Zions Bancorporation, National Association
Q4 2010 Earnings Call Transcript

Published: 25 Jan 2011

[Operator:]

Good day, ladies and gentlemen, and welcome to the Zions Bancorporation Fourth Quarter Earnings Call. [Operator Instructions] I would now like to turn the conference over to your host, James Abbott.

[James Abbott:]

Thanks, John, and good evening. We welcome you to this conference call to discuss our fourth quarter 2010 earnings results. 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 statements made in this call. We will be referring to several schedules in the press release during this call. And if you do not yet have a copy of the press release, it is available as an Adobe Acrobat file at zionsbancorporation.com. We will limit the length of this call to one hour, which will include time for you to ask questions. During the Q&A section, we 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?

[H. Simmons:]

Thank you very much, James, and thanks to all of you who are listening in. We are generally quite pleased with the events of the fourth quarter. The big story this quarter is a strong improvement in credit quality. That's a trend that's been developing since really back in the spring of last year, but certainly accelerated toward the end of the year. We made some very strong efforts during the fourth quarter to resolve a significant amount of problem credits. As a result, we were able to reduce classified loans by over $1 billion, a 23% reduction over the three-month period of the fourth quarter. Due to the new disclosures required by the SEC regarding our allowance for credit losses, which will show up in our 10-K and subsequent filings, we are disclosing our classified loan balances this quarter and expect to continue doing so going forward. If you're not familiar with the definition of a classified loan, we have included a definition in the footnote at the end of the text in the press release. We'd note that the classified loans that we're reflecting here are, in large part in fact, over 2/3 of them, are actually current. And yet these are the population of commercial and real estate credits primarily in which we see continuing stress. But that number is coming down rather dramatically during the fourth quarter. Most of these loans were resolved in a manner favorable to the company and the shareholders through, for example, payoffs and paydowns, upgrades to passed grades, which together greatly exceeded charge-offs. Notably, we didn't do any bulk sales of problem credits at deep discounts to achieve this reduction in problem credits. And other credit quality metrics showed similar improvement including non-performing loans, other real estate owned balances and expenses attributable to other real estate owned. We did experience a slightly higher level of net loan charge-offs compared to the prior quarter, largely reflective of the number and dollar amount of problem loans that we resolved. While we don't expect to experience as rapid a decline in classified loans in the first quarter as we did in the fourth quarter, we expect to continue to see significant improvement. We also expect net charge-offs to decline significantly in the first quarter. A lower level of classified loans, together with our expectation that loan quality will continue to improve, our expectation of a lower-level of loan charge-offs going forward, obviously, have favorable implications for the likely amount of loan loss provision that we may have to make in future quarters. As we look at various macroeconomic trends within our footprint, we remain quite encouraged with various market data emerging from our major markets. Specifically, we are seeing some continuing signs that rental income is stabilizing across our footprint. And in some cases, we're seeing increases in rental rates, particularly in the Houston, Orange County and San Diego markets. Vacancy trends are improving across majority of our property types in our footprint. And further, we are pleased with continued steadiness in cap rates during the last several months. All of these factors should facilitate faster problem credit resolution and improving loan growth. Finally, I'd like to note the emerging growth in commercial and industrial loans, which increased at a 5% annualized rate compared to the prior quarter. Production volume and particularly, C&I volume, increased significantly. And we expect an even stronger first quarter as our pipelines continue to strengthen. So with that overview, on the credit front, I'm going to ask Doyle Arnold, our Vice Chairman and Chief Financial Officer, to review the rest of the numbers. Doyle?

[Doyle Arnold:]

Thank you, Harris. Good afternoon, everyone. As noted in the release, we posted a net loss applicable to common shareholders of $110.3 million or $0.62 per diluted common share in the fourth quarter. However, excluding the non-cash sub debt amortization and FDIC loan discount accretion, the loss improved to $0.25 per share from $0.30 a share in the prior quarter. As Harris has already covered credit quality, I'll highlight two other key areas

[Operator:]

[Operator Instructions] We'll take our first coming from Steven Alexopoulos from JPMorgan.

