UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2006
OR
For the transition period from to
COMMISSION FILE NUMBER 0-2610
ZIONS BANCORPORATION
(Exact name of registrant as specified in its charter)
UTAH
87-0227400
(State or other jurisdiction
of incorporation or organization)
(I.R.S. Employer
Identification No.)
ONE SOUTH MAIN, SUITE 1134
SALT LAKE CITY, UTAH
84111
Registrant’s telephone number, including area code: (801) 524-4787
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, without par value, outstanding at April 28, 2006
ZIONS BANCORPORATION AND SUBSIDIARIES
INDEX
2
CONSOLIDATED BALANCE SHEETS
March 31,
2006
December 31,
2005
ASSETS
Cash and due from banks
Money market investments:
Interest-bearing deposits
Federal funds sold
Security resell agreements
Investment securities:
Held to maturity, at cost (approximate market value $633,784, $642,258, and $629,684)
Available for sale, at market
Trading account, at market (includes $34,340, $43,444, and $114,302 transferred as collateral under repurchase agreements)
Loans:
Loans held for sale
Loans and leases
Less:
Unearned income and fees, net of related costs
Allowance for loan losses
Loans and leases, net of allowance
Other noninterest-bearing investments
Premises and equipment, net
Goodwill
Core deposit and other intangibles
Other real estate owned
Other assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand
Interest-bearing:
Savings and money market
Time under $100,000
Time $100,000 and over
Foreign
Securities sold, not yet purchased
Federal funds purchased
Security repurchase agreements
Other liabilities
Commercial paper
Federal Home Loan Bank advances and other borrowings:
One year or less
Over one year
Long-term debt
Total liabilities
Minority interest
Shareholders’ equity:
Capital stock:
Preferred stock, without par value; authorized 3,000,000 shares; issued and outstanding, none
Common stock, without par value; authorized 350,000,000 shares; issued and outstanding 106,070,045, 105,147,562, and 89,891,146 shares
Retained earnings
Accumulated other comprehensive loss
Deferred compensation
Total shareholders’ equity
See accompanying notes to consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
Interest income:
Interest and fees on loans
Interest on loans held for sale
Lease financing
Interest on money market investments
Interest on securities:
Held to maturity – taxable
Held to maturity – nontaxable
Available for sale – taxable
Available for sale – nontaxable
Trading account
Total interest income
Interest expense:
Interest on savings and money market deposits
Interest on time and foreign deposits
Interest on short-term borrowings
Interest on long-term debt
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income:
Service charges and fees on deposit accounts
Loan sales and servicing income
Other service charges, commissions and fees
Trust and investment management income
Income from securities conduit
Dividends and other investment income
Market making, trading and nonhedge derivative income
Equity securities gains (losses), net
Fixed income securities gains, net
Other
Total noninterest income
Noninterest expense:
Salaries and employee benefits
Occupancy, net
Furniture and equipment
Legal and professional services
Postage and supplies
Advertising
Impairment losses on long-lived assets
Restructuring charges
Merger related expense
Amortization of core deposit and other intangibles
Provision for unfunded lending commitments
Total noninterest expense
Income before income taxes and minority interest
Income taxes
Net income
Weighted average shares outstanding during the period:
Basic shares
Diluted shares
Net income per common share:
Basic
Diluted
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
(In thousands)
Common
stock
Retained
earnings
Accumulated
other
comprehensive
income (loss)
Deferred
compensation
Total
shareholders'
equity
Balance, December 31, 2005
Comprehensive income:
Net income for the period
Other comprehensive loss, net of tax:
Net realized and unrealized holding losses on investments and retained interests
Foreign currency translation
Reclassification for net realized gains on investments recorded in operations
Net unrealized losses on derivative instruments
Other comprehensive loss
Total comprehensive income
Stock redeemed and retired
Net stock options exercised
Reversal of deferred compensation, adoption of SFAS 123R
Share-based compensation
Cash dividends – common, $.36 per share
Change in deferred compensation
Balance, March 31, 2006
Balance, December 31, 2004
Balance, March 31, 2005
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Impairment losses on long lived assets
Depreciation of premises and equipment
Amortization
Deferred income tax benefit
Excess tax benefits from share-based compensation
Loss allocated to minority interest
Equity securities losses (gains), net
Net increase in trading securities
Principal payments on and proceeds from sales of loans held for sale
Additions to loans held for sale
Net gains on sales of loans, leases and other assets
Net increase in cash surrender value of bank owned life insurance
Undistributed earnings of affiliates
Change in accrued income taxes
Change in accrued interest receivable
Change in other assets
Change in other liabilities
Change in accrued interest payable
Other, net
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in money market investments
Proceeds from maturities of investment securities held to maturity
Purchases of investment securities held to maturity
Proceeds from sales of investment securities available for sale
Proceeds from maturities of investment securities available for sale
Purchases of investment securities available for sale
Proceeds from sales of loans and leases
Net increase in loans and leases
Net decrease (increase) in other noninterest-bearing investments
Proceeds from sales of premises and equipment
Purchases of premises and equipment
Proceeds from sales of other real estate owned
Net cash used in investing activities
6
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits
Net change in short-term funds borrowed
Proceeds from FHLB advances and other borrowings over one year
Payments on FHLB advances and other borrowings over one year
Proceeds from issuance of common stock
Payments to redeem common stock
Dividends paid
Net cash provided by financing activities
Net increase (decrease) in cash and due from banks
Cash and due from banks at beginning of period
Cash and due from banks at end of period
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest
Noncash items:
Loans transferred to other real estate owned
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Zions Bancorporation (“the Parent”) and its majority-owned subsidiaries (collectively “the Company,” “we,” “our,” “us”) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain prior period amounts have been reclassified to conform with the current period presentation.
Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected in future periods. The balance sheet at December 31, 2005 is from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in Zions Bancorporation’s Annual Report on Form 10-K for the year ended December 31, 2005.
The Company provides a full range of banking and related services through banking subsidiaries in ten Western states as follows: Zions First National Bank (“Zions Bank”), in Utah and Idaho; California Bank & Trust (“CB&T”); Amegy Corporation (“Amegy”), in Texas; National Bank of Arizona (“NBA”); Nevada State Bank (“NSB”); Vectra Bank Colorado (“Vectra”), in Colorado and New Mexico; The Commerce Bank of Washington (“TCBW”); and The Commerce Bank of Oregon (“TCBO”). Amegy was acquired effective December 3, 2005 as discussed in Note 3. TCBO was opened in October 2005 and is not expected to have a material effect on consolidated operations for several years.
2. OTHER RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, Accounting for Certain Hybrid Financial Instruments, an Amendment of FASB Statements No. 133 and 140. This Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, to require evaluation of all interests in securitized financial assets under SFAS 133, eliminating a previous exemption under SFAS 133 for such financial instruments. Entities must now distinguish interests that are freestanding derivatives, hybrid financial instruments containing embedded derivatives requiring bifurcation, or hybrid financial instruments containing embedded derivatives that do not require bifurcation. In addition, the Statement permits fair value remeasurement for any hybrid instrument (on an instrument-by-instrument basis) that contains an embedded derivative that would otherwise require bifurcation. The Statement also amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, by eliminating the prohibition on a qualifying special-purpose entity (“QSPE”) from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.
8
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140. This Statement permits entities to choose to either subsequently measure recorded servicing rights at fair value and report changes in fair value in earnings, or amortize servicing rights in proportion to the estimated net servicing income or loss and assess the rights for impairment or the need for an increased obligation. In addition, the Statement, among other things, clarifies when a servicer should separately recognize servicing assets and liabilities, and requires initial fair value measurement, if practicable, of such recognized assets and liabilities.
In general, both Statements are effective as of the beginning of an entity’s fiscal year after September 15, 2006, or January 1, 2007 for calendar-year entities. Management is evaluating the impact these Statements may have on the Company’s financial statements.
