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City National Corporation (NYSE:CYN)

Q2 FY08 Earnings Call

July 24, 2008, 5:00 PM ET

Executives

Cary Walker - Sr. VP and Manager of Corporate Public Relations

Russell Goldsmith - Chairman, President and CEO

Christopher J. Carey - EVP and CFO

Analysts

Brett Rabatin - FTN Midwest Securities Corp.

David Rochester - FBR Capital Markets

Rajiv Patel - Sinova Capital

Andrea Jao - Lehman Brothers

Edward Timmons - Sterne, Agee & Leach, Inc.

Joe Morford - RBC Capital Markets

Brian Klock - KBW

Terry Maltese - Sandler O’Neill Asset Management

Operator

Good afternoon. I would like to welcome everyone to this discussion of City National Corporation's financial results for the second quarter of 2008. My name is Stephanie, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. [Operator Instructions]. This call is being recorded and will be available shortly after it is completed on City National's website at www.cnb.com.

Now, I will turn the conference over to Cary Walker, Senior Vice President and Manager of Corporate Communications for City National. Please proceed.

Cary Walker - Senior Vice President and Manager of Corporate Public Relations

Thank you. Good afternoon. Here to discuss City National's second quarter highlights are Russell Goldsmith, our President and Chief Executive Officer and Chris Carey, our Chief Financial Officer. This call will include comments and forward-looking statements based on current plans, expectations, events and financial industry trends that may affect the company's future operating results and financial conditions.

Such statements involve risks and uncertainties, and future activities and results may differ materially from these expectations. The speakers on this call claim the protection of the Safe Harbor provisions contained in the Securities Litigation Reform Act of 1995. For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from expected results, see the company's annual report on Form 10-K for the full year ended December 31, 2007.

This afternoon City National issued a news release outlining its financial results for the second quarter of 2008. To obtain a copy, please visit our website at www.cnb.com. After comments by management today, we'll open this call up to your questions.

And now I will turn the call over to our CEO, Russell Goldsmith.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Good afternoon, and thank you for joining us again this quarter. A few minutes ago, we announced second quarter 2008 earnings for City National of $35.5 million or $0.73 a share. Through the first half of '08, City National has now earned just under $80 million or $1.64 per share on revenue of $459.6 million. City National is on track for its 15th consecutive profitable year and actually this is our 61st consecutive quarter of profitability.

In the second quarter, our businesses performed well, generally speaking. Loans grew at double digit rates and so did non-interest income, as City National continued to add new wealth management and cash management clients as well. Core deposits also increased noticeably from the first quarter.

Our company remains well capitalized as evidenced by today's dividend declaration and our continuing stock buyback program. I think it's important to emphasize once again that City National has avoided virtually all of the more publicized problems in the banking sector like subprime mortgages and subprime CDOs, problems that are plaguing other institutions, but not City National.

We have no option ARMs, no brokered mortgages. And for all practical purposes, we have no auto loans or consumer credit card debt to affect us in anyway. In spite of today's challenging economic environment, City National remains strong, consistently profitable, and well reserved.

As you noticed, second quarter earnings were below 2007 because we've recorded $35 million provision for credit losses as compared with no provision in the second quarter of 2007. This provision for the second quarter of '08 takes into account two positive factors actually, City National's loan growth and a $17 million build in our strong credit reserves taking it up to 1.5% of total loans, one of the stronger levels in banking.

Of course, this level of provision also reflects the higher costs created by additional and significant housing market deterioration in the second quarter that has clearly taken a toll on our home-builder clients. In light of current economic conditions, which are likely to persist through this year and into 2009, we have lowered our full-year earnings per share guidance, logically [ph] because we are determined to maintain solid credit reserves and have to anticipate further credit deterioration in light of the economy.

With that reserve prudently in place, City National is both well positioned to weather this economic opportunity... economic downturn, and at the same time can remain profitable while taking advantage of some attractive growth opportunities. In our opinion, there is a shift underway that favors strong banks like City National that have a strong deposit and capital base and are open for business with the ability to meet their client's reasonable financial needs.

As the market for leverage and securitization recedes or dries up entirely in many cases and investors demand more appropriate pricing for the risks they take on and as it's very obvious these days, some of the most aggressive lenders disappear from the landscape, we believe over the long term that more solid well managed companies with credit needs and deposits will turn more often to banks like City National, and do so on more attractive terms.

Certainly, we are seeing that happening here at City National as we attract and retain... as we attract new clients and retain and expand our relationship with existing clients who are maintaining or expanding good loans with us rather than pursue a shrinking number of alternatives.

As we attract new businesses and new clients, we are protecting our margins and preserving and even enhancing our conservative credit underwriting standards. Chris Carey, and I will take your questions in a few minutes as usual. But first, let's review City National's second quarter results in somewhat greater detail.