[Steven Alexopoulos:]

We've only had a couple of banks report so far, but some of them have had very sharp declines in provision, like 40%, 50%. Do you guys think maybe you're a quarter behind this because of the classified load in workout? And then you could see a drop in that range? Or is that too much because you're continuing to work out these classified loans? I guess I'm trying to size this term meaningfully.

[H. Simmons:]

Based on what we see now, it's going to be meaningful. We just don't see anything close to this level of charge-offs coming through in the first quarter that we've been experiencing for the last year now, kind of in the 240 to 250 range on average. Our current thinking is you're not going to see a zero provision from us or a negative provision from us. There's not going to be a huge reserve release. But if you have a significant decline in charge-offs and a continued decline in classifieds, it would not be unreasonable to expect a continued underprovision of roughly the kind of magnitude, dollar magnitude that we've had the last couple of quarters now. So you've got charge-offs declining, and you could get that provision down quite significantly and still not be just bleeding lots of reserves out. And I'm not going to try to quantify it. We've just been -- we don't want to declare victory here too early, but things are looking pretty good right now.

[Steven Alexopoulos:]

Based on where credit and capital ended the year and where they're trending, do you think there's any real chance you could have TARP repayment discussions in the first half of the year? Or realistically, is this a second half event?

[H. Simmons:]

I suspect my regulators are actually listening in. They don't have a microphone. But my own expectation would be that we could start having more -- as I said, I've been saying this now probably since around late third quarter or early fourth, that I thought that if classified levels came down materially and the trends were still positive, if earnings were positive, at least before TARP dividends, and for us, there's this kind of added question of how do they and we think about the non-cash charges, which are volatile and can be high related to the sub debt conversion. But anyway, I think those two trends are clearly in place, i.e. earnings improvement, loan quality improvement and capital ratios having significantly improved, that we should -- we'll at least start to ask in the second quarter if we can have those discussions. We are, as always, mindful of approaching TARP repayment in the most intelligent way possible. And we're not, as I've said before, totally fixated on the idea that we have to do whatever it takes to pay it off all at once. We may do it over a few quarters. But again, all of that subject to discussion with the guys listening on the phone and maybe some of their friends in Washington.

[Operator:]

And we'll take our next question from Brian Zabora from Stifel, Nicolaus.

[Brian Zabora:]

You gave us before the [indiscernible] of that loan loss reserve. Do you have that number this quarter?

[Doyle Arnold:]

Well, first of all, the numbers aren't exactly comparable as we will discuss in greater detail in our 10-Q. We've changed our quantitative methodology this quarter to capture -- make sure that we keep them in the rearview mirror. And firmly in the calculation, the loss impact from the 12 to 18 months ago losses, which were much higher. So in other words, we had been taking the higher of six or 12 months losses by loan grade category, bank, et cetera. We've extended that back to six, 12 or 18 months. And that change soaked up some of the qualitative reserves, if you will. But I think there's still about even with that change, there's a pretty large qualitative factor, $300 million to.

[H. Simmons:]

About $280 million.

[Doyle Arnold:]

Pretty significant qualitative adjustments.

[Brian Zabora:]

And just remind us the DTA decision at this point.

[Doyle Arnold:]

DTA, on a GAAP basis, was $555 million at year end. That's down from $585 million the prior quarter. The regulatory disallowed DTA included in risk-based capital on a consolidated basis is approximately $121 million this quarter, down from $179 million in the prior quarter. The balance sheet earnings do not reflect any GAAP reserve against the deferred tax asset.

[Operator:]

We will take our next question coming from Christopher Nolan from CRT Capital.

[Christopher Nolan:]

Could you go through the remaining balance for the subordinated debt that's eligible for conversion into preferred stock?

[H. Simmons:]

The amount -- well, there is $800 million in total. One of three issues has the option this quarter. It's the roughly similar size. So the amount that could elect this quarter is probably in the $200 million range, maybe a bit more. I'm not -- if we can come up with a precise number on the call, we'll get it. But that will be...

