Zions Bancorporation, National Association
Q3 2010 Earnings Call Transcript

Published: 19 Oct 2010

[Operator:]

Good day ladies and gentlemen and thank you for standing by, and welcome to the Zions Bancorporation third quarter 2010 earnings call. This call is being recorded. I would now like to turn the time over to James Abbott, director of investor relations. Please go ahead.

[James Abbott:]

Thank you. We welcome you to this conference call to discuss our third quarter 2010 earnings. I would like to remind you that during this call we will be making forward-looking statements and that actual results may differ materially. We encourage you to review the disclaimer in the press release dealing with forward-looking information, which applies equally to the statements made in this call. We will be referring to several schedules in the press release during this call. If you do not yet have a copy of the press release, it is available as an Adobe Acrobat file at zionsbancorporation.com and can be downloaded and printed. We will limit the length of this call to one hour, which will include the time for you to ask questions. During the Q&A section, we will ask you to limit your questions to one primary and one follow-up question to enable other participants to ask questions. I will now turn the time over to Harris Simmons, chairman and chief executive officer. Harris?

[Harris Simmons:]

Thank you very much, James, and thank you to all of you who are joining us this afternoon for our call. We are quite encouraged with our third quarter results, with core pre-tax, pre-credit income relatively stable, moderating rate of decline in our loan balances, and a broad-based improvement in credit metrics, specifically the continued decline in problem credits and a significantly lower rate of inflow into the various problem credit categories. Looking at our results, there were several items that obscured some of our core operating trends and we've identified them throughout the release. A good example would be our FDIC indemnification asset. As our credit quality has improved, we write that asset down, it actually increases our non-interest expense. There's some offset non-interest income but you really have to pull some of those items out to get a clear picture. When you adjust for these items, you'll see, I think, that we have relatively stable core earnings before credit costs when compared to the prior quarter. On a GAAP basis, we reported a loss of $0.47 per common share to shareholders, an improvement from a loss of $0.84 per share in the prior quarter. We're pleased with the credit performance - non-accrual loans, delinquent loans, net charge-offs, and provisions all declined compared to the prior quarter. We still have, certainly, work ahead of us. We certainly not have declared victory yet, but we're encouraged with the [inaudible] rate of new, non-accrual inflows and a healthy rate of problem credit resolution. In the third quarter, we resolved more than 20% of our non-accrual and real estate-owned assets, which is consistent with the resolution rate year to date in terms of the amount of the beginning balance that we've been able to resolve during the quarter. As we look at various macro-economic trends within our footprint, we see more signs of emerging optimism than pessimism these days. In the real estate markets we're seeing rental income, though still declining moderately within various major markets within our footprint, is showing signs of stabilizing. Vacancy trends are stable to improving across the majority of our footprint. Furthermore, cap rates are showing some consistent signs of stabilizing during the last several months across a wide variety of geographies and property types. All of these factors facilitate faster problem credit resolution. Importantly, non-accrual term commercial real estate loans declined for the second consecutive quarter, are now down 19% from their peak. Losses from these loans also declined to about a 1.6% annualized charge-off rate of total term CRE loans, down from 2.1% in the prior quarter. Finally, we further enhanced both our GAAP and our regulatory capital ratios during the quarter through the issuance of common shares, warrants, preferred stock via sub-debt conversion, and by reducing the risk weighting of certain securities. So we've been very busy this quarter. With that overview, I will ask Doyle Arnold, our vice chairman and chief financial officer, to review the quarterly performance.

[Doyle Arnold:]

Thank you Harris. Good afternoon everyone. As noted in the release, we posted a net loss applicable to common shareholders of $80.5 million or $0.47 per diluted common share for the third quarter. That's a significant improvement over the prior quarter and the same quarter a year ago. I'm going to highlight primarily three key areas

[Operator:]

[Operator instructions.] Our first question in queue comes from Brian Klock with Keefe, Bruyette, and Woods. Your line is now open. Please go ahead.

