Edgar Filing: CITY NATIONAL CORP

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

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)

Delaware		95-2568550
(State of Incorporation)		(I.R.S. Employer Identification No.)

City National Plaza

555 South Flower Street, Los Angeles, California, 90071

(Address of principal executive offices)(Zip Code)

(213) 673-7700

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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

Large accelerated filer x		Accelerated filer o

Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)

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 April 30, 2013, there were 54,149,103 shares of Common Stock outstanding (including unvested restricted shares).

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TABLE OF CONTENTS

PART I
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	49
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	78
Item 4.	Controls and Procedures	82

PART II
Item 1A.	Risk Factors	83
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	83
Item 6.	Exhibits	83

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CITY NATIONAL CORPORATION

CONSOLIDATED BALANCE SHEETS

	March 31,			December 31,
(in thousands, except share amounts)	2013			2012
	(Unaudited)
Assets
Cash and due from banks	$	144,290		$	151,969
Due from banks - interest-bearing	123,146			246,336
Federal funds sold and securities purchased under resale agreements	219,500			17,100
Securities available-for-sale - cost $7,610,489 and $9,057,238 at March 31, 2013 and December 31, 2012, respectively:
Securities pledged as collateral	40,102			48,697
Held in portfolio	7,697,949			9,157,292
Securities held-to-maturity - fair value $1,434,836 and $1,446,599 at March 31, 2013 and December 31, 2012, respectively	1,400,890			1,398,403
Trading securities	53,526			115,059
Loans and leases, excluding covered loans	15,216,906			14,818,295
Less: Allowance for loan and lease losses	282,328			277,888
Loans and leases, excluding covered loans, net	14,934,578			14,540,407
Covered loans, net of allowance for loan losses	909,563			986,223
Net loans and leases	15,844,141			15,526,630
Premises and equipment, net	152,389			149,433
Deferred tax asset	133,923			124,461
Goodwill	642,622			642,622
Customer-relationship intangibles, net	46,207			48,139
Affordable housing investments	150,466			154,011
Customers’ acceptance liability	1,581			7,859
Other real estate owned ($43,751 and $58,276 covered by FDIC loss share at March 31, 2013 and December 31, 2012, respectively)	63,537			79,303
FDIC indemnification asset	142,906			150,018
Other assets	576,579			601,160
Total assets	$	27,433,754		$	28,618,492
Liabilities
Demand deposits	$	13,800,017		$	14,264,797
Interest checking deposits	2,132,392			2,459,972
Money market deposits	5,705,033			5,610,844
Savings deposits	425,935			398,824
Time deposits-under $100,000	232,350			203,422
Time deposits-$100,000 and over	641,859			564,496
Total deposits	22,937,586			23,502,355
Short-term borrowings	806,760			1,423,798
Long-term debt	702,967			706,051
Reserve for off-balance sheet credit commitments	25,205			24,837
Acceptances outstanding	1,581			7,859
Other liabilities	361,653			407,162
Total liabilities	24,835,752			26,072,062
Redeemable noncontrolling interest	41,113			41,112
Commitments and contingencies
Shareholders’ equity
Preferred stock, par value $1.00 per share; 5,000,000 shares authorized; 175,000 shares issued at March 31, 2013 and December 31, 2012	169,920			169,920
Common stock, par value $1.00 per share; 75,000,000 shares authorized; 54,133,065 and 53,885,886 shares issued at March 31, 2013 and December 31, 2012, respectively	54,133			53,886
Additional paid-in capital	496,013			490,339
Accumulated other comprehensive income	74,222			86,582
Retained earnings	1,788,041			1,738,957
Treasury shares, at cost - 495,447 and 669,454 shares at March 31, 2013 and December 31, 2012, respectively	(25,440		)	(34,366		)
Total common shareholders’ equity	2,386,969			2,335,398
Total shareholders’ equity	2,556,889			2,505,318
Total liabilities and shareholders’ equity	$	27,433,754		$	28,618,492

See accompanying Notes to the Unaudited Consolidated Financial Statements.

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CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	For the three months ended
	March 31,
(in thousands, except per share amounts)	2013			2012
Interest income
Loans and leases	$	170,290		$	168,102
Securities	44,262			45,387
Due from banks - interest-bearing	112			93
Federal funds sold and securities purchased under resale agreements	1,136			10
Total interest income	215,800			213,592
Interest expense
Deposits	2,939			4,033
Federal funds purchased and securities sold under repurchase agreements	278			31
Subordinated debt	6,106			4,061
Other long-term debt	4,979			4,754
Other short-term borrowings	425			—
Total interest expense	14,727			12,879
Net interest income	201,073			200,713
Provision for credit losses on loans and leases, excluding covered loans	—			—
Provision for losses on covered loans	9,892			7,466
Net interest income after provision	191,181			193,247
Noninterest income
Trust and investment fees	46,653			33,654
Brokerage and mutual fund fees	8,066			5,028
Cash management and deposit transaction charges	13,009			11,168
International services	9,619			8,785
FDIC loss sharing (expense) income, net	(4,352		)	866
Gain on disposal of assets	1,114			2,191
Gain on sale of securities	1,046			449
Other	18,373			13,559
Impairment loss on securities:
Total other-than-temporary impairment loss on securities	(492		)	(2,432		)
Less: Portion of loss recognized in other comprehensive income	492			2,432
Net impairment loss recognized in earnings	—			—
Total noninterest income	93,528			75,700
Noninterest expense
Salaries and employee benefits	128,195			120,245
Net occupancy of premises	15,989			13,686
Legal and professional fees	11,612			11,880
Information services	9,391			8,149
Depreciation and amortization	8,172			7,428
Amortization of intangibles	1,932			1,886
Marketing and advertising	8,316			6,816
Office services and equipment	4,946			3,948
Other real estate owned	5,250			12,094
FDIC assessments	5,481			4,479
Other operating	12,056			10,109
Total noninterest expense	211,340			200,720
Income before income taxes	73,369			68,227
Income taxes	21,261			21,719
Net income	$	52,108		$	46,508
Less: Net income attributable to noncontrolling interest	585			243
Net income attributable to City National Corporation	$	51,523		$	46,265
Less: Dividends on preferred stock	2,406			—
Net income available to common shareholders	$	49,117		$	46,265
Net income per common share, basic	$	0.90		$	0.86
Net income per common share, diluted	$	0.90		$	0.86
Weighted average common shares outstanding, basic	53,731			52,741
Weighted average common shares outstanding, diluted	54,068			53,021
Dividends per common share	$	—		$	0.25