Between March 21 and June 30 of this year, City National's loans grew at an annualized rate of more than 14%. Commercial lending accounted for over half of the growth, but residential mortgage loans to our private banking clients with very conservative loan-to-value ratios also made a meaningful contribution.

We clearly are remaining cautious and disciplined as a lender in this economic climate, and we are pleased with a high grade nature of our loan growth. Credit quality is something that City National has always been very focused upon. Second quarter non-performing assets were actually down slightly from the first quarter; although, net charge-offs were up. About 75% of second quarter charge-offs and non-accruals came from our portfolio of loans to residential housing developers which, without minimizing it is really the one area with any meaningful and they are meaningful issues in our $12 billion loan portfolio.

To put this in a little perspective, our loans to residential developers account for about $560 million or less than 5% of City National's entire loan portfolio, and we believe we have appropriately reserved for this portfolio based upon today's reduced values and consistent with current market conditions, which as you know were hit hard in the second quarter. Most of these home-builders are long-term clients and nearly all of our loans to them are guaranteed or supported by some form of credit enhancements, some borrowers are paying interest out of pocket, others are re-margining.

We are continuously reviewing the home-builder projects in our portfolio and regularly reappraising property values as appropriate. Given the state of housing... in the states we do business in and in this country, we obviously anticipate that there will be further writedowns in this portfolio, but they are certainly manageable for City National. It is worth noting that the projects in our portfolio are concentrated largely in the Greater Los Angeles area, as well as the San Francisco Bay area, I think sometimes we are tarred [ph] unduly as being California or Nevada.

The fact is we have relatively little exposure to residential development projects in Riverside, San Bernardino, and Sacramento communities that are often cited as among the hardest hit in the housing downturn here in California. Beyond the residential home-builder sector, City National's loan portfolio continues to perform satisfactorily.

Let's start with commercial real estate. Obviously, we are paying close attention to this portfolio, although, commercial real estate has accounted for no charge-offs and essentially no non-accruals during the first half of 2008. City National's commercial real estate portfolio includes loans for both construction and finished properties. Without the loans to home-builders, the portfolio amounted to about $3 billion out of our $12 billion portfolio at the end of the second quarter.

About two-thirds of this $3 billion portfolio is for finished properties, primarily industrial and office facilities. I think it's worth noting that 43% of the loans in this category are financing owner user properties where we don't just have the property, but we have the relationship with the company that's based in that building. Clearly economic conditions have affected and will affect values and cap rates, and we do expect some manageable stress on our construction portfolio in the coming months. We are fortunate; however, that most of what we finance are in-fill projects in major metropolitan areas, where we are still seeing demand for the right products.

We expect most of these projects to hold up well in today's downturn and we believe our underwriting standards left room for some deterioration in cap rates and so forth. It's also worth noting that our construction loans are diverse in terms of geography and product type and most of them are recourse loans to well established developers. Other banks have been willing to finance SPEC [ph] hotels, SPEC office buildings and other very special purpose projects but that's something that we have generally avoided. As for City National's C&I portfolio, it also continued to perform satisfactorily.

Recoveries have actually exceeded charge-offs over the last four years. City National's single-family mortgage book also remains pristine. Our mortgage borrowers are private banking clients, their average FICO score is 720. We've built this portfolio over the last ten to 12 years, and at origination, over that period, the loan-to-value ratio is around 50%. In all the years that City National has been making home loans, we have not had to foreclose on a single one, and we have no home mortgage foreclosures at this time.

Of course, City National is committed to staying well reserved, and right now, we believe, our reserves are appropriately sized to handle the issues that are, as I said, principally in our home-builder portfolio. The reserved build that we've added to the second quarter takes our reserve to a 152 basis points of total loans, up from a 143 basis points in the first quarter and again places City National among the strongest reserve levels in the banking industry. Let me turn to the economy for just a couple minutes. California, like the rest of the nation, is seeing little or no growth in employment, real household income and taxable sales.

Certainly, we anticipate continuing contraction in the housing sector and an unemployment rate, north of 6.5% for the remainder of the year. While these present challenges and get a lot of attention in the news, the sky isn't falling out here. So far problems in housing and related sectors have not spread to other areas of the economy. That's not just true in our client base or in our opinion, the recent and respected UCLA Anderson Forecast summed it up nicely by saying, "what happened in housing, stayed in housing".

Anecdotally, having spent a lot of time with a number of clients over the last couple of months, I can tell you that although they are under a certain amount of pressure in a number of cases both from the slowdown in the economy and the rise in energy prices in particular, virtually all of our clients appear to be managing through this kind of economic environment, and so far remaining profitable. At City National, we share UCLA's long term confidence that California will weather the slowdown on the strength of its remarkably diversified economy, the eighth largest in the world.