[Brian Klock:]

Doyle, I'm looking at the end-of-period balances. So deposits have come down compared to average and so have the money market assets. Maybe you can kind of give us an idea, where do you think the margin could be headed here into the fourth quarter versus that core adjusted margin that you guys disclosed during the third?

[Doyle Arnold:]

A couple of comments. First of all, a lot of the reduction, particularly the reduction in DDA balances that occurred in the third quarter occurred in the month of September, so if nothing else changed we would see a further decline in average balances in the fourth quarter in deposits just because of the pattern of when that occurred. I don't think we expect to have as dramatic a change in the actual balances in the fourth quarter, but you'll get a few hundred million at least of average balance decline. And we do continue to try to push out some non-relationship CDs as they come up for renewal, etc. So I think what I said with regard to the margin is that margins probably stable to maybe slight upward pressure, but I think we're comfortable that the core margin is in the low fours, but I can't pin it down to within a few basis points for you.

[Brian Klock:]

Okay. And then my last question here, just on the construction. You continue to work the construction down. Was there any of that, or can you kind of gauge how much of that was termed out, anything that rolled over from construction to permanent?

[Doyle Arnold:]

I don't think we have that with us here today. We will try to find an investor forum later in the quarter perhaps to get that. But we have not analyzed that yet.

[Operator:]

Our next question in queue comes from John Pancari with Evercore. Please go ahead.

[John Pancari:]

Could you talk a little bit about, in terms of your outlook for loan growth, can you give us a little bit of detail on where the utilization rate stands right now by - I don't know if you have any detail by loans. And where do you expect that you could see some improvement on that front?

[James Abbott:]

The utilization rate is unchanged linked quarter. There was some movement month to month, but unchanged, and it's around 38% or so.

[Harris Simmons:]

It's up just one percent from last quarter.

[James Abbott:]

On a percentage point, yeah. [Laughter.]

[Harris Simmons:]

On a percentage point from 37% to 38%, really down from a high in the low forties a year ago.

[Doyle Arnold:]

It's been stable, relatively stable, in the high 30s now, for about three quarters.

[John Pancari:]

Doyle, I know you mentioned that reserve releases are probably modest near term, I guess if you can just help us understand the timing of when you think, given its trajectory right now in non-accruals and in your delinquency trends, how soon we could expect a more material reduction in the reserve levels.

[Doyle Arnold:]

Well, that is a very good question, and I will just point out the obvious, that there's probably a real tension between what the regulators would like to see, which is little or no reserve release ever, and what GAAP would indicate, which is if the likelihood of a recession that begins to fade, and therefore the loss content inherent in the portfolio today continues to look more favorable, then we've got to release more reserves at some point. The qualitative adjustment to the quantitative reserve calculation, which was - that adjustment between what the pure quantitative factors would indicate was a bit over $200 million last quarter. It was over $300 million this quarter. So the qualitative adjustments have gotten larger and that may not be sustainable for more than another quarter or two before we have to start making some change in the reserves, unless the economic outlook does continue to be very cloudy. And as I indicated there are some macro-observers, including the Fed, that clearly have come to believe that the macro outlook today is not as favorable as it was a few months ago. So we're going to remain cautious until it becomes clearer that the recovery is on a firm footing.

[John Pancari:]

And then lastly, if I can just ask on capital, and particularly on TARP. Are you getting any additional color from the government in terms of the capital raise that could be required to get out of TARP or are they really going to look at how much you've already done and take that into consideration. Just trying to get some type of detail around how much you could have to raise.

[Doyle Arnold:]

We have no clarity. In fact we've had no meaningful conversations on that point to date.

[Operator:]

Our next question in queue comes from the line of Marty Mosby with Guggenheim Securities. Please go ahead with your question.

