UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

CITY NATIONAL CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

 

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 the filing requirements for at least the past 90 days. Yes  xNo  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (Check one):

Large Accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

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

As of August 1, 2007, there were 48,935,930 shares of Common Stock outstanding.

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CITY NATIONAL CORPORATION

CONSOLIDATED BALANCE SHEET

		June 30,			December 31,			June 30,
Dollars in thousands, except per share amounts		2007			2006			2006
		(Unaudited)			(Unaudited)
Assets
Cash and due from banks		$	513,463		$	423,114		$	467,076
Due from banks - interest-bearing		139,539			60,940			50,416
Federal funds sold		170,000			127,000			1,900
Securities available-for-sale - cost $2,880,736; $3,018,190; and $3,348,607 at June 30, 2007, December 31, 2006 and June 30, 2006, respectively		2,798,538			2,954,372			3,211,590
Trading account securities		117,456			147,907			123,418
Loans		11,018,834			10,386,005			9,821,755
Less allowance for loan and lease losses		157,849			155,342			157,580
Net loans		10,860,985			10,230,663			9,664,175
Premises and equipment, net		106,672			94,745			84,802
Deferred tax asset		143,956			125,992			146,477
Goodwill		427,909			249,641			253,286
Intangibles, net		91,009			37,920			44,718
Bank-owned life insurance		71,146			70,156			68,772
Affordable housing investments		67,158			65,800			66,468
Customers' acceptance liability		7,958			3,877			4,582
Other assets		280,307			292,254			288,248
Total assets		$	15,796,096		$	14,884,381		$	14,475,928
Liabilities
Demand deposits		$	5,926,048		$	6,002,068		$	5,880,630
Interest checking deposits		753,428			755,098			711,368
Money market deposits		3,751,589			3,216,949			3,214,296
Savings deposits		164,433			153,417			168,526
Time deposits-under $100,000		240,660			198,329			177,392
Time deposits-$100,000 and over		2,294,247			1,846,955			1,826,618
Total deposits		13,130,405			12,172,816			11,978,830
Federal funds purchased and securities sold under repurchase agreements		269,938			422,903			234,995
Other short-term borrowings		72,818			97,525			143,724
Subordinated debt		266,962			269,848			266,675
Long-term debt		219,282			217,569			209,864
Reserve for off-balance sheet credit commitments.		17,832			16,424			15,206
Other liabilities		160,422			164,079			196,177
Acceptances outstanding		7,958			3,877			4,582
Total liabilities		14,145,617			13,365,041			13,050,053
Minority interest in consolidated subsidiaries		29,029			28,425			27,985
Commitments and contingencies
Shareholders' Equity
Preferred Stock authorized - 5,000,000; none outstanding		—			—			—
Common Stock-par value-$1.00; authorized - 75,000,000;
Issued - 50,825,254; 50,718,794; and 50,734,861 shares at June 30, 2007,
December 31, 2006 and June 30, 2006, respectively.		50,825			50,719			50,735
Additional paid-in capital		419,277			412,248			402,476
Accumulated other comprehensive loss		(50,609		)	(41,386		)	(86,931		)
Retained earnings		1,307,638			1,264,697			1,186,637
Treasury shares, at cost - 1,578,322; 2,835,908; and 2,214,875 shares at June 30, 2007, December 31, 2006 and June 30, 2006, respectively		(105,681		)	(195,363		)	(155,027		)
Total shareholders' equity		1,621,450			1,490,915			1,397,890
Total liabilities and shareholders' equity		$	15,796,096		$	14,884,381		$	14,475,928

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

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CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