See accompanying Notes to the Unaudited Consolidated Financial Statements.

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CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

	For the three months ended
	March 31,
(in thousands)	2013			2012
Net income	$	52,108		$	46,508
Other comprehensive (loss) income, net of tax:
Securities available-for-sale:
Net unrealized (losses) gains arising during the period	(11,523		)	9,570
Reclassification adjustment for net gains included in net income	(516		)	(229		)
Non-credit related impairment loss	(286		)	(1,414		)
Net change on cash flow hedges (1)	(35		)	(42		)
Pension liability adjustment	—			1,085
Total other comprehensive (loss) income	(12,360		)	8,970
Comprehensive income	$	39,748		$	55,478
Less: Comprehensive income attributable to noncontrolling interest	585			243
Comprehensive income attributable to City National Corporation	$	39,163		$	55,235

(1) See Note 12 for additional information on other comprehensive income related to cash flow hedges.

See accompanying Notes to the Unaudited Consolidated Financial Statements.

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CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the three months ended
	March 31,
(in thousands)	2013			2012
Cash Flows From Operating Activities
Net income	$	52,108		$	46,508
Adjustments to net income:
Provision for losses on covered loans	9,892			7,466
Amortization of intangibles	1,932			1,886
Depreciation and amortization	8,172			7,428
Share-based employee compensation expense	5,091			4,706
Deferred income tax (benefit) expense	(598		)	297
Gain on disposal of assets	(1,114		)	(2,191		)
Gain on sale of securities	(1,046		)	(449		)
Other, net	1,472			(2,430		)
Net change in:
Trading securities	61,692			(20,559		)
Other assets and other liabilities, net	(25,394		)	(41,395		)
Net cash provided by operating activities	112,207			1,267
Cash Flows From Investing Activities
Purchase of securities available-for-sale	(293,985		)	(629,049		)
Sales of securities available-for-sale	1,034,250			5,173
Maturities and paydowns of securities available-for-sale	695,518			1,362,442
Purchase of securities held-to-maturity	(9,965		)	(530,159		)
Maturities and paydowns of securities held-to-maturity	6,736			1,005
Loan originations, net of principal collections	(313,834		)	(346,887		)
Net payments for premises and equipment	(11,128		)	(7,025		)
Net cash paid in acquisitions	—			(850		)
Other investing activities, net	23,927			20,592
Net cash provided by (used in) investing activities	1,131,519			(124,758		)
Cash Flows From Financing Activities
Net (decrease) increase in deposits	(564,769		)	400,155
Net decrease in federal funds purchased and securities sold under repurchase agreements	(510,600		)	(40,000		)
Net increase in short-term borrowings	100,000			—
Issuance of long-term debt	5,603			—
Repayment of long-term debt	(214,081		)	(1,500		)
Proceeds from exercise of stock options	11,835			2,000
Tax benefit from exercise of stock options	2,627			770
Cash dividends paid	(2,406		)	(13,302		)
Other financing activities, net	(404		)	(1,272		)
Net cash (used in) provided by financing activities	(1,172,195		)	346,851
Net increase in cash and cash equivalents	71,531			223,360
Cash and cash equivalents at beginning of year	415,405			244,814
Cash and cash equivalents at end of period	$	486,936		$	468,174
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest	$	26,960		$	22,386
Income taxes	9,261			27,163
Non-cash investing activities:
Transfer of loans to other real estate owned	$	9,675		$	8,292
Transfer of SERP liability to equity	—			8,348

See accompanying Notes to the Unaudited Consolidated Financial Statements.

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CITY NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

									Accumulated
	Common					Additional			other									Total
	shares	Preferred		Common		paid-in			comprehensive			Retained			Treasury			shareholders’
(in thousands, except share amounts)	issued	stock		stock		capital			income			earnings			shares			equity

Balance, January 1, 2012	53,885,886	$	—	$	53,886	$	489,200		$	72,372		$	1,611,969		$	(82,578	)	$	2,144,849
Net income (1)	—	—		—		—			—			46,265			—			46,265
Other comprehensive income, net of tax	—	—		—		—			8,970			—			—			8,970
Issuance of shares under share-based compensation plans	—	—		—		(12,175		)	—			—			12,337			162
Share-based employee compensation expense	—	—		—		4,549			—			—			—			4,549
Tax expense from share-based compensation plans	—	—		—		(136		)	—			—			—			(136		)
Common stock dividends	—	—		—		—			—			(13,373		)	—			(13,373		)
Net change in deferred compensation plans	—	—		—		42			—			—			—			42
Change in redeemable noncontrolling interest	—	—		—		(111		)	—			—			—			(111		)
Other (2)	—	—		—		8,348			—			—			—			8,348
Balance, March 31, 2012	53,885,886	$	—	$	53,886	$	489,717		$	81,342		$	1,644,861		$	(70,241	)	$	2,199,565

