City National: A Smart, Solid Banking Play

S&P says City National is one of the strongest midcap financial institutions it covers, and rates the shares a strong buy

by Erik Oja From Standard & Poor's Equity Research

Although the wealth management industry is dominated by Bank of America (BAC), Citigroup (C), Merrill Lynch (MER), Morgan Stanley (MS), and UBS (UBS), all of whom have over $400 billion in U.S. private client assets, our research indicates that the smaller wealth managers, those with about $20 billion in U.S. private client assets, are gaining market share, and we expect this trend to continue. Included in that group is this week's Focus Stock, City National (CNY; $68.15).

We consider City National to be one of the strongest mid-cap financial institutions we cover, based on historical, current, and expected trends in lending profits, credit quality, and wealth management growth. City National does not make subprime mortgage loans and does not hold subprime-oriented mortgage-backed or collateralized debt obligations in its securities portfolio. We think City National has an excellent credit risk profile, which we estimate will result in a lower future level of required loan loss provisions than most peers. We see this as a competitive advantage, as we expect credit headwinds to increase industrywide in 2007 and 2008.

Despite the turbulent market for financial stocks, we view City National as a "best in breed" financial institution, in terms of lending margins, a growing wealth management division, and corporate governance. Based on our price-earnings analysis, we believe that City National's valuation is compelling, and we have a 5-STARS (strong buy) recommendation on the shares.

Company Overview

City National is the holding company for City National Bank, which delivers banking, trust, and investment services through 62 offices in Southern California, the San Francisco Bay area, and New York City.

The company's banking operations consist of lending and deposit gathering as well as other banking-related products and services, including investment and trust services. The company's target market includes small to midsize businesses, entrepreneurs, professionals, and affluent individuals. Investment and trust services include investment management and advisory services, brokerage services, portfolio management, securities trading, asset management, personal and business trust and investment services, estate and financial planning, and custodial services.

City National's loan portfolio of nearly $11.2 billion as of Sept. 30 consists of 38% commercial loans, 17% commercial real estate, 28% residential mortgages, and 12% real estate construction, with the remaining 5% in home equity lines and installment loans. Lending growth in the most recent quarter was 6.2% on an annualized basis, and 12% for the 12-month period ended Sept. 30. The latter figure includes the Business Bank of Nevada acquisition, which closed in March of this year. We estimate that loan growth, excluding BBN, would have been 6% in the last 12 months, which is still an above-industry growth rate, in our view.

As of June 30, 2006, which is the latest available FDIC branch-level data, City National had 60 branches and $12.4 billion in deposits, including, on a pro forma basis, BBN. About 95% of deposits and 87% of branches were concentrated in California, according to Highline Data. In California, City National had 52 branches, $11.8 billion in deposits, and a deposit market share of about 1.4%, ranking tenth in deposit market share. In Nevada, if we count BBN as a unit of City National, it had seven branches, $400 million in deposits, and a deposit market share of about 0.3%, ranking 23rd. City National had one branch in New York.