		For the three months ended						For the six months ended
		June 30,						June 30,
In thousands, except per share amounts		2007			2006			2007			2006
Interest Income
Loans .		$	192,295		$	166,377		$	372,938		$	321,809
Securities available-for-sale		31,704			38,121			63,824			79,973
Trading account		910			833			1,697			1,389
Due from banks - interest-bearing		756			269			1,287			481
Federal funds sold and securities purchased under resale agreements		320			604			503			744
Total interest income		225,985			206,204			440,249			404,396
Interest Expense
Deposits		57,434			36,527			107,758			63,980
Federal funds purchased and securities sold under repurchase agreements		6,190			6,716			13,746			15,649
Subordinated debt		4,048			3,706			8,072			7,197
Other long-term debt		3,721			3,196			7,318			6,528
Other short-term borrowings		1,528			2,061			2,999			4,638
Total interest expense		72,921			52,206			139,893			97,992
Net interest income		153,064			153,998			300,356			306,404
Provision for credit losses		—			(610		)	—			(610		)
Net interest income after provision for credit losses		153,064			154,608			300,356			307,014
Noninterest Income
Trust and investment fees		34,823			24,909			65,077			46,683
Brokerage and mutual fund fees		13,958			12,269			27,738			23,953
Cash management and deposit transaction charges		8,472			7,691			16,943			15,755
International services		7,562			6,870			14,025			12,859
Bank-owned life insurance		761			677			1,385			1,611
Gain (loss) on sale of securities		866			(716		)	1,135			(8		)
Loss on sale of loans and other assets		—			—			(46		)	—
Other		7,307			6,888			13,467			12,665
Total noninterest income		73,749			58,588			139,724			113,518
Noninterest Expense
Salaries and employee benefits		80,904			73,718			158,888			145,334
Net occupancy of premises		10,362			9,460			19,820			18,472
Legal and professional fees		9,318			9,190			18,641			18,662
Information services		5,243			4,571			10,242			9,027
Depreciation and amortization		5,122			4,662			10,122			9,322
Marketing and advertising		5,783			4,990			9,781			9,006
Office services		2,938			2,549			5,685			5,240
Amortization of intangibles		2,623			1,974			4,253			3,865
Equipment		797			623			1,515			1,255
Other operating		7,446			6,222			13,352			11,871
Total noninterest expense		130,536			117,959			252,299			232,054
Minority interest expense		2,325			1,213			4,401			2,441
Income before income taxes		93,952			94,024			183,380			186,037
Income taxes		34,799			35,283			67,682			70,063
Net income		$	59,153		$	58,741		$	115,698		$	115,974
Net income per share, basic		$	1.22		$	1.20		$	2.39		$	2.36
Net income per share, diluted		$	1.19		$	1.16		$	2.34		$	2.28
Shares used to compute income per share, basic		48,675			48,957			48,323			49,220
Shares used to compute income per share, diluted		49,838			50,654			49,461			50,977
Dividends per share		$	0.46		$	0.41		$	0.92		$	0.82

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

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CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY

AND COMPREHENSIVE INCOME

(Unaudited)

										Accumulated
							Additional			other									Total
		Shares		Common			paid-in			comprehensive			Retained			Treasury			shareholders'
Dollars in thousands		issued		stock			capital			income (loss)			Earnings			stock			equity
Balance, December 31, 2005		50,600,943		$	50,601		$	396,659		$	(51,551	)	$	1,121,474		$	(59,175	)	$	1,458,008
Adjustment to initially apply Staff Accounting Bulletin No. 108		—		—			—			—			(10,174		)	—			(10,174		)
Balance, January 1, 2006		50,600,943		50,601			396,659			(51,551		)	1,111,300			(59,175		)	1,447,834
Net income		—		—			—			—			115,974			—			115,974
Other comprehensive loss net of tax:
Net unrealized loss on securities available-for-sale, net of reclassification of $2.9 million for net loss included in net income		—		—			—			(34,363		)	—			—			(34,363		)
Net unrealized loss on cash flow hedges, net of reclassification of $2.8 million net loss included in net income		—		—			—			(771		)	—			—			(771		)
Other net unrealized loss		—		—			—			(246		)	—			—			(246		)
Total other comprehensive loss		—		—			—			(35,380		)	—			—			(35,380		)
Issuance of shares for stock options		68,246		68			(3,406		)	—			—			12,150			8,812
Restricted stock grants, net of cancellations		65,672		66			(66		)	—			—			—			—
Stock-based employee compensation expense		—		—			6,026			—			—			—			6,026
Tax benefit from stock options		—		—			3,263			—			—			—			3,263
Cash dividends paid		—		—			—			—			(40,637		)	—			(40,637		)
Repurchased shares, net		—		—			—			—			—			(108,002		)	(108,002		)
Balance, June 30, 2006		50,734,861		$	50,735		$	402,476		$	(86,931	)	$	1,186,637		$	(155,027	)	$	1,397,890
Balance, December 31, 2006		50,718,794		$	50,719		$	412,248		$	(41,386	)	$	1,264,697		$	(195,363	)	$	1,490,915
Adjustment to initially apply FASB Interpretation 48		—		—			—			—			(28,036		)	—			(28,036		)
Balance, January 1, 2007		50,718,794		50,719			412,248			(41,386		)	1,236,661			(195,363		)	1,462,879
Net income		—		—			—			—			115,698			—			115,698
Other comprehensive loss net of tax:
Change due to amortization of prior service cost		—		—			—			109			—			—			109
Net unrealized loss on securities available-for-sale, net of reclassification of $0.4 million for net gain included in net income		—		—			—			(10,653		)	—			—			(10,653		)
Net unrealized gain on cash flow hedges, net of reclassification of $2.0 million net loss included in net income		—		—			—			1,321			—			—			1,321
Total other comprehensive loss		—		—			—			(9,223		)	—			—			(9,223		)
Issuance of shares for stock options		—		—			(13,936		)	—			—			29,776			15,840
Restricted stock grants, net of cancellations		106,460		106			(106		)	—			—			—			—
Stock-based employee compensation expense		—		—			6,981			—			—			—			6,981
Tax benefit from stock options		—		—			6,179			—			—			—			6,179
Cash dividends paid		—		—			—			—			(44,721		)	—			(44,721		)
Repurchased shares, net		—		—			—			—			—			(20,198		)	(20,198		)
Issuance of shares for acquisition		—		—			7,911									80,104			88,015
Balance, June 30, 2007		50,825,254		$	50,825		$	419,277		$	(50,609	)	$	1,307,638		$	(105,681	)	$	1,621,450

