ZIONS BANCORPORATION, NATIONAL ASSOCIATION quarterly report, Q3 FY2016

Zions Bancorporation, National Association — 2016 Q3 Form 10-Q Summary

Business context and reporting period

Zions Bancorporation is a financial holding company headquartered in Salt Lake City, Utah, providing banking and related services through seven separately managed brands across 11 Western and Southwestern states. Following the December 31, 2015 charter consolidation, the banking subsidiaries operate under a single bank, ZB, N.A., while retaining local brands and management. This filing covers the unaudited three and nine months ended September 30, 2016, compared primarily with the same periods in 2015 and December 31, 2015 balance-sheet amounts.

Key financial metrics

Metric	Q3 2016	Q3 2015	9M 2016	9M 2015
Total interest income	$490.7 million	$456.2 million	$1.45 billion	$1.36 billion
Net interest income	$469.2 million	$425.4 million	$1.39 billion	$1.27 billion
Provision for loan losses	$18.8 million	$18.3 million	$95.5 million	$17.3 million
Noninterest income	$144.9 million	$125.9 million	$387.4 million	$238.6 million
Noninterest expense	$403.3 million	$391.3 million	$1.18 billion	$1.18 billion
Net income	$127.3 million	$101.0 million	$331.6 million	$207.0 million
Net earnings applicable to common shareholders	$116.9 million	$84.2 million	$286.3 million	$158.4 million
Diluted earnings per common share	$0.57	$0.41	$1.39	$0.77

Q3 net interest margin was 3.36%, compared with 3.11% in the prior-year quarter. The efficiency ratio was 66.0%, compared with 69.1%; year-to-date efficiency was 66.3%. Tangible return on average tangible common equity was 7.88%, compared with 6.05% in Q3 2015. The Q3 effective tax rate was 33.7%, compared with 28.8%; management expects an effective tax rate of approximately 34% to 35% for the next three months.

Balance sheet, capital, debt and liquidity

Total assets were $61.0 billion at September 30, 2016, up from $59.7 billion at December 31, 2015.
Total loans were $42.5 billion, up from $40.6 billion. Growth was concentrated in commercial real estate term loans, residential lending, and commercial and industrial loans.
Investment securities were $11.2 billion, up from $8.2 billion, primarily reflecting purchases of agency-backed mortgage securities and other high-quality liquid assets.
Total deposits were $50.8 billion, up from $50.4 billion. The loan-to-deposit ratio was 83.7%, compared with 80.7% at year-end 2015.
Long-term debt declined to $570.4 million from $812.4 million. Federal funds and other short-term borrowings increased to $1.12 billion from $347.0 million, including $750 million of short-term FHLB borrowings outstanding at quarter-end that matured and was repaid in October 2016.
Shareholders’ equity increased to $7.68 billion from $7.51 billion. Tangible common equity was $5.95 billion, or 9.91% of tangible assets. Basel III common equity Tier 1, Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 12.04%, 11.27%, 13.48% and 15.31%, respectively.
Cash, interest-bearing deposits and security resell agreements totaled approximately $3.6 billion at September 30, 2016, compared with $7.4 billion at year-end 2015. Management stated that liquidity policies were met and that the company exceeded applicable modified liquidity coverage requirements.
Available borrowing capacity from the FHLB and Federal Reserve was approximately $16.5 billion, supported by approximately $25.9 billion of pledged loans.

Cash flow and capital actions

For the first nine months, operating activities provided $462.8 million of cash, investing activities used $1.48 billion, and financing activities provided $771.2 million. Investing cash use primarily reflected purchases of investment securities and net loan growth. Cash and due from banks declined by $245.2 million year to date to $553.2 million.

The company redeemed approximately $119 million of preferred stock during the second quarter, producing a one-time $9.8 million reduction to earnings applicable to common shareholders. During Q3, it repurchased approximately 1.47 million common shares for $45 million at an average price of $30.64. Subsequent to September 30, it repurchased an additional $45 million of common stock, leaving $90 million of capacity under the 2016 capital plan. The quarterly common dividend increased to $0.08 per share.