[Doyle Arnold:]

Chris, I'm showing about $330 million actually. This is the larger of the three issues. Except when you think about it, two of the issues convert in the second and fourth quarters. And that sum would be about $470 million that's remaining eligible to convert. That's why the second and fourth quarter are a little bit larger or could be a little bit larger conversion.

[Christopher Nolan:]

So James, the total amount conversion right now is $470 million you just mentioned or is it larger?

[James Abbott:]

The amount that could elect this quarter is $330 million. We won't know until about February 15 how much did elect. That's when the elections become irrevocable. And realistically, we don't really get a sense -- most of these elections come in the last couple of the days, so we have no kind of early indication right now to offer you.

[Christopher Nolan:]

The aggregate amount including the $330 million would be somewhere around $800 million, if I understood Doyle correctly?

[James Abbott:]

That's correct. It's just over $800 million, I think, $804 million, something like that.

[Operator:]

And we'll take our next question from Bob Patten from Morgan Keegan.

[Robert Patten:]

Can you give us some color around the NPA sales and break down charge-offs between what were charge-offs? And are the charge-offs related to the sales? What kind of marks you guys took? And since you didn't do a bulk sale, give us an idea of what kind of sales you did do?

[H. Simmons:]

The old-fashioned way, one at a time. I mean, we did post some repossessed smaller commercial properties on our auction site and participated in the auction of about 70 properties. And we took -- we accepted bids on some of those, we rejected bids on others. But they were individual buyers. There wasn't an offer that's a take-one, take-all kind of a thing. And then we subsequently worked out a number of them, and we didn't take from the auction one at a time. So no bulk sales. I don't know. Do you have a non-accrual resolution? I've got a classified loan resolution. Do you have that, James?

[James Abbott:]

Sure. On the non-accrual, the loans that were moved back to accrual status were about $133 million. The amount of non-accrual loans that paid off or paid down was about $290 million, $285 million. And then we moved to about a little over $100 million to OREO for the quarter. And then there were charge-offs obviously.

[Robert Patten:]

Can you then give me an idea of what the charge-off related to loan sales specifically were?

[Doyle Arnold:]

I don't think we have that. We resolved a lot of problem credits without increasing net charge-offs much above where they were last time. And we resolved -- we net reduced OREO by, I think, around $50 million, if memory serves me. Let me see here, yes, $305 million down to $260 million. So about $45 million, which is a pretty meaningful percentage. And yet OREO expense declines, as I mentioned earlier, from about $44 million down to $25 million or $26 million. So the loss severity did not increase materially over what we have been experiencing in order to move a massive amount of problem credits in OREO this quarter.

[Kenneth Peterson:]

And Doyle, this is Ken Peterson, the Chief Credit Officer. Anecdotally, there were a number of transactions in which we actually experienced gains from the sale of OREO for the first time.

[Operator:]

Our next question coming from Joe Morford from RBC Capital.

[Joe Morford:]

I'm just curious, the available-for-sale securities portfolio was up almost $1 billion or so this quarter, 28%. What was driving that and what exactly are you buying? And just thoughts around the securities portfolio in general?

[H. Simmons:]

It's a pretty straightforward answer, but I'll let David Hemingway get it.

[W. Hemingway:]

$700 million of the increase was actually excess cash at the holding company that we moved into a separate account in purchased Treasury bills in anticipation. That's half the amount of TARP that we'd like to pay back. And so that $700 million is sitting in Treasury bills, ready for the Treasury whenever they're willing to take it. The other increase was in fact, we purchased some Fannie and Freddie five-year ARMs, a couple of hundred million dollars for the banks. And these are underlying as floating rate, but agency ARMS.

[Joe Morford:]

And then the other question was just can you quantify the impact of the Durbin amendment at all related here?

[H. Simmons:]

We have. The approximate gross impact would be about $50 million annually. And as you're hearing from others, we are very focused on various strategies to help us recapture a substantial portion of that through repricing of accounts, et cetera, et cetera. But that's still a little premature.

[Operator:]

And we'll take our last question from Craig Siegenthaler from Crédit Suisse.

