ZIONS BANCORPORATION, NATIONAL ASSOCIATION quarterly report, Q2 FY2012

Zions Bancorporation, National Association — Q2 2012 Form 10-Q Summary

Business context and reporting period

Zions Bancorporation provides banking, lending, wealth management, capital markets, and related financial services through eight community and regional banks operating primarily in ten western and southwestern states. This unaudited Form 10-Q covers the three and six months ended June 30, 2012, with comparisons to the corresponding 2011 periods and December 31, 2011 balance-sheet data.

Key financial metrics

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Net interest income	$432.0 million	$416.2 million	$874.3 million	$840.0 million
Noninterest income	$123.0 million	$128.3 million	$230.0 million	$262.5 million
Noninterest expense	$401.7 million	$416.3 million	$794.0 million	$824.6 million
Net income applicable to controlling interest	$91.7 million	$72.9 million	$181.4 million	$125.7 million
Net earnings applicable to common shareholders	$55.2 million	$29.0 million	$80.7 million	$43.8 million
Diluted earnings per share	$0.30	$0.16	$0.44	$0.24
Net interest margin	3.62%	3.62%	3.67%	3.69%

Q2 net income applicable to common shareholders increased approximately 90%, while diluted EPS increased from $0.16 to $0.30.
Q2 income before taxes was $142.5 million; the effective tax rate was 35.7%, versus 42.7% in the prior-year quarter.
Q2 taxable-equivalent net interest income was $436.6 million. Management’s non-GAAP core net interest margin was 3.72%, compared with 4.07% in Q2 2011.
Cash flow from operating activities was $508.8 million for the first six months, compared with $615.4 million in the prior-year period. Cash and due from banks ended at $1.125 billion.
At June 30, total assets were $53.407 billion, deposits were $43.160 billion, net loans were $35.902 billion, and total shareholders’ equity was $6.489 billion.
Long-term debt was $2.275 billion, compared with $1.954 billion at December 31, 2011. Consolidated cash and interest-bearing deposits totaled approximately $9.0 billion.
Loan-to-deposit ratio was 85.4%, and approximately $13.5 billion of additional Federal Home Loan Bank and Federal Reserve borrowing capacity was available.

Material changes versus prior comparable periods

Q2 net interest income increased $15.8 million, principally from lower funding costs, higher securities yields, and reduced debt-related amortization expense; the benefit was partly offset by lower loan yields and a greater mix of low-yielding money market assets.
Q2 noninterest expense declined $14.6 million, led by an $11.5 million reduction in other real estate expense, a $5.3 million reduction in other expense, and lower credit-related expenses and FDIC premiums.
Noninterest income declined $5.3 million in Q2. Other service charges and fees declined $5.4 million, and fair-value and nonhedge derivative income shifted from a $4.2 million gain to a $6.8 million loss, primarily due to the total return swap.
The Q2 provision for loan losses increased to $10.9 million from $1.3 million, but first-half provision expense declined to $26.5 million from $61.3 million. Net charge-offs declined to $43.3 million in Q2 from $113.2 million.
Nonperforming lending-related assets declined to $938 million from $1.063 billion at December 31, 2011 and $1.513 billion at June 30, 2011. The ratio of nonperforming lending-related assets to net loans and other real estate owned improved to 2.53% from 2.83% and 4.06%, respectively.
Loans declined 0.7% from December 31, 2011 to $36.873 billion. Construction and land-development loans declined to 5.7% of the portfolio from 7.5% a year earlier.
The allowance for loan losses declined to $971.7 million from $1.050 billion at December 31, 2011 and $1.238 billion at June 30, 2011. The allowance represented 2.64% of net loans.
Average noninterest-bearing deposits increased to $16.2 billion, or 35.0% of total average liabilities, from $14.2 billion, or 32.1%, in Q2 2011. Brokered deposits declined to $127 million from $328 million a year earlier.

Capital, debt, liquidity, outlook, and risks

In March 2012, the company redeemed $700 million, or 50%, of its $1.4 billion TARP preferred stock. Management expected to redeem the remaining $700 million in the second half of 2012, subject to specified liquidity, capital-return, and regulatory conditions.
The company issued $558 million of four- to five-year senior notes, net proceeds of approximately $533 million, and repaid $255 million of FDIC-guaranteed notes during the first half. It also issued $143.75 million of Series F preferred stock at a 7.9% dividend rate and redeemed $142.5 million of Series E preferred stock carrying an 11% dividend rate.
June 30 capital ratios included common equity Tier 1 of 9.78%, Tier 1 leverage of 12.31%, Tier 1 risk-based capital of 15.03%, and total risk-based capital of 16.89%. Management expected to meet final Basel III requirements but noted uncertainty regarding the final rules.
Management expected modest net interest margin compression for several quarters because of competitive loan pricing, loan-rate resets, expiring interest-rate floors, low interest rates, and debt discount amortization. It identified potential support from lower nonperforming assets, reduced low-yielding liquidity balances, and modest loan growth.
Management expected credit costs to remain low and criticized and classified loans and net charge-offs to continue declining, absent a significant economic downturn. Classified loans were $1.9 billion at June 30, 2012, compared with $2.7 billion a year earlier.
The investment portfolio remained exposed to illiquid bank and insurance trust-preferred CDOs. Net credit-related impairment losses were $7.3 million in Q2 and $17.5 million year to date. Available-for-sale Level 3 securities had $1.005 billion of fair value versus $1.874 billion of amortized cost.
The $1.16 billion total return swap with Deutsche Bank reduced credit and regulatory risk associated with certain CDOs but generated approximately $5.4 million of expected net quarterly costs. If terminated because of counterparty nonperformance, risk-weighted assets could increase by approximately $3.3 billion and risk-based capital ratios could decline by approximately seven percentage points.
Aggregate reasonably possible legal losses for matters that could be estimated ranged from $3 million to $90 million, including accrued liabilities. Management stated that existing legal accruals were adequate, while noting that actual outcomes could be material.
The company remained somewhat asset-sensitive to interest rates. A 200-basis-point increase was estimated to increase first-year interest-sensitive income by 9.2% to 12.2%, depending on deposit repricing assumptions; a decrease was estimated to reduce it by 1.5% to 1.9%.
Subsequent to quarter-end, the company exited corporate-debt trading in preparation for expected Volcker Rule regulation and did not expect a material earnings impact.

Important facts for investors to verify

Whether the planned second $700 million TARP preferred-stock redemption was completed and whether required capital returns and regulatory approvals were obtained.
The sustainability of credit-quality improvements, including declining nonaccrual loans, classified loans, charge-offs, and the allowance coverage ratio.
Valuation sensitivity and future impairment exposure in the bank and insurance trust-preferred CDO portfolio, including Level 3 assumptions and deferral/default trends.
The effect of continued low interest rates, loan repricing, competitive pricing, and debt discount amortization on net interest margin and earnings.
The final Basel III capital rules and their effect on the company’s regulatory capital ratios, risk-weighted assets, and permitted capital distributions.
Actual legal-loss outcomes relative to the disclosed $3 million to $90 million reasonably possible loss range.
The performance and counterparty exposure of the Deutsche Bank total return swap and the consequences of any termination.
The expiration of temporary unlimited FDIC insurance for noninterest-bearing transaction accounts after December 31, 2012 and its potential effect on deposit balances and funding costs.