International trade, tourism, entertainment, technology and agriculture, as well as professional services all continued to perform reasonably well. Of course, City National, as I hope you know also does business in Nevada and New York City. Nevada is being tested by the housing crisis and the slowing economy and the rising energy prices. Gaming revenue, visitor volume and McCarran International Airport passenger levels have all shown declines. Yet the state's longer term prospects are still quite good, and City National is well positioned to take advantage of those opportunities.

Since we bought a bank in Nevada, it's been just over a year since we unveiled the City National brand in Nevada. Since then we've made solid progress, increasing brand awareness and market share, as we offer expanded capabilities from international banking and cash management to private banking and wealth management. I think it's worth noting, we only have four home mortgage loans in Nevada with loan-to-value ratios just north of 50%. We also feel very good about our bank in New York, which continues to grow very well.

We've added a successful new commercial banking team over the last six to eight months expanding the office's capabilities to complement our private banking teams who have successfully been serving professionals and law firms, entrepreneurs in the entertainment industry since we opened there more than five years ago.

As challenging is economic conditions are today and we all know they are challenging, we feel good about City National and its prospects. In addition to our strong capital position and sound credit reserves, City National has an exceptional deposit base. Our markets are some of the very best in the world and we intend to take advantage through these challenging times of some very attractive growth opportunities.

I believe City National's organization and team of over 3,000 people is better than ever before, and we are committed to and continuing to improve it as we invest in and improve our people and our capabilities.

Let me just give you a couple of examples, just in the last month, we consolidated several of our best businesses into a new Treasury Services Division because we were able to attract an outstanding banking veteran, Jim Daley to run it.

Jim's background, experience, and success in California lends itself perfectly to the execution of our strategy to grow our deposit base even further. We've also been able to selectively add terrific talent with some new bankers joining our private and commercial banking teams in downtown Los Angeles, the San Fernando Valley, and San Francisco.

Our newest wealth management affiliate, Convergent Wealth Advisors, is on track with our new Los Angeles office for them and they recently hired two outstanding managing directors greatly enhancing the presence, reach and capabilities of Convergent's office here in California.

They are off to a strong start and they add important capabilities in wealth management to our already successful complement of wealth management companies. In addition to investing in a range of outstanding new talent.

Next month, we are opening a new banking office in the very affluent south bay community of Manhattan Beach here in California next month. We are also seeing success with our investments in a range of things inside the bank, our technology capabilities, our products division, our wealth management business, our new Asian markets group in our international division, and we're having success with our new preferred banking offering through our 62 branch offices. All of this continued growth and investment in City National is only possible because City National remains strong and focused upon private and business banking and wealth management, conservative and well capitalized.

And even as we build reserves, we remain profitable because City National has avoided the very costly and highly publicized problems that stemming from the subprime mortgage crisis. We have the ability to focus not only upon serving our clients, but also upon enhancing our ability to do that, and upon growing our businesses and building for the future.

I'm encouraged by the progress that we are making and by a number of initiatives that are ongoing inside City National at this time. They will help us restore earnings growth in the future.

Now for some more detail about our second quarter results, let me turn it over to Chris Carey, our CFO.

Christopher J. Carey - Executive Vice President and Chief Financial Officer

Thank you, Russell. Good afternoon, all. I want to add a few comments about the margin, deposit trends, non-interest income and expense control, and also I'll talk about our guidance for the year. City National's margin averaged 4.23%, down only three basis points from the first quarter and considering the very sharp downturn in interest... on interest rates and our actually strong loan growth in the second quarter, we are pleased with that result.

Our average loan yield fell 63 basis points, but that was nearly offset by 59 basis points decline in deposit costs. The net cost of wholesale funding also fell substantially, 125 basis points in fact down from the first quarter. We did get a nice lift from the second quarter growth core deposits, and I'll talk about that in a moment. In the second quarter overall, average deposit balances came to $11.7 billion, up 2% from the first quarter.

Even more encouraging is the fact that core deposits grew 4% for the first quarter, which is a 15% annualized growth and actually it's the first really bright sign we've had in this category in a couple of years, and we had been talking about a lower interest rate environment and all the work we are doing to gather deposits, and hopefully it's a sign of better things to come.

Demand deposits were up $200 million from the first quarter, and while some of that increase can be attributed to seasonal income tax payments, it's clear that we are also attracting new clients and more core deposit balances. Title and escrow deposits were stable from the first quarter this year, and we are encouraged with looking at the market, the real estate markets and the new talent that we brought in, and the strong group that we have there that over time this is a business that we are going to be able to grow.