 

See accompanying Notes to Unaudited Consolidated Financial Statements.

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CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

		For the six months ended
		June 30,
Dollars in thousands		2007			2006
Cash Flows From Operating Activities
Net income		$	115,698		$	115,974
Adjustments to net income:
Provision for credit losses		—			(610		)
Amortization of intangibles		4,253			3,865
Depreciation and amortization		10,122			9,322
Amortization of cost and discount on long-term debt		354			353
Stock-based employee compensation expense		7,078			6,094
Net change in deferred income tax benefit		(6,809		)	(25,450		)
Loss on sale of loans and other assets		46			—
(Gain) loss on sales of securities		(1,135		)	8
Net decrease (increase) in trading securities		30,451			(64,074		)
Net change in other assets and other liabilities		(44,442		)	(49,802		)
Other, net		10,753			75,504
Net cash provided by operating activities		126,369			71,184
Cash Flows From Investing Activities
Purchase of securities available-for-sale		(119,342		)	(79,156		)
Sales of securities available-for-sale		48,502			401,099
Maturities and paydowns of securities		272,842			358,538
Loan originations, net of principal collections		(241,479		)	(556,153		)
Purchase of premises and equipment		(14,701		)	(11,256		)
Acquisition of BBNV, net of cash acquired		(50,398		)	—
Acquisition of CWA, net of cash acquired		(100,621		)	—
Other investing activities		(5,244		)	(20,061		)
Net cash (used) provided by investing activities		(210,441		)	93,011
Cash Flows From Financing Activities
Net increase (decrease) in deposits		516,496			(159,642		)
Net (decrease) increase in federal funds purchased and securities sold under repurchase agreements		(152,965		)	44,805
Net (decrease) increase in short-term borrowings, net of transfers from long-term debt		(24,707		)	43,724
Net increase (decrease) in other borrowings		96			(147		)
Proceeds from exercise of stock options		15,840			8,812
Tax benefit from exercise of stock options		6,179			3,263
Stock repurchases		(20,198		)	(108,002		)
Cash dividends paid		(44,721		)	(40,636		)
Net cash provided (used) by financing activities		296,020			(207,823		)
Net increase (decrease) in cash and cash equivalents		211,948			(43,628		)
Cash and cash equivalents at beginning of year		611,054			563,020
Cash and cash equivalents at end of period		$	823,002		$	519,392
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest		$	142,645		$	89,106
Income taxes		52,595			63,143

 

See accompanying Notes to the Unaudited Consolidated Financial Statements.

 

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CITY NATIONAL CORPORATION

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.     Basis of Presentation - 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 62 offices in Southern California, the San Francisco Bay area, Nevada and New York City.  As of June 30, 2007, the Corporation had a majority ownership interest in nine investment advisor subsidiaries and a minority interest in one other firm.  The Company also has an unconsolidated subsidiary, Business Bancorp Capital Trust I.  Because the Bank comprises substantially all of the business of the Corporation, references to the “Company” mean the Corporation and the Bank together.  The Corporation is approved as a financial holding company pursuant to the Gramm-Leach-Bliley Act of 1999.  The financial statements of the Company include the accounts of the Corporation, its non-bank subsidiaries, the Bank, and the Bank’s wholly-owned subsidiaries, after the elimination of all material intercompany transactions.

2.     Acquisitions - On February 28, 2007, the Company completed the acquisition of Business Bank Corporation, the parent of Business Bank of Nevada (“BBNV”) and an unconsolidated subsidiary, Business Bancorp Capital Trust I, in a cash and stock transaction valued at $167 million.  BBNV operated as a wholly-owned subsidiary of City National Corporation until after the close of business on April 30, 2007, at which time it was merged into the Bank.

