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Zions Bancorporation (NASDAQ:ZION)

February 12, 2013 11:00 am ET

Executives

Doyle L. Arnold - Chief Financial Officer and Vice Chairman

Analysts

Craig Siegenthaler - Crédit Suisse AG, Research Division

Doyle L. Arnold

Well thanks for inviting us. I don't know if I told you that...

Craig Siegenthaler - Crédit Suisse AG, Research Division

No, no. I'm really excited you guys could come. If everyone can please get seated, we're going to begin now. Up next, we have Zions Bancorp., a U.S. regional bank with its footprints spread across the Southwest and West, including the states of Utah, California and Texas. We estimate Zions is one of the most asset-sensitive banks in our coverage and has several opportunities to refinance part of its more expensive liability structure this year. Here to provide details on the bank, we are pleased to present Zions Bankcorp.'s CFO, Doyle Arnold. But before I hand it off to him, we actually have some prepared questions to poll the audience here. So if you look in front of you, you have these digital kind of remote devices.

Question-and-Answer Session

Craig Siegenthaler - Crédit Suisse AG, Research Division

We're just going to have 4 questions for you guys, just kind of get your view. Question #1, what do you think is the most important driver for the Zions stock in 2013?

[Presentation]

Craig Siegenthaler - Crédit Suisse AG, Research Division

All right. Question #2, what is your expectations for Zions' year-over-year loan growth in 2013?

[Presentation]

Craig Siegenthaler - Crédit Suisse AG, Research Division

Question #3, in CCAR 2013 stress test results, what do you think is the most important capital action for Zions?

[Presentation]

Craig Siegenthaler - Crédit Suisse AG, Research Division

And the final question here, what do you think the total net benefit to tangible book value from the CDO portfolio will be going forward?

[Presentation]

Craig Siegenthaler - Crédit Suisse AG, Research Division

All right, so we're going to provide you the feedback on those questions at the end of Doyle's presentation. But Doyle, we're ready to go.

Doyle L. Arnold

Thanks, Craig. I thought it was pretty clever to -- "What's the most important driver," to play the Stones' "Start Me Up." That's good, that's good. Hi, everybody. Nice to see you. Thanks you for your interest in Zions. Thanks for being here. We're going to first enter into the record the forward-looking statement that we don't know the future much better than you do, so discount the forward-looking stuff, but we'll do the best we can to give you some of the drivers and outlook. I see some faces in the audience that are not familiar to me, so I'm assuming that maybe a few of you here in the room are here because you want to learn about the company overall and maybe aren't as familiar with it. So we'll start with a brief overview, then we'll get into some of the things that Craig just touched on in his questions that he posed, things like capital and capital actions and so forth, profitability drivers, including net interest margin, and then some guidance. And then for those of you who want some more detail on some of the topics I'll cover, there is an Appendix that has some additional detail in it.

So overview. As Craig said, we are a regional bank holding company, operating 8 banks in the South, Southwest and the West, ranging from Amegy Bank in Texas over to California Bank & Trust in mostly Southern California but some in the Bay Area, then a couple of small executive and professional business-oriented banks in the Pacific Northwest. And of course, the original bank, which is still the largest Zions Bank, in Utah and Idaho. Putting it all together, it's a little under 500 branches, $55 billion in assets, a loan book more like $40 billion but kind of -- that's who we are.

The Greenwich awards just came out within the last week or two. We were, again, very pleased with the honors that we were afforded by that survey of, basically, bit small and middle-market business customers. We won excellence awards in 13 categories, same number as last year. Mostly won them in the same categories as last year. And given that we are a very business and treasury management-focused bank, that's more so than consumer, this is a great recognition of the excellence in service that we provide to customers in that segment of the market. Some of the other awards we've noted there below, we're also quite proud of.