The Company’s adoption of SFAS No. 123R, Share-Based Payment, is discussed in Note 6.
3. MERGER AND ACQUISITION ACTIVITY
Effective December 3, 2005, we acquired 100% of the outstanding stock of Amegy Bancorporation, Inc. headquartered in Houston, Texas. The tax-free merger included the formation of a new holding company, Amegy Corporation (“Amegy”), which became a wholly-owned subsidiary of the Company. The merger expands the Company’s banking presence into Texas. Amegy’s results of operations for the month of December 2005 and for the three months ended March 31, 2006 were included with the Company’s results of operations.
Details of the merger, including the allocation of the purchase price, are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The allocation of the purchase price is subject to change when the determination of Amegy’s asset and liability values is finalized within one year from the merger date. As of March 31, 2006, the allocation had not changed from December 31, 2005.
The following unaudited pro forma condensed combined financial information presents the Company’s results of operations for the three months ended March 31, 2005 assuming the merger had taken place as of January 1, 2005. Also shown for comparative purposes are the historical results of operations for the Company without Amegy (in thousands, except per share amounts):
9
March 31, 2005
Noninterest income
Other noninterest expense
Merger related expenses for this merger of $5.7 million for the three months ended March 31, 2006 consisted of systems integration and related charges of $3.1 million and severance and other employee-related costs of $2.6 million.
As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, Amegy accrued as of the date of merger approximately $15.2 million of liabilities from purchase accounting adjustments for certain exit and termination costs. These costs consisted of employee-related costs of $12.2 million and other exit costs of $3.0 million. As of March 31, 2006, Amegy had paid approximately $8.1 million of these costs.
4. LONG-TERM DEBT
On March 31, 2006, we filed an “automatic shelf registration statement” with the Securities and Exchange Commission as a “well-known seasoned issuer” under their revised rules effective December 1, 2005 with respect to the registration, communications and offering processes under the Securities Act of 1933. The shelf registration replaced a previous shelf registration and covers securities of the Company, Zions Capital Trust C and Zions Capital Trust D.
On April 27, 2006, under the new shelf registration, we issued $250 million of floating rate senior notes due April 15, 2008. The notes require quarterly interest payments at three-month LIBOR plus 0.12%. They are not redeemable prior to maturity and are not listed on any national securities exchange. Proceeds from the notes will be used to retire all of the $150 million of 2.70% senior notes due May 1, 2006 and all of the remaining $104.2 million of 6.95% subordinated notes due May 15, 2011 and redeemable May 15, 2006.
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5. SHAREHOLDERS’ EQUITY
Changes in accumulated other comprehensive income (loss) are summarized as follows (in thousands):
Net unrealized
gains (losses)
on investments,
retained interests
and other
Netunrealized
losses
on derivative
instruments
Minimumpension
liability
Three Months Ended March 31, 2006:
Net realized and unrealized holding losses during the year, net of income tax benefit of $12,365
Reclassification for net realized gains recorded in operations, net of income tax expense of $17
Net unrealized losses on derivative instruments, net of reclassification to operations of $(5,334) and income tax benefit of $12,410
Three Months Ended March 31, 2005:
Net realized and unrealized holding losses during the period, net of income tax benefit of $6,539
Reclassification for net realized gains recorded in operations, net of income tax expense of $549
Net unrealized losses on derivative instruments, net of reclassification to operations of $7,175 and income tax benefit of $19,477
6. SHARE-BASED COMPENSATION
We have a stock option and incentive plan which allows us to grant stock options and restricted stock to employees and nonemployee directors. The total shares authorized under the plan are 8,900,000 of which 7,789,048 shares are available for future grant as of March 31, 2006.
Prior to January 1, 2006, we accounted for share-based compensation under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and related Interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation. Accordingly, we did not record any compensation expense for stock options, as the exercise price of the option was equal to the quoted market price of the stock on the date of grant.
11
Effective January 1, 2006, we adopted SFAS No. 123R, Share-Based Payment, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of income based on their fair values. This accounting utilizes a “modified grant-date” approach in which the fair value of an equity award is estimated on the grant date without regard to service or performance vesting conditions. We adopted SFAS 123R using the “modified prospective” transition method. Under this transition method, compensation expense is recognized beginning January 1, 2006 based on the requirements of SFAS 123R for all share-based payments granted after January 1, 2006, and based on the requirements of SFAS 123 for all awards granted to employees prior to January 1, 2006 that remain unvested as of that date. Results of operations for prior periods have not been restated.
As a result of adopting SFAS 123R, the Company’s income before income taxes and minority interest and net income for the three months ended March 31, 2006 were approximately $3.9 million and $2.8 million lower, respectively, than if it had continued to account for share-based compensation under APB 25. Basic and diluted net income per common share for the three months ended March 31, 2006 would have been $1.33 and $1.30, respectively, if we had not adopted SFAS 123R, compared to reported basic and diluted net income per common share of $1.30 and $1.28, respectively. As required by SFAS 123R, we also reversed $11.1 million of unearned compensation related to restricted stock from deferred compensation and common stock.
The impact on net income and net income per common share if we had applied the provisions of SFAS 123 to stock options for the three months ended March 31, 2005 was as follows (in thousands, except per share amounts):
Net income, as reported
Deduct: Total share-based compensation expense determined under fair value based method for stock options, net of related tax effects
Pro forma net income
Basic – as reported
Basic – pro forma
Diluted – as reported
Diluted – pro forma
We classify all share-based awards as equity instruments and recognize the vesting of the awards ratably over their respective terms. As of March 31, 2006, compensation expense not yet recognized for nonvested share-based awards was approximately $30.7 million, which is expected to be recognized over a weighted average period of 2.4 years.
SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation expense resulting from the exercise of share-based awards to be reported as a financing cash flow. For the three months ended March 31, 2006, this requirement reduced net operating cash flows and increased net financing cash flows by approximately $5.2 million.
12
Stock Options
Options granted to employees vest at the rate of one third each year and expire seven years after the date of grant. Options granted to nonemployee directors are exercisable in increments from six months to three and a half years and expire ten years after the date of grant.
In 2005, we discontinued our broad-based employee stock option plan; however, existing options continue to vest at the rate of one third each year and expire four years after the date of grant.
For the three months ended March 31, 2006, the additional compensation expense of $3.9 million for stock options under SFAS 123R is included in salaries and employee benefits in the statement of income with the corresponding increase to shareholders’ equity included in common stock. The related tax benefit recognized as a reduction of income tax expense was $1.1 million.
During the three months ended March 31, 2006, the amount of cash received from the exercise of stock options was $41.0 million and the tax benefit realized as a reduction of income taxes payable was $9.2 million. Of this amount, $3.4 million reduced goodwill for the tax benefit of vested share-based awards converted in the Amegy acquisition that were exercised during the quarter and $5.8 million was included in common stock as part of net stock options exercised.
Compensation expense was determined from the estimates of fair values of stock options granted using the Black-Scholes model. The methodology is consistent with the estimates used for the pro forma presentation in periods prior to the adoption of SFAS 123R. Significant assumptions on a weighted average basis used in the Black-Scholes model include expected life, expected volatility, expected dividend yield, and risk-free interest rate. These assumptions reflect management’s judgment and include consideration of historical experience. The risk-free interest rate is based on the U. S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option. No stock options were granted during the three months ended March 31, 2006.
The following summarizes our stock option activity for the three months ended March 31, 2006:
Weightedaverage
exercise
price
Balance at December 31, 2005
Granted
Exercised
Expired
Forfeited
Balance at March 31, 2006
Outstanding options exercisable as of March 31, 2006
We issue new authorized shares for the exercise of stock options. During the three months ended March 31, 2006, the total intrinsic value of options exercised was approximately $28.1 million.
