Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Zions Bancorp. (NASDAQ:ZION)

Q1 2011 Earnings Call

April 18, 2011 5:30 pm ET

Executives

James Abbott - Senior Vice President of Investor Relations & External Communications

Kenneth Peterson - Chief Credit Officer and Executive Vice President

Doyle Arnold - Vice Chairman, Chief Financial Officer and Executive Vice President

H. Simmons - Chairman, Chief Executive Officer, President, Member of Executive Committee and Chairman of Zions First National Bank

Analysts

Craig Siegenthaler - Crédit Suisse AG

Paul Miller - FBR Capital Markets & Co.

Joe Morford - RBC Capital Markets, LLC

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Erika Penala - Merrill Lynch

Marty Mosby - Guggenheim Securities, LLC

Robert Patten - Morgan Keegan & Company, Inc.

Steven Alexopoulos - JP Morgan Chase & Co

Ken Zerbe

Operator

Welcome to Zions Bancorporation's First Quarter 2011 Earnings Conference Call. [Operator Instructions] I will now turn the time over to Mr. James Abbott. Sir, you may begin.

James Abbott

Good evening, and we welcome you to this conference call to discuss our first quarter 2011 earnings. I would like to remind you that during this call, we will be making forward-looking statements and that actual results may differ materially. We encourage you to review the disclaimer in the press release dealing with forward-looking information, which applies equally to the statements made in this call. We will be referring to several schedules in the press release during this call. If you do not yet have a copy of the 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. [Operator Instructions]

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

H. Simmons

Thank you very much, James, and welcome to all of you. We're very pleased to report a return to profitability this quarter. As you see in our numbers, the primary driver of this is the linked-quarter improvement in loan loss provision expense. And this was made possible by a significant reduction in net loan charge-offs, which we believe has improved to a level that is at least sustainable. And we would actually expect to see further improvement as we continue to move through 2011.

We also experienced a continued reduction in classified loans and nonaccrual loans. Classified loans declined 11% compared to the prior quarter and a very substantial 41% compared to the year ago period, so we're clearly making -- continuing to make progress on the asset quality front.

Macroeconomic trends across our footprint during the first quarter also continued to show improvement from the already encouraging fourth quarter trends. The first quarter marked really kind of a shift in the number of promising signs in just a few of our major markets' deposit trends across nearly our entire footprint. We saw rental income for all of the major property types improving in a great majority of our markets. Similarly, cap rates have continued to exhibit some favorable trends. Vacancy rates also improved across the majority of property types in the footprint. And all of these factors should facilitate further problem credit resolution and improved loan growth going forward.

Finally, I'd like to highlight the emerging growth in commercial and industrial loans, which increased at a 5% annualized rate compared to the prior quarter, so we're seeing some moderate acceleration there. 6 of the 8 banks in our company experienced growth, and thus the growth was more geographically diversified to the prior quarter. We also experienced growth in term commercial real estate, owner-occupied and consumer loans. As we look forward, we expect that lending is going to continue to strengthen at a moderate rate.

We are certainly looking forward to the time when we can begin to further rationalize our capital structure. That's obviously one of the things that's creating some drag on the earnings available to common. But at some point in the not distant future, we expect we'll be able to start to make some inroads there.

Doyle Arnold, our Vice Chairman and Chief Financial Officer, will now go through the quarterly performance. Doyle?

Doyle Arnold

Thanks, Harris. Good afternoon, everybody. As noted in earnings release, we posted net income applicable to common shareholders of $14.8 million or $0.08 per diluted common share for the first quarter. In the first paragraph of the release, we've also presented the earnings in a way that excludes the non-cash sub debt amortization and the accretion on discount on FDIC-assisted loans. We think this is useful to longer-term oriented investors, as we do not expect those income expense items to be with us in the perpetuity. On that basis, earnings improved to $0.29 per share from a loss of $0.25 a share last quarter.

Additionally, we did point out one item in the press release, an after-tax income item of about $0.06 per share from loans recently determined to be covered by FDIC indemnification. Essentially, we bid on one of the -- the last failed bank in California on a balance sheet as of a particular date. The transaction closed on a later subsequent date. And during the interim period, a number of loans had been charged off and not -- with no reflection of any loss-sharing agreements, we discussed with the FDIC and they ultimately agreed that those loans should have been covered by loss sharing. So the $18.9 million represents a onetime, one-event income item from the FDIC which we received in the first quarter, and therefore this item won't recur.

In the rest of our remarks, I'll highlight three key areas: revenue, then a bit more detail on credit and then finally capital and then a few miscellaneous items and some guidance. And then we'll take your questions.