Our company really has an exceptional deposit base. 90% of it consist of core deposits that contribute to City National's relatively low cost of funds and that's up from 88% in the first quarter. Now, a few comments on non-interest income. City National also continues to grow its fee-based businesses. Non-interest income grew a 11% in the second quarter and now accounts for 35% of our company's total revenue. The biggest share becomes from our wealth management businesses. And while overall, the business performed well, and I think the earnings overall from our combined businesses are going to be up around 15% for the quarter. You will notice that assets under management were down 6% from the second quarter of 2007 and the first quarter of this year.

The decline is primarily to a decision by the former owner of our institutional money manager to shift funds to an in-house investment advisor. Although this shift is something we expected and actually factored into the purchase price, it is coming in about a year ahead of schedule, but we are also are getting to reduce the earn-out payment that we would've been required to make by approximately 30%.

Still investment-related fee income increased 8% from the previous year, thanks partly to the acquisition of Convergent Wealth Advisors and a strong increase in our brokerage and mutual one-fund [ph] fees. We are clearly seeing a flight to quality due to the environment in our wealth management business and also in our banking business. For the most part the City National's wealth management division and our independent affiliates comfortably outperformed their benchmarks in the second quarter also.

Cash management international fees also continued to grow. As you can see from the release, income from cash management deposit transaction fees grew 44% from the second quarter of '07 due largely to falling short-term interest rates, but also to continued sales to our clients and new clients. Fee income from foreign exchange and letters of credits grew 8%.

To some degree that reflects an increase in U.S. exports stemming from the weaker dollar. Now a few comments about expenses which we continue to manage carefully, expenses were up 7% from the second quarter of '07, although excluding the FAA... excluding the FDIC costs that most banks are starting to bear this quarter, they would be up 5.5%. I think the better news is that, with all that, they are active [ph] still down slightly from the first quarter, and we also are continuing to invest here, as Russell mentioned partly both in talent that were bringing in and some of the facilities to house the talent.

One more comment on FDIC. The impact of the quarter was $1.4 million or $0.02 a share. Our second quarter efficient ratio was higher than it was a year ago, reflecting the continued... reflecting primarily the continued expansion of our fee-based businesses. Looking at the remainder of the year, we expect expenses to remain under pretty tight control. Now, coming to the guidance, we have revised our guidance, we think it's appropriate in this environment, and I think it's important to say that it really reflects changing view on the credit side. The underlying businesses in all categories, net interest income, non-interest... expenses are all coming in better than we thought, but the environment is worse.

So, we are trying to be careful here with continued deterioration in the housing market. So, we've decided to move our guidance down lower and we will continue to monitor that. We are still concerned about the economy and the possible duration of today's slowdown, but we are very confident in our ability over time to grow our company. Couple comments on the balance sheet, we intend to stay well reserved and well capitalized.

Our capital ratios are very strong, and certainly at the top level of the top 50 banks. Our AA rating and the other things we do in capital management consider... continue to be a way for us to build shareholder value. Given our ongoing profitability during the first two quarters of the year, we repurchased more than 420,000 shares. We expect to continue to buy back a comparable amount of shares in the second half subject to market conditions. City National is a very attractive value right now, this is the first time since the early 1990s that we traded at less than 1.5 times of book.

In conclusion, our underlying business is good. We have a strong balance sheet, a premier deposit base, and a conservative approach to credit quality and capital management, we are investing in our businesses, we have the means to grow, and to take full advantage of the large and growing markets that we serve.

Now, Russell and I'd be happy to take your questions.

Question and Answer

Operator

At this time, I would like to invite questions from analysts and investors. [Operator Instructions]. Your first question comes from Brett Rabatin with FTN Midwest Securities Corp.

Brett Rabatin - FTN Midwest Securities Corp.

Hi, guys. Good afternoon.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Brett, how are you?

Brett Rabatin - FTN Midwest Securities Corp.

I am doing well, thanks. Wanted to ask some more... for some more color on the home-builder portfolio, if you could break out how much of that is for-sale-housing, and how much is residential land at the end of the quarter?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Sure. That $560 million is residential housing; the land component of it is roughly $200 million.

Brett Rabatin - FTN Midwest Securities Corp.

Okay. And then you've obviously made a lot of comments about that… that's where you are seeing the stress, I was curious if you were seeing any kind of first migration trends and either the shopping center or the condo portfolios, with the construction?

Russell Goldsmith - Chairman, President and Chief Executive Officer

I wouldn't comment on specific categories like that. I would say the principal risk migration trends have been though in the housing portfolio not in condos and apartment areas. I think that if you have a long-up precision or a slowdown, you're eventually going to hit some of those areas.

Brett Rabatin - FTN Midwest Securities Corp.