13
Additional selected information on stock options at March 31, 2006 follows:
Exercise price range
Number of
shares
Weightedaverageremainingcontractual
life (years)
$ 0.32 to $ 19.99
$ 20.00 to $ 29.99
$ 30.00 to $ 39.99
$ 40.00 to $ 44.99
$ 45.00 to $ 49.99
$ 50.00 to $ 54.99
$ 55.00 to $ 59.99
$ 60.00 to $ 64.99
$ 65.00 to $ 69.99
$ 70.00 to $ 76.51
For outstanding options at March 31, 2006, the aggregate intrinsic value was $193.0 million. For exercisable options at March 31, 2006, the aggregate intrinsic value was $145.5 million and the weighted average remaining contractual life was 3.9 years.
Restricted Stock
Restricted stock granted vests over four years. During the vesting period, the holder has full voting rights and receives dividend equivalents. For the three months ended March 31 2006, compensation expense recognized for issuances of restricted stock and included in salaries and employee benefits in the statement of income was $1.0 million. The amount for the three months ended March 31, 2005 was not significant. The corresponding increase to shareholders’ equity was included in common stock. Compensation expense was determined based on the number of restricted shares granted and the market price of our common stock at the grant date.
The following summarizes our restricted stock activity for the three months ended March 31, 2006:
grant
Nonvested restricted shares at beginning of period
Vested
Nonvested restricted shares at end of period
The total fair value of restricted stock vesting during the three months ended March 31, 2006 was $97,776. The amount for the three months ended March 31, 2005 was not significant.
14
7. GUARANTEES
The following are guarantees issued by the Company (in thousands):
Standby letters of credit:
Financial
Performance
The Company’s Annual Report on Form 10-K for the year ended December 31, 2005 contains further information on the nature of these letters of credit along with their terms and collateral requirements. At March 31, 2006, the carrying value recorded by the Company as a liability for these guarantees was $4.8 million.
Certain mortgage loans sold have limited recourse provisions for periods ranging from three months to one year. The amount of losses resulting from the exercise of these provisions has not been significant.
As of March 31, 2006, the Parent has guaranteed approximately $580.3 million of debt issued by a subsidiary and by affiliated trusts issuing trust preferred securities. The trusts and related trust preferred securities are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Zions Bank provides a liquidity facility (“Liquidity Facility”) for a fee to Lockhart Funding, LLC (“Lockhart”), a QSPE securities conduit. Lockhart purchases floating rate U.S. Government and AAA-rated securities with funds from the issuance of commercial paper. Zions Bank also provides interest rate hedging support and administrative and investment advisory services for a fee. Pursuant to the Liquidity Facility contract, Zions Bank is required to purchase securities from Lockhart to provide funds for Lockhart to repay maturing commercial paper upon Lockhart’s inability to access the commercial paper market, or upon a commercial paper market disruption as specified in governing documents for Lockhart. Pursuant to the governing documents, including the liquidity agreement, if any security in Lockhart is downgraded below AA-, Zions Bank must either 1) place its letter of credit on the security, 2) obtain credit enhancement from a third party, or 3) purchase the security from Lockhart at book value. At any given time, the maximum commitment of Zions Bank is the book value of Lockhart’s securities portfolio, which is not allowed to exceed the size of the Liquidity Facility commitment. At March 31, 2006, the book value of Lockhart’s securities portfolio was $5.2 billion, which approximated market value, and the size of the Liquidity Facility commitment was $6.12 billion. No amounts were outstanding under the Liquidity Facility at March 31, 2006.
The FASB continues to deliberate other projects that propose to amend SFAS 140 in addition to those discussed in Note 2. These include isolation of transferred assets and permitted activities of QSPEs. The proposed amendments, among other things, may require changes to the operating activities of QSPEs and other aspects relating to the transfer of financial assets. Subject to the requirements of any final standards when they are issued, Lockhart’s operations may need to be modified to preserve its off-balance sheet status.
15
8. RETIREMENT PLANS
The following disclosures are required for interim financial statements by SFAS No. 132R, Employers’ Disclosures about Pensions and Other Postretirement Benefits (in thousands):
Service cost
Interest cost
Expected return on plan assets
Amortization of net actuarial (gain) loss
Net periodic benefit cost
As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, we expect to contribute $634 thousand in 2006 to meet estimated benefit payments to participants in our postretirement welfare plan. As of March 31, 2006, we have contributed $160 thousand of this amount and expect to contribute the remaining portion during the rest of 2006. We do not expect to make any contributions to the pension plan in 2006 and have not done so as of March 31, 2006. As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, participation and benefit accruals for the pension plan were frozen effective January 1, 2003.
9. OPERATING SEGMENT INFORMATION
We manage our operations and prepare management reports and other information with a primary focus on geographical area. As of March 31, 2006, we operate eight community/regional banks in distinct geographical areas. Performance assessment and resource allocation are based upon this geographical structure. Zions Bank operates 112 branches in Utah and 23 in Idaho. CB&T operates 91 branches in California. Amegy operates 75 branches in Texas. NBA operates 53 branches in Arizona. NSB operates 72 branches in Nevada. Vectra operates 40 branches in Colorado and one branch in New Mexico. TCBW operates one branch in the state of Washington. TCBO operates one branch in Oregon. The operating segment identified as “Other” includes the Parent, certain nonbank financial service and financial technology subsidiaries, other smaller nonbank operating units, TCBO, and eliminations of transactions between segments. Results for Amegy only include the three months ended March 31, 2006.
The accounting policies of the individual operating segments are the same as those of the Company. Transactions between operating segments are primarily conducted at fair value, resulting in profits that are eliminated for reporting consolidated results of operations. Operating segments pay for centrally provided services based upon estimated or actual usage of those services.
16
The following table presents selected operating segment information for the three months ended March 31, 2006 and 2005:
(In millions)
CONDENSED INCOME STATEMENT
Net interest income excluding hedge income
Hedge income recorded directly at subsidiary
Allocated hedge income
Noninterest expense
Income tax expense (benefit)
Net income (loss)
AVERAGE BALANCE SHEET DATA
Assets
Net loans and leases
Deposits
Shareholder’s equity
Consolidated
Company
17
ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL HIGHLIGHTS
EARNINGS
Taxable-equivalent net interest income
Taxable-equivalent revenue
PER COMMON SHARE
Net income (diluted)
Dividends
Book value
SELECTED RATIOS
Return on average assets
Return on average common equity
Efficiency ratio
Net interest margin
18
FINANCIAL HIGHLIGHTS (Continued)
AVERAGE BALANCES
Total assets
Securities
Total deposits
Core deposits (1)
Shareholders’ equity
Weighted average common and common-equivalent shares outstanding
AT PERIOD END
Sold loans being serviced (2)
Allowance for unfunded lending commitments
Common shares outstanding
Average equity to average assets
Common dividend payout
Tangible common equity ratio
Nonperforming assets
Accruing loans past due 90 days or more
Nonperforming assets to net loans and leases and other real estate owned at period end
19
FORWARD-LOOKING INFORMATION
Statements in Management’s Discussion and Analysis that are based on other than historical data are forward-looking, within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and include, among others:
These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties and actual results may differ materially from those presented, either expressed or implied, in Management’s Discussion and Analysis. Factors that might cause such differences include, but are not limited to:
Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in the 2005 Annual Reports on Form 10-K of Zions Bancorporation and
20
Amegy Bancorporation, Inc. filed with the Securities and Exchange Commission (“SEC”) and available at the SEC’s Internet site (http://www.sec.gov).
The Company specifically disclaims any obligation to update any factors or to publicly announce the result of revisions to any of the forward-looking statements included herein to reflect future events or developments.
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT ESTIMATES
The Company has made no significant changes in its critical accounting policies and significant estimates from those disclosed in its Annual Report on Form 10-K for the year ended December 31, 2005, except for the adoption of SFAS No. 123R, Share-Based Payment.