Balance, January 1, 2013	53,885,886	$	169,920	$	53,886	$	490,339		$	86,582		$	1,738,957		$	(34,366	)	$	2,505,318
Net income (1)	—	—		—		—			—			51,523			—			51,523
Other comprehensive loss, net of tax	—	—		—		—			(12,360		)	—			—			(12,360		)
Issuance of shares under share-based compensation plans	247,179	—		247		(337		)	—			—			8,926			8,836
Share-based employee compensation expense	—	—		—		4,297			—			—			—			4,297
Tax benefit from share-based compensation plans	—	—		—		1,651			—			—			—			1,651
Dividends:
Preferred	—			—		—			—			(2,406		)				(2,406		)
Common	—	—		—		—			—			(33		)	—			(33		)
Net change in deferred compensation plans	—	—		—		122			—			—			—			122
Change in redeemable noncontrolling interest	—	—		—		(59		)	—			—			—			(59		)
Balance, March 31, 2013	54,133,065	$	169,920	$	54,133	$	496,013		$	74,222		$	1,788,041		$	(25,440	)	$	2,556,889

(1) Net income excludes net income attributable to redeemable noncontrolling interest of $585 and $243 for the three month periods ended March 31, 2013 and 2012, respectively. Redeemable noncontrolling interest is reflected in the mezzanine section of the consolidated balance sheets. See Note 17 of the Notes to the Unaudited Consolidated Financial Statements.

(2) Conversion of pension liability to equity due to SERP amendment. See Note 14 for additional information.

See accompanying Notes to the Unaudited Consolidated Financial Statements.

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CITY NATIONAL CORPORATION

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Organization

City National Corporation (the “Corporation”) is the holding company for City National Bank (the “Bank”). The Bank delivers banking, trust and investment services through 78 offices in Southern California, the San Francisco Bay area, Nevada, New York City, Nashville, Tennessee and Atlanta, Georgia. As of March 31, 2013, the Corporation had five consolidated investment advisory affiliates and one 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.

Consolidation

The consolidated 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. It also includes noncontrolling interest, which is the portion of equity in a subsidiary not attributable to a parent. Redeemable noncontrolling interests are noncontrolling ownership interests that are redeemable at the option of the holder or outside the control of the issuer. The redeemable noncontrolling interests of third parties in the Corporation’s investment advisory affiliates are not considered to be permanent equity and are reflected in the mezzanine section between liabilities and equity in the consolidated balance sheets. Noncontrolling interests’ share of subsidiary earnings is reflected as Net income attributable to noncontrolling interest in the consolidated statements of income.

The Company’s investment management and wealth advisory affiliates are organized as limited liability companies. The Corporation generally owns a majority position in each affiliate and certain management members of each affiliate own the remaining shares. The Corporation has contractual arrangements with its affiliates whereby a percentage of revenue is allocable to fund affiliate operating expenses (“operating share”) while the remaining portion of revenue (“distributable revenue”) is allocable to the Corporation and the noncontrolling owners. All majority-owned affiliates that meet the prescribed criteria for consolidation are consolidated. The Corporation’s interests in investment management affiliates in which it holds a noncontrolling share are accounted for using the equity method. Additionally, the Company has various interests in variable interest entities (“VIEs”) that are not required to be consolidated. See Note 16 for a more detailed discussion on VIEs.

Use of Estimates

The Company’s accounting and reporting policies conform to 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. Circumstances and events that differ significantly from those underlying the Company’s estimates and assumptions could cause actual financial results to differ from those estimates. The material estimates included in the financial statements relate to the allowance for loan and lease losses, the reserve for off-balance sheet credit commitments, other real estate owned (“OREO”), valuation of share-based compensation awards, income taxes, goodwill and intangible asset impairment, securities impairment, private equity and alternative investment impairment, valuation of assets and liabilities acquired in business combinations, including contingent consideration liabilities, subsequent valuations of acquired impaired loans, Federal Deposit Insurance Corporation (“FDIC”) indemnification assets, valuation of noncontrolling interest, and the valuation of financial assets and liabilities reported at fair value.

The Company has applied its critical accounting policies and estimation methods consistently in all periods presented in these financial statements. The Company’s estimates and assumptions are expected to change as changes in market conditions and the Company’s portfolio occur in subsequent periods.

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Note 1. Summary of Significant Accounting Policies (Continued)

Basis of Presentation

The Company is on the accrual basis of accounting for income and expenses. The results of operations reflect any adjustments, all of which are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q, and which, in the opinion of management, are necessary for a fair presentation of the results for the periods presented. In accordance with the usual practice of banks, assets and liabilities of individual trust, agency and fiduciary funds have not been included in the financial statements. 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, 2012.

The results for the 2013 interim period are not necessarily indicative of the results expected for the full year. The Company has not made any significant changes in its critical accounting policies or in its estimates and assumptions from those disclosed in its 2012 Annual Report other than the adoption of new accounting pronouncements and other authoritative guidance that became effective for the Company on or after January 1, 2013. Refer to Accounting Pronouncements for discussion of accounting pronouncements adopted in 2013.