[Craig Siegenthaler:]

It sounds like your response to the first question, that the word meaningful in kind of your charge-off deficit [ph] could imply pre-TARP dividend profitability in the first half. Is this fair? Or am I just kind of getting a little aggressive here?

[H. Simmons:]

It could imply that. Again I mean, particularly if you're willing to exclude the non-cash impact of the sub debt conversion costs, which ironically the more things improve, it may be that more people are willing to do that conversion which actually trashes the GAAP earnings. But we have no way to know that. But if you've set that aside, then I would not argue with your premise.

[Craig Siegenthaler:]

And in your discussion with regulators, do they exclude the non-cash charges? And also are they looking at your earnings result x the TARP dividend?

[H. Simmons:]

Well, I think they're struggling with that is the best answer I can give, particularly knowing that Charlie is on the line. I do think they're struggling with that. I think they do understand that that's somehow different and reflects an ongoing impact of past capital actions and has nothing to do with the fundamental operating income of the company. And at least at some level, they're willing to acknowledge that. But again when you get down to TARP repayment discussions and things like that, I believe that was a component of your question, we haven't -- that's premature. We'll have a little more insight into that next quarter if we are able to then at that time actually sit down and discuss that heavily.

[Craig Siegenthaler:]

And Doyle, just once more the kind of CDO losses, they're kind of down here to a low levels. Should it be only kind of a couple more quarters here for CDO to trump losses?

[Doyle Arnold:]

I think unless something really dramatic comes out of the woodwork, it's likely that there will be a trickle of these for a while as continued bank closures, but the fundamental trends are good. Most of our losses have been coming out -- the vast majority of the losses have come out of banks that have previously deferred their dividend. And we have modeled anything that's deferred with a very high default probability. And the number of new deferrals has been declining consistently for over a year now and is getting down to lower and lower levels, which portends well for future bank failures. The number of bank failures has peaked and begun to decline. And I believe the FDIC has stated that they expect they have peaked and will decline. The size of the bank failures has dropped dramatically in 2010 compared to what was going on in 2009. Therefore, the amount in our collateral pool is way down. And finally, the percent of failures to which we have exposure has declined from the 45%, 50% range, if we go back two years, to 20%, 25% in more recent quarters. So all of which I think bodes well for future OTTI remaining at pretty low levels, but it may continue for a little while.

[Operator:]

And we'll take our next question from Erika Penala, Bank of America.

[Erika Penala:]

My first question is on I guess, thinking in a more normal environment, what place if any, does $1.1 billion in preferred that's yielding 9% have? I mean, I'm thinking as they fully convert, how do you think of that in context of a more normal earnings environment?

[H. Simmons:]

Well, as noted in a discussion with investors, and you can certainly get this us out of our SEC filings, our capital structure contains a very high degree of optionality. And once we get past TARP repayment, the things I'm about to mention, we can't do until TARP has been fully repaid. But once it is, in 2012, we have about $150 million of non-cum perpetual preferred with an 11% coupon that is callable in mid-2012. The preferred that you mentioned, the 9 1/2% of preferred, and that's what most of the sub debt that is converting is converting into. That's callable in mid-2013. So I think what you could anticipate is that if capital market conditions are favorable, we would look to restructure our capital to either reduce the total amount of preferred if we didn't need it and/or refinance it with a lower-cost instrument, assuming, in your words, things are more normal out there. So there's a lot of optionality in the capital structure that would allow continued increases in net income to call in, given the same operating performance over the next two and half years.

[Erika Penala:]

James, I didn't catch how it would be the second half amount is in terms of the sub debt that is eligible for election?

[James Abbott:]

In the current quarter, it's 330-some-odd million dollars. And in the second quarter, it is $470 million is the total eligible pool that may convert.

[H. Simmons:]

The two pieces together are $800 million. That's what's left out there that hasn't already converted. And any conversions that happen this quarter will reduce the remaining pool that is eligible to convert.

[Operator:]

And our next question is coming from Jennifer Demba from SunTrust.