Material changes versus comparable periods

Q3 net interest income increased $43.8 million year over year, supported by loan growth, a shift from lower-yielding money market investments into loans and securities, and lower long-term debt costs.
Average investment securities increased substantially, while average money market investments declined. Management purchased approximately $1.5 billion of high-quality liquid securities during Q3 and expects additional purchases in Q4 2016 and 2017.
Year-to-date noninterest income benefited significantly from the absence of the approximately $136.8 million pretax loss on the sale of the remaining collateralized debt obligation portfolio recorded in 2015. Q3 also included approximately $8 million of increased market value on an SBIC investment; management does not expect those gains to recur.
Q3 noninterest expense increased 3.1% year over year, primarily due to legal matters, back-office operating alignment, employee-related costs, higher occupancy expense and higher FDIC premiums. Year-to-date expense remained approximately flat.
Net nonaccrual and credit-quality measures deteriorated principally because of oil and gas-related loans. Nonperforming assets increased to $587 million, or 1.37% of loans and leases plus OREO, from $357 million, or 0.87%, at year-end 2015.
The allowance for loan losses declined to $597.2 million from $606.0 million, while the reserve for unfunded lending commitments declined to $61.6 million from $74.8 million.

Guidance, outlook and management commentary

Management remains committed to adjusted 2016 noninterest expense below $1.58 billion and an efficiency ratio below 66%. It expects to achieve more than the initially targeted $120 million of annual pretax cost savings by year-end 2017.
Management expects continued growth in residential mortgage and commercial lending, but limited commercial real estate growth because of concentration limits and risk-management practices.
Management expects quarterly credit-loss provisions over the next four quarters to be generally stable relative to the first and second quarters of 2016, assuming no significant change in market conditions.
The company expects further deterioration in its oil and gas-related portfolio, particularly oilfield services, and states that additional deterioration could occur if low oil and gas prices continue.
The company expects to remain asset-sensitive to interest rates, although continued purchases of agency securities are expected to reduce that sensitivity. Under modeled assumptions, a parallel 200-basis-point increase in rates would increase first-year net interest income by 7.8% under the fast repricing scenario and 14.2% under the slow scenario.

Risks, contingencies and unusual items

Oil and gas-related credit exposure was approximately $4.1 billion, including $2.3 billion of loans and $1.8 billion of unfunded commitments. The criticized, classified and nonaccrual ratios for this portfolio increased materially from year-end 2015. Q3 oil and gas-related net charge-offs were $41 million.
Total nonaccrual loans were approximately $579 million, and classified loans were $1.6 billion. Total unfunded lending commitments were $19.1 billion.
The company reached an agreement in principle to settle the Reyes payment-processing class action for approximately $37.5 million to $37.75 million, subject to final court approval. The company stated that it had fully reserved for its obligations, with a portion covered by insurance.
A Department of Justice inquiry into payment-processing practices remained subject to settlement discussions. Other governmental inquiries and civil litigation also remained unresolved. The estimated range of reasonably possible legal losses in excess of accrued amounts was $0 to approximately $10 million for matters for which a meaningful estimate could be made; this excludes matters where estimation was not possible.
A $2.6 million pension partial-settlement loss was recorded in Q3. Similar losses could recur if lump-sum distributions continue to exceed expected interest cost.
Approximately $7 million of private equity investments remained prohibited under the Volcker Rule, with an additional approximately $1 million of related unfunded commitments. The required divestiture deadline was extended to July 21, 2017.
Management identifies interest-rate movements, deposit migration, securities prepayments, oil and gas prices, commercial real estate, regulatory capital and liquidity requirements, litigation, cybersecurity, technology execution and competitive pricing as significant risks.

Most important facts for investors to verify

Whether oil and gas-related nonaccrual loans, classified loans, charge-offs and allowance coverage stabilize or worsen.
Whether the company achieves its below-66% efficiency-ratio and below-$1.58 billion adjusted-expense targets.
The sustainability of loan growth and net interest margin as securities purchases increase and competitive loan pricing pressures yields.
The effect of additional preferred and common stock repurchases on capital ratios, earnings per share and dividends.
The final resolution and cost of the Reyes settlement, the Department of Justice inquiry and other legal proceedings.
Actual liquidity coverage, funding costs and reliance on short-term borrowings as cash is redeployed into investment securities and loans.
The impact of future accounting standards, particularly the expected-credit-loss standard scheduled for adoption in 2020, which management expects to have a material financial statement impact.