On May 1, 2007, the Corporation completed the acquisition of Lydian Wealth Management in an all-cash transaction.   The investment advisory firm is headquartered in Rockville, Maryland and now manages or advises on client assets totaling $8.2 billion.  Lydian Wealth Management changed its name to Convergent Wealth Advisors (CWA) and became a subsidiary of Convergent Capital Management LLC, the Chicago-based asset management holding company that the Company acquired in 2003.  All of the senior executives of CWA signed employment agreements and acquired a significant minority ownership interest in CWA.

3.     Accounting Policies - Our accounting and reporting policies conform to generally accepted accounting principles (“GAAP”) and practices in the financial services industry.  The Company is on the accrual basis of accounting for income and expense.  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 Company’s Annual Report on Form 10-K for the year ended December 31, 2006.  The results for the 2007 interim periods are not necessarily indicative of the results expected for the full year.

During the six months ended June 30, 2007, the following accounting pronouncements were issued or became effective:

·      The Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) on January 1, 2007.  FIN 48 provides a single model for addressing uncertainty in tax positions and requires expanded annual disclosures about tax positions.  Upon adoption, the Company recognized a cumulative effect adjustment as a charge to January 1, 2007 retained earnings and the contingent tax reserve of $28.0 million.

·      On February 15, 2007 the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”).   SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value.  SFAS 159’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently.  SFAS 159 will be effective for the Company as of January 1, 2008. The implementation may result in recognizing certain financial assets and liabilities (for which the fair value option was selected) at fair value, with the effect of the adoption recorded as a cumulative effect adjustment to beginning retained earnings. Additional disclosures will be required upon implementation. The statement is not expected to have a significant impact on the Company’s financial statements.

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

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4.     Investment Securities - All securities other than trading securities are classified as available-for-sale and are valued at fair value.  Unrealized gains or losses on securities available-for-sale are excluded from net income but are included as a separate component of other comprehensive income, net of taxes. Premiums or discounts on securities available-for-sale are amortized or accreted into income using the interest method over the expected lives of the individual securities. The value of securities is reduced when unrealized losses are considered other-than-temporary, and a new cost basis is established for the securities. Any other-than-temporary loss is included in net income. Realized gains or losses on sales of securities available-for-sale are recorded using the specific identification method.  Trading securities are valued at market value with any unrealized gains or losses included in net income.

5.     Equity Securities - 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, 2007:

							Total number of Shares
				Average			(or Units) Purchased as		Maximum Number of
		Total Number of		Price Paid			Part of Publicly		Shares that May Yet
		Shares (or Units)		per Share (or			Announced Plans or		Be Purchased Under
Period		Purchased		Unit)			Programs		the Plans or Programs
06/01/07 - 06/30/07		16,500		$	74.74		16,500		778,200
		16,500		74.74			16,500	(1)	778,200	(1)

 

(1)    On July 6, 2006, the Company’s Board of Directors authorized the Company to repurchase 1.5 million additional shares of the Company’s stock following completion of its previously approved initiative.  Unless terminated earlier by resolution of our Board of Directors, the program will expire when the Company has repurchased all shares authorized for repurchase there under.  During the second quarter of 2007, the Company repurchased an aggregate of 16,500 shares of our common stock pursuant to this repurchase program and there are 778,200 shares remaining to be purchased.  We received 935 shares in payment for the exercise price of stock options.

Basic earnings per share are based on the weighted average shares of common stock outstanding less unvested restricted shares and units.  Diluted earnings per share give effect to all potential dilutive common shares, which consist of stock options and restricted shares and units that were outstanding during the period.  At June 30, 2007, there were 304,354 antidilutive options compared to 511,497 antidilutive options at June 30, 2006.

6.     Stock-Based Compensation - The Company applies FASB Statement No. 123 (revised), Share Based Payment, (“SFAS 123R”) in accounting for stock option plans.  The Company uses a Black-Scholes model to determine the stock-based compensation expense for these plans.  On June 30, 2007, the Company had one stock-based compensation plan, which provides for granting of stock options, restricted shares and restricted units.  The compensation cost that has been charged against income for all stock-based awards was $3.7 million for the three months ended June 30, 2007, and $7.1 for the six months ended June 30, 2007, compared to $3.4 million and $6.1 million for the three and six-month periods ended June 30, 2006, respectively.  The Company received $17.3 million and $9.7 million in cash for the exercise of stock options during the six month periods ended June 30, 2007 and June 30, 2006, respectively.  These shares had a corresponding tax benefit of $6.2 million and $3.1 million for the six month periods ended June 30, 2007 and June 30, 2006, respectively.