First, revenue drivers. I'll start this time with loan growth within certain segments, which is a story that seems to be gaining traction. On Page 12 of the release, you will note that broadly, the loan portfolio declined by about 0.5% sequentially, which compares reasonably favorably to the industry's loan decline of 2% based on Fed H8 data, which of course we haven't seen a lot of earnings releases yet this quarter to confirm that. But more importantly I think, we experienced healthy growth in C&I loans up 1.2%, even though line utilization rates declined very moderately to 34.8% from 35.8%. The consumer loans increased by about 0.9% sequentially, driven primarily by 1- to 4-family housing mortgages.

In the commercial real estate category, we again experienced a large decline in construction and land development loans totaling $612 million. To give you -- anticipating perhaps some of the follow-up questions on the decline, about $296 million of that was financed by us into term CRE as construction is completed and leased up, stabilized. This explains most of the increase in term CRE for the quarter. As you recall from investor presentations and discussions, we don't convert construction loans and term loans unless and until the loan meets our general terms CRE underwriting guidelines.

During the quarter, we charged off $48 million of construction loans or about 8% of the gross decline of a little over $600 million. That's actually an improvement from 12% charge-off of the declining balance in prior quarter and in the high teens to low 20s for the 4 quarters prior to that. So even as we've worked down a very large part of the original construction and development portfolio, the loss content in the remaining portfolio does not seem to be getting more severe. In fact, it seems to be improving as a general statement. Factoring in a modest amount of production, approximately $300 million of construction loans were financed away from us. Don't have hard data on this, but anecdotally we know that life insurance companies were somewhat more active in term lending and other banking organizations also financed some of those loans.

We're aware of some analysts that still expect very large charge-offs from our remaining $3.0 billion of construction loans, which as I pointed out is down from about $7.2 billion a little over 3 years ago. Some of these forecasts, we think, have even $1 billion or more of loss coming out of that portfolio, representing a very large portion of the remaining balance. Given recent experience, it doesn't seem likely to us that such scenarios are going to materialize. As I point out, the current loss rate is running around 8% to 10% or so of all of the loans that kind of roll off our balance sheet.

On Page 16, the GAAP NIM expanded 27 basis points to 3.76% from 3.49% in the prior quarter. The core NIM, which excludes the accelerated amortization of subordinated debt discounts and items related to FDIC loan outperformance, that core NIM was actually quite stable. We calculate it at 4.06% versus 4.07% in the prior quarter. And I think this is broadly consistent with the guidance we've been giving throughout.

The adverse impact of sub debt amortization on the NIM was 36 basis points, which compares to 62 in the prior quarter. And note that a lot of this impact shows up as the cost of long-term debt, which was 18.8% in the first quarter, substantially due to the accelerated discount and amortization.

The average yield on loans declined modestly, 5 basis points to about 5.51%. We continue to make some advances in lowering interest-bearing deposit costs, which declined 4 basis points. And we've also had continued improvement in the mix of deposit funding. Average balances in the interest-bearing categories declined very modestly, while noninterest-bearing deposits increased in the modest case.

So non-interest-bearing deposits continued to grow, while interest-bearing deposits declined. Net deposits declined $343 million or just slightly more than loan attrition, leaving the loan-to-deposit ratio at 90%. As we can convert more of our excess cash into better earning assets like loans, that represents a NIM and revenue expansion possibility.

In addition to the excess cash balances, the NIM is pressured by approximately 20 bps due to nonaccrual assets and interest reversals on loans moved into nonaccrual status.

Finally, the balance sheet remains fairly asset-sensitive. Under a scenario where interest rates rise 200 basis points in a parallel shift and some $5.3 million of non-interest-bearing deposits ...

H. Simmons

Billion.

Doyle Arnold

Billion, $5.3 billion, of non-interest-bearing deposits or other low-cost deposits were replaced with market-rate funds, we would expect to see about a 6% increase in net interest income under some various nonparallel shifts in the yield curve. We still remain asset-sensitive, although less so than would be implied by the 6% increase that I just described.

A little additional detail on credit coming from Page 13. Nonaccrual inflows again declined about 9% from the prior quarter to $337 million. As Harris mentioned earlier, we've also added a history of classified loans to this page, the very last line. As you can see that basically over the last year, classified loans have declined from about $5.1 billion down to -- or $5.2 billion down to just over $3 billion, a decline of about $2.1 billion in 1 year.

The rate of problem credit resolution slowed somewhat compared to the prior quarter, again I think consistent with our guidance. But I would note that we still worked through more than 470 loans of at least $50,000 in size during the quarter. It's down from 660 loans the prior quarter, but well above the average in 2010, which was more like 200 problem loans per quarter.

Loss severity as measured by loss given classified status, that is how much do we lose on classified loans, continued to trend slightly better for the portfolio overall. C&I loss severity improved the most, while most of the other categories were modestly better or stable.

