Zions Bancorporation, National Association — 2018 Q3 Form 10-Q
Business context and reporting period
The filing covers the unaudited three and nine months ended September 30, 2018, compared primarily with the same periods in 2017 and, for selected metrics, June 30, 2018. Zions is a commercial bank headquartered in Salt Lake City serving 11 Western and Southwestern states through seven separately managed banking brands.
On September 30, 2018, Zions Bancorporation merged into its subsidiary bank, formerly ZB, N.A. The surviving entity was renamed Zions Bancorporation, National Association, eliminating the bank holding company structure and making the OCC the primary regulator. The Bank also ceased to be designated as a systemically important financial institution under the Dodd-Frank Act.
Financial performance and key metrics
| Metric | Q3 2018 | Q3 2017 | Change |
|---|---|---|---|
| Net income | $223 million | $160 million | 41% increase |
| Net earnings applicable to common shareholders | $215 million | $152 million | 41% increase |
| Diluted EPS | $1.04 | $0.72 | 44% increase |
| Net interest income | $565 million | $522 million | 8% increase |
| Noninterest income | $136 million | $139 million | 2% decrease |
| Noninterest expense | $420 million | $413 million | 2% increase |
| Effective tax rate | 23.6% | 34.2% | Lower by 10.6 percentage points |
| Net interest margin | 3.63% | 3.45% | Up 18 basis points |
| Return on average tangible common equity | 14.2% | 9.8% | Up 440 basis points |
| Efficiency ratio | 58.8% | 62.3% | Improved |
For the nine months ended September 30, 2018, net income was $658 million and net earnings applicable to common shareholders were $633 million, compared with $469 million and $436 million, respectively, in the prior-year period. Diluted EPS was $3.01 versus $2.06.
Adjusted pre-provision net revenue was $291 million in Q3 2018, up 16% from $251 million in Q3 2017. Customer-related fees increased 2% year over year to $125 million. Securities gains declined to a $1 million loss from a $5 million gain in the prior-year quarter.
Balance sheet, credit, liquidity, and capital
- Total assets were $66.7 billion at September 30, 2018, compared with $66.3 billion at December 31, 2017.
- Loans and leases increased to $45.8 billion from $44.8 billion at year-end 2017. Growth was strongest in 1-4 family residential, municipal, construction and land development, and owner-occupied lending; term CRE loans declined modestly.
- Total deposits were $53.8 billion, up from $52.6 billion at December 31, 2017. Noninterest-bearing demand deposits were $24.1 billion, or approximately 45% of average total deposits during the quarter.
- Long-term debt increased to $879 million from $383 million following issuance of a $500 million senior note bearing 3.5% interest and maturing August 27, 2021. Short-term borrowings were $3.8 billion, down from $5.0 billion at year-end.
- Net cash provided by operating activities was $825 million for the first nine months, while investing activities used $739 million and financing activities used $117 million. Cash and due from banks ended the period at $517 million.
- Investment securities and cash and money market investments totaled approximately $17.3 billion, or 26% of total assets. High-quality liquid assets were $12.0 billion.
- Available additional borrowing capacity from the FHLB and Federal Reserve was approximately $14.9 billion. Management stated that available liquidity was adequate for reasonably foreseeable short- and intermediate-term needs.
- Nonperforming assets declined to $292 million, or 0.64% of loans and leases and OREO, from $418 million, or 0.93%, at December 31, 2017. Nonaccrual loans were $288 million.
- The provision for loan losses was a $(11) million benefit in Q3 2018 versus a $5 million provision in Q3 2017. Net loan recoveries were $1 million in the quarter, compared with $8 million of net charge-offs in the prior-year quarter.
- The allowance for loan losses was $480 million, and the total allowance for credit losses, including the reserve for unfunded commitments, was $538 million at September 30, 2018.
- Basel III common equity tier 1, tier 1 leverage, tier 1 risk-based, and total risk-based capital ratios were 12.1%, 10.5%, 13.1%, and 14.6%, respectively. The Bank reported compliance with applicable capital requirements.
