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Zions Bancorporation (NASDAQ:ZION)

Q4 2008 Earnings Call

January 26, 2009 5:30 pm ET

Executives

Clark B. Hinckley – Senior Vice President, Investor Relations

Harris H. Simmons – President and Chief Executive Officer

Doyle L. Arnold – Chief Financial Officer

Nolan Bellon – Senior Vice President, Controller

Gerald J. Dent – Executive Vice President, Credit Administration

Analysts

Steven Alexopoulos - JP Morgan

James Abbot - Friedman Billings Ramsey

Ken Zerbe – Morgan Stanley

Jason Goldberg - Barclays Capital

Jennifer Demba – SunTrust Robinson Humphrey

Anthony Davis - Stifel Nicolaus

Kenneth Usdin - Banc of America Securities

Operator

Welcome to the Zions Bancorp’s fourth quarter 2008 earnings conference call. (Operator Instructions) As a reminder, this call is being recorded.

Before we begin, the company has asked me to read the following statement. Today’s presentation by management contains forward-looking statements with the meaning of the Securities and Exchange Act of 1934. These forward-looking statements represent the company’s present expectations or beliefs concerning future events. The company cautions that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties which could cause actual results to differ materially from those indicated today. These risk factors include changes in general economic conditions, recent geopolitical events, increased competition, work stoppages and slowdowns, exchange rate fluctuation, variations in the mix of products sold, fluctuations in effective pass through rates resulting from shifts or sources of income, and the ability to successfully integrate and operate acquired businesses. Further information on these risk factors is included in the company’s filings with the Securities and Exchange Commission.

I would now like to turn the call over to the host for today’s conference, Mr. Clark Hinckley, Senior Vice President.

Clark B. Hinckley

Good evening everyone. We welcome you to this conference call to discuss our fourth quarter of 2008 earnings. 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 in Adobe Acrobat format at www.zionsbankcorporation.com and can be easily downloaded and printed. We know that your time is limited and very valuable. We will limit the length of this call to one hour, which will include time for you to ask questions.

I will now turn the time over to our Harris Simmons, Chairman and Chief Executive Officer.

Harris H. Simmons

Welcome to all of you. The past quarter was perhaps the most challenging quarter for the industry in our lifetimes. The quarter was marked by a significant decline in economic activity in almost every market and sector of the economy and by a great deal of turmoil in the banking industry.

The quarter resulted in a loss for Zions Bancorporation. That was driven largely by non-cash goodwill impairment reflecting both conditions in the market for bank equities but also of lowered expectations for the performance of some of our subsidiaries in some of these difficult markets in the medium term.

Additionally, the loss was caused by the write-down of impaired securities and of higher provisions for loan losses, including a $105.0 million increase in our reserve for future losses.

This past quarter saw a meaningful decline in credit quality across the industry. We experienced continued deterioration in residential real estate credits in the Southwest. We also saw some weakening in other loan types in other geographies as the country continued to slide deeper into a recession.

With the economy continuing to deteriorate in recent months, we focused a lot of attention on strengthening our balance sheet in the event that economic conditions get worse.

Our capital ratios are at or near record high levels. That’s the result of not only receipt of TARP capital during the fourth quarter, but our own common and preferred capital raises in the third quarter. There is increasing focus on tangible common equity ratios and we believe that we are in relatively strong shape in this regard relative to many in the industry.

We came into this cycle with a great majority of our tier-1 capital consisting of common equity. In order to ensure that common equity remains strong through the remainder of this very difficult cycle we announced today an 88% reduction in our quarterly dividend to $0.04 per share.

We have essentially eliminated all net short-term borrowings and we have substantial unused borrowing capacity at both the Fed and the Home Loan Bank system, equal to about one-third of our entire deposit base. We have sufficient cash at the parent-company level to meet our needs for about two years so we have some strength there.

Indeed, for all the challenges we are seeing in this environment, there are some real strengths. In addition to strong capital and liquidity positions, our margin remains one of the strongest in the industry and we are seeing improvements in credit spreads. And losses in the loan portfolio, while elevated, remain in better shape that we have generally seen around the industry.

With that brief introduction, I am going to ask Vice Chairman and Chief Financial Officer, Doyle Arnold to review the quarterly numbers.

Doyle L. Arnold

Harris has already hit the three big drivers of the bottom line results this quarter. The goodwill impairment, we wrote off all of the goodwill at our subsidiaries at Nevada State Bank, National Bank of Arizona, and Vectra Bank and all the goodwill at a small financial Tex-sub. Together those were $353.8 million, or accounted for $2.97 a share. We did recognize impairment losses and valuation losses on securities of $204.0 million, or $1.07 per share.

It’s hard to know which analyst included what, but if you back out both of those two things, we lost about $0.32 a share for the quarter. I think if there was a consensus it was somewhere around that number, $0.30 to $0.32 loss for the quarter.

Turning to some of the particulars now on page 11 of the attachments to the release, net interest income of $508.4 million actually increased at an annualized growth rate of over 13% from the prior quarter. In part this was driven by, at the bottom of that page, increase in the net interest margin of 7 basis points.