Let me touch quickly on troubled debt restructurings. Also on that page, you'll note that they declined about 6% in total. Driving the majority of the decline is the A/B note structure where the A note is underwritten at market terms, thus removing that portion of the loan from TDR [troubled debt restructures] status.

As a sidebar on this topic, you'll note the SEC just released guidance that will likely result in an increase in second quarter or third quarter 2011, depending on whether we adopt -- on when we adopt it. I think adoption is required by third quarter. Early adoption is permitted in the second quarter. Essentially, what this means is that some loans that have come off of TDR status under the current RAP [regulatory accounting principles] basis of accounting will have to go back on when we adopt the standard, more like once a TDR, always a TDR.

And then I'd also point out that about half of the TDR balance is on nonaccrual reporting because the financial condition isn't sufficiently strong to classify them as accrual loans yet. And importantly, of those that we have -- hold accruing, our re-default rate that we've experienced over recent quarters has been about 0.1%. So pretty much when we determine that a loan or TDR should go back to accrual status, we've made that call quite reasonably, continued to perform.

Now if we shift to capital. During the quarter as noted in the release, we issued a net of $25 million common equity through common shares. It's been our practice during the credit cycle that we place GAAP losses in dividends through the issuance of common equity. Given our positive earnings for the quarter, some of you may be wondering why we issued any capital and results. The answer simply is that our own results beat our own internal forecast until very late in the quarter.

Capital ratios can be found on Page 9. The Tier 1 common ratio that's increasingly becoming a primary focus of capital planning improved by 32 basis points from the prior quarter to an estimated 9.27%. It's higher by about 30% from the prior year. And as you can see there, most of the other -- the other regulatory capital ratios improved even more than that, reflecting the sub debt that's converted into preferred during the quarter.

A few other miscellaneous items related to noninterest income or noninterest expense. You'll note that securities impairment declined again to $3.1 million, down from about $12 million in the prior quarter. On a related note, you may notice that while the securities portfolio did not have a material impact on P&L this quarter, it did have an adverse impact on GAAP capital. On Page 6 of the release, you can see that we're now carrying the original AAA rated securities at an average of 59% of par compared to 68% at year end. This is primarily due to the fact that some of these securities have begun to trade at a level that bears factoring into our valuation model. We're still at Level 3, but we are incorporating some market-derived information in determining fair value based on some of the trades that we are observing that are non-distressed. Some of you know we've been saying that this day might come for nearly 2 years now. Well, that day kind of came this quarter, where we began to see enough trading as this market slowly begins to make that change.

We think this kind of step function change in the level of OCI is largely behind us, and we don't expect further significant declines in carrying value due to the increased trading. To the contrary as volume improves, we would expect to see liquidity discounts narrow. And indeed, the prices that we have been observing over the last few quarters, particularly in the higher rated tranches, have been trending upward.

And as a reminder for those building your models, assuming that we keep the total return swap in place, we will start incurring a quarterly expense of about $5.3 million for the TRS, starting in the third quarter of this year and then subsequent quarters thereafter as long as we keep it in place. And as noted in the release, other noninterest income, the very last line in that part of the table, includes $18.9 million of income from the FDIC that I previously discussed.

Okay, moving on to noninterest expense. Salary and benefits did bump up by about $8 million compared to the prior quarter, that is the fourth quarter of last year. About $5 million of that difference was due to employee medical insurance costs. Last year through the year, we had accrued too much expense through the course of the year related to medical costs. And when we trued that up in the fourth quarter, there was a reversal of such expenses, which kind of artificially depressed that quarter's expense, while the first quarter expenses this year are more in line with normal levels. And also because we expect to be profitable for the year, we began to accrue modestly higher bonuses for various things than we have in the past couple of years.

Provision for unfunded lending commitments was a negative $9.5 million. We realize this line has been quite volatile. It may be so and it may continue to be so for a while. But I would say that in general, the trend in that line should be about 0. Essentially, quarterly additions to new unfunded commitments would tend to drive that number pretty positive, while improving credit quality in existing commitments tend to drive it down. Wish I could give you more guidance than that, but I think it's going to basically bounce around 0 or maybe low positive single digits as a run rate.

Other noninterest expense line contains $13.1 million of FDIC indemnification write-off, as assets have performed better than originally modeled. We picked up the offset to that up in the revenue lines, but we have to take expense to write off that indemnification asset if we don't think we're going to claim as much from the FDIC. Also absent in the first quarter of 2011 was any accrual for the AML related penalties that we announced early in the quarter, but which we accrued it in the third and fourth quarters of last year.

Okay, shifting to guidance for the next few quarters. The balance sheet, we think the overall balance sheet will remain about flat for the remainder of 2011. We think the net shrinkage in the loan portfolio, which moderated a lot this quarter, will continue to moderate and possibly begin to grow. The demand for C&I, term CRE and to some extent consumer loans appear to be strengthening. And at the same time, we would expect the drag from continued construction and development loan runoff and from working down the FDIC-supported loans to begin to moderate.

