million from March 31, 2003 to $678.8 million at March 31, 2004 as deposits have increased.

 

CAPITAL ADEQUACY REQUIREMENT

 

The following table presents the regulatory standards for well capitalized institutions and the capital ratios for the Corporation and the Bank at March 31, 2004, December 31, 2003, and March 31, 2003.

 

		Regulatory Well Capitalized Standards		March 31, 2004		December 31, 2003		March 31, 2003
City National Corporation
Tier 1 leverage		N/A	%	7.61	%	7.48	%	7.65	%
Tier 1 risk-based capital		6.00		10.67		10.81		10.30
Total risk-based capital		10.00		14.43		14.86		14.46
City National Bank
Tier 1 leverage		5.00		8.41		8.01		7.53
Tier 1 risk-based capital		6.00		11.74		11.51