The TARP Capital Purchase Program capital had a 1 basis point to 2 basis point favorable impact on the margin but most of it was driven by an increase in net interest spread.

Again, back up in the top part of the page, the provision for loan losses, $285.2 million was $128.6 million higher than the prior quarter and $105.0 million in excess of net loan and lease charge-offs and it was driven by the decline in economic conditions that Harris referred to and which you have heard a lot about from other reporting banks in the quarter.

And then finally you will see there the total impairment charge on goodwill of $353.8 million. On page 12 I’ll just highlight a couple of additional numbers. Period end loans and leases of $41.94 million were essentially unchanged from the prior period, $41.98 million, but a lot of change was masked by that.

We had growth, as you will see in a moment, in C&I, consumer and commercial term real estate, and it was offset by pay-downs and charge-offs of other CRE loans, particularly residential construction and development.

We actually originated $2.97 billion of gross new credits during the quarter. For those who want to know what we’re doing with the TARP capital, are we lending it, we are certainly trying to.

We also had substantial draw-downs on credit lines during the period, as well. Bu the net after pay-downs and charge-offs elsewhere was about flat.

Just below that number you can see the resulting balance of goodwill of $1.72 billion, after the impairment charges that I just mentioned. Down from a little over $2.0 billion in the prior quarter. About $1.3 billion of what’s left is in Amigy Bank in Texas and most, if not all, of the rest is at our California subsidiary.

Turning to page 13, on the consolidated balance sheet, going to just focus on the liability section, because we are going to talk more about loans later. You will notice that DDA non-interest-bearing accounts did increase by about $270.0 million from period end to period end, over the quarter. Average DDA was up about $164.0 million, a little less than the period-to-period, but we saw growth during the quarter.

The other big driver of the overall increase of deposits of $2.7 billion, as you can see, is growth in money market accounts, which does include some use of brokerage money market accounts, which we consciously did for two reasons. One, the brokered money market accounts were actually cheaper than our Internet money market accounts and we also consciously raised those to pay down Federal Home Loan Bank borrowings and other wholesale borrowings and free up that backup liquidity capacity.

Significantly then, Federal Home Loan advances and Fed auction borrowings were down $2.7 billion from September 30, 2008. You can see that about three-quarters of the way down the page under Federal Home Loan Bank advances and other one-year-or-less. You can also see that Fed Funds purchase have come down over the course of the last couple of quarters.

Our short-term borrowings, which were $4.7 billion at September 30 actually peaked at about $6.8 billion during the middle of the third quarter, so we have undertaken a sustained and successful effort to reduce those long-term borrowings and improve liquidity during this uncertain economic environment. So we now have short-term liquid assets, cash, and money market instruments slightly in excess of our total wholesale borrowings and we have unused immediately available borrowing capacity at the Fed and Federal Home Loan Bank, as Harris said, to slightly over one-third of our total deposit base.

At the bottom of the page I’ll just note the preferred stock for the U.S. Treasury, $1.295 billion. We actually received $1.4 billion of TARP capital. Our valuation of the warrants that were attached to those led to a value of the preferred itself of $1.295 billion and then as you can see a couple of lines down, common stock has increased by about $105.0 million. There was $105.0 million of TARP value attributed to warrants included in the common stock line.

Turning to page 14, the income statement, I’m not going to highlight a lot. I’ll just note that dividends and other investment income increased to about $16.0 million, driven primarily by BOLI income increasing over $4.0 million and an improvement in the earnings of Farmer Mac by about $6.0 million during the quarter. Despite this improvement in Farmer Mac, about four lines down under equity gains losses, we impaired the value of our holding in Farmer Mac stock. $11.0 million of that $14.0 million loss is writing down our Farmer Mac stock by $11.0 million, or about 50%, due to some of the stresses that that GSE has encountered during the quarter.

Fair value and non-hedged derivative loss, as we suggested it might last quarter, narrowed from a $26.0 million loss to just under a $6.0 million loss. Non-hedged derivative income was actually positive as the spread between prime and LIBOR widened again. It moved in our favor, however we did record losses on FAS 159 securities and other items that drove this line to an overall net loss.

You can see the OTTI impairment of $204.0 million is not hard to miss. I probably don’t need to point that out to you.

On the non-interest expense line, salaries and employee benefits declined significantly, about $18.0 million from the prior quarter, primarily due to reduced or reversed accruals for various incentive, variable pay, benefit plans.

The other real estate expense this quarter was up significantly, $40.0 million, resulting from further write-downs of ORE some of which was disposed of, some of which were just further charged down.

Total growth from fourth quarter this year compared to fourth quarter last year in non-interest expense was $45.0 million. If you net out the change in the ORE expense you get only $6.5 million of growth, or about 1.8% over the year. And most of that was driven by an increase in advertising expense this quarter and as we’ve begun trying to advertise our willingness and ability and eagerness to lend to creditworthy borrowers primarily during the quarter.