Okay. And then the margin was pretty stable actually and that was great, title and escrow was about flat with what you are seeing with competitive deposit landscape and just your core deposit trend, I mean is it fair to assume that the margin should stabilize here or can you give us some thoughts on kind of your margin outlook and how will you manage liquidity going forward?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Well, I think that… I think you are assuming the economy, continues in the [inaudible] that it is that would bode for certainly this year a somewhat stable margin, I mean there is a lot of moving parts there, but I would say in general, it should be somewhat stable.

Brett Rabatin - FTN Midwest Securities Corp.

Okay, great. Thanks for the color.

Operator

[Operator Instructions]. Your next question comes from Dave Rochester with FBR Capital Markets.

David Rochester - FBR Capital Markets

Hi, guys.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Dave, hi. Thanks for joining us.

David Rochester - FBR Capital Markets

Thank you. On the capital, your regulatory ratios are still robust but they were down in the quarter 20 or so basis points, why not sustain a share repurchases and just conserve as much as you can at this point of cycle?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Well, I think that that you can see that our capital levels are still quite robust. We are not repurchasing enormous amounts of stock and, but we look at, again we always talk about trying to use all the tools in the capital tool box, and I think that you can see from that that we have a balance between the dividend level, the repurchases at the pace at which we are doing at a roughly $10 million in the first… in each of the first two quarters, and to some degree the capital ratios reflect just adjustments in the balance sheet values.

David Rochester - FBR Capital Markets

Okay. Just moving to credit for a minute, could you give us some color on what's your range is for your provision assumption for the guidance... the EPS guidance you gave us, it looks like you may be assuming the provisioning actually improves in the third and fourth quarters, am I looking at that right?

Russell Goldsmith - Chairman, President and Chief Executive Officer

I think that that we haven't put out precise guidance on that, but I don't think I would come away from this assuming that provisions are going to be lower in the second half than they were in the first half.

David Rochester - FBR Capital Markets

Okay. Would you say that they would likely be higher in the second half than in terms of the second quarter level?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Well, I think there is going to be, at this junction, there is a range, I think that it's going to tend to be somewhat higher in the aggregate for the second half. How much is not entirely clear which is why we have a range on the EPS guidance.

David Rochester - FBR Capital Markets

Got you. And just real quick on the C&I portfolio this quarter, could you give us some color on the increase in the net charge-offs there as to what industries that reflects? Is that coming from the construction industry portion the $200 million or so you have in that portfolio?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Yeah, there is only three really meaningful charge-offs in that total. The largest one actually comes from a private banking client, that's $2 million and it is not related to the construction industry. The two other ones that in combined are about $2.7 million actually do relate to the construction industry and they are part of that group of that acquired the unsecured part that's up with C&I. So you don't have really much of anything in pure C&I clients really in those numbers.

David Rochester - FBR Capital Markets

Got you. Would you happen to have the watch list for the C&I portfolio or the total portfolio, whatever you have will be great?

Russell Goldsmith - Chairman, President and Chief Executive Officer

I am not sure I truly understand the question, but what do you mean by the watch list?

David Rochester - FBR Capital Markets

Special mention, including some standard and...

Russell Goldsmith - Chairman, President and Chief Executive Officer

We don't provide that information.

David Rochester - FBR Capital Markets

Okay. And also you highlighted in the call NPAs were down, but you built the reserve by $17 million, you'd mentioned it was due to the home-builder portfolio. Do you... if I recall correctly you appraised the entire portfolio in the first quarter, so is the $17 million build, is that in reaction to additional appraisal activities since the first quarter or are you just seeing or adding more and more to the watch list in that portfolio?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Well, I don't think there is anything to do with the watch list. I think what we are trying to do is not only cover net charge-offs but to build our reserves as we've noted there now slightly more than 1.5% of our total loan portfolio in an environment where the home-builder industry and home prices in general continue to deteriorate, and the economy continues to be stagnant, obviously, going through our complexion, fairly sophisticated reserve methodology it seemed appropriate to us to build the reserves further in anticipation of potential challenges in the remainder of this year.

David Rochester - FBR Capital Markets

Okay. And one last question, back on the EPS range in your provision expectations without giving or having to quantify specifically, could you just give a little color as to what's your expectations are on C&I credit going forward? In that number, are you expecting C&I deterioration to increase in the second half? What is that reflect patterns that you just see today and you are extrapolating that for the next six months?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Well, I have been telling everybody for a couple of years we are going to start to have charge-offs in C&I. So I am sure there is some embedded in our forecast, but as we've said earlier we…in other the portfolio is relatively stable right now though so… and we…and our NPAs didn't move this quarter, but when we continue to look out, we typically project that we are going to have some, we have been wrong in that category for a while, but we still expect that we are going to start to have some pure NPAs…NPA hard charge-offs in C&I.

Cary Walker - Senior Vice President and Manager of Corporate Public Relations

Thank you very much, Dave.

David Rochester - FBR Capital Markets

Thank you very much.