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

Accounting Pronouncements

During the three months ended March 31, 2013, the following accounting pronouncements applicable to the Company were issued or became effective:

· In October 2012, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2012-06, Business Combinations (Topic 805), Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution (“ASU 2012-06”). ASU 2012-06 clarifies existing guidance on the subsequent measurement of an indemnification asset recognized as a result of a government-assisted acquisition of a financial institution. Existing guidance specifies that an acquirer must record an indemnification asset at the same time as it recognizes the indemnified item in a business combination. The indemnification asset is initially and subsequently measured on the same basis as the indemnified item, subject to any contractual limitations on its amount or management’s assessment of its collectability. Under ASU 2012-06, when there is a subsequent change in the cash flows expected to be collected on the indemnified asset, the reporting entity should subsequently measure the indemnification asset on the same basis as the underlying loans by taking into account the contractual limitation of the indemnification agreement. Any amortization of changes in value shall be limited to the lesser of the contractual term of the indemnification agreement and the remaining life of the indemnified assets. Adoption of ASU 2012-06 on January 1, 2013 did not have a significant impact on the Company’s consolidated financial statements.

· In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210), Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (“ASU 2013-01”). ASU 2013-01 clarifies that ordinary trade receivables and other receivables are not in the scope of ASU 2011-11, Balance Sheet (Topic 210), Disclosures about Offsetting Assets and Liabilities. Specifically, ASU 2011-11 applies only to derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in the Accounting Standards Codification (“ASC”) or subject to a master netting arrangement or similar agreement. The Company adopted ASU 2013-01 for first quarter 2013 reporting. Refer to Note 19 for balance sheet offsetting disclosures.

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Note 1. Summary of Significant Accounting Policies (Continued)

· In February 2013, the FASB issued ASU 2013-02, Other Comprehensive Income (Topic 220), Reporting of Amounts Reclassified out of Other Comprehensive Income (“ASU 2013-02”). The provisions in the ASU supersede and replace the presentation requirements for reclassifications out of accumulated other comprehensive income (“AOCI”) in ASU 2011-05 and 2011-12. ASU 2013-02 requires entities to disclose additional information about reclassification adjustments, including (1) changes in AOCI balances by component and (2) significant items reclassified out of AOCI. The new disclosure requirements are effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. The Company adopted ASU 2013-02 for its first quarter 2013 reporting. Adoption of the new guidance did not have a significant impact on the Company’s consolidated financial statements.

· In February 2013, the FASB issued ASU 2013-04, Liabilities (Topic 405), Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date (“ASU 2013-04”). ASU 2013-04 provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements. Examples of obligations within the scope of the ASU include debt arrangements, other contractual obligations and settled litigation. ASU 2013-04 requires entities to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date, as the sum of (1) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors, and (2) any additional amount the reporting entity expects to pay on behalf of its co-obligors. Required disclosures include a description of the joint-and-several arrangement and the total outstanding amount of the obligation for all joint parties. The ASU is effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2013. Adoption of the new guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

Note 2. Business Combinations

Rochdale Investment Management

On July 2, 2012, the Company acquired Rochdale Investment Management, LLC and associated entities (collectively, “Rochdale”), a New York City-based investment firm that manages assets for affluent and high-net-worth clients and their financial advisors across the nation. The investment firm was acquired with both cash and contingent consideration, and operates as a wholly owned subsidiary of the Bank.

The Company recognized goodwill of approximately $86.5 million and a client contract intangible of $19.0 million related to the acquisition. The Company recognized a contingent consideration liability at its fair value of $46.7 million. The contingent consideration arrangements require the Company to pay additional cash consideration to Rochdale’s former shareholders at certain points in time over the next six years if certain criteria, such as revenue growth and pre-tax margin, are met. The fair value of the contingent consideration was estimated using a probability-weighted discounted cash flow model. Although the acquisition agreement does not set a limit on the total payment, the Company estimates that the total consideration payment could be in the range of $32 million to $74 million, but will ultimately be determined based on actual future results.

First American Equipment Finance

The Company acquired First American Equipment Finance (“FAEF”), a privately owned equipment leasing company, in an all-cash transaction on April 30, 2012. Headquartered in Rochester, New York, FAEF leases technology and office equipment nationwide. Its clients include educational institutions, hospitals and health systems, large law firms, insurance underwriters, enterprise businesses, professional service businesses and nonprofit organizations. FAEF operates as a wholly owned subsidiary of the Bank.

Excluding the effects of acquisition accounting adjustments, the Company acquired approximately $343.0 million in assets and assumed $325.0 million in liabilities. The Company acquired lease receivables with a fair value of $318.3 million and assumed borrowings and nonrecourse debt with a fair value of $320.9 million. The Company recognized goodwill of approximately $68.4 million.

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Note 3. Fair Value Measurements

The following tables summarize assets and liabilities measured at fair value as of March 31, 2013 and December 31, 2012 by level in the fair value hierarchy:

			Fair Value Measurements at Reporting Date Using
(in thousands)	Balance as of March 31, 2013		Quoted Prices in Active Markets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3
Measured on a Recurring Basis
Assets
Securities available-for-sale:
U.S. Treasury	$	30,370	$	30,370	$	—	$	—
Federal agency - Debt	1,114,603		—		1,114,603		—
Federal agency - MBS	645,480		—		645,480		—
CMOs - Federal agency	5,139,231		—		5,139,231		—
CMOs - Non-agency	50,776		—		50,776		—
State and municipal	445,170		—		398,960		46,210
Other debt securities	309,392		—		294,117		15,275
Equity securities and mutual funds	3,029		3,029		—		—
Trading securities	53,526		50,783		2,743		—
Mark-to-market derivatives (1)	59,055		382		58,673		—
Total assets at fair value	$	7,850,632	$	84,564	$	7,704,583	$	61,485

Liabilities
Mark-to-market derivatives	$	57,862	$	—	$	57,862	$	—
Contingent consideration liability	48,273		—		—		48,273
FDIC clawback liability	10,765		—		—		10,765
Other liabilities	344		—		344		—
Total liabilities at fair value (2)	$	117,244	$	—	$	58,206	$	59,038

Redeemable noncontrolling interest	$	41,113	—		—		$	41,113

Measured on a Nonrecurring Basis
Assets
Collateral dependent impaired loans (3):
Commercial real estate mortgages	$	7,300	$	—	$	—	$	7,300
Other real estate owned (4)	13,337		—		11,218		2,119
Private equity and alternative investments	686		—		—		686
Total assets at fair value	$	21,323	$	—	$	11,218	$	10,105

(1) Reported in Other assets in the consolidated balance sheets.