Material changes versus comparable periods
- Net interest income benefited from higher short-term interest rates, loan growth, and deposit-pricing discipline. Interest income on loans increased $69 million year over year, partly offset by a $31 million increase in interest expense.
- Average loans increased $1.5 billion, or 4%, year over year; average total deposits increased to $53.6 billion from $51.9 billion.
- Credit quality improved materially, particularly in the oil and gas portfolio. Criticized, classified, and nonaccrual loans declined by $585 million, $464 million, and $177 million, respectively, from Q3 2017.
- Income taxes decreased to $69 million from $83 million, reflecting the lower federal corporate tax rate under the Tax Cuts and Jobs Act and other tax effects.
- Noninterest expense growth remained within management's low-single-digit target, although salaries and employee benefits increased $13 million year over year.
- Shareholders' equity declined to $7.6 billion from $7.7 billion at year-end, primarily because of $420 million in common-share repurchases, a $222 million decline in the fair value of available-for-sale securities, and $172 million of common and preferred dividends, partly offset by $658 million of net income.
Guidance, outlook, risks, contingencies, and unusual items
- Management expects overall loan growth to be slightly to moderately increasing and customer-related fees to increase slightly over the following 12 months.
- Management expects 2018 adjusted noninterest expense to increase in the low-single-digit percentage range versus 2017.
- The 2018 effective tax rate was expected to be approximately 23%, including stock-based compensation.
- Management expects moderately higher net interest income in a rising-rate environment because assets generally reprice faster than liabilities. However, deposit migration, competitive pricing, prepayments, a flatter yield curve, and changes in modeled deposit betas could reduce the benefit.
- In an immediate parallel 200-basis-point rate increase scenario, modeled Earnings at Risk indicated a 4.8% increase in first-year net interest income; modeled Economic Value of Equity declined 4.3%. These are model-based estimates sensitive to assumptions.
- The Bank repurchased 3.5 million common shares for $185 million during Q3 and approved an additional $250 million repurchase plan for Q4. The quarterly common dividend increased to $0.30 per share.
- The Bank decided in October 2018 to terminate its pension plan, subject to regulatory approval, with completion expected in early 2020. Additional expense is expected for pension amounts in OCI and participant annuity purchases; the current estimate for annuity-related expense is $5 million to $15 million.
- The Bank identified cyber risk as a highest-level enterprise risk. Other principal risks include credit deterioration, interest-rate and market risk, liquidity and funding conditions, regulatory and legal changes, technology implementation, competition, and economic conditions including tariffs and commodity prices.
- Material legal matters include litigation and governmental or regulatory proceedings, including claims related to alleged Ponzi schemes, wage-and-hour issues, and alleged borrower fraud. The estimated aggregate range of reasonably possible losses in matters where a meaningful estimate was possible was $0 to approximately $15 million above accrued amounts; this does not represent maximum exposure.
- The Bank is implementing major accounting changes, including the expected January 1, 2020 adoption of the current expected credit loss standard. Management stated that the potential impact may be material and remains under evaluation. Lease accounting adoption on January 1, 2019 was estimated to create a right-of-use asset of $200 million to $250 million.
Important facts for investors to verify
- Reconcile the reported earnings improvement with the lower credit-loss provision, higher net interest income, lower tax rate, and the $3 million interest-income recovery benefit.
- Assess sustainability of the 3.63% net interest margin as deposit costs rise and the yield curve remains relatively flat.
- Monitor loan growth, commercial real estate exposure, oil and gas credit quality, criticized and classified loans, nonaccrual loans, and allowance coverage.
- Evaluate liquidity after the $500 million debt issuance, planned $162 million subordinated-note call, share repurchases, and dividend payments.
- Review the effect of the holding-company merger on regulatory oversight, capital flexibility, reporting comparability, and future capital actions.
- Validate the potential pension termination costs, legal-loss estimates, and the eventual impact of CECL adoption.
- Consider the limitations of non-GAAP measures such as adjusted PPNR, adjusted expenses, efficiency ratio, and tangible common equity ratios when comparing Zions with other banks.