Picking an inflection point from net decline to net growth is difficult to precisely predict. But I would expect ending loan balances at June 30 to be relatively flat to somewhat positive compared to March 31 balances. Again, we would expect the core NIM to remain generally stable during the next couple of quarters.

Asset quality. We think the outlook is for continued improvement if the economy continues to show reasonable stability and modest improvement. We would expect charge-offs and provisions both to decline over the next several quarters, but not another step function decline like we experienced in the first quarter. We also think nonaccrual loans and classified and other adversely graded loans will continue to recede at a reasonably good pace.

The tax rate is distorted by the taxes on the -- the tax impact of the sub debt conversions. Essentially, some of the sub debt conversion expense that we recognize each quarter when it occurs is tax-deductible, some is not. So conversion can drive that number around. But we would expect the tax rate to be between 37% and 39% for the year, but probably the second quarter rate will be around 50%, based on what I'm about to tell you. Today was the last date on which holders of 2 of the 3 sub debt issues could give notice of their intent to convert this quarter. And those are the only 2 that have that that right this quarter. The other one, as you know, converted. Had that right last quarter and will again in the third quarter, last quarter and first quarter.

So I'm talking about now that -- I'm about to tell you the sub debt amount that will convert in 2Q. It is based on preliminary information from the bond trustee at the close today. The sub debt amount converting will be about $138.5 million. That is up between $50 million and $60 million from this quarter. That would impact -- have a pretax impact, our first rough estimate is about $61.4 million on pretax earnings in the second quarter and about $50 million after-tax. That $50 million would compare to the $33.3 million impact first quarter. We will file or furnish, not sure technically which it will be, an 8-K with the final totals within a couple of days, but we wanted to give you that heads up since we know that information.

For those of you who are wondering why our earnings announcement didn't come out at 2:15 Mountain, but came out at 3:00 Mountain, 5:00 Eastern instead, we thought it only fair to not give people who are watching their screens that last 45 minutes to know those numbers. So we delayed to make it fair to everybody the earnings announcement, until the conversion election period was closed. So we didn't give you much time to digest the announcement, but I think it was in the interest of being fair to all investors.

We also think that after second quarter, there's reason to believe that the amount of these conversions, and therefore, the attendant noise in our earnings release or earnings each quarter should substantially abate. Basic theory of the case is the arbitrage trade has been pretty strong the last few quarters. And if it wasn't strong enough to get you to convert already, what will it take to get you to convert in later quarters as you get closer to the call date for the preferred you're converting into? So it's a judgment call, but I would think that we're maybe getting through most of the noise after the second quarter.

With that, we will end the prepared remarks. And I have about a half hour left for questions. We'll give you a minute or 2 to queue them up and then start taking your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jennifer Demba from SunTrust Robinson.

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

The loan growth that you did have during the quarter, can you give us some more color geographically? Or any other color you think is pertinent and what you're seeing in demand out there? And are you participating more actively in the syndicated market these days?

Doyle Arnold

The loan growth was -- it broadened geographically. I think we saw either some combination of strengthening growth and/or strengthening pipelines just about everywhere. Maybe Southern Nevada would be an exception to that, although it's not declining as fast as it used to. The economy there remains very weak. The biggest contributor, as it was last quarter, was Texas. And probably the biggest strengthening of the pipeline was in Texas. And as for syndicated loans, no, I don't believe that -- well, there's been some growth in syndicated lending, but I don't know how much.

Kenneth Peterson

Additional advances on existing syndicated loans in Texas in the energy sector.

Doyle Arnold

Did you catch that, Jennifer? That's Ken Peterson, our Chief Credit Officer.

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Okay, great. Thank you. I'll let others jump on. Thank you very much.

Operator

Our next question comes from Craig Siegenthaler from Crédit Suisse.

Craig Siegenthaler - Crédit Suisse AG

Craig Siegenthaler here from Crédit Suisse. Well, given that you're profitable now really in all metrics, you're putting out commentary that you expect to be profitable the remainder of 2011, how are we supposed to think about TARP repayment now, really in terms of kind of timing and method? Are you still thinking about breaking up into tranches?

H. Simmons

I really don't have any additional guidance other than we've saying on that front. As I said before, we don't expect to start having serious discussions with the Fed until maybe later this quarter, probably third quarter. Still not totally opposed to breaking it up into tranches, but would like to get on with it. Our capital ratios, if you look at them, are across the board. It should be perceived as well within the comfort zone of what those who've been repaying TARP have done. But as always, the rules remain unwritten and undefinable until you actually have the discussions.