Plan Description

The City National Corporation Amended and Restated Omnibus Plan, (the “Plan”), approved by shareholders, permits the grant of stock options and restricted stock or restricted units to its employees not to exceed 3.9 million shares of common stock.  The Company believes that such awards better align the interest of its employees with those of its shareholders.  Employee option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant.  These awards vest in four years and have 10-year contractual terms.  Restricted stock awards generally vest over five years.  Certain option and stock awards provide for accelerated vesting if there is a change in control (as defined in the Plan), or upon retirement, for options issued prior to January 31, 2006.  All unexercised options expire 10 years from the grant date.

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

		For the three months ended						For the six months ended
		June 30,						June 30,
		2007			2006			2007			2006
Expected volatility		21.07		%	23.51		%	21.72		%	24.82		%
Weighted-average volatility		21.05		%	23.51		%	21.96		%	23.95		%
Expected dividends		$	2.55		$	2.12		$	2.53		$	2.14
Expected term (in years)		5.86			5.64			6.03			5.91
Risk-free rate		4.70		%	4.84		%	4.66		%	4.60		%

 

Using the Black-Scholes model, the weighted-average grant-date fair values of options granted during the six-month periods ended June 30, 2007 and 2006 were $17.21 and $19.90, respectively.  The total intrinsic values of options exercised during the six-month periods ended June 30, 2007 and 2006 were $16.8 million, and $6.4 million, respectively.

A summary of option activity under the Plan as of June 30, 2007 are presented below:

							Weighted-
				Weighted-			Average		Aggregate
				Average			Remaining		Intrinsic
		Shares		Exercise			Contractual		Value
Options		(000)		Price			Term		($000)
Outstanding at January 1, 2007		4,295		$	49.54		4.90		$	114,045
Options related to acquisition of BBNV		109		10.77			4.06		7,151
Granted		465		74.68			9.65		654
Exercised		(448	)	38.56			3.18		(16,832		)
Forfeited or expired		(69	)	64.48			7.35		(803		)
Outstanding at June 30, 2007		4,352		52.14			5.51		$	104,215
Exercisable at June 30, 2007		3,215		44.94			4.38		$	100,155

 

A summary of the changes in the Company’s unvested options during the six-month period ended June 30, 2007 is presented below:

				Weighted-Average
				Grant-Date
Unvested Shares		Shares (000)		Fair Value
Unvested at January 1, 2007		1,139		$	17.23
Granted		465		17.21
Vested		(403	)	15.43
Forfeited		(64	)	15.99
Unvested at June 30, 2007		1,137		20.51

 

The number of shares vested during the six-month period ended June 30, 2007 was 403,230.  As of June 30, 2007, there was $31.0 million of total unrecognized compensation cost related to unvested stock-based compensation arrangements granted under the Plan.  That cost is expected to be recognized over a weighted-average period of 2.9 years.

7.     Interest Rate Risk Management - As part of its asset and liability management strategies, the Company uses interest-rate swaps to reduce cash flow variability and to moderate changes in the fair value of financial instruments.  In

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accordance with FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”), the Company recognizes derivatives as assets or liabilities on the balance sheet at their fair value. The treatment of changes in the fair value of derivatives depends on the character of the transaction.

In accordance with SFAS 133, the Company documents its hedge relationships, including identification of the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction at the time the derivative contract is executed. This includes designating each derivative contract as either (i) a “fair value hedge” which is a hedge of a recognized asset or liability, (ii) a “cash flow hedge” which hedges a forecasted transaction or the variability of the cash flows to be received or paid related to a recognized asset or liability or (iii) an “undesignated hedge”, a derivative instrument not designated as a hedging instrument whose change in fair value is recognized directly in the consolidated statement of income.  All derivatives designated as fair value or cash flow hedges are linked to specific hedged items or to groups of specific assets and liabilities on the balance sheet.  Effectiveness is measured retrospectively and prospectively, and the Company expects that the hedges will continue to be effective in the future. The Company did not have any undesignated hedges as of June 30, 2007 and did not have any significant undesignated hedges during 2007 or 2006.