Operator

Your next question comes from Rajiv Patel with Sinova Capital.

Rajiv Patel - Sinova Capital

Hey, guys. Thanks for taking my question. Just a couple of quick ones. Your builder portfolio, the $560 million in the resi housing, can you just say what your total commitments are in terms of outstanding?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Yes, I don't have that number right handy with me, Rajiv, I mean it's a little more limited than it's have been of course.

Rajiv Patel - Sinova Capital

Great.

Russell Goldsmith - Chairman, President and Chief Executive Officer

But, I don't have that number.

Rajiv Patel - Sinova Capital

I mean, is it like a multiple of the $500 million or is it more of like 20% higher, 50% higher?

Russell Goldsmith - Chairman, President and Chief Executive Officer

It's not a multiple, it would be a lot less.

Rajiv Patel - Sinova Capital

Okay, good.

Christopher J. Carey - Executive Vice President and Chief Financial Officer

And to some degree, you got to work through whether even though you have a commitment whether they would still qualify to draw down. We have some commitments where for a variety of reasons, they are no longer eligible or as a practical matter, their cash position and their activity level is such that we know they are not going to draw down.

Rajiv Patel - Sinova Capital

Okay.

Christopher J. Carey - Executive Vice President and Chief Financial Officer

Somewhat, it would be somewhat of a misleading number, I think as a practical matter.

Rajiv Patel - Sinova Capital

Okay. And then I don't know if you can answer this, but in your guidance... in your earnings guidance, obviously you have some... you may have an assumption for what NPAs, where NPAs may go given that you know changes in NPAs do affect the nim. So can you kind of provide any sort of color as to where you are assuming NPAs go over the course of the year?

Russell Goldsmith - Chairman, President and Chief Executive Officer

I don't think we really have a specific guidance on that. To some degree, obviously in a deteriorating economy would be logical to assume that you would see some increase in NPAs. But doesn't necessarily mean you will see… I think it's useful to note that NPAs don't always lead to actual loss.

Rajiv Patel - Sinova Capital

Right, right. Okay. And then you said that $2.7 million of the commercial charge-offs related to the construction industry, can you give the dollar value of your commercial loans that are tied to the construction industry, the C&Is?

Russell Goldsmith - Chairman, President and Chief Executive Officer

It's $90 million.

Rajiv Patel - Sinova Capital

$90 million, okay. Great, thanks a lot.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Welcome.

Operator

[Operator Instructions]. Your next question comes from Andrea Jao with Lehman Brothers.

Andrea Jao - Lehman Brothers

Hello, can you hear me?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Andrea?

Andrea Jao - Lehman Brothers

Yes. Good afternoon. Could you hear me?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Yes. Good to hear from you.

Andrea Jao - Lehman Brothers

I was hoping to get more detail, a more detail description of your process of how thoroughly you've looked at the commercial real estate book, not the just the homebuilder book. How often there is a particular credit get reviewed, when do you get updated appraisals?

Christopher J. Carey - Executive Vice President and Chief Financial Officer

Let me start with, as a sign of any meaningful problem, we get updated appraisals. So for example, when you do the for-sale housing appraisal book, we are updating that regularly because we are managing that differently because there are problems in that industry. When you go outside of that book, certain things have looked at quarterly or annually, but if there is a stress or assigning problems because we are in touch with our clients all the time, and do you think there is a problem then you order appraisal and there is a process it goes through. So, it's very much depended upon what's really going on with the credit.

Russell Goldsmith - Chairman, President and Chief Executive Officer

And also think, Andrea, and that's why we brought it up in the conference call, we are very aware of commercial real estate and how it may or may not be affected in this economic climate. So, our people are, I think, being very attentive to it, and as we said in the call, a large percentage of what's in that book is owner occupied, so it's not just the building you are looking to but the actual business itself that your banking, and in a lot of the product categories that we are in such as industrial office, warehouse kind of buildings, which is a big percentage of that portfolio that they can see rates in Los Angeles and other areas where we have that products that remain very low like in the 2% range, and we see what sales are going for and have any number of indicators to get that what Chris is saying as to know whether this is an area that is under pressure. At least, so far both because as I mentioned earlier we have underwritten these things assuming higher level of cap rates, which are above or below depending on how you want to look at it where the market is and these other variables, we think we are quite clear about where these values are and are reserving appropriately as a result.

Andrea Jao - Lehman Brothers

Could you give us an indication of how much of the home-builder book you've had re-appraisals for and how much valuations have dropped?

Christopher J. Carey - Executive Vice President and Chief Financial Officer

Yeah, I know… I mean I wouldn't been able to say… I mean, we any problem credit in there, we have a valuation on an either and I think I have mentioned it before, the individual [inaudible] appraisal update or we do what we call a dust appraisal where we take current market activity and get to the same answer. So, they are done as needed as the market changes.