I would note that we have continued to take actions to reduce overall operating expenses. We have contracted to sell 51 grocery store branches in Utah and Nevada and those deposits for the most part will be consolidated into other free-standing branches. We are building a few new free-standing branches to offset those, but nowhere near the 51 that we have sold to another party.

We have essentially effective the first of the year frozen base salaries for most mid-level and senior officers and executives in the company and are limiting overall increases for other employees to very modest levels and various incentive-based pay is being curtailed significantly around the company.

If you go to page 16, changes in shareholders’ equity and OCI, I’ll only point out a couple of things there. In the bottom two sections of the page you can see that in the third column from the right, accumulated other comprehensive income, that number was a negative $157.0 million at September 30. It’s a negative $99.0 million at year end. That’s a net improvement of $58.0 million, which is reflected in GAAP common equity but does not have impact on risk-based capital measures.

The big drivers there are the net unrealized gains and losses on investment securities which were negative offset by some other items there, $122.0 million improvement. We can come back and answer questions, I don’t want to dwell on that, but there were some pretty big moving parts that net-net added about 11 basis points or 12 basis points to common equity.

Pages 17 and 18, in response to questions and comments from last quarter, we have this quarter provided you with two versions of the schedule that breaks out our held to maturity and available for sale securities holdings. Over the last quarter or two, as you are aware, particularly happening in the fourth quarter, there is now a very wide divergence in ratings of a number of these securities by the various rating agencies.

So we have given you two versions of the schedule, one to show you what we hold based on the highest rating, applicable to each security, and the other based on the lowest rating. That’s page 18. The differences previously had been rather immaterial, but as I said there is a wide disparity at this point.

We have also added a new column to these schedules to show you the starting point, the par value, instead of starting with a carrying value kind of number. So we are trying to improve the disclosure there.

There is a lot that we could go through there. I’m going to not go through this in detail but what I do want to tell you is that of the OTTI that we recognized this quarter, if you want to put out page 17 in front of you, $141.0 million of it related to held to maturity A-rated securities. So on page 17 that would be the third line of numbers, the one that is $1.19 billion.

We impaired those securities by $141.0 million this quarter. We currently on average have an estimating fair value on those securities of 50%. 72% of the OTTI that we took this quarter were in tranches of those A-rated held to maturity securities.

One line below that, $32.0 million, or 17% of the total OTTI charge, was related to the triple-B held to maturity securities.

The next biggest tranche was down in available for sale under the A-rated real estate investment trusts. We impaired those by another $9.0 million and are now carrying them at $6.0 million. That’s about 40%, I guess, of par.

Overall, the re-trust preferred securities we are now carrying at 11% of par but that is after disposing selling a significant dollar amount of re-trust preferred securities that previously were being carried at $0.01 to $0.03 on the dollar and we sold them for a couple of tens of thousands of dollars, primarily so that we could realize the tax loss. It was $80.0 million of par value and we sold it for $20,000 so we could recognize the tax loss and that’s why the overall REITs came down a lot. But also why the average remaining price went up slightly, as a percent of par.

I would like to give you some metrics on how we approach the valuation. As we have discussed with you in the past, there are two big drivers of how we value these securities, particularly those in determining OTTI. One is probability of default and the other is the discount rate we use on the cash flows.

So I am going to give you some metrics on both. On probabilities of default, we obtain these from third parties. Kamakura for those that are publicly rated and we use LACE ratings to map to the Kamakura default probabilities for the ones that aren’t.

We have now, after acquisitions and what-not, we had a total exposure universe of 994 banks that we’re holding exposure to. In 2008 14 of the banks to which we had exposure failed. Our analysis had predicted 19 so we were conservative by about a quarter in our analysis in 2008, just on failures alone.

Cumulatively, from 2008 through 2009, our analysis is assuming that 106 banks to which we have exposure are defaulted, or 10.6% of our universe. For five years, that is through 2013, it leads you to 164 banks defaulting, or 16.5%, and over the lifetime a 30-year default probability of 246 banks, or just under 25% of our exposure universe.

Defaulting banks determine whether or not a security is OTTI. Once it is deemed OTTI we do the cash-flow waterfalls, etc. and we apply a discount rate that is after the credit stressing has already been done. And to just give you a feel for that, for the first 10 years of cash flows, for A-rated securities we are using a discount rate of LIBOR plus 9.75% and for triple-Bs a discount rate of LIBOR plus 13%. For triple-As it’s less and so forth.

And again I want to stress that this is after credit defaults. Some of the discount rates that have been disclosed by others we believe are being applied without regard to whether or not the cash flows have already been credit stressed. If you simply take the written down value of our securities and determine a yield to maturity to get them back to par at a maturity date, our discount rates are significantly higher than those disclosed. And we can take questions on that later if you wish.

Now, that said, our analysis suggests, as it had in the past, that we may well take further impairments on this portfolio if default probabilities continue to rise, including deterioration and LACE ratings and if there are changes in these discount rates.

In Harris’s presentation tomorrow at the Citigroup Investor Conference, which we will file as an 8-K, within the next hour or two, we will disclose some stress test analyses showing you the impact of different assumptions, stressing probabilities of default, etc. that could result in a range of additional OTTI over the next few quarters of $150.0 million to $450.0 million.