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

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

 For fair value hedges, the Company uses interest-rate swaps to hedge the fair value of certain certificates of deposits, subordinated debt and other long-term debt.  The certificates of deposit are single maturity, fixed-rate, non-callable, negotiable certificates of deposit that pay interest only at maturity and contain no compounding features.  The certificates cannot be early redeemed except in the case of the holder’s death.  The interest-rate swaps are executed at the time the deposit transactions are negotiated.  The subordinated debt and other long-term debt consists of City National Bank ten-year subordinated notes with a face value of $115.9 million due on January 15, 2008, City National Bank ten-year subordinated notes with a face value of $150.0 million due on September 1, 2011 and City National Corporation senior notes with a face value of $225.0 million due on February 15, 2013.  Interest-rate swaps are structured so that all key terms of the swaps match those of the underlying deposit or debt transactions, therefore ensuring there is no hedge ineffectiveness at inception.  The Company ensures that the interest-rate swaps meet the requirements for utilizing the short cut method in accordance with paragraph 68 of FAS 133 and maintains appropriate documentation for each interest-rate swap.  On a quarterly basis, fair value hedges are analyzed to ensure that the key terms of the hedged items and hedging instruments remain unchanged, and the hedging counterparties are evaluated to ensure that there are no adverse developments regarding counterparty default, thus ensuring continuous effectiveness.  For these fair value hedges, the effective portion of the changes in the fair value of derivatives is reflected in current earnings, on the same line in the consolidated statement of income as the related hedged item.

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

The Company discontinues hedge accounting prospectively when (i) a derivative is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item, (ii) a derivative expires or is sold, terminated, or exercised, (iii) a derivative is un-designated as a hedge, because it is unlikely that a forecasted transaction will occur; or (iv) the Company determines that designation of a derivative as a hedge is no longer appropriate.  If a fair value hedge derivative instrument is terminated or the hedge designation removed, the previous adjustments to the carrying amount of the hedged asset or liability would be subsequently accounted for in the same manner as other components of the carrying amount of that asset or liability. For interest-earning assets and interest-bearing liabilities, such adjustments

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would be amortized into earnings over the remaining life of the respective asset or liability. If a cash flow hedge derivative instrument is terminated or the hedge designation is removed, related amounts reported in other comprehensive income are reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings.

8.     Income Taxes - The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN 48”) on January 1, 2007.  Upon adoption, the Company recognized a cumulative effect adjustment as a charge to January 1, 2007 retained earnings and a reduction to the contingent tax reserve of $28.0 million, which is comprised of a $25.2 million tax liability and $2.8 million of accrued interest.

As previously reported, on December 31, 2003, the California Franchise Tax Board (FTB) announced that it had taken the position that certain REIT and regulated investment company (“RIC”) tax deductions would be disallowed.  Prior to this announcement, the Company had created two REITs (one of which was formed as a RIC in 2000) to raise capital for the Bank. While company management continues to believe that the tax benefits related to the REITs are appropriate, the Company deemed it prudent to participate in the statutory Voluntary Compliance Initiative-Option 2, requiring payment of all California taxes and interest on potential tax exposures for the 2000-2002 tax years.  The Company may then claim a refund for the taxes paid while avoiding potential penalties. The Company has elected to proceed with its claim for refund as allowed by law. At December 31, 2006, the Company had a state tax receivable of $43.1 million, or $28.0 million after giving effect to Federal tax benefits.

As mentioned above, in connection with the adoption of FIN 48, the Company reduced the state tax receivable balance to zero.  Management continues to aggressively pursue its claims with the Franchise Tax Board for the REIT and RIC refunds for the tax years 2000 through 2004.  While an outcome from the claims cannot be predicted with certainty, a potentially adverse result will not have any material impact on the Company’s financial position.

The Company recognizes accrued interest and penalties relating to unrecognized tax benefits as an income tax provision expense.   For the six-month period ended June 30, 2007, the Company recognized approximately $186,000 in interest and penalties.  The Company had approximately $9.4 million and $6.6 million of accrued interest and penalties as of June 30, 2007 and December 31, 2006, respectively.

The Company is currently under examination by the Internal Revenue Service (“IRS”) for the tax years 2002 and 2003.  The Company expects to begin IRS appeals proceedings related to certain tax positions taken in these years.  The potential financial statement impact of these items range from a tax benefit of $3.6 million to a tax expense of $6.8 million.

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

9.    Retirement Plans - The Company has a profit-sharing retirement plan with an Internal Revenue Code Section 401(k) feature covering eligible employees. Contributions are made annually into a trust fund and are allocated to participants based on their salaries.  The Company recorded profit sharing contributions expense of $4.2 million and $8.1 million for the three-month and six-month periods ended June 30, 2007, compared to $4.6 million and $8.6 million for the three-month and six-month periods ended June 30, 2006, respectively.

The Company has a Supplemental Executive Retirement Plan (‘SERP’) for one of its executive officers.  The SERP meets the definition of a pension plan per FASB Statement No. 87, Employers’ Accounting for Pensions. The Company applies FASB Statement No. 158, Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS 158), in accounting for the SERP.  At June 30, 2007, there was a $4.4 million unfunded pension liability related to the SERP.  The total expense for the second quarter of 2007 was $0.2 million, and $0.4 million for the six-month period ended June 30, 2007, compared to $0.2 million and $0.4 million for the second quarter of 2006 and the six-month period ended June 30, 2006, respectively.