Craig Siegenthaler - Crédit Suisse AG

And then just real quickly on the sub debt conversion speed here. How should we think about the pace of the 2005 sub debt conversion, 3Q versus kind of the first quarter if it's comparable? It sounds like from your commentary on the arbitrage opportunity, it sounds like it should actually decline in terms of the volume. Is that kind of your expectation here?

H. Simmons

I agree with your finish. You said something about 2005?

Craig Siegenthaler - Crédit Suisse AG

No, I said the 2015 sub debt. I believe that's the one that converts in the first and the third quarter seasonally.

Doyle Arnold

Well, I would think so. And again my argument, it's been a pretty strong pickup for the last 2 or 3 quarters now in the -- if you take the price at which the sub debt was trading and therefore, theoretically the price at which investors may have marked it, the preferred C has been at a 3 or 4-point premium to that. So by converting, you could pick up an immediate pop, and that trade has been there for a while now in all of the issues as they've come up. In addition, you get a 9.5% dividend instead of 5.5% to 6% dividend, although at the risk of trading down in the capital stack. Well, that trade's been so strong, if you haven't already done it, why would you do it in the third quarter or the fourth quarter? Particularly because every quarter that goes by, we get closer to the date at which the preferred C can be called by us. And so you run the risk of trading into something that gives you a higher yield for a little while, but not nearly as long as you'll get the interest on the debt. So that's the theory on the case. That's why I would expect it now to start to decline.

James Abbott

Craig, this is James. The present value of cash flows, by holding on to the subordinated debt, are higher now than if you were to convert into the preferred stock at this point. So that may be helpful.

Doyle Arnold

At least to James' discount rate. He can't speak for every hedge fund out there.

Craig Siegenthaler - Crédit Suisse AG

That's assuming it's a longer period, right?

Doyle Arnold

It's a longer period, that's right. So I'm just using market rates, implied market rates on these discount rates to get that.

H. Simmons

Most of the stuff that's converted is converted in the preferred C, which is callable in mid-2013, whereas the debt maturities are in 2014 and '15, depending on the issue.

Doyle Arnold

Got it. All right, great. Thanks for my questions. I'll jump out here.

Operator

Our next question comes from Paul Miller from FBR.

Paul Miller - FBR Capital Markets & Co.

On the asset quality, which is tremendously better than I think our expectations are, you released -- what type of release, provision releases can we expect going forward? Is it going to be about the same we saw today? Or would it start to trend down?

H. Simmons

You mean as in get smaller, the releases?

Paul Miller - FBR Capital Markets & Co.

The provision, yes, yes, yes. We know it's going to get smaller but by this same degree, I guess, is a better way to answer -- to ask the question.

H. Simmons

I would -- that's really hard to predict, because it's going to depend not only on what we know now, but information that we will develop over the course of the quarter, both in terms of how much additional classified and reductions we achieve and then what loss rate on those reductions. But I would think that the reserve release is not going to get smaller for the next quarter or 2. It's going to be -- continue probably at a similar pace and it might even be slightly higher.

Doyle Arnold

With the charge-offs falling as much as they did, that was a helpful factor in the reserve release. And then also, the classified loan balances dropped a little bit more than we expected. I think Ken, on the last conference call, estimated a drop between 5% and 10% and came in at the high end of that range. And so those are the 2 major driving factors.

Paul Miller - FBR Capital Markets & Co.

I know you guys had a big step factor. But are you seeing the same pace? Or is it supposed to have improvement so far this month? Or has it started to slow way down?

H. Simmons

Well, it's way too early -- you can't read much into the first month, even of a given quarter, because most of the action occurs in the third quarter of the month -- third month of the quarter, sorry. The fourth quarter was a really big quarter where we achieved a 30% or more reduction in classified loans without a big step up in charge-offs. We achieved another 10% reduction this quarter with a big step down in charge-offs. And if you read our description of our loan loss reserve methodology in the 10-K, the 2 big drivers are classified loans and the loss rate on classified loans. So if one's improving and one is stable to improving, it implies a further reduction in credit costs in quarters going forward.

Paul Miller - FBR Capital Markets & Co.

Okay. Thank you very much, gentlemen.

H. Simmons

I want to come back just -- before we take the next question, I just want to come back to I think a comment Craig made about profits for the year. Yes, I did say we expect to be profitable for the year in my prepared remarks. I just want to point out that the $138 million of conversions and that cost will be a bigger cost than -- $50 million is bigger than last quarter. So we should be profitable comfortably so before preferred dividends and/or excluding sub debt costs for the second quarter. But that amount of conversion expense will make it tough to post a big profit in the second quarter. It might be more around breakeven, broadly speaking. But I didn't want -- in case anybody read into that profitability in the second quarter, that's a harder call to make, but then profitable for the year, which I'm quite comfortable with.

Operator

Our next question comes from Steven Alexopoulos from JPMorgan.