Russell Goldsmith - Chairman, President and Chief Executive Officer

I think it's fair to assume I am not quite sure what is your concern is, but our people are intensely aware of every single home-builder project that's in our loan portfolio and our... I think aggressively trying to stay on top of the values, and I think our senses with the level of reserves that we keep putting on that we're ahead of the curve and we have a number of reasons to think we are being perhaps more aggressive in building reserves and riding down values than you may be seeing in some other companies.

Andrea Jao - Lehman Brothers

This is helpful, thank you.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Ed Timmons with Sterne, Agee.

Edward Timmons - Sterne, Agee & Leach, Inc.

Good afternoon.

Christopher J. Carey - Executive Vice President and Chief Financial Officer

Hi, Ed.

Edward Timmons - Sterne, Agee & Leach, Inc.

I am just wondering here, I was, just last quarter you gave this guidance for the loan loss provision of $15 million to $20 million a quarter and now just 90 days later it's kind of twice of that. NPAs are going down or at least stable and it sounds like the watch list is about the same, what is changed in that time, or are you seeing the market in general does get that much worse over this past quarter?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Well, I think principally, it's again it's the home-builder sector of the portfolio when the home prices and sales velocity deteriorated a lot further and faster in the second quarter, then normally we anticipated when we gave that guidance but then the builders themselves, and I think generally the variety of sources. Also as I said on the positive side, we've had more loan growth than we originally thought we would see in this kind of climate, good quality loan growth and as you put each new loan on incrementally, you have to add your reserves for that. In addition, a number of loans are staying on the books longer because as I mentioned some of the sources for take out that had been out there for any number of years have dried up or a lot less attractive to our clients, and so they are turning back to us to extend over or renew loans that might have run off. So, there is some good news in the growth of the provision because of the more robust loan growth, but I think principally you would look to the greater deterioration in home-builders.

Edward Timmons - Sterne, Agee & Leach, Inc.

And from, I guess, from what you've seen then this quarter, do you have any opinion as to when the market stabilizes? Is this early '09 event, late '09, '10?

Russell Goldsmith - Chairman, President and Chief Executive Officer

If I could precisely answer that question, I think that would be a remarkable achievement. I am not sure anybody knows for sure. I am encouraged by the action of the house representatives and this builder, I think, will get pass later in the week and to get signed by the President. I think that will not solve everything, but I think incrementally that's a step in the right direction, obviously the steps that are being taken with Fannie and Freddie will help.

I think we are seeing a number of positive things happening in Washington and we are seeing a number of positive things happening on the ground, an example, I would give you is what we see happening out in the Inland Empire, which is one of the epicenters. We don't have a lot of product out there through our clients, I am happy to say, we have a bid, but that scenario where prices have come down from the $400,000 plus range into the $200,000 plus range and in talking to a client of ours out there in the escrow business, business is booming because a lot of first time home buyers have stepped up in the last few months at 200, 225, 240 multiple buyers, multiple offers, and for closed homes in many cases. And that's starting to absorb some of the inventory.

So, I know the existing home sales numbers that came out today nationally weren't fabulous, but I did notice that California was actually doing somewhat better as I heard the numbers, and anecdotally, we are seeing some signs of that, and we are seeing a number of signs at the higher ends of values holding up demand, holding up. So, I don't think it's black or white, I think there were some encouraging signs, but we want to be prudent about this and anticipate that there will probably be some more deterioration before this thing turns around.

Edward Timmons - Sterne, Agee & Leach, Inc.

Okay. Thanks a lot, guys.

Operator

Your next question comes from Joe Morford with RBC Capital Markets.

Joe Morford - RBC Capital Markets

Good afternoon, Russell and Chris.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Hey, Joe, how are you?

Joe Morford - RBC Capital Markets

Very well, thanks. I was just curious if you have had any initial feedback yet from the shared national credit exam in terms of classified trends or reserve requirements, and if so, has that been reflected in the second quarter results?

Russell Goldsmith - Chairman, President and Chief Executive Officer

No, we haven't, Joe. I don't, I'm not. I think we are expecting any big amount in there frankly. We don't have something formal from that.

Joe Morford - RBC Capital Markets

Okay. And along those lines, so you're just kind of curious where you all are in your normal exam cycle and on the regulators maybe do back in for the next [inaudible] exam?

Christopher J. Carey - Executive Vice President and Chief Financial Officer

We don't normally discuss our activities with the regulators. I think it's safe to assume that given our size that there is always some regularly scheduled exam going on.