Turning now to credit quality. We are going to look on page 19. I will just point out that the total non-performing assets increased to 2.71% of loans in REO. NPAs in the National Bank of Arizona actually declined due to sales and substantial charge-offs. But we saw increases in NPAs in several other banks, including Zions Bank.

The net charge-offs were $179.7 million for the quarter, or annualizing that quarter it was a 1.71% annualized rate. That fourth quarter charge-off ratio is about the industry average in the third quarter. If you take our charge-off ratio for the year, it was about 0.96%. Based on the announcements we have been able to analyze to date we think that when all the results are in our charge-off rate this quarter will still be significantly below the weighted average charge-off rate for the industry.

The bulk of the charge-offs occurred in commercial real estate loans, primarily residential land development and construction and primarily in Arizona and Nevada, 67% combined. California Bank & Trust, which had about 19% of the loan portfolio, accounted for only 10% of the charge-offs.

As I think Harris mentioned, we do continue to build reserves in this environment, adding $105.0 million to the provision in excess of charge-offs and at the end of the quarter the allowance, compared to loans and leases, was 1.64% and 1.76% if you add in the unfunded lending commitment reserves.

On to page 20, just show you that, again, the loan growth was primarily first in commercial and industrial lending. There was also some growth in commercial term. It’s new commitments there and then you had significant pay-downs and charge-offs of construction and development and commercial real estate. And you can also see a pretty significant uptick in home equity credit line draws in the quarter. I will note that the delinquency performance that will be in the Citi presentation that we will file tonight remains remarkably good. A slight uptick but still very low delinquencies.

The net interest margin, on page 21, bottom of the page, you can see the spread increased 6 basis points the margin, 7 basis points the difference as I mentioned earlier is primarily due to the TARP capital. And then I would note that we believe that we are asset-sensitive at this point. It’s very hard to engage in the kind of sustained hedging that, given the aberrant behavior of prime versus LIBOR and other things that we have in the past, also the fact that it’s very hard to see prime lowering anymore, given Fed Funds at near zero. But we think we are asset-sensitive at this point.

On page 23, there are a couple of things that I want to point out. Tangible common equity ratio, I know there has been a lot of focus on that, 5.89%, down slightly. Third quarter is actually up almost 20 basis points from one year ago. That primarily reflects the issuance of $250.0 million of common by the company in the third quarter.

The risk-based capital measures reflect mostly the TARP capital. And finally, at the bottom of that page, since we focused in the beginning of the press release on some non-GAAP numbers, we give you the reconciliation of GAAP and non-GAAP, both on a dollar- and an EPS-basis.

I would just like to mention a couple of things not in the schedules and the release but may be of interest to you given announcements that others have made.

Lockhart Funding at year end had total assets of $738.0 million and the fair value of those assets was $119.0 million less than book value. The fair value mark is for information only and does not appear on the balance sheet or the income statement of either Lockhart of Zions. Again, it only becomes meaningful if and when we have to buy a security out of Lockhart because of a downgrade or other reasons.

During the quarter we did purchase one security from Lockhart with a book value of $78.3 million. We recognized a loss of $7.9 million on that security, which is included in the $204.0 million of impairment loss and valuation losses on securities.

If, and we don’t anticipate this, but if Lockhart were included on our balance sheet in its entirety, the impact on tangible capital ratios would be about 17 basis points. And as noted in the press release, we sort of stabilized the funding or financing of Lockhart by participating in the commercial paper funding facility program that is run by the Fed.

We did last week issue just under $255.0 million of floating rate senior notes at a rate of three-month LIBOR plus 37 basis points, due in June of 2012. This was under the FDIC’s temporary liquidity guarantee program and with the placement of those notes, we estimate that the parent company has cash to cover all its obligations for about two years.

We have taken a number of actions including that and the TARP capital and the repayment of Federal Home Loan and Fed borrowings to strengthen liquidity significantly, both at the parent and the bank level over the last few months.

So, summary of guidance, it’s very hard to give guidance in this very uncertain environment but we will do our best.

Loan growth, we are actively seeking to extend new credit to creditworthy borrowers and we have had some success in growing loan originations. However, in the current environment pay-downs, charge-offs, and other reductions are likely to largely offset originations so we expect residential construction development balances to continue to decline, others to increase, and the result to be relatively flat.

Deposit growth may also be moderate, modest over the near term but we do continue to look at bidding on the deposits of failed banks.

With regard to the margins, loan spreads are improving. The deposit market remains competitive. We are, we believe, asset-sensitive. It’s hard to figure out what that means for the margin. Perhaps stable to slightly up. But it really depends on a lot of things.

FDIC premium expense should increase from about $20.0 million in 2008 to $59.0 million in 2009.

With regard to credit quality, conditions we think will continue to soften in most markets for the next couple of quarters and residential land and home prices will continue to decline somewhat in Arizona, Nevada, and some other markets.