Steven Alexopoulos - JP Morgan Chase & Co

I want to ask Paul's question a little bit of a different way. If we just look at the pace of reserve reduction around $80 million, it would seem that it would take you, I don't know, at least another 2 years to get the reserve down to a more normal level. Wouldn't you need the charge-offs to pick up to consume the reserves you've already set up? Or do you expect to start taking negative provision the way we've seen some of your peer banks do it to get the reserve to a more normal level?

H. Simmons

I'm just curious, what are you calling a more normal level?

Steven Alexopoulos - JP Morgan Chase & Co

I just put 2% on. It seems like a good level.

H. Simmons

It's hard to -- well, first of all, Steve, it's hard to know. It's not a secret, there's a lot of tension between what the regulators would like to have happen and what the GAAP, current GAAP methodology would allow in terms of what is a "more normal reserve". I think the regulators would probably like to cajole, push, find, get past needed change in a way that would achieve a normal reserve somewhat higher than that. So we're not necessarily predicating our thinking over the next 2 years on a 2%, but probably something a little higher than that. And the regulators don't like negative provisions. But you're right, there have been some. So could I, -- if we have this kind of improvement, could I see a quarter or 2 of close to 0 provision at least? Yes, I could. I don't know which quarter, but it is going to be hard to justify much of a provision in a couple of quarters going forward, if we continue to see: a. improvement in our own internal results, and b. continued reasonable stability in the economy. But those things will dictate the facts and circumstances at the end of each quarter on which we have to base this decision.

Kenneth Peterson

I think I'll just add to that. With respect to kind of the qualitative adjustments we make to the quantitative approach to this problem, the qualitative adjustments we're making are really probably the high end of the range of where we can comfortably go. And so if the economy continues to improve and we see lower charge-offs in the second quarter than we did in the first, which we think is going to be the case, you could see certainly see a little more release next quarter.

James Abbott

We have a follow-up question that came through email. I'm just going to let Doyle answer it while we're on the topic. The question is, is the outlook for 2011 profitability for the full year? Does that include sub debt conversion and TARP dividend?

Doyle Arnold

Yes, it does. As long as -- particularly as long as my forecast that the sub debt conversions are going to start to decline, or at least not go up. I mean it's really hard to see them going up any higher. I think out of this quarter now, roughly half or more of the total sub debt, I think over half of what could convert has converted as of second quarter. I think something like close to $700 million has converted and there was originally $1.2 billion that could. So it almost has to be less. And yes, that's factoring in all -- that's net earnings to common. That's preferred dividends, sub debt costs, et cetera.

Kenneth Peterson

I'll just note if you go to Page 17 of the release, the top of the page there, you get some better ideas of what that looks like, adjusted for when you see these sub debt conversions start to slow and come to an end.

Doyle Arnold

We have about $579 million worth of sub debt par value that is left to convert at this point.

H. Simmons

After the second quarter numbers.

Doyle Arnold

After the quarter numbers that we just gave you.

H. Simmons

And again, the original amount was about $1.2 billion.

Operator

Our next question comes from Erika Penala from Bank of America.

Erika Penala - Merrill Lynch

My first question is on operating expenses. Just trying to back into what you were saying, if on a more normal quarterly run rate, does $410 million, $420 million sound fair?

James Abbott

Let me get back to that page of the earnings. Erika, what we referred to was the health care benefit expense as well as the compensation and salary benefit expense, which are all included in that 1 line item.

Doyle Arnold

The $215 million there -- I was commenting on the first line of under noninterest expense of $215 million. And then the very last line, the other, those are the 2 lines I commented on. And yes, I mean, that's probably -- I forgot. I'm drawing a blank now, James, on what was in the other.

James Abbott

FDIC indemnification.

Doyle Arnold

We have had good performance out of the FDIC, so we could continue to have a little bit of expense in there. But I'd also point out again, Erika, I think everybody's familiar with this. A few quarters ago, we tried also to break out some of the other clearly credit related costs. And those are the 3 lines, OREO expense, credit related expenses and the provision for unfunded. The $9.50 million bracketed on the unfunded lending is not sustainable. You ought to probably pencil in 0 as an ordinary run rate or small positive number. But OREO, you can you kind of see that other credit related expense may have already begun to drift down and clearly OREO expense seems to have drifted down. And we would expect both of those to continue to improve in future quarters as credit quality improves, if that helps you.

Erika Penala - Merrill Lynch

I'll follow up with James offline. In terms of the -- I just wanted to clarify your comment on adopting the new SEC guidelines for TDRs. It sounds to me like the lion's share of what's in the TDR bucket is actually more permanent in nature in that it's A note and B note, it's an A note/B note structure. So even if you had to reclassify what was sent back to accrual, it doesn't actually impact reserving or the provisions going forward.