Joe Morford - RBC Capital Markets

Okay, well then, maybe kind of I just ask your thoughts on liquidity, if it certainly encouraging to see some deposit growth this quarter, same time the loan to deposit ratio crossed over 100%, should we look for loan growth to be increasingly funded with wholesale borrowings there? What's your thoughts going forward?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Well, I think that as I said we are making a conservative effort to grow deposits. We have the ability depending on how we want to price it to grow deposits through our customer base, as you can see from the numbers we've actually led the higher priced CD kind of deposits come down over the last year or so, and I think that's been a successful strategy. We are actually as Chris noted seeing core deposits rising, so I think again we tried to use all the tools in the tool box, we are very focused on deposits.

When you look at our level of core deposits up around 90% on and you know our franchise pretty well, Joe, 90% I think if that's not the top percentage in the nation, it's pretty close. So, there is a lot of room if we feel the need to raise prices and pull in more deposits, also anecdotally in trigger seeing this in Northern California, we are certainly seeing it throughout the state that as anxiety levels rise, I'd say I start measuring it from the Bear Stearns crisis through the IndyMac crisis, through the Downey Savings article today in the Los Angles Times, we literally are seeing millions of dollars come into the bank and into our money market funds as people look for a safer place to put their money.

Joe Morford - RBC Capital Markets

Great. It's good to hear. Thanks, Russell.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Good to hear from you, Joe.

Operator

Your next question comes from Brian Klock with KBW.

Brian Klock - KBW

Good afternoon, gentlemen?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Brian, how are you doing today?

Brian Klock - KBW

Hey, not too bad… not too bad. And I am sorry if I missed this, and you've answered already. Within the guidance for '08, what level of managed margins and earnings asset growth that incorporate?

Christopher J. Carey - Executive Vice President and Chief Financial Officer

We didn't give any guidance on that. We just really updated our EPS kind of range.

Brian Klock - KBW

Okay, okay. I guess, within the other company as of income, there was about $21 million increase in the negative OCI for the quarter, can you, I guess, give us a little color on what type of securities that increased negative markdown?

Christopher J. Carey - Executive Vice President and Chief Financial Officer

Well, it's cash or whole securities plus, I mean we have, which is mostly a fixed income book. We do have some equity securities. I don't think it's disproportionate to the equity securities. So, I would comment about that small not amount against that large book, but it is substantial to the full book.

Brian Klock - KBW

Okay. And, Chris, do you guys have any Fannie or Freddie preferred stock?

Russell Goldsmith - Chairman, President and Chief Executive Officer

We have 23 million although. We have much newer vintage preferred stock that has a big evaluation although. At quarter-end it was pretty close to before we bought it because it is newer and newly issued. It went through a little bit of shock after quarter at although it bounced back and come back from there, but we have 23 million.

Brian Klock - KBW

Last question, not sure if you have already broken this out or not, but the $86 million of non-accrual construction loans, can you break out how much of that is land versus vertical construction?

Christopher J. Carey - Executive Vice President and Chief Financial Officer

First of all, I don't have the exact number, but a smaller…it's predominantly not land.

Brian Klock - KBW

Okay. Okay. Thanks, guys.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Terry Maltese with Sandler O'Neill Asset Management.

Terry Maltese - Sandler O’Neill Asset Management

Could you guys hear me?

Russell Goldsmith - Chairman, President and Chief Executive Officer

Yes. We are hearing.

Terry Maltese - Sandler O’Neill Asset Management

Hi, hello. Just a quick question, I might have misunderstood something you've said earlier, but you had about $19 million... $18.9 million of charge-offs. And did I hear you said the largest of them was a $2 million loan and then the next largest were $2.7 million, so...?

Christopher J. Carey - Executive Vice President and Chief Financial Officer

No, let me correct.

Terry Maltese - Sandler O’Neill Asset Management

Okay. Yeah.

Christopher J. Carey - Executive Vice President and Chief Financial Officer

I was just giving someone who asked question on our commercial charge-offs. So, when you go into, there are two categories of charge-offs, commercial charge-offs and real estate constructions.

Terry Maltese - Sandler O’Neill Asset Management

Okay. And you were referring to just sort the commercial charges-offs?

Christopher J. Carey - Executive Vice President and Chief Financial Officer

Yeah.

Terry Maltese - Sandler O’Neill Asset Management

Okay. All right. That was it. Thank you.

Christopher J. Carey - Executive Vice President and Chief Financial Officer

Thanks. Welcome.

Operator

At this time, there are no more questions in audio queue. So I would like to turn the call back over Mr. Goldsmith.

Russell Goldsmith - Chairman, President and Chief Executive Officer

Okay. Well, for those of you who are still on the call, I want to again thank you for joining us today and for taking time out of your day to understand City National and its performance in the second quarter. We always appreciate your interest and look forward to talking with you again at the end of the third quarter. Meanwhile, of course, Chris, Carey, and I are available to try to respond to any further questions.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.

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Source: City National Corp. Q2 2008 Earnings Call Transcript
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