NPA is likely to increase modestly. The rate of increase has been trending downward in NPAs. We hope that that will continue. Can’t promise it but there has been a slight tail off, partly due to increased charge-offs.

Charge-off provisions are likely to remain somewhat elevated. I don’t know that they will be as high as fourth quarter but it’s hard to tell at this point. We have built reserves in this quarter with continued weakness in mind and are likely to continue to build reserves over the next couple of quarters.

With regard to securities, we do believe, as I already indicated, there could be some additional OTTI during the quarter.

With regard to goodwill impairment, I have told you where the most of it is. We will probably be looking at goodwill on a quarterly basis, not waiting for our annual date, which is October 1. In fact, we looked both at October 1 and did further impairment at December 31 of goodwill this quarter reflecting declines in bank stock prices and general weakness in the market. I think it’s possible that goodwill impairment at Amigy and/or California Bank & Trust could occur. I can’t say for sure that it will but we will have to be looking at that.

We note that our capital ratios are near historic levels. Historic meaning probably as high as they’ve been in at least the last decade on most measures. We think we are well positioned for the quarter ahead, which we do expect that that quarter and probably the one or two after it, will remain rather challenging.

I’ve tried to walk you through the highlights and probably some additional detail beyond the highlights. We will pause now and try to respond to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steven Alexopoulos - JP Morgan.

Steven Alexopoulos - JP Morgan

Doyle, could we start with the dividend. It was $0.33, $0.32, now $0.04. What is the methodology that is being used to set the dividend? Is it a payout ratio? What are you thinking about there?

Doyle Arnold

I think at the minimum that we want to make sure we think we can cover the dividend out of earnings to common at least after netting after non-cash and/or truly extraordinary items, like goodwill impairment and maybe some of the OTTI. Things that we don’t think will go on forever. They may not be a one-time charge but there’s a sort of a finite nature to those things.

So the reduction and then the additional reduction, I think reflects our deteriorating outlook for the company and generally for the industry and the economy as a whole. There’s nothing particularly unique to us. We are trying to assure that we don’t pay out more than we are earning and that we are conserving common equity in a very uncertain environment.

Harris, do you want to add anything to that?

Harris Simmons

No, I think there’s a limit to the science you can apply to it. I think it’s clearly a substantial reduction but not an elimination.

Steven Alexopoulos - JP Morgan

Looking at page 18, what would explain the difference in the estimated fair value of the bank and insurance TruPS? If you look at held to maturity and then available for sale. Like if I look at the single-A, valued at 46% of par and held to maturity, but 78% in available for sale. Why would they be different?

Doyle Arnold

You’re talking about the $124.0 million compared to the $268.0 million. And then under the bank TruPS, the $136.0 million compared to the $175.0 million.

We cash flow each of those securities, each of the tranches and each of those buckets differently. We are applying the same discount rate to those cash flows based on that rating. We are doing our own default probabilities, not using Moody’s or Fitch’s or S&P. as I told you where ours come from. So basically what it says is that not all As are the same. As rated by, in this case these are mostly Fitch. In our estimation. Some As are created better than other As at this point.

Steven Alexopoulos - JP Morgan

How much are the charge-offs are related to that Flying J and do you have any left?

Harris Simmons

It is not in the charge-off numbers. It has been reasonably heavily reserved. But at this point we believe it is premature to be charging it off. The loan is actually current, at the end of the year.

It’s a company that has had a very strong cash flow for the first three quarters of this past year. It was a Chapter 11 filing that arose out of another [inaudible] investment drops and commodity prices and not as a result of a fundamental breakdown in the business. Their primary business is actually running the largest chain of truck stop kind of travel plazas in the United States. They are the largest distributor of diesel fuel, we believe, in the United States. And we are actually at this point still reasonably optimistic that we will see a successful restructuring and work out of this credit.

As we learn more we will continue to assess the credit but it remains on the books.

Steven Alexopoulos - JP Morgan

How big is the position you hold?

Doyle Arnold

It is slightly under $50.0 million. It is all on non-accrual and as Harris mentioned, it’s got a pretty hefty reserve against it but it’s not been charged off and it’s all current at the moment.

Operator

Your next question comes from James Abbot - Friedman Billings Ramsey.

James Abbot - Friedman Billings Ramsey

Can you go through your outlook on expenses? One of the things that was pretty volatile in there this quarter was the REO expense and as a percentage of REO holdings, at least from the third quarter REO, it was pretty high, 25%, 26%. What is your take there? What is your outlook? Were those some old properties that you finally just threw in the towel and sold or what are we looking at from that perspective? And also on comp, kind of a run rate there.

Doyle Arnold

I think at this point that that line is likely to be more volatile than it has in the past. Our practice when we move a property in REO is to get a current appraisal and then haircut that anywhere from 12% to 20%, depending on the market, the nature of the property, etc. And we take a charge down at that point, as we book it.

If there are further appraisals that reduce value or sale of the property at less than the current value it then results in an additional charge down. In the quarter, in Arizona we did sell a number of properties. We got new bids on some others that we didn’t take but led to some additional charge-downs of properties and I would guess that that attempt to accelerate the disposition or recognition of loss on some of the exposures in Arizona drove most of that rather larger charge this quarter.