(2) Reported in Other liabilities in the consolidated balance sheets.

(3) Impaired loans for which fair value was calculated using the collateral valuation method.

(4) Includes covered OREO.

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Note 3. Fair Value Measurements (Continued)

			Fair Value Measurements at Reporting Date Using
(in thousands)	Balance as of December 31, 2012		Quoted Prices in Active Markets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3
Measured on a Recurring Basis
Assets
Securities available-for-sale:
U.S. Treasury	$	20,397	$	20,397	$	—	$	—
Federal agency - Debt	2,349,202		—		2,349,202		—
Federal agency - MBS	693,032		—		693,032		—
CMOs - Federal agency	5,318,253		—		5,318,253		—
CMOs - Non-agency	61,513		—		61,513		—
State and municipal	454,474		—		407,429		47,045
Other debt securities	307,417		—		289,275		18,142
Equity securities and mutual funds	1,701		1,701		—		—
Trading securities	115,059		113,010		2,049		—
Mark-to-market derivatives (1)	67,496		218		67,278		—
Total assets at fair value	$	9,388,544	$	135,326	$	9,188,031	$	65,187

Liabilities
Mark-to-market derivatives	$	64,432	$	—	$	64,432	$	—
Contingent consideration liability	47,724		—		—		47,724
FDIC clawback liability	9,970		—		—		9,970
Other liabilities	368		—		368		—
Total liabilities at fair value (2)	$	122,494	$	—	$	64,800	$	57,694

Redeemable noncontrolling interest	$	41,112	$	—	$	—	$	41,112

Measured on a Nonrecurring Basis
Assets
Collateral dependent impaired loans (3):
Commercial (4)	$	2,655	$	—	$	—	$	2,655
Commercial real estate mortgages	10,963		—		3,950		7,013
Residential mortgages	1,811		—		—		1,811
Real estate construction	7,918		—		—		7,918
Home equity loans and lines of credit	780		—		—		780
Installment	550		—		550		—
Other real estate owned (5)	44,396		—		34,624		9,772
Private equity and alternative investments	6,178		—		—		6,178
Total assets at fair value	$	75,251	$	—	$	39,124	$	36,127

(1) Reported in Other assets in the consolidated balance sheets.

(2) Reported in Other liabilities in the consolidated balance sheets.

(3) Impaired loans for which fair value was calculated using the collateral valuation method.

(4) Includes lease financing.

(5) Includes covered OREO.

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Note 3. Fair Value Measurements (Continued)

At March 31, 2013, $7.85 billion, or approximately 29 percent, of the Company’s total assets were recorded at fair value on a recurring basis, compared with $9.39 billion, or 33 percent, at December 31, 2012. The majority of these financial assets were valued using Level 1 or Level 2 inputs. Less than 1 percent of total assets were measured using Level 3 inputs. At March 31, 2013, $117.2 million of the Company’s total liabilities were recorded at fair value using Level 2 or Level 3 inputs, compared with $122.5 million at December 31, 2012. There were no transfers between Level 1 and Level 2 of the fair value hierarchy for assets or liabilities measured on a recurring basis during the three months ended March 31, 2013. At March 31, 2013, $21.3 million of the Company’s total assets were recorded at fair value on a nonrecurring basis, compared with $75.3 million at December 31, 2012. These assets represent less than one percent of total assets and were measured using Level 2 and Level 3 inputs.

Recurring Fair Value Measurements

Assets and liabilities for which fair value measurement is based on significant unobservable inputs are classified as Level 3 in the fair value hierarchy. The following table provides a reconciliation of the beginning and ending balances for Level 3 assets and liabilities measured at fair value on a recurring basis for the three months ended March 31, 2013 and 2012.

Level 3 Assets and Liabilities Measured on a Recurring Basis

	For the three months ended March 31, 2013									For the three months ended March 31, 2012
(in thousands)	Securities Available-for- Sale			Contingent Consideration Liability			FDIC Clawback Liability			Securities Available-for- Sale			FDIC Clawback Liability
Balance, beginning of period	$	65,187		$	(47,724	)	$	(9,970	)	$	19,583		$	(8,103	)
Total realized/unrealized gains (losses):
Included in earnings	—			—			(795		)	—			(616		)
Included in other comprehensive income	(199		)	—			—			964			—
Settlements	(3,555		)	—			—			(1,562		)	—
Other (1)	52			(549		)	—			24			—
Balance, end of period	$	61,485		$	(48,273	)	$	(10,765	)	$	19,009		$	(8,719	)

(1) Other rollforward activity consists of amortization of premiums and accretion of discounts recognized on the initial purchase of the securities available-for-sale and accretion of discount related to the contingent consideration liability.