[Marty Mosby:]

Yes, I have two questions. One was as we're seeing asset quality, especially non-performers, delinquent loans, OREO all starting to move down nicely, it starts to put us on the back side of the asset quality cycle, and we've raised $1.2 billion, $1.3 billion worth of the capital in the last two quarters. How are we starting to feel about - with TARP out there and with the capital that we need, how much more capital issuance should we expect as we're really starting to move on the back side of some of these pressured issues?

[Doyle Arnold:]

Well, I think as we indicated on last quarter's call we will probably continue to raise very modest amounts of capital as long as we are not profitable, and in particular not sufficiently profitable to cover the preferred dividends. But those numbers are getting generally smaller every quarter now and eventually will go to zero. As we get closer to that point that's when it would be more appropriate to have discussion with the Fed and others about TARP repayment plans. In addition to having a very large loan loss reserve in the face of significantly improving credit metrics, we've also pushed a lot of capital down into our banks, and that's where those credit metrics are improving. So at some point we would hope to withdraw some of that capital back to the parent. But what the mix is going to be of all of that to repay TARP not sure, but there's no plan to raise significant amounts of capital right now prior to having that TARP discussion, just very modest amounts for reasons that we've previously indicated.

[James Abbott:]

I think too that a significant factor in all of this is what happens to commercial real estate losses, in particular the term portfolio. That's been a source of concern for a lot of observers. So far that is not playing out in our portfolio and has been reasonably benign around the industry and a lot of indications are that that market's commercial real estate is stabilizing and even strengthening. If you look at CMBS spreads and some other indicia of this it's appearing that maybe we're not going to see the kind of storm some had predicted. But I think until it's clear, it's going to take another two or three quarters perhaps before it's really clear, that there aren't substantial losses around the industry in that product type and if that happens my hope would be that regulators would become more comfortable with reliance on existing capital and capital ratios as we start to think about what it will take to repay TARP.

[Marty Mosby:]

And Doyle, I wanted to recap some of the items, just real quickly. On the favorable side this quarter we had $4 million on mark on securities. We had about a net $7 million security net gains, and about $14 million gained on the sale from the net deposit unit. That's about $35 million of favorables. If you take the two total return swap issues, $22 million in the premium and then $12 million on the structuring, which at least next three quarters aren't there, that's about $34 million. So those two things kind of net out. And then you end up with $28 million negative from discount accretion, and then another $24 million in trust impairment. You put those together and you've got about a $50 million negative left hanging out there. You could see some pretty strong improvement over the next couple quarters. So to the degree a lot of your losses are coming out of these two items, and leading capital to just cover these two things, if they improve you should see some relief I would think.

[Doyle Arnold:]

I would think. [Laughter.]

[Marty Mosby:]

Any other thoughts about the progress on those two line items?

[Doyle Arnold:]

We will announce later this week, I guess about an hour and 12 minutes ago was the deadline by which holders of sub-debt eligible for conversion had to give notice if they planned to convert. So we will announce within two or three days what amount we'll convert this quarter and our estimate of the drag fourth quarter on earnings from that. It will, based on what we've seen so far, that number will continue to be meaningful in the fourth quarter and I won't try to narrow it down any more than that. I think your other one was the TruPs OTTI, was that the other one you highlighted?

[Marty Mosby:]

Yeah.

[Doyle Arnold:]

Barring a big surprise there, the general trend is that we think the worst of that's behind us and the trend is stable to improving there. So you've got those two items and then the other one is of course the one we've already had several questions on, which is reserve release, or how much under-provision can we prudently allow to take place going forward.

[Operator:]

Our next question in queue comes from Ken Zerbe with Morgan Stanley. Please go ahead.

[Ken Zerbe:]

When you think about your non-performing loan balances, it looks like in total the NPA reduction is accelerating, and that's great. But when you look at the composition it looks like a lot of the reduction is coming from the construction loans with less of a decline in commercial, but still down of course. One of your competitors highlighted the risk that as more of the non-performers became commercial as opposed to construction the pace of NPA reductions would decline. Do you find that might be the case in your portfolio as well, or is there any reason to think you can more quickly resolve a lot of the commercial non-performers?