Harris Simmons

We had about $64.0 million in sales of both notes as well as real estate in Arizona and it does reflect the fact that the property values there have continued to plummet and they are getting down to points that they almost have to slow because they’re down to, in a lot of cases, less than $0.20 on the dollar from when the loans were made. But that’s where they are.

James Abbot - Friedman Billings Ramsey

And on the compensation expense, do you expect that to bounce back up a little bit? How much was the reversal of accrued incentive compensation and so forth?

Doyle Arnold

This quarter was not a lot of reversal. But I guess there was some reversal of annual bonus accruals that was $5.0 million to $10.0 million. Norm?

Norm Bellon

I think it was closer to $10.0 million.

Doyle Arnold

Probably closer to $10.0 million of reversals. And we reversed the number of incentive comp and other accruals in each of the prior two quarters as well. I would guess in the first quarter it should pop up a bit simply because we are back to FICA and Medicare withholding for all employees. And it will take longer to get to the point where some people have hit their maximum simply because there are going to be the same bonus levels being paid in the first quarter of this year that there were in the first quarter last year, across a pretty broad swath of executives and senior management.

I would think over the course of the year that salary and benefit line, the increase is going to be driven more by health care benefits being up 3% or 4% than it will be by base salaries being up 3% or 4%.

James Abbot - Friedman Billings Ramsey

The FDIC assessment, the FDIC cost in the fourth quarter versus what you expected for 2009?

Doyle Arnold

What’s in that run rate? Why don’t we take another question while we look that up? And then we will interject that answer if we can find here.

James Abbot - Friedman Billings Ramsey

That’s all for my expense questions and I will leave it at that and let everybody else ask the rest.

Doyle Arnold

This quarter, fourth quarter of 2008, the FDIC expense included on the income statement was about $6.0 million. So that’s a run rate of $24.0 million for the year but it’s going to be up $59.0 million. So it’s going to somewhat more than double, from a run rate standpoint.

Operator

Your next question comes from Ken Zerbe – Morgan Stanley.

Ken Zerbe – Morgan Stanley

On your TruPS portfolio, I’m sure you’ve probably seen some of the write-downs that a number of other banks have taken. I think Webster most recently wrote it’s everything A-rated and below down to about $0.17 on the dollar from par value. Can you talk about where you see the biggest differences there? Is either Webster being way too aggressive, or, I’m just trying to reconcile the difference between, I think it’s roughly 75% if I did my math right, on your portfolio versus some of the other marks at other banks.

Doyle Arnold

We don’t know the methodology that Webster used. We did see their announcement. That actually caused us to go take a real hard look at what we did. I will explain a couple of possible differences and you can make your own judgment.

I’ve told you where we got our default probabilities and what numbers are in there that lead you to, we are in effect saying that over the life 25% of the banks to which we have exposure will fail. That’s a pretty hefty haircut. We have talked with one other bank, I won’t tell you which one, and we don’t think their numbers are radically different on that basis.

But the bank failures get you to which securities are OTTI. Then you get to what discount rate do you apply. There are two things that drive the discount rate. In our methodology one is the rating of the security and the other is whether or not you include credit losses. You assume those have already been recognized or not. If you applied the lowest rating by any agency and used the discount rates that we are using implied by those difference in ratings, we would have recognized about $60.0 million to $80.0 million more OTTI this quarter than we did.

Consistent with last quarter, we used the higher of the two ratings on Swift ratings. But if you want roughly the impact had we used the other.

The other difference is you’re going to get to, okay, give it a rating or whatever, what’s the appropriate discount rate? The ratings being quoted by one of the most widely-used sources, from which these discount rates are obtained, are yields to maturity, basically they include credit loss exposure as well as liquidity discount. We believe that some parties have used those discount rates and we do not believe that is the appropriate methodology. We are using a slighter lower discount rate that we believe is appropriate, after you assume the defaults in the portfolio. And I’ve told you we’re assuming 25% defaults over the lifetime of these securities.

So those we think are perhaps the two bigger sources of explanation and the latter one probably more important than the former one in what you ultimately get to.

Ken Zerbe – Morgan Stanley

So just as a follow-on to that, is there any way to help us try to get a better sense of ultimate write-downs, because I guess what we have seen the last quarter or so has been, I think you started out with a roughly $100.0 million to $200.0 million estimate for losses, and you do give us a very thorough explanation of how you developed that loss estimate. And that went from roughly $100.0 million to $200.0 million to $200.0 million to $400.0, and then obviously you take this loss plus another $200.0 million to $400.0 million I think it was, or $450.0 million. So now we’re up to sort of $400.0 million to $600.0 million. Can you talk about the main drivers of the sequential increases in your loss assessment? Is it the LACE rating changes?

Doyle Arnold

I’m going to preface this with a comment that I don’t want to sound flip because it’s not, but we have looked in vain for the FASB pronouncement that allows you to let’s just put it all behind us. And mark it down to nothing and be done with it.