Redeemable noncontrolling interest is classified as Level 3 in the fair value hierarchy and measured on a recurring basis. Refer to Note 17, Noncontrolling Interest, for a rollforward of activity for the three months ended March 31, 2013 and 2012.

Level 3 assets measured at fair value on a recurring basis consist of municipal auction rate securities and collateralized debt obligation senior notes that are included in securities available-for-sale. At March 31, 2013, municipal auction rate securities were valued using an average yield on California variable rate notes that were comparable in credit rating and maturity to the securities held, plus a liquidity premium. Senior notes totaling $15.3 million at March 31, 2013 were valued using the discounted cash flow method with the following unobservable inputs: (1) risk-adjusted discount rate consistent with similarly-rated securities, (2) prepayment rate of 2 percent, (3) default rate of 0.75 percent of performing collateral, and (4) 15 percent recovery rate with a 2-year lag.

Level 3 liabilities measured at fair value on a recurring basis consist of contingent consideration and an FDIC clawback liability that are included in other liabilities. Refer to Note 2, Business Combinations, for further discussion of the methodology used to value the contingent consideration liability. The FDIC clawback liability was valued using the discounted cash flow method based on the terms specified in loss-sharing agreements with the FDIC, the actual FDIC payments collected and the following unobservable inputs: (1) risk-adjusted discount rate reflecting the Bank’s credit risk, plus a liquidity premium, (2) prepayment assumptions and (3) credit assumptions.

There were no purchases, sales, or transfers out of Level 3 assets measured on a recurring basis during the three months ended March 31, 2013 and 2012. Paydowns of $3.6 million and $1.6 million were received on Level 3 assets measured on a recurring basis for the three months ended March 31, 2013 and 2012, respectively.

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Note 3. Fair Value Measurements (Continued)

Nonrecurring Fair Value Measurements

Assets measured at fair value on a nonrecurring basis using significant unobservable inputs include certain collateral dependent impaired loans, OREO for which fair value is not solely based on market observable inputs, and certain private equity and alternative investments. Private equity and alternative investments do not have readily determinable fair values. These investments are carried at cost and evaluated for impairment on a quarterly basis. Due to the lack of readily determinable fair values for these investments, the impairment assessment is based primarily on a review of investment performance and the likelihood that the capital invested would be recovered.

The table below provides information about valuation method, inputs and assumptions for nonrecurring Level 3 fair value measurements. The weight assigned to each input is based on the facts and circumstances that exist at the date of measurement.

Information About Nonrecurring Level 3 Fair Value Measurements

(in thousands)	Fair Value at March 31, 2013		Valuation Method	Unobservable Inputs
Collateral dependent impaired loans	$	7,300	Market	- Adjustments to external or internal appraised values (1)
				- Probability weighting of broker price opinions
				- Management assumptions regarding market trends or other relevant factors

Other real estate owned	$	2,119	Market	- Adjustments to external or internal appraised values (1)
				- Probability weighting of broker price opinions
				- Management assumptions regarding market trends or other relevant factors

Private equity and alternative investments	$	686	Cost Recovery	- Management’s assumptions regarding recoverability of investment based on fund financial performance, market conditions and other relevant factors

(1) Appraised values may be adjusted to reflect changes in market conditions that have occurred subsequent to the appraisal date, or for revised estimates regarding the timing or cost of the property sale. These adjustments are based on qualitative judgments made by management on a case-by-case basis.

Market-based valuation methods use prices and other relevant information generated by market transactions involving identical or comparable assets. Under the cost recovery approach, fair value represents an estimate of the amount of an asset expected to be recovered. The Company only employs the cost recovery approach for assets that are not readily marketable and for which minimal market-based information exists.

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Note 3. Fair Value Measurements (Continued)

For assets measured at fair value on a nonrecurring basis, the following table presents the total net (losses) gains, which include charge-offs, recoveries, specific reserves, OREO valuation write-downs and write-ups, gains and losses on sales of OREO, and impairment write-downs on private equity investments, recognized in the three months ended March 31, 2013 and 2012:

	For the three months ended March 31,
(in thousands)	2013			2012
Collateral dependent impaired loans:
Commercial	$	—		$	(368	)
Commercial real estate mortgages	145			(365		)
Residential mortgages	9			(582		)
Real estate construction	—			(6,472		)
Home equity loans and lines of credit	116			54
Installment	(138		)	(107		)
Other real estate owned (1)	(2,853		)	(8,465		)
Private equity and alternative investments	(399		)	(127		)
Total net losses recognized	$	(3,120	)	$	(16,432	)

(1) Net losses on OREO includes $2.8 million and $7.6 million of net losses related to covered OREO for the three months ended March 31, 2013 and 2012, respectively, a significant portion of which is reimbursable by the FDIC.

Fair Value of Financial Instruments

A financial instrument is broadly defined as cash, evidence of an ownership interest in another entity, or a contract that imposes a contractual obligation on one entity and conveys a corresponding right to a second entity to require delivery or exchange of a financial instrument. Refer to Note 1, Summary of Significant Accounting Policies, in the Company’s 2012 Form 10-K for additional information on fair value measurements.

The disclosure does not include estimated fair value amounts for assets and liabilities which are not defined as financial instruments but which have significant value. These assets and liabilities include the value of customer-relationship intangibles, goodwill, affordable housing investments carried at cost, other assets, deferred taxes and other liabilities. Accordingly, the total of the fair values presented does not represent the underlying value of the Company.

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Note 3. Fair Value Measurements (Continued)

The following tables summarize the carrying amounts and estimated fair values of those financial instruments that are reported at amortized cost in the Company’s consolidated balance sheets. The tables also provide information on the level in the fair value hierarchy for inputs used in determining the fair value of those financial instruments. Most financial assets and financial liabilities for which carrying amount equals fair value are considered by the Company to be Level 1 measurements in the fair value hierarchy.