[Jennifer Demba:]

On credit, number one, I was wondering if you could give us a sense of where you're seeing the improvement in non-accrual and classified loans by geography? And secondly, on your restructured loans, can you give us a sense of what percentage of restructured loans might be up for review this year and eligible to go back on performing status? And how high would you see that absolute dollar amount being peaking, I guess, during the cycle?

[H. Simmons:]

I'll take a swag at your first question, and maybe, Ken, if you want to chime in on restructured loans. I'd tell you the classified loan balances, which probably reflects similar patterns in accruals, et cetera, came down in just about, I think, in every single subsidiary, affiliate bank this quarter. And the trend generally is flat to down for the last three quarters across all those banks. The largest dollar amount of reductions came out of Amegy and Zions First National Bank here in the Intermountain West, but the reductions were noticeable everywhere; and were in all loan types including C&I, including term CRE and including construction and development loans. I'll pause there. Does that address the first part of your question? Ken, do you have any response on the restructured?

[Kenneth Peterson:]

Just to add to that first question, we've even seen in our worst markets a leveling out of the problems, Nevada and Arizona, in particular. So across the entire footprint, I think trends are improving. In terms of our -- let's just take the classified loan reductions, we have had some marked success in AB note structures this quarter over last quarter, and a number of them still in the process for resolutions. I would expect that there's going to be a continued effort in restructuring, coming up with potential AB note structures during this quarter and next quarter. We do expect the classifieds to come down probably somewhere between 8% and 10% in the first quarter and an additional 5% or better in the second quarter.

[Operator:]

And our next question is coming from Ken Zerbe from Morgan Stanley.

[Ken Zerbe:]

First question I had, just in terms of your share issuance, the ATM or the[indiscernible], it looks like you have about $6 million left. Do you guys anticipate an additional capital need going forward such that you may increase the ATM offering?

[H. Simmons:]

I think, Kevin [ph], built the Tier 1 common to north of 9%. We're not going to want to see that erode from that level, meaningfully. So there, again, depending upon after-tax and after dividend losses, if any, we could see a need to issue some additional capital. The need to build the capital ratio, we think, is largely behind us; again, subject to any discussions with the regulators about TARP and things of that nature. Whether we would do that in the form of continued ATM or other means, and we do use other means like warrant sales and other things or a combination of things, we haven't yet decided, Ken.

[Ken Zerbe:]

It looks like you got a little bit less of the tax benefit on your losses this quarter. Anything unusual in the tax rate?

[H. Simmons:]

Yes, everything is unusual in the tax rate. Do you want to take that?

[Doyle Arnold:]

Yes, Ken, the primary reason is sub debt conversion, only half of it is tax deductible; the other half is not. So while we initially expected a higher tax benefit rate in the fourth quarter, because there was so much sub debt conversion, the tax rate was not as favorable to us as we had initially expected it. But that's really what's going on. Just kind of looking out for the year, it's a little bit hard to give guidance on tax rate given the volatility of sub debt conversions and the lack of tax deductibility there. But we think it could be in the 45% to 55% range, depending on sub debt conversion amounts. And there's a lot of subjectivity to that so a big grain of salt.

[H. Simmons:]

And again because a chunk of that cost is not tax-deductible, the part that was booked directly to capital as opposed to as a gain comes back without tax benefit when it converts.

[Operator:]

Our next question is coming from John Pancari from Evercore Partners.

[John Pancari:]

Doyle, you mentioned in the discussions around TARP repayment and the potential capital need there. Now that you're north of 9% on Tier 1 common, can you talk about how that discussion with regulators has changed in terms of that potential raise? Are you getting any credit for the amount of ATMs that you've completed to date?

[Doyle Arnold:]

I think I said we haven't really had any serious discussions with the regulators about TARP repayment. And my best estimate at the moment is that that's not likely to occur until after first quarter results are announced. So I have no color to offer you, and I wasn't trying to foreshadow anything about initial capital raises in my earlier comment.

[H. Simmons:]

Since from the beginning of this cycle, we've raised a new common equity issuance, about $1.65 billion in common equity and about another $400 million in preferred, so it has been a meaningful change in capital. And so we would hope and expect that, that would be taken into account as we have those discussions.

[John Pancari:]

On terms of loan growth, I know you mentioned that you expect it to be flat for the year, and that you could see it down at first and then a pick up. Can you talk about the timing of that inflection point, and give us just an idea in terms of your pipeline and your utilization rate on the commercial side?

[Doyle Arnold:]

Pipeline continues to strengthen pretty much across the franchise, particularly in C&I lending, some term CRE lending and some consumer categories. Again, by far the biggest runoff is C&D loans. If we didn't have that drag, loans would've been flat this quarter even with the work out of the FDIC loans. So we do expect that -- C&I loans do seem to be picking up as we got later in the last quarter, in the first part of this quarter. And it kind of when the line crosses [ph], it's going to be dependent on when the C&D runoff abates. Personally, I can't see it continuing in anything like the level of the fourth quarter. If it did, our C&D balances will be zero in the first quarter of 2012. And I don't think that'll happen, but there'll probably be some additional attrition. So I don't know that inflection point, but I would guess there might be modest shrinkage this quarter turning flattish in the middle part of the year and positive sometime in the second half of the year.

[H. Simmons:]

I'll just add a little bit of historical data to help a little bit, perhaps, is on the C&I front. We did produce about $1 billion worth of new credit there this quarter. That's up from less than $500 million last quarter, so more than double the production. And it takes a little while for those lines of credit to be utilized to their full degree. Line of credit utilization did decline a couple of percentage points to about 37% or so, 36 point something or other, and I think it rounds to 37%. So as those new lines of credit -- as we see draws upon those new lines of credit, rather then we'll start to see improving balance there. Term commercial real estate production was about 30% better than it was in the prior quarter. Owner-occupied production was similar to the prior quarter. So we are seeing some good production there. And we do have a fair amount of construction loans that are cash flowing, so there may be some conversion in there where we'd see production from that, too. It's about 40 or so percent, we estimate, is cash flowing. The 1

[Operator:]

We'll take our last question from Marty Mosby from Guggenheim.

[Marty Mosby:]

I wanted to focus on maybe a little bit different angle. Something you'd talked about with the macro economic kind of in your region, really starting to improve and starting to hit some favorable strides. And then you kind of let it out there that the pipeline going into the first quarter was stronger than it was going into the fourth quarter when we started to see at least some C&I kind of growth. Can you quantify how much larger the pipeline is and give us a little bit more feel on the traction that you're feeling in your regional and economic areas?

[Doyle Arnold:]

I don't know. We don't have a consolidated pipeline that we monitor here, centrally. That's really done at the individual banks. So what we do is we have monthly calls with them about their largest problem credits, but also generally about loan pipeline; how it's developing, what's happening in their market. And it's from those calls kind of every month over the last few months that we just get a sense that month by month by month, those pipelines are incrementally improving. And in the case of C&I, at a fairly decent rate. I can't quantify it for you. There was another part -- the economic conditions around. Harris gave some statistics, kind of real estate related, I think, in general, in most markets there's either some bottoming or slight pick up in economic activity. I think that's true in Texas, it's true here in the Intermountain West and Southern California where most of our exposure is. Things seem to be improving a bit. Nevada, much less so. That's just going to be a very long term workout in Southern Nevada; measured in years, not quarters. And Arizona somewhere in between.

[H. Simmons:]

Let's say even the bottom market, their pace of resolution has really picked up and that seems to be continuing. So I think it's clearly been the toughest market for us.

[James Abbott:]

I think, John, that'll probably have to be our last question today. We're out of time. But I do have the list of those who are still in the queue, and I would give you a call back as soon as I can tonight. And I'll be around until everybody gets a call. So we thank you for you time and participation today. And we will see you at the next Investor Relations conference or the next conference call.

[H. Simmons:]

Next week for some of you, probably. We'll be back on the East Coast so look forward to it.

[James Abbott:]

Thank you.

[Operator:]

Okay. Ladies and gentlemen, this does conclude your conference. You may now disconnect. Have a great day.