[Doyle Arnold:]

I think we do have several large commercial non-performers that are headed toward favorable resolution and as I cautioned James earlier today in how we characterize this I'll caution you in the use of the word "accelerating". That is a true statement historically over this quarter compared to prior. I don't know how far out to extrapolate a positive second derivative on top of a favorable first derivative. But we're not at the point yet where we think that it's going to get a lot harder to resolve C&I credits compared to construction and CRE credits.

[Operator:]

Our next question in queue comes from Steven Alexopoulos with JPMorgan. Please go ahead.

[Steven Alexopoulos:]

I just want to follow up on John's question regarding the reserve release. Doyle, given the tension you talk about with the regulators who want to keep the reserve higher, what's the key variable you need to see change to give you the flexibility to really drop the reserve here? Is it more a function of the inflows into non-performer, the charge-off levels, or is this view on the broader economy really key here?

[Doyle Arnold:]

How many angels can dance on the head of a pin? [Laughter.] I don't -

[Harris Simmons:]

I think that clearly substantial reductions in non-performing assets, our internal grading of assets, if that significantly improves that is a very substantial factor in the way we calculate reserves and is likely to remain so for some time. As that's coming down, we are trying to be very careful about not simply letting non-performing asset levels drive the reserves entirely then. We're trying to make sure we're reasonably conservative in what is still a very uncertain economic climate. But I do think internally the pressures to release reserves will accelerate as non-performing assets continue to come down. I think there's no question about that. Otherwise, too much of this becomes simply qualitative concern about future and certainly we don't have any corner on views as to what the future's going to be. But we're trying to be careful about it.

[Steven Alexopoulos:]

Harris, maybe if I could follow up - on prior calls you had expressed the hope at least to reach profitability by the end of this year. Is your optimism at least to get the provision down below pre-tax pre-provision? Has your optimism been tempered a bit? In other words, has that view been pushed out here?

[Harris Simmons:]

First thing I'd say is our view about releases is not linked to any determination as to when we want to become profitable. I wanted to become profitable long ago. So we try to make a determination about what we're going to do with reserves independent of any goal that we might have to be profitable in a particular quarter. And I think all of you are smart enough to be able to do math and figure out - you'll have your own views as to core profitability, etc. So I think it's becoming clear to us that the trends in non-performing assets, classified loans, etc. are improving at a pace that we are likely to be profitable here reasonably soon. I don't know if that's the fourth quarter or the first quarter, but I expect that we're going to see - if the internal trends we're seeing continue to play out, in terms of resolution problems and a significant decrease in the amount of new problems coming into the front end of the hopper, that the calculations will be such that you'll see increased releases. It's really premature for us to be hazarding a guess as to the amount of that, and thus the timing of returning to profitability.

[Doyle Arnold:]

What we've said, I think, for at least two quarters now, maybe even longer, was that we thought return to profitability late this year or very early next year. I still stand by that. Trying to narrow it down any more than that is very difficult because there are three or four really big moving parts here. The core pre-tax, pre-credit cost earnings have held up remarkably well through all of this. We're very very pleased about that. The credit costs are trending favorably. The OTTI costs are trending favorably. But then we have this other thing that is not necessarily economically linked and is out of our control, which is the sub-debt to preferred conversions, and those can be large enough that they could postpone profitability at quarter. They could send us back to unprofitability for a quarter after returning to profitability. They're a non-cash item. It just depends on how you're modeling and recommending to investors to look at that. And I don't know how all of you are treating that item. The things that are somewhat under our control are generally looking fairly good, and that one's a bit more volatile.

[Operator:]

Our next question in queue comes from Joe Morford with RBC Capital Markets. Your questions please.