	March 31, 2013
	Carrying		Total		Fair Value Measurements Using
(in millions)	Amount		Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	144.3	$	144.3	$	144.3	$	—	$	—
Due from banks - interest bearing	123.1		123.1		123.1		—		—
Federal funds sold and securities purchased under resale agreements	219.5		219.5		19.5		200.0		—
Securities held-to-maturity	1,400.9		1,434.8		—		1,434.8		—
Loans and leases, net of allowance	14,934.6		15,416.9		—		—		15,416.9
Covered loans, net of allowance	909.6		975.1		—		—		975.1
FDIC indemnification asset	142.9		118.8		—		—		118.8
Investment in FHLB and FRB stock	84.1		84.1		—		84.1		—

Financial Liabilities:
Deposits	$	22,937.6	$	22,941.7	$	—	$	22,063.4	$	878.3
Federal funds purchased and securities sold under repurchase agreements	703.6		703.6		703.6		—		—
Other short-term borrowings	103.2		103.2		100.0		—		3.2
Long-term debt	703.0		785.2		—		713.1		72.1

	December 31, 2012
	Carrying		Total		Fair Value Measurements Using
(in millions)	Amount		Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	152.0	$	152.0	$	152.0	$	—	$	—
Due from banks - interest bearing	246.3		246.3		246.3		—		—
Federal funds sold	17.1		17.1		17.1		—		—
Securities held-to-maturity	1,398.4		1,446.6		—		1,446.6		—
Loans and leases, net of allowance	14,540.4		14,988.6		—		4.5		14,984.1
Covered loans, net of allowance	986.2		1,055.0		—		—		1,055.0
FDIC indemnification asset	150.0		123.9		—		—		123.9
Investment in FHLB and FRB stock	90.0		90.0		—		90.0		—

Financial Liabilities:
Deposits	$	23,502.4	$	23,506.9	$	—	$	22,734.5	$	772.4
Federal funds purchased and securities sold under repurchase agreements	1,214.2		1,214.2		1,214.2		—		—
Other short-term borrowings	209.6		210.7				207.6		3.1
Long-term debt	706.1		774.8		—		698.9		75.9

Following is a description of the methods and assumptions used in estimating the fair values of these financial instruments:

Cash and due from banks, Due from banks—interest bearing, Federal funds sold and Securities purchased under resale agreements — For these short-term instruments, the carrying amount is a reasonable estimate of fair value. The fair value of securities purchased under term resale agreements is determined using a combination of quoted market prices and observable market inputs such as interest rates and credit spreads.

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Note 3. Fair Value Measurements (Continued)

Securities held-to-maturity — For securities held-to-maturity, the fair value is generally determined by quoted market prices, where available, or on observable market inputs appropriate for the type of security.

Loans and leases — Loans and leases, excluding covered loans, are not recorded at fair value on a recurring basis. Nonrecurring fair value adjustments are periodically recorded on impaired loans that are measured for impairment based on the fair value of collateral. Due to the lack of activity in the secondary market for the types of loans in the Company’s portfolio, a model-based approach is used for determining the fair value of loans for purposes of the disclosures in the previous table. The fair value of loans is estimated by discounting future cash flows using discount rates that incorporate the Company’s assumptions for current market yields, credit risk and liquidity premiums. Loan cash flow projections are based on contractual loan terms adjusted for the impact of current interest rate levels on borrower behavior, including prepayments. Loan prepayment assumptions are based on industry standards for the type of loans being valued. Projected cash flows are discounted using yield curves based on current market conditions. Yield curves are constructed by product type using the Bank’s loan pricing model for like-quality credits. The discount rates used in the Company’s model represent the rates the Bank would offer to current borrowers for like-quality credits. These rates could be different from what other financial institutions could offer for these loans.

Covered loans — The fair value of covered loans is based on estimates of future loan cash flows and appropriate discount rates, which incorporate the Company’s assumptions about market funding cost and liquidity premium. The estimates of future loan cash flows are determined using the Company’s assumptions concerning the amount and timing of principal and interest payments, prepayments and credit losses.

FDIC indemnification asset — The fair value of the FDIC indemnification asset is estimated by discounting estimated future cash flows based on estimated current market rates.

Investment in FHLB and FRB stock — Investments in Federal Home Loan Bank of San Francisco (“FHLB”) and Federal Reserve Bank (“FRB”) stock are recorded at cost. Ownership of these securities is restricted to member banks and the securities do not have a readily determinable market value. Purchases and sales of these securities are at par value with the issuer. The fair value of investments in FRB and FHLB stock is equal to the carrying amount.

Deposits — The fair value of demand and interest checking deposits, savings deposits, and certain money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit (“CD”) is determined by discounting expected future cash flows using the rates offered by the Bank for deposits of similar type and remaining maturity at the measurement date. This value is compared to the termination value of each CD given the Bank’s standard early withdrawal penalties. The fair value reported is the higher of the discounted present value of each CD and the termination value after the recovery of prepayment penalties. The Bank reviews pricing for its CD products weekly. This review gives consideration to market pricing for products of similar type and maturity offered by other financial institutions.

Federal funds purchased and Securities sold under repurchase agreements — The carrying amount is a reasonable estimate of fair value.

Other short-term borrowings — The fair value of the current portion of long-term debt classified in short-term borrowings is obtained through third-party pricing sources. The fair value of nonrecourse debt is determined by discounting estimated future cash flows based on estimated current market rates. The carrying amount of the remaining other short-term borrowings is a reasonable estimate of fair value.