We think that we have to do this sequentially and incrementally based on the information that we have or can project, so yes, there have been three different drivers of the incrementally worsening OTTI and some of the deterioration in the outlook.

One is the Kamakura and most other default probability services, including Moody’s, KMB, I’m not sure about some of the others, but those two for sure base their PDs on a number of variables but two of the biggest drivers are the level and volatility of the stock price of the underlying names.

Well, it’s no secret that over the last year and even over the last quarter and even over the last weeks, the level has gone down and the volatility has generally trended upward. With the exception of a brief period in the third quarter, it certainly hasn’t gotten any better. So those have driven the default probabilities that we have obtained on the 40% or so of our names progressively higher.

The LACE ratings, which we get on all the banks but they become relevant on the non-public banks, have also deteriorated. Those come out with a slightly over one-quarter lag. When we first did the OTTI analysis this quarter we only had June 30 LACE ratings available. We actually did re-run it in January after getting the September 30 ones. It made not much difference in the aggregate so we were pretty comfortable with that. But there was deterioration in the LACE ratings.

The reason it didn’t make that much difference is that we already assigned pretty high default probabilities to LACE D- and E-rated banks and there was not a lot of new migration from A, B, and C into the D or E category. There was migration from D to E but net-net it didn’t have that much difference. But there may be some further deterioration in LACE ratings and Kamakura default probabilities this quarter.

The other is that the discount rates, particularly through last year, were deteriorating. I would say net-net the discount rates we are using aren’t that much different this quarter than last quarter.

But those are the three big drivers. So what we are going to file and it will be available very shortly are some sensitivities, again assuming that all PDs on every bank we are exposed to increased by 20%, like the 20% defaults go to 24%, etc. We’re going to give you that one. We’re going to give you one on assuming all the D and E LACE rated banks fail and nothing else does and it happened this quarter, first quarter, what would that do. That’s kind of all we can do to guide you at this point.

Operator

Your next question comes from Jason Goldberg - Barclays Capital.

Jason Goldberg - Barclays Capital

Just a follow-up, the $150.0 million to $450.0 million of possible OTTI, is that a backward-looking view or did you take a forward-looking view in terms of where these LACE ratings and discount rates may go?

Harris Simmons

You’re talking about the stress testing. That would be if those assumptions that we are going to spell out came to play. It’s not a backward-looking.

Jason Goldberg - Barclays Capital

And of that $150.0 million to $450.0 million how much would be held to maturity versus available for sale? Or what would be the capital impact?

Doyle Arnold

We haven’t had time to break that out.

Jason Goldberg - Barclays Capital

And if you look at trust preferred, bank and insurance available for sale, estimated fair value, actually increased from $630.0 million last quarter to $660.0 million this quarter, can we get a sense of what drove the increase?

If I’m on page 17, available for sale, bank and insurance, trust preferreds of $660.0 million, estimated fair value, as I looked at the third quarter release, that number would be $630.0 million. So that actually increased during the course of the quarter?

Harris Simmons

We bought a $78.0 million security out of Lockhart, wrote it down and it went into available for sale.

Operator

Your next question comes from Jennifer Demba – SunTrust Robinson Humphrey.

Jennifer Demba – SunTrust Robinson Humphrey

I have a question for Gerry. Can you give us a sense of what your earlier stage delinquencies are in 30 to 89 days past due? I am also wondering what your cumulative losses have been in the Nevada and Arizona residential construction and land books over the last year.

Gerald J. Dent

The delinquencies in the commercial real estate are running about 5%. The whole loan portfolio is about 1.5% total, 30 to 89 days.

Jennifer Demba – SunTrust Robinson Humphrey

How would that compare to the third quarter?

Gerald J. Dent

I don’t have the third in front of me?

Jennifer Demba – SunTrust Robinson Humphrey

And the cumulative loss you’ve seen thus far in this cycle in Nevada and Arizona?

Clark Hinckley

Maybe we could get that for you.

I don’t know what the cycle is but for the full year of 2008, the total net charge-offs in Arizona were $147.0 million and in Nevada it was around $72.0 million.

Jennifer Demba – SunTrust Robinson Humphrey

And I assume most of that was residential construction development.

Clark Hinckley

Yes. $132.5 million was commercial real estate construction, the vast majority of that would be residential, in Arizona. $47.1 million in Nevada.

Jennifer Demba – SunTrust Robinson Humphrey

You said that other categories were showing some steady deterioration. Can you give some more color there, particularly what you’re seeing in Texas and Washington and Colorado, etc.

Gerald J. Dent

The other categories besides the commercial real estate loans are basically in the C&I portfolio and in Texas we are seeing both C&I and [inaudible].

Operator

Your next question comes from Anthony Davis - Stifel Nicolaus.

Anthony Davis - Stifel Nicolaus

You mentioned that NPAs actually went down in California.

Doyle Arnold

In Arizona.

Anthony Davis - Stifel Nicolaus

Could you just give us some color or follow-up on NPI changes by state in the quarter? I think that would be useful. And Gerry, on Jennifer’s question, I just wonder if you’ve got a cumulative mark of the $946.0 million year end in NPLs? A cumulative mark down from original book for that.