Note 6 of the Notes to Consolidated Financial Statements discusses the Company’s adoption on January 1, 2006 of SFAS 123R, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of income based on their fair values. The Company adopted SFAS 123R using the “modified prospective” transition method and did not restate results of operations for prior periods. Rather, the Company presented the pro forma effect on operations as if it had adopted the provisions of SFAS 123.
The Company uses the Black-Scholes option-pricing model to estimate the fair value of stock options for the adoption of SFAS 123R and for the pro forma presentations in prior periods. Use of the assumptions is subjective and requires judgment. The adoption of SFAS 123R decreased income before income taxes and minority interest and net income by approximately $3.9 million and $2.8 million, respectively, for the three months ended March 31, 2006, or $0.03 per diluted share. The Company currently estimates that the adoption of SFAS 123R will reduce 2006 pretax income by approximately $17 million. In 2005, the Company began granting shares of restricted stock in connection with the adoption of a new stock option and incentive plan. No stock options were granted during the three months ended March 31, 2006.
RESULTS OF OPERATIONS
Zions Bancorporation (“the Parent”) and subsidiaries (collectively “Zions,” “the Company,” “we,” “our”) reported net income of $137.6 million or $1.28 per diluted share for the first quarter of 2006 compared with $110.2 million or $1.20 per diluted share for the first quarter of 2005. The annualized return on average assets was 1.31% in the first quarter of 2006 compared to 1.40% for the same period of 2005. For the same comparative periods, the annualized return on average common equity was 12.92% compared to 15.83%.
As previously disclosed, the Company completed its acquisition of Amegy Bancorporation, Inc. in December 2005. Results of operations for the first quarter of 2006 include Amegy Corporation for the entire quarter and the fourth quarter of 2005 includes one month of Amegy.
Net Interest Income, Margin and Interest Rate Spreads
Taxable-equivalent net interest income for the first quarter of 2006 increased 34.0% to $428.8 million compared with $320.1 million for the comparable period of 2005. The increase reflects the acquisition of Amegy, strong loan and deposit growth, and the effect of an increase in the net interest margin. The incremental tax rate used for calculating all taxable-equivalent adjustments is 35% for all periods presented.
The Company’s net interest margin was 4.69% for the first quarter of 2006 compared to 4.62% for the fourth quarter of 2005 and 4.53% for the first quarter of 2005. The increased margin mainly results from an improved asset mix, in particular, reductions in lower-yielding short-term investments have been used to fund higher-
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yielding loans. The margin for the first quarter of 2006 was also influenced by continued solid loan growth and the inclusion of Amegy’s noninterest-bearing deposit balances for the entire quarter.
One of the challenges we face in 2006 is an anticipated increase in pricing pressure on both loans and deposits as the economy expands and competition for good business increases. Reflecting this pricing pressure, the spread on average interest-bearing funds for the first quarter of 2006 was 3.95%, down from 4.04% for the first quarter of 2005. The yield on average earning assets increased 100 basis points during the first quarter of 2006 compared to the same period in 2005. The average rate paid this quarter on interest-bearing funds increased 109 basis points from the first quarter of 2005.
The Federal Reserve raised its target for the federal funds rate twice during the quarter by a combined 50 basis points. These increases were followed by corresponding increases in the prime rate charged by most major banks, including Zions’ subsidiary banks. The Federal Reserve has indicated that it may implement additional rate changes, as appropriate. The Company expects to continue its efforts to maintain a slightly “asset sensitive” position with regard to interest rate risk. However, its actual position is highly dependent upon changes in both short-term and long-term interest rates, as well as the actions of competitors and customers in response to those changes.
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CONSOLIDATED AVERAGE BALANCE SHEETS, YIELDS AND RATES
Money market investments
Securities:
Held to maturity
Available for sale
Total securities
Net loans and leases (2)
Total loans and leases
Total interest-earning assets
LIABILITIES
Interest-bearing deposits:
Savings and NOW
Money market
Total interest-bearing deposits
Borrowed funds:
Federal funds purchased and security repurchase agreements
FHLB advances and other borrowings:
Total borrowed funds
Total interest-bearing liabilities
Noninterest-bearing deposits
Total liabilities and shareholders’ equity
Spread on average interest-bearing funds
Taxable-equivalent net interest income and net yield on interest-earning assets
(1) Taxable-equivalent rates used where applicable.
(2) Net of unearned income and fees, net of related costs. Loans include nonaccrual and restructured loans.
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Provisions for Credit Losses
The provision for loan losses is the amount of expense that, based on our judgment, is required to maintain the allowance for loan losses at an adequate level based upon the inherent risks in the portfolio. The provision for unfunded lending commitments is used to maintain the allowance for unfunded lending commitments at an adequate level. See “Credit Risk Management” for more information on how we determine the appropriate level for the allowances for loan and lease losses and unfunded lending commitments.
The provision for loan losses for the first quarter of 2006 was $14.5 million compared to $9.4 million for the same period in 2005. On an annualized basis, the provision was 0.19% of average loans for the first quarter of 2006 and 0.17% for the first quarter of 2005. The provision for unfunded lending commitments was $(0.3) million for the first quarter of 2006 compared to $1.7 million for the first quarter of 2005. From period to period, the amounts of unfunded lending commitments may be subject to sizeable fluctuation due to changes in the timing and volume of loan originations and fundings. The related provision will generally reflect these fluctuations. When combined, the provisions for credit losses for the first quarter of 2006 were $14.2 million compared to $11.1 million for the first quarter of 2005. The increased provision reflects the strong loan growth during the first quarter of 2006.
Noninterest Income
For the first quarter of 2006, noninterest income increased 26.2% to $129.9 million compared to $103.0 million for the first quarter of 2005. The increases in total and individual categories of noninterest income for the first quarter of 2006 compared to the first quarter of 2005 were mainly due to the Amegy acquisition. Significant changes and trends in noninterest income categories not resulting from the Amegy acquisition are discussed as follows.
The Company has experienced strong deposit growth during the last year, but continues to see a decline in service charges and fees on deposit accounts. Excluding Amegy service charges and fees for the first quarter of 2006, service charges and fees on deposit accounts decreased $0.8 million for the first quarter of 2006 compared to the first quarter of 2005. We believe this decline was primarily the result of higher earnings credit rates on commercial transaction accounts as market interest rates continued to rise.
Loan sales and servicing income decreased $2.6 million for the first quarter of 2006 compared to the first quarter of 2005. The decline results from decreased sales of mortgage and other loans and the impact of rising rates on excess servicing income.
Income from securities conduit represents fees that we receive from Lockhart Funding, a “qualifying special-purpose entity” securities conduit, in return for liquidity, an interest rate agreement and administrative services that Zions Bank provides to the entity in accordance with a servicing agreement. The decrease in income for the first quarter of 2006 when compared to the same period in 2005 resulted from compression of spreads between Lockhart’s assets and liabilities.
Trading income for the first quarter of 2006 was $3.9 million compared to $4.2 million for the same period in 2005. Excluding $1.4 million of trading income from Amegy in the first quarter of 2006, trading income decreased $1.8 million compared to the first quarter of 2005. The decrease mainly results from a decision made by the Company in the fourth quarter of 2005 to close its London trading office and reduce the amount of trading assets in response to continued margin pressures. Nonhedge derivative income for the first quarter of 2006 was $0.5 million compared to losses of $0.5 million for the comparable period of 2005.
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Net equity securities gains were $0.6 million for the first quarter of 2006 compared with net losses of $1.4 million for the same period in 2005 and included net losses on venture capital equity investments of $0.2 million in 2006 compared to net losses of $1.7 million in 2005. Adjusted for expenses, minority interest and income taxes, venture capital funds reduced net income by $0.4 million and $1.1 million for the first quarter of 2006 and 2005, respectively.
