DBRS Comments on the Q2 2009 Earnings of UnionBanCal Corporation – Senior at “A”

DBRS has today commented on the Q2 2009 earnings of UnionBanCal Corporation (UB or the Company). DBRS rates UB’s Issuer & Senior Debt at “A” with a Stable trend. UB reported a net loss from continuing operations of $80.0 million for the quarter, down from a net loss of $9.8 million in the previous quarter and net income from continuing operations of $134.3 million in Q2 2008. While revenues were basically flat relative to Q1 2009, incremental loan loss provisioning for loan losses of $111 million and an FDIC special assessment of $34 million more than offset lower privatization expenses resulting in the larger quarterly loss. DBRS notes that the Company has aggressively built the loan loss reserve over the past several quarters to address deteriorating asset quality, revenues have held up relatively well and deposit growth trends are very strong. Nonetheless, DBRS has little tolerance for another quarterly loss given the current Stable trend. If UB incurs another quarterly loss and/or asset quality continues to rapidly deteriorate, the trend would likely be revised to Negative.

Asset quality continues to deteriorate, but remains better than those of similarly rated peers in terms of both non-performing asset (NPA) and net charge-off (NCO) levels. However, NPAs reached $1.1 billion or 2.34% of loans and foreclosed assets, in the second quarter. This amount has grown considerably from 1.69% in the previous quarter and 0.49% a year ago. Once again, NPAs were up across all loan categories with commercial mortgages and construction loans driving the majority of the increase. Meanwhile, NCOs have been accelerating, but remain manageable. During the quarter, NCOs rose to $151 million, or 1.23% of average loans annualized, from $116 million, or 0.95%, in the first quarter. Year-to-date, approximately 86% of all NCOs have come from either the CRE (including construction) or C&I loan portfolios. DBRS notes that while the residential mortgage portfolio (represents about one third of the total loan portfolio) has seen an increase in NPAs, the loss content remains very low at $15 million over the first six months. California housing has seen significant price declines, but the Company’s conservative underwriting as evidenced by low loan-to-values and high FICO scores have kept losses low. The total provision for credit losses was $375 million and included $15 million for off-balance sheet commitments. Overall, the reserve remains healthy at 2.21% of total loans and 98.14% of nonaccruals. With the California economy still struggling and unemployment yet to peak, credit costs are likely to remain elevated.

Positively, UB delivered remarkable deposit growth during the quarter demonstrating its franchise strength. Indeed, average non-interest bearing and interest bearing deposits increased 11% and 19%, respectively. The majority of the quarterly deposit growth was held at the Federal Reserve, which contributed to significant net interest margin compression of 38 basis points to 3.41%. UB remains very liquid and boasts a very low all-in cost of funds of 0.88%.

While low risk, the asset growth associated with the deposit growth pressured the tangible common equity ratio, which declined to 6.56% from 7.12% in the first quarter. The tangible common equity ratio remains relatively strong compared to peers, but UB has historically operated with the ratio above 7%.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.