Turning now to the key drivers. Capital. Simply put, this is kind of an overview for all of this, we think we're done raising capital over a couple of years ago. And now, the task last year and this year and next year is to restructure the capital base and the funding base that we have, the non-deposit funding base, and lower its cost. We think we have plenty of capital. We have plenty of loan loss reserve. And so that's the challenge.

This slide begins to document what do I mean by plenty of capital and plenty of loan loss reserve. 9.8% Tier 1 common puts us about in the middle of the pack of regional peers. The total allowance for credit losses at 2.7% of loans, this puts near the top. You can see total loss-absorbing capital, which would include preferred plus loan loss reserve. We are considerably in excess of either the peer median, the yellow line, or the kind of the composite of all U.S. national banks.

The reserve coverage, not of loans, but of problem issues is now strong and getting increasingly strong. Reserves to net charge-offs is now something like 1,300%, factoring in the very low net charge-offs in the fourth quarter. And you can see how that stacks up -- how it's been building on the top and how it stacks up against a variety of peers on the bottom part of the graph.

I mentioned that the capital build and the reserve build are over. The challenge, last year and this, is to begin to rationalize some of the things that we did during the crisis to avoid issuing a lot more common during the crisis to build capital. As some of you who have followed us recall, we modified and marked-to-market a large amount of subordinated debt, which created common equity. We also tendered for some -- or exchanged some debt for common equity. We issued a lot of Series C preferred, as that modified some subordinated debt converted into preferred, and we did a variety of other things.

We've begun to unwind those things now. We repaid TARP last year in 2 tranches without a common raise on the way out. I think we were one of the -- maybe us and M&T are about the only banks to do that. We repaid all of our TLGP debt. We got that done, in part, by bringing back up to the parent a lot of capital that we had pushed down to the banks during the crisis. That freed up cash. It allowed us to pay down those items without issuing dollar-for-dollar in new debt. We called our Series E preferred, which was a fairly small issue, just under $150 million, but very expensive at 11%. We replaced it with a new Series at 7.9% back in April, could probably do that closer to 6% or less today. We just did a 10-year fix to floating preferred issue at 6.3% 2 weeks ago. And that's what we've done so far in 2013.

There are -- throughout this slide deck, there's some greater detail on what's doable, but some of the highlights are: We have $293 million of 8% trust preferred Series B that is callable at any time at par. We have $800 million of 9.5% after-tax cost Series C preferred that is callable September 15. Again, we can do a lot better than 9.5% today. We have a lot of expensive debt. We have $500 million of senior debt that was issued at a discount that is -- matures in 2014 in September that has an effective cost of 11%. The replacement cost today would be like 4.5% to 5%, something in that range. And so tenders for some of that, some of the sub debt that also is quite costly that matures in '14 and '15, are things you might look for this year. This -- I won't go into this in detail, but this lays out a bit more of what is either callable now or matures over the next few years that we will be seeking to address.

Addressing that is very important to us. On the left, the middle bar kind of is illustrative of the rather complicated capital and funding stack that we have today at the parent. And the right-hand of the 3 bars, on the left-hand part of the slide, is what we're targeting in the medium term. If we do all of the things that are implied by that at the cost at which we estimate that we could do them today, that alone, if nothing else happens, if there's no operating leverage in the company, there's no loan growth, what have you, that is an -- could generate an increase in return on equity of several percentage points. And that's why it's very important for us to get on with that.

As a segue into the next slide, because I may skip a bit of the next section -- I'm going to try to go back here. There we go. We're going to now turn to profitability, and we're going to talk about NIM, but let me describe what's going on. As Craig said in his introduction, we're very asset-sensitive, which means that the earnings of the company from its earning -- interest-earning assets and its -- and funding that we have would benefit significantly from a rise in interest rates. Now if you think about what's -- over the next couple of years, we're currently in a low and relatively flat interest rate environment. The maximum opportunity to generate improved earnings and return on capital from all of those capital and financing actions means taking advantage of that environment. In other words, if rates stay low and flat, we get an earnings pickup from our ability to execute on refinancing all of that debt and that preferred into much cheaper issuances.