Doyle Arnold

That's probably fair. And going back to accrual isn't necessarily impacted by the SEC guidance. It simply says whether it's accruing or not. I mean, our historic practice more or less has been that a restructure debt, if it could support the contemplated payments, et cetera, and we would either put it on accruing status if the cash flow's been there all along to support that level or after six months of performance, put it on and it can eventually roll off of TDR status. Well now under the new guidances, I think we interpret it, it can never come off of TDR status until the loan is, at some future point, re-underwritten to then totally market terms, rates, conditions, et cetera, if and when that ever may be. So some things that in accordance with GAAP we have removed from TDR status over this quarter and last may have to go back on TDR status when we adopt this new SEC guidance. And going forward, we'll have this kind of incremental rolled up in TDRs because once in jail, always in jail. But it's not going to be big. And I think the important thing to focus on is that the accrual nonaccrual breakdown again, where we've called it accruing at TDR, the re-default rate is 0.1% over, I think, the last year or so, cumulative. So it's not -- you're right, it's not going -- whatever this SEC guidance is, starts out to have any impact on those lines will have no impact on our reserving.

Erika Penala - Merrill Lynch

Thanks.

Operator

Our next question comes from Bob Patten from Morgan Keegan.

Robert Patten - Morgan Keegan & Company, Inc.

Most of my questions have been asked. But can you give us any color in terms of the inflows and what you're seeing in terms of migration of downgrades? And what type of credits? And obviously it looks like the loss content's a lot less. So just any update you can give us there.

H. Simmons

James is flipping through our big binder here.

James Abbott

Yes. Inflows were down pretty nicely on the quarter, Bob. The overall nonaccrual inflows this quarter, about $337 million.

Robert Patten - Morgan Keegan & Company, Inc.

Yes, that was in the release.

James Abbott

And that's down from $371 million last quarter. We had about $8,000 worth of loans that had an increasing balance, pretty small....

Robert Patten - Morgan Keegan & Company, Inc.

$8,000?

James Abbott

I'm sorry, $8 million. And then about $87 million of loans were changed to accrual status. About $131 million were paid off, and about $62 million paid down in some form or fashion. Then we had about $107 million of charge-offs just out of the nonaccrual camp, and then about $71 million of nonaccrual loans moved to the OREO bucket.

H. Simmons

I think probably the other commentary would be compared to where we were a year ago, the rate of inflows is down about 60% or 70%, I believe, on a quarterly basis. And it's very widespread. It's pretty much across all the geographies and loan types.

Robert Patten - Morgan Keegan & Company, Inc.

And would it be safe to assume, and Harris can answer this one, the ATM is dead?

H. Simmons

Well, we're going to obviously have to, as we get further in the quarter and start to understand really what the quarter's going to look like, we're still committed to -- if we actually have a net loss to common to cover that. And so we'll see later in the quarter. I'm just going to hang on probably largely to what the reserve release looks like this quarter.

Doyle Arnold

I think it's is safe to say, it's not say d-e-a-d dead, but it's at least de minimis, d-e-m-i-n. We're partially done with that.

Robert Patten - Morgan Keegan & Company, Inc.

Thanks, guys.

Operator

Our next question comes from Joe Morford from RBC Capital Markets.

Joe Morford - RBC Capital Markets, LLC

I had a question on the OREO expense line. Does that include both kind of the operational costs as well as kind of updated appraisals? And just what was your experience with getting updated appraisals during the quarter?

H. Simmons

Well, yes, it does include both. I will note that we've actually kind of had, I think, improving results with OREO workouts in that we have resolved -- in the first quarter, we resolved more OREO in the first 90 days after putting it in the OREO. So any subsequent charge downs that occurred on those properties in that period went back against charge-offs, net loan charge-offs and there were a few million dollars of those. I don't have the number that otherwise would have been in OREO. I think in general, we're solving stuff a little quicker and probably on better terms. Ken, do you want to...

Kenneth Peterson

I'd also just note, I mean, we're seeing more frequently, we're actually seeing recoveries. We're seeing some gains on the sale of OREO, which we certainly hadn't been seeing much at all off of a year ago, but we're seeing that today.

H. Simmons

Yes, we had -- the OREO expense was reduced in the quarter by $5 million of recoveries. In other words, we sold it for more than we initially marked it down to when we put it into OREO.

Joe Morford - RBC Capital Markets, LLC

Great. That's encouraging. And I also was curious, any update on kind of C&I pricing and kind of what your experience has been lately with that?

Doyle Arnold

Competition's getting more and more intense out there, and I don't know. Harris, do you want to...

H. Simmons

Well, I was pointing out to the group the other day, some of the pricing that we're seeing, with the kind of capital levels that everybody is carrying these days, it's really hard to do some simple math and figure out how you get any kind of return on equity that covers your cost of capital. We're talking about a deal that was LIBOR plus 90 or something like this. But everybody's scratching around, trying to find earning assets. And I think we continue to be in a period where there's a lot of competition for the really high quality credits. It's less so as you get into the middle market and down for a little bit.