[Joe Morford:]

I just wondered if you could talk a little bit more about the progress you made this quarter on terms of deposit re-pricing and specifically in lowering some of your money market rates in the quarter, and how much of that would have been reflected in the third quarter and maybe more in the fourth.

[Doyle Arnold:]

I would say that we've really put the pressure on our banks to take another hard look at this in meetings we had with them in August. One of our banks, for example, in late August or September, dropped its rate on term CDs, if you have no other product with us, from 40 basis points to 5 basis points, which means basically it's a not open for business sign for that product, and we're basically not opening any more of those. A lot of the adjusting that took place took place in September, so I do think you'll see more. The full impact didn't show through in this quarter. You could expect more reduction, I think, in funding costs in the fourth. It's not going to be dramatic, because you've got to wait for CDs to renew, etc., but mid-single digits basis point reduction is not unreasonable to expect I would think. You have a different view James?

[James Abbott:]

No, that's probably fair. One of the things I was going to highlight is the cost of CDs sitting in the 120 range for the quarter on the balance sheet and new production for CDs for the quarter was down around 60 or so basis points.

[Doyle Arnold:]

I would think in September it was probably lower than that.

[James Abbott:]

It was actually relatively stable, but anyway. That gives you kind of an order of magnitude on what costs can do on CDs. Money market there's a wide range of ways to look at that, but maybe we'll take that question off line as far as how to look at the industry there.

[Joe Morford:]

Okay. And then I guess a separate follow up question was just following up on the loan growth. It sounds like across the board you're seeing some more stability. I was curious if any of the banks or markets are showing stronger trends than others, more positive trends than others, and do you have much of an appetite right now at all for non-owner-occupied term CRE lending?

[Doyle Arnold:]

I think yes. You know, there's stuff that you can finance now. Generally it's well structured, it's well supported by owners' equity, favorable, good terms and rates, so yes, we are making new term CRE loans.

[Harris Simmons:]

And again, just a reminder. Our market is not the trophy high rise office building major city downtown, it's a different, more exurbs, suburbs, middle market type of CRE. I don't think the cap rate swings and other valuation indices are as violent as they are in some of those trophy CMBS type markets.

[Joe Morford:]

And are those opportunities coming across your footprint, are you seeing some markets better than others?

[James Abbott:]

They're primarily coming in the Texas and California markets. That's where the sun is starting to shine a little earlier than the other states.

[Operator:]

Our next question in queue comes from Jennifer Demba with SunTrust Robinson. Your line is open.

[Jennifer Demba:]

Just wondering if you had any changes in thoughts about M&A versus a couple of months ago now that credit costs are continuing to decline.

[Doyle Arnold:]

No change in our thoughts at the moment. We're not seeing attractive things to bid on at the FDIC. And the terms offered by the FDIC are worse, the pricing on the successful bids are worse, and the quality of the franchises are all much worse than what we actually bid on and won a year ago.

[Jennifer Demba:]

And one follow up question on origination -

[Doyle Arnold:]

I would just add one other thing. You know, one of the things that seems to be happening, at least in our territory, and you're probably aware of this, is that those institutions that are troubled enough to probably want to consider selling but not so troubled that there's no franchise value have had some success in recapping themselves during the quarter as opposed to selling themselves. So you are seeing the sick get sicker and go down, but those that had pneumonia but there's a doctor at hand are curing, and that frankly is helping our trust-preferreds recover as well. So just a little elaboration on my previous answer.

[Jennifer Demba:]

The origination jump you had from second quarter, was any of that seasonable do you think in nature?

[Doyle Arnold:]

Seems to be more of a trend line. I think if you went back a couple of quarters earlier the gross new origination somewhere late last year or very early this year were down about $1 billion or so or even slightly less than that. And we've seen increases of a few hundred million each quarter, still not enough - so we're double the low point but it's still not quite enough to fully offset the charge-offs and the pay-downs and other things, but we're getting closer.