And if after that -- but if the Fed loses control, on the other hand, and rates rise early or the economy accelerates early, maybe we can't achieve quite as much as I just implied there, but the asset sensitivity means that the company would benefit greatly on the earnings side from that event. So the way I look at it is we kind of get it either way. We get it one way or the other. We'll either get our significant earnings pickup from working on the lower right-hand part of the balance sheet or we'll get an earnings pickup from the left-hand side of the balance sheet, from the asset side.

In a great world, we get both. In other words, we'll have 18 months, 2 years to get all the capital and refinancing done and then let the economy take off and rates rise, which just about the time frame the Fed is talking about, and we will get both of those things. So that's sort of a high-level picture of how the company is positioned.

Now the rest of this is a lot of -- just a lot of kind of detail about that second alternative, the what happens to the earnings from the balance sheet side. We are seeing a modest bit of loan growth. We are beginning to see a flattening out of the 2 main drags on loan growth. We expect that commercial construction and development loan runoff to pretty much be over. In the net on 2013, we expect to see growth in that category. The runoff in the owner-occupied portion of the portfolio will continue through much of 2013, and then that will be over. But as you can see, that's not nearly as severe as the runoff in construction has been. And the other categories tend to be flat to increasing, and that's kind of what we expect for the year.

We've had very strong growth in commitments. That's -- on the left-hand side, the orange bar is growth in commitments over the last 2 years on an indexed basis, where 100 is where we were fourth quarter of 2010. And you can see the growth in commitments has been about close to 25% over that time period, while the growth in actual loans outstanding has been much more attenuated. Part of that is a very strong growth in commercial construction commitments that is not yet funded because we require that the developer's equity go in first before they can begin to draw the loan. So as those draws occur, we -- that's why we expect growth in that category.

I'm going to keep moving along here in the interest of time. For most of the last year, 1.5 years, we have seen a stabilizing trend in loan pricing. This is a very crude look at that measure. This is the weighted average spread over match maturity, funding cost of all loans newly originated or renewed during a quarter. The general pattern, as some of you heard me say before, is at precrisis, that was in 3% to 3.5% range. It ran up to over 5% in the depths of the crisis, came back down to 3% and 3.5%, and that seems to be about where it has stabilized. This is not mix-adjusted. This is just everything consumer, construction, term, C&I, whatever, in that quarter.

We had quite a buildup in cash on the balance sheet. Huge growth in commercial DDA accounts. And that has been a big drag on the margin over -- an increasing drag over the last couple of years. We think we've seen probably the end of that, and the peak was right near the end of 2012. To give you an idea of what's happened, in mid-October of last year, even after repaying $1.4 billion of TARP, we were still parking about $7.5 billion a night in our Fed account, earning 25 basis points. That's about the same as it was at the beginning of the year, even though we had, as I said, repaid $1.4 billion. By year-end, that $7.5 billion was up to $10 billion to $10.5 billion in the last 2 weeks of December. It ended the year just under $10 billion. So a growth of $2.5 billion to $3 billion in just 2 months. So far this quarter, it's back down $2 billion. So we saw that run-up, and we're back down to selling about $7.5 billion a night at the Fed. So it looks like that just continued piling-up of money in DDA accounts has begun to reverse itself, which we welcome.

That cash has a pretty significant impact on the margin. We show here what we look like on the margin in the green bar compared to peers. The little hashmarked slide is if you normalized our cash balances to whatever -- kind of as a percent of the balance sheet, where we would rank on a margin basis, and you can see that's pretty significant. We have not deployed much of that cash into securities. Our securities book, and in particular our mortgage-backed securities book, is about the lowest in the industry and is likely to remain so because we're -- I guess, for reasons I sort of articulated earlier, we're not going to dramatically reduce that asset sensitivity, and we don't want to take on the extension risk of mortgage-backs.