The Company does not provide any other post-retirement benefits.

10.   Guarantees - In connection with the liquidation of an investment acquired in a previous bank merger, the Company has an outstanding long-term guarantee. The maximum liability under the guarantee is $17.9 million, but the Company does not expect to make any payments under the terms of this guarantee.

11.   Segment Reporting - The Company has one primary reportable segment, Commercial and Private Banking.  All other subsidiaries, Wealth Management Services and the portion of corporate departments allocated to the operating segments

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other than Commercial and Private Banking are aggregated in a second reportable segment called Other.  The factors considered in determining whether individual operating segments could be aggregated include that the operating segments:  (i) offer the same products and services, (ii) offer services to the same types of clients, (iii) provide services in the same manner and (iv) operate in the same regulatory environment.

The Commercial and Private Banking reportable segment is the aggregation of the Commercial and Private Banking, Real Estate, Entertainment and Core Banking operating segments.  The Commercial and Private Banking segment provides banking products and services, including commercial and mortgage loans, lines of credit, deposits, cash management services, international trade finance and letters of credit to small and medium-sized businesses, entrepreneurs and affluent individuals.  This segment primarily serves clients in California, New York and Nevada.

The Other segment includes the Bank’s Wealth Management Services division, all non-bank subsidiaries including the asset management affiliates, and the portion of corporate departments, including the Treasury Department and the Asset Liability Funding Center, that have not been allocated to Commercial and Private Banking.

Business segment earnings are the primary measure of the segment’s performance as evaluated by management.  Business segment earnings include direct revenue and expenses of the segment as well as corporate and inter-unit allocations.  Allocations of corporate expenses, such as data processing and human resources, are calculated based on estimated activity levels for the fiscal year.  Inter-unit support groups, such as Operational Services, are allocated based on actual expenses incurred.  Capital is allocated using a methodology similar to that used for federal regulatory risk-based capital purposes.  If applicable, any provision for credit losses is allocated based on various credit factors, including but not limited to, credit risk ratings, ratings migration, charge-offs and recoveries and loan growth.  Income taxes are charged on unit income at the Company’s statutory tax rate of 42 percent.

Exposure to market risk is managed in the Treasury department.  Interest rate risk is removed from the units comprising the Commercial and Private Banking segment to the Funding Center through a fund transfer pricing (FTP) model.  The FTP model records a cost of funds or credit for funds using a combination of matched maturity funding for most assets and liabilities and a blended rate based on various maturities for the remaining assets and liabilities.

The Bank’s investment portfolio and unallocated equity are included in the Other segment.  Core deposit intangible amortization is charged to the affected operating segments.

Operating results for the Commercial and Private Banking reportable segment are discussed in the Segment Results section of Management’s Discussion and Analysis.  Selected financial information for each segment is presented in the following tables.

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CITY NATIONAL CORPORATION

Segment Results

		Commercial			Commercial
		& Private			& Private									Consolidated			Consolidated
(Dollars in thousands)		Banking			Banking			Other			Other			Company			Company
Three months ended June 30,		2007			2006			2007			2006			2007			2006
Earnings Summary:
Net interest income		$	154,382		$	150,570		$	(1,318	)	$	3,428		$	153,064		$	153,998
Provision for credit losses		—			(610		)	—			—			—			(610		)
Noninterest income		17,819			16,648			55,930			41,940			73,749			58,588
Depreciation and amortization		1,597			1,424			3,525			3,238			5,122			4,662
Noninterest expense and minority interest		95,432			90,217			32,307			24,293			127,739			114,510
Income before income taxes		75,172			76,187			18,780			17,837			93,952			94,024
Income taxes		26,350			28,195			8,449			7,088			34,799			35,283
Net income		$	48,822		$	47,992		$	10,331		$	10,749		$	59,153		$	58,741
Selected Average Balances:
Loans		$	10,898,571		$	9,789,871		$	112,289		$	113,022		$	11,010,860		$	9,902,893
Total Assets		11,307,535			10,234,403			4,145,045			4,548,066			15,452,580			14,782,469
Deposits		11,316,062			10,557,892			1,253,872			1,372,837			12,569,934			11,930,729
Performance measures:
Return on average assets (annualized)		1.7		%	1.9		%	1.0		%	0.9		%	1.5		%	1.6		%

 

		Commercial			Commercial
		& Private			& Private									Consolidated			Consolidated
(Dollars in thousands)		Banking			Banking			Other			Other			Company			Company
Six months ended June 30,		2007			2006			2007			2006			2007			2006
Earnings Summary:
Net interest income		$	302,465		$	296,861		$	(2,109	)	$	9,543		$	300,356		$	306,404
Provision for credit losses		—			(610		)	—			—			—			(610		)
Noninterest income		33,820			32,241			105,904			81,277			139,724			113,518
Depreciation and amortization		3,158			2,852			6,964			6,470			10,122			9,322
Noninterest expense and minority interest		186,656			178,951			59,922			46,222			246,578			225,173
Income before income taxes		146,471			147,909			36,909			38,128			183,380			186,037
Income taxes		51,802			55,190			15,880			14,873			67,682			70,063
Net income		$	94,669		$	92,719		$	21,029		$	23,255		$	115,698		$	115,974
Selected Average Balances:
Loans		$	10,679,058		$	9,655,709		$	105,103		$	109,012		$	10,784,161		$	9,764,721
Total Assets		11,079,807			10,089,819			4,066,396			4,714,433			15,146,203			14,804,252
Deposits		11,016,657			10,576,607			1,228,272			1,183,575			12,244,929			11,760,182
Performance measures:
Return on average assets (annualized)		1.7		%	1.9		%	1.0		%	1.0		%	1.5		%	1.6		%

 

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CITY NATIONAL CORPORATION
FINANCIAL HIGHLIGHTS

											Percent change
		At or for the three months ended									June 30, 2007 from
		June 30,			March 31,			June 30,			March 31,		June 30,
Dollars in thousands, except per share amounts		2007			2007			2006			2007		2006
		(Unaudited)						(Unaudited)
For The Quarter
Net income		$	59,153		$	56,545		$	58,741		5	%	1	%
Net income per common share, basic		1.22			1.18			1.20			3		2
Net income per common share, diluted		1.19			1.15			1.16			3		3
Dividends per common share		0.46			0.46			0.41			0		12
At Quarter End
Assets		$	15,796,096		$	15,264,047		$	14,475,928		3		9
Securities		2,915,994			2,939,527			3,335,008			(1	)	(13	)
Loans		11,018,834			10,649,598			9,821,755			3		12
Deposits		13,130,405			12,606,381			11,978,830			4		10
Shareholders’ equity		1,621,450			1,590,538			1,397,890			2		16
Book value per common share		33.21			32.73			29.05			1		14
Average Balances
Assets		$	15,452,580		$	14,836,422		$	14,782,469		4		5
Securities		2,945,091			2,971,386			3,581,206			(1	)	(18	)
Loans		11,010,860			10,554,944			9,902,893			4		11
Deposits		12,569,934			11,916,314			11,930,729			5		5
Shareholders’ equity		1,603,837			1,518,744			1,454,175			6		10
Selected Ratios
Return on average assets (annualized)		1.54		%	1.55		%	1.59		%	(1	)	(3	)
Return on average shareholders’ equity (annualized)		14.79			15.10			16.20			(2	)	(9	)
Corporation’s tier 1 leverage		7.97			8.59			8.38			(7	)	(5	)
Corporation’s tier 1 risk-based capital		9.82			10.62			11.20			(8	)	(12	)
Corporation’s total risk-based capital		12.28			13.12			14.26			(6	)	(14	)
Period-end shareholders’ equity to period-end assets		10.26			10.42			9.66			(2	)	6
Dividend payout ratio, per share		38.22			39.11			34.43			(2	)	11
Net interest margin		4.47			4.49			4.65			(0	)	(4	)
Efficiency ratio (1)		57.73			57.18			55.20			1		5
Asset Quality Ratios
Nonaccrual loans to total loans		0.20		%	0.22		%	0.15		%	(9	)	33
Nonaccrual loans and OREO to total loans and OREO		0.20			0.22			0.15			(9	)	33
Allowance for loan and lease losses to total loans		1.43			1.51			1.60			(5	)	(11	)
Allowance for loan and lease losses to nonaccrual loans		707.58			687.55			1,050.47			3		(33	)
Net (charge-offs)/recoveries to average loans (annualized)		(0.08		)	0.05			0.05			(260	)	(260	)
At Quarter End
Assets under management (2)		$	35,849,921		$	27,074,427		$	26,617,271		32		35
Assets under management or administration (2)		57,328,627			48,432,580			46,963,373			18		22

 

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

(2)   Excludes $10.5 billion, $9.3 billion, and $9.3 billion of assets under management for an asset manager in which City National held a minority ownership interest as of June 30, 2007, March 31, 2007, and June 30, 2006, respectively.

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