Noninterest Expense
Noninterest expense for the first quarter of 2006 was $325.9 million, an increase 36.2% over the $239.3 million for the first quarter of 2005. The increases in total and individual categories of noninterest expense for the first quarter of 2006 compared to the first quarter of 2005 were mainly due to the Amegy acquisition. The Company’s efficiency ratio was 58.3% for the first quarter of 2006 compared to 56.6% for the same period of 2005. The deterioration in the efficiency ratio reflects higher noninterest expenses, including merger related expenses and amortization of intangibles related to the acquisition of Amegy, and a higher cost structure at Amegy.
Salaries and employee benefits increased $47.9 million or 34.7%, compared to the first quarter of 2005. Excluding Amegy related salaries and employee benefits of $35.4 million and share-based compensation expense of $3.9 million resulting from the adoption of SFAS 123R, salaries and benefits increased $8.6 million or 6.2%. The increase from the prior year, excluding Amegy, was due to salary increases and increased staffing levels in selected areas.
Impairment losses on long-lived assets for the first quarter of 2006 of $1.3 million include a loss of $1.0 million related to a branch building at Vectra that was placed for sale and $0.3 million related to capitalized management software.
See Note 3 of Notes to Consolidated Financial Statements for an explanation of the $5.7 million of Amegy merger related expenses incurred during the first quarter of 2006.
At March 31, 2006, the Company had 10,136 full-time equivalent employees, 469 domestic branches, and 582 ATMs, compared to 7,958 full-time equivalent employees, 386 domestic branches, and 472 ATMs at March 31, 2005.
Income Taxes
The Company’s income tax expense increased to $75.3 million for the first quarter of 2006 compared to $59.7 million for the same period in 2005. The Company’s effective income tax rates, including the effects of minority interest, were 35.4% and 35.1% for the first quarter of 2006 and 2005, respectively. As discussed in previous filings, the Company has received federal income tax credits under the Community Development Financial Institutions Fund set up by the U.S. Government that will be recognized over the next seven years. The effect of these tax credits was to reduce income tax expense by $1.0 million and $0.8 million for the first quarter of 2006 and 2005, respectively. The tax rates reflect a lower proportion of tax exempt income to total income for 2006 compared to 2005, partially offset by the increased tax credits.
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BALANCE SHEET ANALYSIS
As previously discussed, the Company completed its acquisition of Amegy Bancorporation, Inc. in December 2005. The Company’s consolidated balance sheets at March 31, 2006 and December 31, 2005 include Amegy.
Interest-Earning Assets
Interest-earning assets are those assets that have interest rates or yields associated with them and consist of money market investments, securities and loans.
Average interest-earning assets increased 29.2% to $37.1 billion for the three months ended March 31, 2006 compared to $28.7 billion for the comparable period in 2005 reflecting the Amegy acquisition. Interest-earning assets comprised 86.9% of total average assets for the first three months of 2006, compared with 90.1% for the comparable period of 2005. The decreased percentage is mainly a result of increased goodwill and other intangible assets from the Amegy acquisition.
Average money market investments, consisting of interest-bearing deposits, federal funds sold and security resell agreements, decreased 37.3% to $512 million for the first three months of 2006 compared to $816 million for the first three months of 2005. Reductions in money market instruments have been used to fund new loan growth. Average net loans and leases for the first three months of 2006 increased by 34.4% when compared to the same period in 2005. Average total deposits for the first three months of 2006 increased 37.9% compared to the same period in 2005, with interest-bearing deposits increasing 36.8% and noninterest-bearing deposits increasing 40.5%.
Investment Securities Portfolio
The following table presents the Company’s held-to-maturity and available-for-sale investment securities:
HELD TO MATURITY
Municipal securities
AVAILABLE FOR SALE
U.S. Treasury securities
U.S. Government agencies and corporations:
Small Business Administration loan-backed securities
Other agency securities
Mortgage/asset-backed and other debt securities
Other securities:
Mutual funds
Stock
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The amortized cost of investment securities at March 31, 2006 decreased 1.6% from the amount at December 31, 2005, but was up from the balance at March 31, 2005 as a result of the Amegy acquisition. During 2005, we reduced the securities portfolio to fund a portion of the Company’s new loan growth.
We review investment securities on an ongoing basis for other than temporary impairment taking into consideration current market conditions, offering prices, trends and volatility of earnings, current analysts’ evaluations, our ability and intent to hold investments until a recovery of fair value, which may be maturity, and other factors. Our review did not result in an other than temporary impairment adjustment during the quarter ended March 31, 2006.
The investment securities portfolio includes $1.0 billion of nonrated, fixed income securities, essentially unchanged from the balances at both December 31, 2005 and March 31, 2005. These securities include nonrated municipal securities as well as nonrated, asset-backed subordinated tranches.
Loan Portfolio
Net loans and leases at March 31, 2006 were $31.1 billion, an annualized increase of 13.5% from December 31, 2005 and an increase of 35.6% over the balance at March 31, 2005.
The following table sets forth the loan portfolio by type of loan:
Commercial lending:
Commercial and industrial
Leasing
Owner occupied
Total commercial lending
Commercial real estate:
Construction and land development (1)
Term
Total commercial real estate
Consumer:
Home equity credit line and other consumer real estate (1)
1-4 family residential (1)
Bankcard and other revolving plans
Total consumer
Foreign loans
Other receivables
Total loans
(1) Certain balances at the end of periods previous to March 31, 2006 have been reclassified between construction and land development, home equity credit line and other consumer real estate, and 1-4 family residential to conform with the current presentation.
The strong loan growth noted above for commercial and commercial real estate lending was widely diversified across our geographical footprint and consistent with the economic activity in that area. Management believes it is likely this strong loan growth will continue in the immediate future.
Sold Loans Being Serviced
Zions performs loan servicing on both loans that it holds in its portfolios and also on loans that are owned by third party investor-owned trusts. In addition, Zions has a practice of securitizing and selling a portion of the loans that it originates, and in many instances provides the servicing on these loans as a condition of the sale.
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Residual interests
on balance sheet at March 31, 2006
Sales for three
months ended
March 31,2006
Outstanding
balance at
Subordinated
retained
interests
Capitalized
residual
cash flows
Home equity credit lines
Small business loans
SBA 7(a) loans
Farmer Mac
Loan securitizations being serviced for others totaled $3.2 billion at the end of the first quarter of 2006, $3.4 billion at December 31, 2005 and $3.0 billion at March 31, 2005.
As of March 31, 2006, the Company had recorded assets, comprised of subordinated retained interests and capitalized residual cash flows, in the amount of $342 million in connection with the $3.2 billion of sold loans being serviced. As is a common practice with securitized transactions, the Company had retained subordinated interests in the securitized assets that totaled $235 million at March 31, 2006, and represented junior positions to the other investors in the trust securities. The capitalized residual cash flows, which are sometimes referred to as “excess servicing,” of $107 million primarily represent the present value of the excess cash flows that have been projected over the lives of the sold loans.
As of March 31, 2006, conforming long-term first mortgage real estate loans being serviced for others were $1,263 million, compared with $1,274 million at December 31, 2005 and $462 million at March 31, 2005. The increase reflects the acquisition of Amegy.
Other Noninterest-Bearing Investments
As of March 31, 2006, the Company had $972 million of other noninterest-bearing investments compared with $939 million at December 31, 2005 and $691 million at March 31, 2005.
Bank-owned life insurance
Federal Home Loan Bank and Federal Reserve stock
SBIC investments
Other public companies
Other nonpublic companies
Trust preferred securities
The increases in other noninterest-bearing investments are mainly a result of the Amegy acquisition.