So quickly, a slide that shows the -- that measures the asset sensitivity that we measure as how much would earnings change if parallel shifts in the yield curve occurred, even if we had substantially more runoff in non-interest-bearing deposits, which, frankly, we would expect in that rising rate environment. So this is not a static balance sheet. This assumes -- it's in the footnotes down there. A lot of runoff of DDA and replacing it with market rate funds even as market rates were rising.

Not a lot to say about net noninterest income and noninterest expense. We think, incrementally now, noninterest income grows from here. Of course, Durbin Amendments and NSF funds, things have all flushed through that, and we think there's growth from here. And we think, basically, noninterest expense remains relatively stable as further reduction in credit-related expenses, as credit quality continues to improve, offsets any nominal increase in, largely, salary and benefit expenses.

So one last look at the opportunity cost of those -- of the expensive preferred and debt at the parent. The net income that we report is in the green bars on the left. If we adjust for the slow release of loan loss reserves that we've done, that's the yellow bars on the left. The bars on the right are the sum of the parts. That's what the earnings are at the banks, but we've not downstreamed to our banks all the cost of that expensive debt and stuff at the parent. So most of that gap is what we can address with the actions that I described earlier.

So briefly, some guidance. Loan balances. As I've noted, we expect modest growth through the year. Some of the drags to growth that we've had in the last year or 2 are beginning to be behind us, and we're not seeing a strong reversal of the year-end run-up this year as we did a year ago. Core net interest income should begin to stabilize. As I said, there's not as much pressure on the margin, and it takes less loan growth to fully offset what margin pressure remains than it did last year.

Credit quality continues to improve. We didn't really talk about that, but that's going to lead to continued very low credit costs for the year. Provision should remain somewhere around 0, very slightly positive, or some additional release over the next few quarters. Core noninterest income, as I said, should grow incrementally from here. Noninterest expense, we think, will be stable.

Preferred dividends, just so you know, will rise in the first few quarters of the year as we issue preferred in anticipation of calling Series C preferred in September. But after that, then the net dividend -- once we call it, the net dividend cost thereafter are lower than they are today. All of which means that we think net income to common, the general trend should be increasing from here.

With that, I think we're about right on time, is that about right?

Craig Siegenthaler - Crédit Suisse AG, Research Division

You were doing good. But first, could we actually get the feedback from the initial questions we polled the audience?

Doyle L. Arnold

Okay.

Craig Siegenthaler - Crédit Suisse AG, Research Division

All right. Next one, please. Okay, so this one is, "What is your expectations for Zions' year-over-year loan growth in 2013?" And about almost 50% of the audience says 2% to 3%. Next one, please? And this question we polled the audience, "In CCAR 2013, what do you think is the most important capital action for Zions?" And it was kind of mixed, but the tender for expensive debt and also all of the above were actually the highest signaled one -- signaled responses here. And last one. "What do you think the total net benefit to tangible book value from the CDO portfolio will be going forward?" And a lot of mix responses here, but less than $0.50, $0.50 to $1 and even $1, but response is really all over the place in this one, as it's a pretty difficult one for, I think, everyone.

But maybe now we can get into Q&A from the audience. And audience, just FYI, there's no breakout session here, so you probably want to get your questions answered here. And I'll just start it off.

Doyle L. Arnold

Can you go back to the first one?

Craig Siegenthaler - Crédit Suisse AG, Research Division

Can we go back to the first one real quick? Yes, this one is, "What do you think is the most important driver for the Zions stock in 2013?" And by far, the audience answered loan growth.