Gerry J. Dent

I don’t believe we have that. You want the change in non-accruals?

Anthony Davis - Stifel Nicolaus

I wanted to see where we ended the year by state. And how that changed from September. We could follow up on that if you want to.

Doyle Arnold

I have the change here that I could give. The largest increase was $104.0 million in Utah and close to half of that would be the previously discussed. Next would be $59.0 million in Nevada, most of that is CRE. And then everything after that is in the $15.0 million or less.

Operator

Your last question comes from Kenneth Usdin - Banc of America Securities.

Kenneth Usdin - Banc of America Securities

I was wondering if you could go through the thoughts on reserving going forward and obviously you did build the reserve a lot this quarter by $105.0 million and you are talking about a reserve incrementally. I’m wondering, hearing your comments about your uncertainty of provisions up or down, do you just get a sense of where you think the reserve needs to go, generally speaking, and given the incremental comments about deterioration in some of those other markets that maybe hadn’t turned as much to date?

Doyle Arnold

I don’t know that we have a target level in mind for the reserves to total loans. I would guess it’s probably going to increase by 20 basis points to 40 basis points more over the course of the year. It could be more than that.

And the deterioration we are talking about in other markets, compared to what we’ve seen in the Southwest residential real estate, I mean, we’re not talking about that kind of deterioration. In the grand scheme of things I would characterize it as still fairly modest.

And with the oil prices in Texas having bounced off the low and the high to mid-30s back up into the upper-40s, they’ve gone through their energy portfolio pretty finely here in the last few weeks and are reasonably comfortable that there’s only one or two potential problems that they can identify.

We are just kind of reflecting a pretty high degree of caution given that the economy still has a very uncertain but generally downward path, it appears to us.

Harris, do you want to comment otherwise?

Harris Simmons

I think that’s right. Clearly, if you look at commercial mortgage-backed securities as a proxy for things, I think we expect that we will see more strain in non-residential commercial real estate. We don’t expect it to become anywhere nearly as bad as what we’ve seen in residential.

We think, particularly in the middle market, kind of lower end of that market, you didn’t have the same kind of craziness going on, but we are certainly seeing more stress in the retailing sector and office, etc. And we think that that will show some fraying but we don’t see anything in the numbers at this point that would suggest that the bottom is going to fall out.

I think likewise, we talk about Texas energy, we have gone through that portfolio. The expiration production kind of portfolio, where we are supporting producers. We think that looks actually quite good. There have been a lot of production hedges, which is going to help for the next couple of years with these producers to lock in higher prices and let them amortization debt.

Lower levels of capital expenditure by the producers, and that’s going to hurt some of the service companies that service the big production companies, but even there I think we don’t expect it to be really awful. There’s still really quite a lot of activity going on.

Most producers have are trying to cut back to capital expenditure programs that kind of mirror their cash flow. They’re not doing a lot of borrowing, which we actually view as a good thing. And so we think there will be some slow down but they also come into with very strong balance sheets because they have seen a lot of strong activity in the last couple of years.

Rig count today, it has retreated from where it was back from, say September of 2008, but it is not expected to get nearly as bad as it was, say back in the 80s, at this point.

Kenneth Usdin - Banc of America Securities

On the margin you had alluded to the fact that the company now feels like it is asset-sensitive. With rates coming down as much as they had in the fourth quarter, I was a little surprised to see the margin actually moving up relative to the movements of deposit costs and asset yields. Can you walk us through a little more of your confidence that the margin can hold up here as opposed as fall subject to that repricing on the asset side?

Doyle Arnold

One of the reasons this has become far more difficult to hedge is that we are increasingly getting floors that are sticking on a lot of loans, which has supported the margin in the last quarter. We have a couple of banks that have a discretionary prime that is not tied to New York prime or Wall Street prime and they have been able to not lower prime as aggressively as the New York banks were cajoled into doing by the Fed it would appear.

And so there are a number of moving parts on the asset side that give us some belief. And the fact is that there can almost, by definition, be no—the New York prime is more or less tied to the target Fed Funds rate and that just can’t go any lower. It’s zero and 25 basis points now.

The other thing that we’ve had to do is that a number of our interest rate swap hedges have become ineffective. Given all the aberrant price behavior and we have had to tear them up. Which means that more of the assets on the asset side of the balance sheet are now in effect floating rate again, but with floors. So just our best judgment is that we are now asset-sensitive, that the yields won’t come down that much more from here and if there is any uptick in interest rates that yields will go up.

Out of deference to the lateness of the hour, we will not take more questions. But if there are follow-up questions, as always Clark will be around to answer them and Harris will be speaking tomorrow morning. His presentation will include some additional trending information on 30-day-and-over delinquencies, some of the stuff that we have discussed on the OTTI securities valuation, etc.

With that I want to thank you all for your attention in a very difficult quarter and we will look forward to talking to you again three months from now.

Operator

This concludes today’s conference call.

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Source: Zions Bancorporation Q4 2008 Earnings Call Transcript
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