[Operator:]

Our next question in queue comes from Brian Zabora with Stifel Nicolaus. Please go ahead.

[Brian Zabora:]

Just a question on competition on loan size, which you touched on a little bit, but is, compared to say 90 days ago, is competition still mostly in the larger high-quality, investment-grade C&I loans, or do you think it's spread at all?

[James Abbott:]

Just anecdotally I think it's still in remains in larger investment-grade or call it [inaudible] you see it most significantly. As I said everybody's looking for good earning assets. I'm sure there's some of that at other levels, but where we're hearing about it tends to be with the larger clients.

[Brian Zabora:]

And just a question on charge-offs in the C&I category. It's up a bit from last quarter, $72 million versus $52 million in second quarter. Was there any sizable charge-off in there?

[Doyle Arnold:]

I don't think there was any one noteworthy one.

[Operator:]

Our final question for today comes from Peter [inaudible] with Carlson Capital. Please go ahead.

[Peter [inaudible]:]

I wanted to applaud the moves you guys took on the high-cost funding and the lending origination and renewals. It all looks like headed the right way for the P&L, and thank you for sharing the qualitative reserve with us, because we can do a little bit of math and figure out where you would have been without it, which looks good. I was wondering, we saw the warrant issue, right? Was that in addition to the $200 million DRIP, or was that part of the $200 million DRIP.

[Doyle Arnold:]

Well, we announced that we had authorization for a $200 million DRIP. We did not indicate that we expected to use all of it ever, and we didn't use all of it in the quarter, so this was a separate capital issuance, but you shouldn’t necessarily take the warrant and add it to the $200 million and say they're going to go issue $235 million of common equity.

[Peter [inaudible]:]

Well, here's what I'm trying to do, right? We're all trying to gauge, as we talked about on the call, reserve release, when, if, depends on the environment, Q4, Q1, profitability, well we don't know, but it looks like we're headed in the right direction. What I'm trying to figure out is can I use this $200, right? Take out the $75 million that you issued, that you told us in the release, take out this $36 - $100 all together is $90 million, right? And I'm trying to say is it reasonable if I extrapolate the current environment and I know everything's conditional, but if nothing else were to come up on the environment to the negative side is it reasonable to assume that that is the cumulative pain that you guys see that is left?

[Doyle Arnold:]

Boy, you're trying to nail me down with it. You're basically trying to get me to forecast the cumulative losses over the next two quarters and say they're not - [Laughter.]

[Peter [inaudible]:]

I know I'm not going to be able to nail you down, Doyle. Directionally, am I in the ballpark?

[Doyle Arnold:]

You're more or less in the ballpark, but again, back to some of the earlier questions -

[Peter [inaudible]:]

Right, the caveats. Gotcha.

[Doyle Arnold:]

The caveats about TARP in particular. We've had some discussion about to what degree, what will "count", etc., etc.

[Peter [inaudible]:]

No, I'm just trying to get in the green. I know the Feds are a whole other issue, but hopefully they'd give you some credit for where your tier one common is and your TCE is, blah blah blah, right? The reserve levels. So I've got to imagine some people over there doing some math, but hey listen, thanks for taking my call guys.

[Doyle Arnold:]

If the Fed and the OCC are listening on the call please take careful note of what the gentleman has said. [Laughter.]

[Peter [inaudible]:]

Well, NPA formation down 28%, that was my key. That, to us, is early-stage. You guys see stuff way up further the pipe that's early-stage to you, but we feel cool when we're looking at the [Y9Cs and CMPA] formation down 28%, because that should lead to lower charge-offs in the future, so thanks for sharing that metric.

[James Abbott:]

Okay, thank you very much everyone for your time. I will be available throughout the evening to take any additional questions or housekeeping items. You can reach me at 801-844-7637 and we look forward to talking to you intra-quarter. If not then, then at the next earnings call. Thank you. Copyright policy