Doyle L. Arnold

Interesting. Well, that either means that you totally discounted the impact of the capital and funding actions that we hope to take, which I think are largely in the bag, or you think they're already incorporated into the stock. But if you don't think either of those things, I hope I changed your mind about this slide, although sort of liability management and capital management wasn't one of the options. I also note that one of the options you didn't put up was that the CDO portfolio would actually cost us money going forward. I appreciate that. But I do think there's -- I mean, clearly, we think that over the -- we didn't really talk about the CDO portfolio, but I mean, we wouldn't be going through the pain that we're going through if we didn't think that there's long-term value there for the shareholders, and that continues to be what we believe. So just a little feedback on your feedback.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Well, just to start the Q&A. If we go to Slide 32, and for a lot of you out there on the line, this slide is kind of back -- this has been a big popular slide for Zions over the past kind of 2 years in the capital structure.

Doyle L. Arnold

Yes, 32.

Craig Siegenthaler - Crédit Suisse AG, Research Division

32. There's an underlying assumption here, you used to kind of footnote, too, that replacement cost assumes basically 100% replacement with a lot of these debt and preferred issues. Given how much cash you have, isn't there a high likelihood that, that's a very conservative assumption? You can actually repay some of this debt with cash and cash generation in the future?

Doyle L. Arnold

Some, but it's important not to overestimate that. Of the $7 billion to $7.5 billion of cash that we have in total, only about $700 million or so belongs to the parent. The rest is at the banks, and all of the stuff from Page 32 are obligations of the parent. So we have to -- the only cash that will count toward -- that is currently on hand is that which can be dividend-ed up or repatriated from the banks to the parent. We do expect, obviously, the banks have all returned to profitability and they are dividend-ing some of their earnings and they are -- I mean, we repatriated a lot of capital from the banks up to the parent last year as a part of the TARP repayment plan. I think when I say a lot, I think I mean about $800 million, if I'm remembering correctly. There's probably a few hundred million more that's achievable, but when you add up all of the stuff that needs to be addressed, it's a couple of billion. So between the $700 million plus or minus that we have today and a few hundred -- several hundred million from the banks, they're still, net, a lot of capital markets activity yet to come to really address all of this. But you're right fundamentally in that this says, okay, this is the impact of replacing, in most cases, dollar for dollar except where footnoted. For the Series C, we've noted that we will probably fund that with $600 million or so of new preferred and then the rest with debt. So there's some of that, but there's mix shift in there. There's a net reduction in the total amount of external financing. So yes, there's a little bit of benefit that's hidden and not shown on this page from those 2 things.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Any questions in the audience? Doyle, I actually have one more. If you look at Slide 18, you kind of illustrate how small your securities portfolio is versus peers. What's it going to take for you to start growing that? Because right now, your earnings are depressed versus peers from a lack of securities and excess cash here.

Doyle L. Arnold

Well, incrementally, I mean, we are adding new securities to the book, but we're also seeing paydowns and payoffs in the more senior CDO tranches. We had -- I can't remember, it's over $100 million but less than $200 million of paydowns, maybe closer to $200 million of net reduction and amortized cost between the OTTI that we took and the paydowns that were achieved or received. So that book is paying down. We're growing a municipal book that we originate. We're not buying them out of market. We're originating through our municipal advisory business. We are looking at other things. The thing we're staying away from are mortgage-backs because of what we see as much higher-duration extension risk than is measured by the normal measures, given the historically low rate environment we're in. In the broader picture that I tried to illustrate earlier, which is that right now, we've -- the asset sensitivity and the liability in capital management activities kind of hedge each other. If we don't get one, we'll get the other, and we get an earning pickup either way. So prematurely deploying that asset sensitivity into something else would start to erase that, and so we'll probably -- we'll continue to be cautious about buying securities, particularly those with duration extension, but we do look for asset classes where that risk isn't present.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Okay, I think that's it for questions. Doyle, thank you very much.

Doyle L. Arnold

All right.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Up next and track 2 is actually David Rubenstein, co-founder and co-CEO of the Carlyle Group. That's going to be our lunch presentation. Doyle, thank you very much.

Doyle L. Arnold

Thank you. Great.

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Source: Zions Bancorp. Presents at 2013 Credit Suisse Financial Services Forum, Feb-12-2013 11:00 AM
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