Total deposits at the end of the first quarter of 2006 increased to $32.9 billion, an annualized increase of 2.8% from the balances reported at December 31, 2005, and increased 37.7% over the March 31, 2005 amounts. Core deposits at March 31, 2006 increased 0.68%, annualized, compared to the December 31, 2005 balance and 34.6% compared to the balance at March 31, 2005. Noninterest-bearing demand deposits were essentially unchanged compared to year-end balances and increased 38.4% from balances at March 31, 2005.
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The mix of deposits remained favorable during the first quarter of 2006 as demand, savings and money market deposits comprised 80.0% of total deposits at the end of the first quarter, compared with 79.7% and 85.9% as of December 31, 2005 and March 31, 2005, respectively. The decrease in this ratio from March 31, 2005 is a primarily a result of the mix of deposits at Amegy. However, management expects that deposit growth may continue to lag behind loan growth, and that some future loan growth, therefore, may be funded from higher cost sources.
RISK ELEMENTS
Since risk is inherent in substantially all of the Company’s operations, management of risk is an integral part of its operations and is also a key determinant of its overall performance. We apply various strategies to reduce the risks to which the Company’s operations are exposed, including credit, interest rate and market, liquidity and operational risks.
Credit Risk Management
Effective management of credit risk is essential in maintaining a safe and sound financial institution. We have structured the organization to separate the lending function from the credit administration function, which adds strength to the control over and the independent evaluation of credit activities. Formal loan policies and procedures provide the Company with a framework for consistent underwriting and a basis for sound credit decisions. In addition, the Company has a well-defined set of standards for evaluating its loan portfolio, and management utilizes a comprehensive loan grading system to determine the risk potential in the portfolio. Further, an independent, internal credit examination department periodically conducts examinations of the Company’s lending departments. These examinations are designed to review credit quality, adequacy of documentation, appropriate loan grading administration and compliance with lending policies, and reports thereon are submitted to the Credit Review Committee of the Board of Directors.
Both the credit policy and the credit examination functions are managed centrally. Each affiliate bank is permitted to modify corporate credit policy to be more conservative; however, corporate approval must be obtained if a bank wishes to create a more liberal exception to policy. Historically, only a limited number of such exceptions have been approved. This entire process has been designed to place an emphasis on early detection of potential problem credits so that action plans can be developed and implemented on a timely basis to mitigate any potential losses.
Another aspect of the Company’s credit risk management strategy is to pursue the diversification of the loan portfolio. The Company maintains a diversified loan portfolio with some emphasis in real estate. As set forth in the following table, at March 31, 2006 no single loan type exceeded 23.2% of the Company’s total loan portfolio.
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% of
total loans
The Company’s potential risk from concentration in owner occupied commercial loans is substantially reduced by the emphasis we place on lending programs sponsored by the Small Business Administration. On these types of loans, the Small Business Administration bears a major portion of the credit risk. In addition, the Company attempts to avoid the risk of an undue concentration of credits in a particular industry, trade group or property type. The Company also has no significant exposure to highly-leveraged transactions and the majority of the Company’s business activity is with customers located within the states of Utah, California, Texas, Arizona, Nevada, Colorado, Idaho and Washington. Finally, the Company has no significant exposure to any individual customer or counterparty.
A more comprehensive discussion of our credit risk management is contained in Zions’ Annual Report on Form 10-K for the year ended December 31, 2005. In addition, as discussed in the following sections, the Company’s level of credit quality continued to be very strong during the first quarter of 2006 compared to historical standards. We believe that this level of credit quality will not be able to be maintained indefinitely.
Nonperforming Assets
Nonperforming assets include nonaccrual loans, restructured loans and other real estate owned. Loans are generally placed on nonaccrual status when the loan is 90 days or more past due as to principal or interest, unless the loan is both well secured and in the process of collection. Consumer loans are not normally placed on nonaccrual status, inasmuch as they are generally charged off when they become 120 days past due. Loans occasionally may be restructured to provide a reduction or deferral of interest or principal payments. This generally occurs when the financial condition of a borrower deteriorates to the point that the borrower needs to be given temporary or permanent relief from the original contractual terms of the loan. Other real estate owned is acquired primarily through or in lieu of foreclosure on loans secured by real estate.
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The following table sets forth the Company’s nonperforming assets:
(Amounts in millions)
Nonaccrual loans
Restructured loans
% of net loans and leases* and other real estate owned
% of net loans and leases*
* Includes loans held for sale.
Total nonperforming assets increased 8.4% as of March 31, 2006 compared with the balance at December 31, 2005.
Included in nonaccrual loans are loans that we have determined to be impaired. Loans, other than those included in large groups of smaller-balance homogeneous loans, are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement, including scheduled interest payments. The amount of the impairment is measured based on either the present value of expected cash flows, the observable market value of the loan, or the fair value of the collateral securing the loan.
The Company’s total recorded investment in impaired loans was $40 million at March 31, 2006, compared with $31 million at December 31, 2005 and $39 million at March 31, 2005. Estimated losses on impaired loans are included in the allowance for loan losses. At March 31, 2006, the allowance for loan losses included $4 million for impaired loans with a recorded investment of $26 million. At December 31, 2005, the allowance included $3 million for impaired loans with a $14 million recorded investment, and at March 31, 2005 the allowance included $5 million for impaired loans with a $22 million recorded investment.
Allowances for Credit Losses
Allowance for Loan Losses – In analyzing the adequacy of the allowance for loan losses, we utilize a comprehensive loan grading system to determine the risk potential in the portfolio and also consider the results of independent internal credit reviews. To determine the adequacy of the allowance, the Company’s loan and lease portfolio is broken into segments based on loan type.
For commercial loans, we use historical loss experience factors by loan segment, adjusted for changes in trends and conditions, to help determine an indicated allowance for each portfolio segment. These factors are evaluated and updated using migration analysis techniques and other considerations based on the makeup of the specific segment. These other considerations include:
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The allowance for consumer loans is determined using historically developed experience rates at which loans migrate from one delinquency level to the next higher level. Using average roll rates for the most recent twelve-month period and comparing projected losses to actual loss experience, the model estimates expected losses in dollars for the forecasted period. By refreshing the model with updated data, it is able to project losses for a new twelve-month period each month, segmenting the portfolio into nine product groupings with similar risk profiles. This methodology is an accepted industry practice, and the Company believes it has a sufficient volume of information to produce reliable projections.
The methodology used by Amegy to estimate its allowance for loan losses has not yet been conformed to the process used by the other affiliate banks. However, the process used by Amegy is not significantly different than the process used by our other affiliate banks.
The following table shows the changes in the allowance for loan losses and a summary of loan loss experience:
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Three MonthsEnded
Twelve Months
Ended
Loans* and leases outstanding (net of unearned income) at end of period
Average loans* and leases outstanding (net of unearned income)
Allowance for loan losses:
Balance at beginning of period
Allowance of companies acquired
Provision charged against earnings
Loans and leases charged-off:
Commercial lending
Commercial real estate
Consumer
Recoveries:
Net loan and lease charge-offs
Balance at end of period
Ratio of annualized net charge-offs to average loans and leases
Ratio of allowance for loan losses to net loans and leases at end of period
Ratio of allowance for loan losses to nonperforming loans
Ratio of allowance for loan losses to nonaccrual loans and accruing loans past due 90 days or more
Net loan and lease charge-offs, along with their annualized ratios to average loans and leases, are shown in the preceding table for the periods presented. The same respective amounts for the fourth quarter of 2005 were $8.2 million and 0.13%.
The allowance for loan losses at March 31, 2006 increased $2.9 million from the level at year-end 2005. Excluding Amegy, which as previously discussed has not yet been conformed to Zions’ methodology, the amount of the allowance for loans losses attributable to the commercial loan portfolio increased $5.3 million when compared to year-end 2005. The amount of the allowance indicated for criticized and classified commercial loans increased $1.1 million. Criticized and classified loans increased slightly for both the commercial and commercial real estate portfolios. The level of the allowance for noncriticized and classified commercial loans increased $4.2 million, mainly the result of $906 million of new commercial and commercial real estate loan growth during the quarter, excluding Amegy loans. The allowance for consumer loans decreased $3.6 million when compared to December 31, 2005 mainly driven by improving consumer loan delinquencies.
Allowance for Unfunded Lending Commitments – The Company also estimates an allowance for potential losses associated with off-balance sheet commitments and standby letters of credit. We determine the
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allowance for unfunded lending commitments using a process that is similar to the one we use for commercial loans. Based on historical experience, we have developed experience-based loss factors that we apply to the Company’s unfunded lending commitments to estimate the potential for loss in that portfolio. These factors are generated from tracking commitments that become funded and develop into problem loans.
The following table sets forth the allowance for unfunded lending commitments:
Three Months
December 31, 2005
Allowance of company acquired
Provision charged (credited) against earnings
The following table sets forth the combined allowances for credit losses:
Total allowances for credit losses
Interest Rate and Market Risk Management
Interest rate risk is the potential for loss resulting from adverse changes in the level of interest rates on the Company’s net interest income. Market risk is the potential for loss arising from adverse changes in the prices of fixed income securities, equity securities, other earning assets and derivative financial instruments as a result of changes in interest rates or other factors. As a financial institution that engages in transactions involving an array of financial products, the Company is exposed to both interest rate risk and market risk.
Interest Rate Risk – Interest rate risk is one of the most significant risks to which the Company is regularly exposed. In general, our goal in managing interest rate risk is to have the net interest margin increase slightly in a rising interest rate environment. We refer to this goal as being slightly “asset sensitive.” This approach is based on our belief that in a rising interest rate environment, the market cost of equity, or implied rate at which future earnings are discounted, would also tend to rise. Under most, but not all, reasonably plausible interest rate scenarios examined, our models suggest that we are slightly asset sensitive.
We attempt to control the effects that changes in interest rates will have on net interest income through the management of maturities and repricing of the Company’s assets and liabilities and also with the use of interest rate swaps. The prime lending rate and the London Interbank Offer Rate (“LIBOR”) curves are the primary indices used for pricing the Company’s loans, and the 91-day Treasury bill rate is the index used for pricing many of the Company’s liabilities. The Company does not hedge the prime/LIBOR/Treasury Bill spread risk through the use of derivative instruments.
We monitor interest rate risk through the use of two complementary measurement methods: duration of equity and income simulation. In the duration of equity method, we measure the changes in the market values of equity in response to changes in interest rates. In the income simulation method, we analyze the changes in income in response to changes in interest rates. For income simulation, Company policy requires that
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interest sensitive income from a static balance sheet be expected to decline by no more than 10% during one year if rates were to immediately rise or fall in parallel by 200 basis points. As of March 31, 2006, the results of the duration of equity and income simulation computations were not significantly different from those set forth in Zions’ Annual Report on Form 10-K for the year ended December 31, 2005.
Market Risk – Fixed Income – The Company engages in trading and market making of U.S. Treasury, U.S. Government Agency, municipal and corporate securities. This trading and market making exposes the Company to a risk of loss arising from adverse changes in the prices of these fixed income securities held by the Company.
During the fourth quarter of 2005 the Company closed its London trading office and substantially reduced the size of its trading assets in response to continued narrow margins in its odd-lot electronic bond trading business. At March 31, 2006 the Company had $152 million of trading account assets and $56 of securities sold, not yet purchased compared with $102 million and $303 million of trading assets and $65 million and $298 million of securities sold, not yet purchased at December 31, 2005 and March 31, 2005, respectively.
The Company monitors risk in fixed income trading and market making through Value-at-Risk (“VAR”). VAR is the worst-case loss expected within a specified confidence level, based on statistical models using historical data.
Market Risk – Equity Investments – Through its equity investment activities, the Company owns equity securities that are publicly traded and subject to fluctuations in their market prices or values. In addition, the Company owns equity securities in companies that are not publicly traded and that are accounted for under either fair value, equity, or full consolidation methods of accounting, depending upon the Company’s ownership position and degree of involvement in influencing the investees’ affairs. In either case, the value of the Company’s investment is subject to fluctuation. Since the market prices or values associated with these securities may fall below the Company’s investment costs, the Company is exposed to the possibility of loss.
The Company conducts minority investing in pre-public venture capital companies in which it does not have strategic involvement, through four funds collectively referred to as Wasatch Venture Funds (“Wasatch”). Wasatch screens investment opportunities and makes investment decisions based on its assessment of business prospects and potential returns. After an investment is made, Wasatch actively monitors the performance of each company in which it has invested, and often has representation on the board of directors of the company.
In addition to the program described above, Amegy has in place an alternative investments program. These investments are primarily directed towards equity buyout and mezzanine funds with a key strategy of deriving ancillary commercial banking business from the portfolio companies. Early stage venture capital funds are not part of the strategy since the underlying companies are typically not credit worthy.
The Company also, from time to time, either starts and funds businesses or makes significant investments in companies of strategic interest. These investments may result in either minority or majority ownership positions, and usually give board representation to Zions or its subsidiaries. These strategic investments generally are in companies that are financial services or financial technologies providers.
A more comprehensive discussion of the Company’s interest rate and market risk management is contained in Zions’ Annual Report on Form 10-K for the year ended December 31, 2005.
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Liquidity Risk Management
Liquidity is managed centrally for both the Parent and the bank subsidiaries. The Parent’s cash requirements consist primarily of debt service, investment in and advances to subsidiaries, operating expenses, income taxes, dividends to shareholders and share repurchases. The Parent’s cash needs are routinely met through dividends from its subsidiaries, investment income, subsidiaries’ proportionate share of current income taxes, management and other fees, bank lines, equity contributed through the exercise of stock options and debt issuances.
During the first three months of 2006, the Parent received $84.1 million in dividends from its subsidiaries. At March 31, 2006, $339.0 million of dividend capacity was available for the subsidiaries to pay to the Parent under regulatory guidelines.
Operational cash flows, while constituting a funding source for the Company, are not large enough to provide funding in the amounts that fulfill the needs of the Parent and the bank subsidiaries. For the first three months of 2006, operations contributed $212.9 million toward these needs. As a result, the Company utilizes other sources at its disposal to manage its liquidity needs.
On March 31, 2006, the Company filed an “automatic shelf registration statement” with the Securities and Exchange Commission as a “well-known seasoned issuer.” This new type of shelf registration does not require a maximum amount of securities that may be issued to be specified. The shelf registration replaced a previous shelf registration and covers securities of the Company, Zions Capital Trust C and Zions Capital Trust D.
On April 27, 2006 under the new shelf registration, we issued $250 million of floating rate senior notes due April 15, 2008. The notes require quarterly interest payments at three-month LIBOR plus 0.12%. They are not redeemable prior to maturity and are not listed on any national securities exchange. Proceeds from the notes will be used to retire all of the $150 million of 2.70% senior notes due May 1, 2006 and all of the remaining $104.2 million of 6.95% subordinated notes due May 15, 2011 and redeemable May 15, 2006.
The Parent also has a program to issue short-term commercial paper. At March 31, 2006, outstanding commercial paper was $153.3 million. In addition, at March 31, 2006, the Parent had a secured revolving credit facility with a subsidiary bank totaling $40 million. No amount was outstanding on this facility at March 31, 2006.
The subsidiaries’ primary source of funding is their core deposits, consisting of demand, savings and money market deposits, time deposits under $100,000 and foreign deposits. At March 31, 2006, these core deposits, in aggregate, constituted 91.8% of consolidated deposits, compared with 92.3% of consolidated deposits at December 31, 2005. For the first three months of 2006, increases in deposits resulted in net cash inflows of $230.3 million.
The Federal Home Loan Bank (“FHLB”) system is also a significant source of liquidity for each of the Company’s subsidiary banks. Zions Bank and TCBW are members of the FHLB of Seattle. CB&T, NSB, and NBA are members of the FHLB of San Francisco. Vectra is a member of the FHLB of Topeka and Amegy is a member of the FHLB of Dallas. The FHLB allows member banks to borrow against their eligible loans to satisfy liquidity requirements. For the first three months of 2006, the activity in short-term FHLB borrowings resulted in a net cash outflow of approximately $14.5 million.
The Company uses asset securitizations to sell loans, which also provides an alternative source of funding for the subsidiaries and enhances flexibility in meeting their funding needs. During the first quarter of 2006, loan
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sales (other than loans held for sale) provided $59.4 million in cash inflows and we expect that asset securitizations will continue to be a tool that we will use for liquidity management purposes.
At March 31, 2006, the Company managed approximately $3.2 billion of securitized assets that were originated or purchased by its subsidiary banks. Of these, approximately $2.0 billion were credit-enhanced by a third party insurance and held in Lockhart Funding, LLC, which is a qualifying special-purpose entity securities conduit and an important source of funding for the Company’s loans. Zions Bank provides a Liquidity Facility for a fee to Lockhart, which purchases floating-rate U.S. Government and AAA-rated securities with funds from the issuance of commercial paper. Zions Bank also provides interest rate hedging support and administrative and investment advisory services for a fee. Pursuant to the Liquidity Facility, Zions Bank is required to purchase securities from Lockhart to provide funds for it to repay maturing commercial paper upon Lockhart’s inability to access the commercial paper market, or upon a commercial paper market disruption, as specified in the governing documents of Lockhart. In addition, pursuant to the governing documents, including the Liquidity Facility, if any security in Lockhart is downgraded below AA-, Zions Bank must either 1) place its letter of credit on the security, 2) obtain a credit enhancement on the security from a third party, or 3) purchase the security from Lockhart at book value. At any given time, the maximum commitment of Zions Bank is the book value of Lockhart’s securities portfolio, which is not allowed to exceed the size of the Liquidity Facility.
At March 31, 2006, the book value of Lockhart’s securities portfolio was $5.2 billion, which approximated market value, and the size of the Liquidity Facility commitment was $6.12 billion. No amounts were outstanding under this Liquidity Facility at March 31, 2006, December 31, 2005 or March 31, 2005. Lockhart is limited in size by program agreements, agreements with rating agencies and by the size of the Liquidity Facility.
As described in Note 2 of the Notes to Consolidated Financial Statements, the FASB has recently issued two accounting pronouncements that amend SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. These amendments and other proposals to further amend SFAS No. 140 may require changes to the operating activities of qualifying special-purpose entities and other aspects relating to the transfer of financial assets. As a result of these amendments and proposals, Lockhart’s operations may need to be modified to preserve its off-balance sheet status.
The Company’s investment activities can also provide or use cash. For the first three months of 2006, investment securities activities resulted in a decrease in investment securities holdings and a net increase of cash in the amount of $94.0 million.
Maturing balances in the various loan portfolios also provide additional flexibility in managing cash flows. In most cases, however, loan growth has resulted in net cash outflows from a funding standpoint. For the first three months of 2006, loan growth resulted in a net cash outflow of $1.0 billion.
A more comprehensive discussion of our liquidity management is contained in Zions’ Annual Report on Form 10-K for the year ended December 31, 2005.
Operational Risk Management
Operational risk is the potential for unexpected losses attributable to human error, systems failures, fraud, or inadequate internal controls and procedures. In its ongoing efforts to identify and manage operational risk, the Company has created an Operating Risk Management Group, whose responsibility is to help Company management identify and monitor the key internal controls and processes that the Company has in place to mitigate operational risk.
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To manage and minimize its operating risk, the Company has in place transactional documentation requirements, systems and procedures to monitor transactions and positions, regulatory compliance reviews, and periodic reviews by the Company’s internal audit and credit examination departments. In addition, reconciliation procedures have been established to ensure that data processing systems consistently and accurately capture critical data. Further, we maintain contingency plans and systems for operations support in the event of natural or other disasters. We expect to continue efforts to improve the Company’s oversight of operational risk throughout 2006.
CAPITAL MANAGEMENT
The Company has a fundamental financial objective to consistently produce superior risk-adjusted returns on its shareholders’ capital. We believe that a strong capital position is vital to continued profitability and to promoting depositor and investor confidence.
Total shareholders’ equity on March 31, 2006 was $4.3 billion, up 2.5% from $4.2 billion at December 31, 2005 and 53.9% from $2.8 billion at March 31, 2005 reflecting the Amegy acquisition. The Company’s capital ratios were as follows as of the dates indicated:
Average common equity to average assets (three months ended)
Risk-based capital ratios:
Tier 1 leverage
Tier 1 risk-based capital
Total risk-based capital
The changes in the average common equity to average assets ratio and the Tier 1 leverage ratios for the quarter ended March 31, 2006 both mainly result from the Amegy acquisition. The averages used in determining the ratios for the quarter ended December 31, 2005 only included the impact of Amegy for one month since it was acquired in December 2005.
It is our belief that capital not considered necessary to support current and anticipated business should be returned to the Company’s shareholders through dividends and repurchases of its shares.
In July 2005, the Company announced that it had suspended the repurchase of shares of its common stock in conjunction with its acquisition of Amegy. The Company anticipates that the common stock buyback program will remain suspended until it achieves a tangible common equity ratio of at least 6.25%.
The Parent and its subsidiary banks are required to maintain adequate levels of capital as measured by several regulatory capital ratios. As of March 31, 2006, the Company and each of its banking subsidiaries, with the exception of NBA, met the “well capitalized” guidelines under regulatory standards. NBA did not meet the “well capitalized” guidelines due to an incorrect risk-weight category being assigned to certain loans. In April 2006, the Company brought NBA above the “well capitalized” level by structuring subordinated debt with the Parent.
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Dividends per common share of $0.36 were paid in the first quarter of 2006 and 2005. For the three months ended March 31, 2006, the Company paid $38.1 million in common stock dividends compared to $32.6 million in the same period of 2005.
At its May 2006 meeting, the Company’s Board of Directors declared a dividend in the amount of $0.36 per share of common stock. The dividend is payable on May 24, 2006 to shareholders of record as of the close of business on May 10, 2006.
Interest rate and market risks are among the most significant risks regularly undertaken by the Company, and they are closely monitored as previously discussed. A discussion regarding the Company’s management of interest rate and market risk is included in the section entitled “Interest Rate and Market Risk Management” in this Form 10-Q.
An evaluation was carried out by the Company’s management, with the participation of the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, these disclosure controls and procedures were effective. There have been no changes in the Company’s internal control over financial reporting during the period covered by this report that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
The Company is a defendant in various legal proceedings arising in the normal course of business. The Company does not believe that the outcome of any such proceedings will have a material effect on its consolidated financial position, operations, or liquidity.
The Company believes there have been no significant changes in risk factors compared to the disclosures contained in Zions Bancorporation’s Annual Report on Form 10-K for the year ended December 31, 2005.
Share Repurchases
The following table summarizes the Company’s share repurchases for the first quarter of 2006:
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Period
Total number
of shares
repurchased (1)
Average
price paid
per share
Total number of shares
purchased as part of
publicly announced
plans or programs
Approximate dollar
value of shares that
may yet be purchased
under the plan (2)
January
February
March
Quarter
(1) Includes 5,162 shares tendered for exercise of stock options.
(2) The Company has suspended the repurchase of shares in conjunction with the acquisition of Amegy Bancorporation, Inc.
Description
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S I G N A T U R E S
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ HARRIS H. SIMMONS
Harris H. Simmons, Chairman, President
and Chief Executive Officer
/s/ DOYLE L. ARNOLD
Doyle L. Arnold, Vice Chairman and
Chief Financial Officer
Date: May 10, 2006
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