Long-term debt — The fair value of long-term debt, excluding nonrecourse debt, is obtained through third-party pricing sources. The fair value of nonrecourse debt is determined by discounting estimated future cash flows based on estimated current market rates.

Off-balance sheet commitments, which include commitments to extend credit, are excluded from the table. A reasonable estimate of fair value for these instruments is the carrying amount of deferred fees and the reserve for any credit losses related to these off-balance sheet instruments. This estimate is not material to the Company’s financial position.

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Note 4. Securities

At March 31, 2013, the Company had total securities of $9.19 billion, comprised of securities available-for-sale at fair value of $7.74 billion, securities held-to-maturity at amortized cost of $1.40 billion and trading securities at fair value of $53.5 million. At December 31, 2012, the Company had total securities of $10.72 billion, comprised of securities available-for-sale at fair value of $9.21 billion, securities held-to-maturity at amortized cost of $1.40 billion and trading securities at fair value of $115.1 million.

The following is a summary of amortized cost and estimated fair value for the major categories of securities available-for-sale and securities held-to-maturity at March 31, 2013 and December 31, 2012:

			Gross		Gross
	Amortized		Unrealized		Unrealized
(in thousands)	Cost		Gains		Losses			Fair Value
March 31, 2013
Securities available-for-sale:
U.S. Treasury	$	30,353	$	17	$	—		$	30,370
Federal agency - Debt	1,111,725		2,951		(73		)	1,114,603
Federal agency - MBS	611,286		35,131		(937		)	645,480
CMOs - Federal agency	5,068,740		81,888		(11,397		)	5,139,231
CMOs - Non-agency	51,201		464		(889		)	50,776
State and municipal	430,002		16,188		(1,020		)	445,170
Other debt securities	306,845		7,722		(5,175		)	309,392
Total debt securities	7,610,152		144,361		(19,491		)	7,735,022
Equity securities and mutual funds	337		2,692		—			3,029
Total securities available-for-sale	$	7,610,489	$	147,053	$	(19,491	)	$	7,738,051

Securities held-to-maturity (1):
Federal agency - Debt	$	95,935	$	3,596	$	—		$	99,531
Federal agency - MBS	305,881		8,867		(946		)	313,802
CMOs - Federal agency	741,007		23,680		(1,960		)	762,727
State and municipal	258,067		3,280		(2,571		)	258,776
Total securities held-to-maturity	$	1,400,890	$	39,423	$	(5,477	)	$	1,434,836

December 31, 2012
Securities available-for-sale:
U.S. Treasury	$	20,393	$	7	$	(3	)	$	20,397
Federal agency - Debt	2,344,374		5,031		(203		)	2,349,202
Federal agency - MBS	653,428		39,673		(69		)	693,032
CMOs - Federal agency	5,233,126		91,165		(6,038		)	5,318,253
CMOs - Non-agency	62,975		662		(2,124		)	61,513
State and municipal	437,266		17,447		(239		)	454,474
Other debt securities	305,340		7,945		(5,868		)	307,417
Total debt securities	9,056,902		161,930		(14,544		)	9,204,288
Equity securities and mutual funds	336		1,365		—			1,701
Total securities available-for-sale	$	9,057,238	$	163,295	$	(14,544	)	$	9,205,989

Securities held-to-maturity (1):
Federal agency - Debt	$	97,183	$	4,032	$	—		$	101,215
Federal agency - MBS	303,642		11,490		(182		)	314,950
CMOs - Federal agency	745,980		28,973		(382		)	774,571
State and municipal	251,598		5,122		(857		)	255,863
Total securities held-to-maturity	$	1,398,403	$	49,617	$	(1,421	)	$	1,446,599

(1) Securities held-to-maturity are presented in the consolidated balance sheets at amortized cost.

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Note 4. Securities (Continued)

Proceeds from sales of securities available-for-sale were $1.03 billion for the three months ended March 31, 2013, compared with $5.2 million for the three months ended March 31, 2012. There were no sales of securities held-to-maturity during the three months ended March 31, 2013 and March 31, 2012. The following table provides the gross realized gains and losses on the sales and calls of securities:

	For the three months ended
	March 31,
(in thousands)	2013		2012
Gross realized gains	$	1,046	$	496
Gross realized losses	—		(47		)
Net realized gains	$	1,046	$	449

Interest income on securities for the three months ended March 31, 2013 and 2012 is comprised of: (i) taxable interest income of $39.8 million and $41.5 million, respectively (ii) nontaxable interest income of $4.4 million and $3.8 million, respectively, and (iii) dividend income of $19 thousand and $41 thousand, respectively.

The following table provides the expected remaining maturities of debt securities included in the securities portfolio at March 31, 2013, except for mortgage-backed securities which are allocated according to the average life of expected cash flows. Average expected maturities will differ from contractual maturities because of the amortizing nature of the loan collateral and prepayment behavior of borrowers.

(in thousands)	One year or less		Over 1 year through 5 years		Over 5 years through 10 years		Over 10 years		Total

Securities available-for-sale:
U.S. Treasury	$	3,021	$	27,349	$	—	$	—	$	30,370
Federal agency - Debt	906,857		207,746		—		—		1,114,603
Federal agency - MBS	16		434,041		211,423		—		645,480
CMOs - Federal agency	174,283		4,750,547		214,401		—		5,139,231
CMOs - Non-agency	6,460		20,738		23,578		—		50,776
State and municipal	91,153		260,487		70,006		23,524		445,170
Other	13,016		296,376