Doyle Arnold

I would just add that based on preliminary, I mean, a LIBOR plus 90 would not be indicative of our portfolio.

H. Simmons

Exactly. I was really referring to pricing we saw on a deal that we were competing for. So I don't know how you make any real money doing that.

Doyle Arnold

We saw a few basis points of compression, maybe 20 basis points of overall compression, in the loan production on a linked quarter basis, Joe. That number's still being trued up and finalized. But that'll get you in the ballpark. So it wasn't massive pricing pressure.

Joe Morford - RBC Capital Markets, LLC

Okay, fair enough. Great colors. Thanks.

Operator

Our next question comes from more Marty Mosby from Guggenheim Partners.

Marty Mosby - Guggenheim Securities, LLC

I wanted to reconcile, you started off of with a balance sheet forecast of being about flat as we go through the remainder of the year. But then we flipped over and we talked about the inflection point between the runoff loan portfolio and the growth portfolio. Such that you said as early as June you might be able to see that flip. So second quarter, you might be able to see the loan growth. So just want to make clear that we're talking about loan growth coming back even in this quarter relative to maybe offsetting it with some security down in the security portfolio for the balance sheet to remain flat.

Doyle Arnold

Well, no, it's really cash. You look at the amount of cash we have, it's $4.5 billion or so, of which the bulk of it is in the banks. So we're happy to replace Fed funds or Fed balances at 25 basis points with loans and not grow the balance sheet at all for a long time.

Marty Mosby - Guggenheim Securities, LLC

We were just wanting to reconcile those two trends. And then lastly when I was there, we talked about the impact of the oil prices. And they really, with Texas and the exposure you had there, that you were actually benefiting from the recent trends. Do you still feel that way? And how would you highlight that?

Doyle Arnold

Well, I think as I said, I think the strongest market for loan growth this quarter as well as last was in Texas and in C&I lending. And I think that's probably -- a chunk of that is directly attributable to increased oil drilling, oil service and related kind of natural gas kind of activities. So it is -- because we don't have a large consumer portfolio, at least if it doesn't get too out of hand, oil in the high double digits to low triple digits is probably a net benefit to us.

Marty Mosby - Guggenheim Securities, LLC

And then a last follow-up would be we talked about deposit cost and we had a big repricing coming through in the first quarter. Did some of that lag into the second quarter? In other words as you average those costs -- we're talking about margin being relatively stable, could we see at least some more movement on the deposit side? And thanks for your comments.

Doyle Arnold

Well, I think the average reduction in the cost of the interest-bearing deposits has been coming down sort of mid single-digit basis points per quarter for several quarters. I'm not sure what the step down or whatever phrase you heard. I don't think we've ever talked about that, but that's kind of the impact. And yes, there's probably a little bit more of that to go as some term CDs re-price to current very low, low levels that were maybe at 1% to 2% the last time they renewed.

Operator

Our next question comes from Ken Zerbe from Morgan Stanley.

Ken Zerbe

I know this is looking out a little bit into the future and I guess after TARP repayment, but when you think about the prefers that you have outstanding, what is your, I guess, ability and willingness? And how aggressive are you guys going to be at paying those down? And is there any reason that might actually stop you or that you might want to keep those and start paying them down?

Doyle Arnold

Yes, in our most recent IR deck, Ken, which was March 19, the Citi conference. I think that's probably still available on our website. We kind of laid out the various costs and call dates of the capital stack that's out there. We've got -- of course, we've got the TARP out there and then the series, the next callable issue is the Series E preferred, which I believe, has a base amount of about $150 million or something like that, but 11% coupon on it. That's callable in 2012, in June. The Series D is now a much larger amount. That's what most of the sub debt's been converting into, Series C, excuse me. That's a 9 1/2% rate and callable in '13. We certainly have that in mind and we've kind of laid out the potential earnings per share impact of those things. Of course, what we actually do will be dependent on market conditions and rates and whatnot at that time.

And I think it's safe to say that we could probably -- if we had to refinance all of it, we could refinance it at a same issue, but at a lower rate today than then, and we'll certainly be having that in mind as we get closer to those call dates.

Ken Zerbe

All things equal, should we make that assumption that if nothing else that you refinance it with similar debt, but lower rates? And best case, you repay it with cash on hand?

Doyle Arnold

Correct, that's our thinking.

Ken Zerbe

Perfect. All right, thank you.

James Abbott

I think that will have to take care of all the questions for now. There are a handful of people still in the queue, and I will get back to you as soon as we can off the call. We appreciate your time today. And if you have further questions, of course, please email me or give me a call at (801) 844-7637. Thank you and have a great evening.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Zions Bancorp.'s CEO Discusses Q1 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts