City National 10-Q 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
For the quarterly period ended June 30, 2005
For the transition period from to
Commission File Number 1-10521
CITY NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Registrants 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.
YES x NO o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
YES x NO o
Number of shares of common stock outstanding at July 31, 2005 49,178,095
See accompanying Notes to the Unaudited Consolidated Financial Statements.
See accompanying Notes to the Unaudited Consolidated Financial Statements.
See accompanying Notes to the Unaudited Consolidated Financial Statements.
CITY NATIONAL CORPORATION
See accompanying Notes to Consolidated Financial Statements.
1. City National Corporation (the Corporation) is the holding company for City National Bank (the Bank). City National Bank delivers banking, trust and investment services through more than 50 offices in Southern California, the San Francisco Bay Area, and New York City. Because the Bank comprises substantially all of the business of the Corporation, references to the Company mean the Corporation and the Bank together. As of July 15, 2005, the Corporation was approved to become a financial holding company pursuant to the Gramm-Leach-Bliley Act of 1999 (the GLB Act). Subject to the GLB Act and related rules and regulations, a financial holding company may engage in activities that are financial in nature or are incidental to financial activity.
2. Our accounting and reporting policies conform with generally accepted accounting principles (GAAP) and practices in the financial services industry. To prepare the financial statements in conformity with GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period. The results of operations reflect any 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 periods presented. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Corporations Annual Report on Form 10-K for the year ended December 31, 2004. The results for the 2005 interim periods are not necessarily indicative of the results expected for the full year.
3. Trading account securities are stated at fair 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 reported as other comprehensive income, which is shown as a separate component of shareholders equity.
4. Certain prior periods data have been reclassified to conform to current period presentation.
5. The following table provides information about purchases by the Company of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act during the quarter ended June 30, 2005.
(1) There were no repurchases by the Company of its common stock pursuant to the repurchase program that was publicly announced on May 24, 2004 (Program).
(2) Remaining shares available for repurchase pursuant to the program approved on May 24, 2004 by the Companys Board of Directors. Unless terminated earlier by resolution of our Board of Directors, the program will expire when we have repurchased all shares authorized for repurchase thereunder.
(3) During the second quarter of 2005, 604 shares were received in payment of the exercise price of stock options.
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 both June 30, 2005 and June 30, 2004, no stock options were antidilutive.
6. The Company applies APB Opinion No. 25 Accounting for Stock Issued to Employees 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 Corporations stock option grants are such that the exercise price equals the current market price of the common stock. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123 Share-Based Payment using the Black-Scholes option-pricing model, the Companys proforma net income would have been reduced to the proforma amounts indicated below:
The Company recorded $1.1 million in expense for restricted stock awards in the second quarter of 2005 and $2.0 million for the first six months of 2005 compared with $0.8 million and $1.3 million for the quarter and first six months of 2004, respectively.
The Black-Scholes option-pricing model requires assumptions on the expected life of the options based upon the pattern of exercise of options granted by the Corporation in the past; volatility based on changes in the price of the Corporations common stock during the past 10 years, measured weekly; the dividend yield and the 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 expected term is based on an historical analysis of exercise activity.
The actual pre-tax value, if any, which a grantee may realize will depend upon the difference between the option exercise price and the market price of the Corporations common stock on the date of exercise.
On April 14, 2005 the Securities and Exchange Commission announced a new rule delaying the implementation of Statement of Financial Accounting Standards No. 123R, Share-Based Payment. The Commissions new rule allows companies to implement Statement No. 123R at the start of their next fiscal year, which begins after June 15, 2005. The Company will comply with the requirements of Statement No. 123R as of January 1, 2006. The current estimate of the full-year cost of complying with Statement No. 123R is $0.07 per share.
7. As part of its asset and liability management strategies, the Company uses interest rate swaps to reduce cash flow variability and to moderate changes in the fair value of long-term financial instruments. In accordance with Statement of Financial Accounting Standards No. 133 Accounting for Derivative
Instruments and Hedging Activities, as amended (SFAS No. 133), the Company recognizes derivatives as assets or liabilities on the balance sheet at their fair value. The treatment of changes in the fair value of derivatives depends on the character of the transaction.
In accordance with SFAS No. 133, the Company documents its hedge relationships, including identification of the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction at the time the derivative contract is executed. This includes designating each derivative contract as either (i) a fair value hedge (a hedge of a recognized asset or liability), (ii) a cash flow hedge (a hedge of a forecasted transaction or of the variability of the cash flows to be received or paid related to a recognized asset or liability) or (iii) an undesignated hedge (a derivative instrument not designated as a hedging instrument whose change in fair value is recognized as a benefit for protection against changing interest rates). All derivatives designated as fair value or cash flow hedges are linked to specific assets and liabilities on the balance sheet. The Company has not had any undesignated hedges during 2005 or 2004.
Both at inception and at least quarterly thereafter, the Company assesses whether the derivatives used in hedging transactions are highly effective (as discussed in SFAS No. 133) in offsetting changes in either the fair value or cash flows of the hedged item. For cash flow hedges, in which derivatives hedge the variability of cash flows related to loans that are indexed to US dollar LIBOR or to the Banks prime interest rate, the interest rate payment characteristics of LIBOR or prime based loans are analyzed, and interest rate swaps are executed to match the key terms of the underlying loan transactions, thus ensuring the effectiveness at inception. At least quarterly, the loan portfolio is evaluated and compared to the related interest rate swap transaction to ensure continuing effectiveness. For fair value hedges, in which derivatives hedge the fair value of certain certificates of deposits, subordinated debt and other long-term debt, the interest rate swaps are structured so that all key terms of the swaps match those of the underlying debt transaction, therefore ensuring hedge effectiveness at inception. On a quarterly basis, fair value hedges are analyzed to ensure that the key terms of the hedged item and hedging instrument remain unchanged, therefore ensuring continuing effectiveness.
For effective fair-value hedges, the changes in the fair value of derivatives is reflected in current earnings on the same line in the consolidated statement of income as the hedged item, i.e. included in interest expense on deposits, other long-term debt and subordinated debt. For ineffective fair value hedges, the changes in fair value (the difference between changes in the fair value of the interest rate swap agreement and the hedged item) are recognized in other non-interest income in the consolidated statement of income. Fair values are determined from verifiable third-party sources that have considerable experience with the interest rate swap market.
For effective cash-flow hedges, changes in the derivatives fair value are reported in other comprehensive income. When the cash flows associated with the hedged item are realized, the gain or loss included in other comprehensive income is recognized on the same line in the consolidated statement of income as the hedged item, i.e. included in the interest income on loans. To the extent these derivatives are not effective, changes in their fair values will be immediately recognized in other non-interest income in the consolidated statement of income.
For both fair value and cash flow hedges, the periodic accrual of interest receivable or payable on interest rate swaps is recorded as an adjustment to net interest income for the hedged items.
The Company discontinues hedge accounting prospectively when (i) a derivative is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item, (ii) a derivative expires or is sold, terminated, or exercised, (iii) a derivative is de-designated as a hedge, because it is unlikely that a forecasted transaction will occur; (iv) the Company determines that designation of a derivative as a hedge is no longer appropriate.
If a derivative instrument in a fair value hedge is terminated or the hedge designation removed, the previous adjustments to the carrying amount of the hedged asset or liability are subsequently accounted for in the same manner as other components of the carrying amount of that asset or liability. For interest-earning assets and interest-bearing liabilities, such adjustments are amortized into earnings over the remaining life of the respective asset or liability. If a derivative instrument in a cash flow hedge is terminated or the hedge designation is removed, related amounts reported in other comprehensive income are reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings.
8. As we previously reported, the California Franchise Tax Board has taken the position that certain real estate investment trust (REIT) and registered investment company (RIC) tax deductions shall be disallowed under California law. As of June 30, 2005, the Company continues to reflect a $36.4 million state tax receivable for the years 2000, 2001 and 2002 after giving effect to reserves for loss contingencies on the refund claims, or an equivalent of $23.7 million after giving effect to Federal tax benefits. Management is aggressively pursuing its claims for REIT and RIC refunds for the 2000 to 2002 tax years, however, no outcome can be predicted with certainty and an adverse outcome on the refund claims could result in a loss of all or a portion of the net $23.7 million state tax receivable.
9. The Corporation has a profit sharing retirement plan covering eligible employees. Contributions are made annually and are allocated to participants based on their salaries. For the second quarter of 2005, the Company recorded profit sharing contributions expense of $3.2 million and $7.8 million for the six-month period ended June 30, 2005, compared to $4.1 million and $8.0 million for the second quarter of 2004 and the six-month period ending June 30, 2004.
The Company has a Supplemental Executive Retirement Plan (SERP) for one of its officers. At June 30, 2005, there was a $2.3 million unfunded pension liability and a $0.8 million intangible asset related to the SERP. The total expense for the second quarter of 2005 was $0.1 million, and $0.3 million for the six-month period ended June 30, 2005, compared to $0.01 million for the second quarter 2004, and $0.3 million for the six-month period ended June 30, 2004, respectively.
(1) Certain prior period balances have been restated to conform to the current period presentation.
(2) The efficiency ratio is defined as noninterest expense, excluding OREO expense, divided by total revenue (net interest income on a tax-equivalent basis and noninterest income).
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.
Critical Accounting Policies
The Companys accounting policies are fundamental to understanding managements 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 could be reported under different conditions or using different assumptions. These policies relate to the accounting for securities, allowance for credit losses, derivatives and hedging activities, and stock-based performance plans. The Company, with the concurrence of the Audit Committee and the Compensation, Nominating and Governance Committee, has reviewed and approved these critical accounting policies, which are further described in Managements Discussion and Analysis and Note 1 (Summary of Significant Accounting Policies) to the Consolidated Financial Statements in the Companys 2004 Form 10-K as of December 31, 2004.
City National Corporation is the parent company of City National Bank, the second largest independent bank headquartered in California. The Corporation offers a full complement of banking, trust and investment services through more than 50 offices, including 12 full-service regional centers, in Southern California, the San Francisco Bay Area and New York City.
The Corporation recorded net income of $57.7 million, or $1.13 per share, for the second quarter of 2005 compared with $52.2 million, or $1.03 per share, for the second quarter of 2004 and $55.5 million, or $1.09 per share, for the first quarter of 2005.
· Revenue for the second quarter of 2005 rose 11 percent over the second quarter of 2004.
· Average loans grew to $8.8 billion, up 9 percent from the second quarter of 2004.
· The net interest margin of 4.73 percent at June 30, 2005 represents a 2-basis-point decrease from the March 31, 2005 net interest margin of 4.75 percent, but a 24-basis-point increase over the June 30, 2004 net interest margin of 4.49 percent.
· Credit quality continued to be strong. Nonaccrual loans as of June 30, 2005 fell to $22.2 million, a 47 percent decline from June 30, 2004. The Corporation required no provision for credit losses, remaining adequately reserved at 1.66 percent of total loans.
· Average deposits for the second quarter reached $11.7 billion, up 5 percent from the same period last year.
As disclosed in the Companys press release on second-quarter earnings, management continues to expect earnings per share for 2005 to be approximately 11 to 14 percent higher than earnings per share for 2004.
Second quarter revenue (net interest income plus noninterest income) grew to $201 million, up 11 percent from the second quarter of 2004, and 2 percent higher than the first quarter of this year.
Net Interest Income
Fully taxable-equivalent net interest income reached $152.7 million in the second quarter of 2005, up 13 percent from $135.6 million for the same period last year. Compared to the first quarter of 2005, fully taxable-equivalent net interest income grew 2 percent from $149.9 million. The margin narrowed primarily because average loans grew faster than average deposits and the yield on the Companys securities portfolio fell 13 basis points, primarily due to the sale of higher yielding preferred stock in government-sponsored enterprises.
The banks prime rate was 6.25 percent on June 30, 2005, up from 4.25 percent at the same time last year, and 5.75 percent on March 31, 2005.
Second-quarter average loan balances increased 9 percent over the same period last year. Residential mortgage loans grew 16 percent, while commercial loans and commercial real estate mortgage loans each rose 6 percent. Real estate construction loans fell 5 percent, primarily as the result of accelerated repayments due to the fast pace of new home sales and early refinancing by income property developers taking advantage of low interest rates. Compared with the first quarter of this year, average loans increased in all categories except real estate construction loans.
In the first six months of 2005, the Companys average loan balances increased 9 percent over the first six months of 2004.
Total loan balances at June 30, 2005 were $300 million higher than they were at March 31, 2005, reflecting the growth of commercial lending and most real estate-related loan categories.
The Companys average deposits reached $11.7 billion in the second quarter, up 5 percent from the same period last year and 1 percent from the first quarter of 2005. In the first six months of 2005, the Companys average deposits grew 7 percent over the first six months of 2004.
Period-end deposits were 3 percent higher than they were at March 31 of this year.
As part of its long-standing asset-liability management strategy, the Company uses plain vanilla interest rate swaps to hedge loans, deposits, and borrowings. The notional value of these swaps was $1.4 billion at June 30, 2005, up $0.3 billion from the second quarter of last year, but unchanged from the first quarter of this year. The swaps added $3.3 million to net interest income in the second quarter of 2005, compared with $4.8 million in the first quarter of 2005, and $8.0 in the second quarter of 2004. These amounts included $2.9 million, $3.6 million, and $5.5 million, respectively, for interest rate swaps qualifying as fair value hedges. Income from swaps qualifying as cash flow hedges was $0.4 million for the second quarter of 2005, compared with $1.2 million for the first quarter of 2005, and $2.5 million for the second
quarter of 2004. Income from existing swaps qualifying as cash-flow hedges of loans expected to be recorded in net interest income within the next twelve months is $3.5 million.
The following table presents the components of net interest income on a fully taxable-equivalent basis for the three and six months ended June 30, 2005 and 2004. 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.