UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2006
OR
For the transition period from to
COMMISSION FILE NUMBER 001-12307
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 October 31, 2006
ZIONS BANCORPORATION AND SUBSIDIARIES
INDEX
PART I.
FINANCIAL INFORMATION
ITEM 1.
Financial Statements (Unaudited)
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
ITEM 4.
Controls and Procedures
PART II.
OTHER INFORMATION
Legal Proceedings
ITEM 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
ITEM 6.
Exhibits
SIGNATURES
2
CONSOLIDATED BALANCE SHEETS
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 $655,170, $642,258 and $641,737)
Available for sale, at market
Trading account, at market (includes $60,331, $43,444 and $141,535 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 106,804,606, 105,147,562 and 90,067,016 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)
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)
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 gains on derivative instruments
Other comprehensive loss
Total comprehensive income
Stock redeemed and retired
Net stock options exercised
Reclassification of deferred compensation, adoption of SFAS 123R
Share-based compensation
Cash dividends – common, $1.08 per share
Change in deferred compensation
Balance, September 30, 2006
Balance, December 31, 2004
Net unrealized losses on derivative instruments
Net stock options exercised and restricted stock issued
Balance, September 30, 2005
Total comprehensive income for the three months ended September 30, 2006 and 2005 was $212,709 and $83,787, respectively.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
September 30,
Nine Months Ended
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by (used in) 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
Gain (loss) allocated to minority interest
Equity securities losses (gains), net
Net decrease (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 (used in) 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 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 paid for acquisitions
Net cash paid for net liabilities on branches sold
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 long-term debt
Payments on long-term debt
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
September 30, 2006
1. BASIS OF PRESENTATION AND CHANGES IN ACCOUNTING ESTIMATES
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 to the current period presentation.
Operating results for the three- and nine-month periods ended September 30, 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 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.
As discussed more fully in the management’s discussion and analysis section of this filing, during the three months ended September 30, 2006 the Company adjusted its valuation assumptions for retained beneficial interests from securitization transactions. The Company recognized a pretax impairment loss of $4.1 million on the carrying value of certain of these retained interests, which has been charged in the statement of income to loans sales and servicing income.
2. CERTAIN RECENT ACCOUNTING PRONOUNCEMENTS
On September 20, 2006, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) ratified EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements, and EITF Issue No. 06-5, Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. EITF 06-4 provides that an employer should recognize a liability for future benefits based on the substantive agreement with the employee. The Issue should be applied to fiscal years beginning after December 15, 2007, with earlier application permitted. EITF 06-5 provides that in determining the amount recognized as an asset, a policyholder should consider the cash surrender value as well as any additional amounts included in the contractual terms of the policy that will be paid upon surrender. The amount that could be realized should be calculated at the individual policy level and consider any probable contractual limitations, including the exclusion of any additional amounts paid for the surrender of an entire group of policies. The Issue is effective for fiscal years beginning after December 15, 2006. Certain banking subsidiaries of the Company have life insurance arrangements that may be affected by these Issues. Management is evaluating the impact these Issues may have on the Company’s financial statements.
8
On September 29, 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R). SFAS 158 requires an entity to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status through other comprehensive income in the years in which changes occur. The Statement also requires an entity to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. While the Statement does not change the determination of net periodic benefit cost included in net income, it does expand disclosure requirements about certain effects on net periodic benefit cost that may arise in subsequent fiscal years. The recognition and disclosure requirements are effective for fiscal years ending after December 15, 2006 for public entities. The measurement requirement is effective for fiscal years ending after December 15, 2008. Early adoption is encouraged, but must apply to all of an entity’s benefit plans. Management is evaluating the impact this Statement may have on the Company’s financial statements. However, due to the frozen status of the Company’s pension and postretirement plans, as disclosed in Note 8 and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, and other factors, management believes that the recognition and disclosure requirements of this Statement will not have a material impact on the Company’s financial statements.
On September 15, 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements. SFAS 157 provides enhanced guidance for using fair value to measure assets and liabilities and expands disclosures about fair value measurements. The Statement applies under other accounting pronouncements that require or permit fair value measurements; however, it does not expand the use of fair value measurements in any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. Management is evaluating the impact this Statement may have on the Company’s financial statements.
In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes that a tax position must meet a minimum more-likely-than-not threshold before it can be recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure, and transition. In addition, FIN 48 removes income taxes from the scope of SFAS No. 5, Accounting for Contingencies. FIN 48 is effective for fiscal years beginning after December 15, 2006, or January 1, 2007 for calendar year-end companies. Management is evaluating the impact this Interpretation may have on the Company’s financial statements.
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 February 2006, the FASB issued 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.
9
In general, both SFAS 155 and SFAS 156 are effective as of the beginning of an entity’s fiscal year after September 15, 2006, or January 1, 2007 for calendar year-end companies. Management is evaluating the impact both of 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
On September 11, 2006, the Company announced that it had signed a definitive agreement to acquire The Stockmen’s Bancorp, Inc. (“Stockmen’s”), headquartered in Kingman, Arizona. As of September 30, 2006, Stockmen’s had approximately $1.2 billion of total assets, $1.1 billion of total deposits, and 32 branches in Arizona and 11 in central California. Consideration of approximately $206 million will consist of approximately 2.6 million shares of the Company’s common stock. The merger is subject to approval by regulators and by Stockmen’s shareholders. Upon completion of the transaction, which is expected in the first quarter of 2007, Stockmen’s parent company will merge into the Company and the banking subsidiary will merge into the Company’s NBA subsidiary.
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 expanded the Company’s banking presence into Texas. Amegy’s results of operations for the month of December 2005 and for the nine months ended September 30, 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 September 30, 2006, the allocation had not changed from December 31, 2005. Management currently anticipates that any changes will not be significant.
10
The following unaudited pro forma condensed combined financial information presents the Company’s results of operations 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):
September 30, 2005
Zions historical
without Amegy
Noninterest income
Noninterest expense
The above pro forma amounts do not reflect cost savings or revenue enhancements anticipated from the acquisition, and are not necessarily indicative of what actually would have occurred if the acquisition had been completed as of the beginning of the period presented, nor are they necessarily indicative of future consolidated results.
Merger related expenses for this merger of $2.5 million and $18.3 million for the three- and nine-month periods ended September 30, 2006 consisted of systems integration and related charges of $0.2 million and $10.3 million, and severance and other employee-related costs of $2.3 million and $8.0 million, respectively.
At September 30, 2006, Amegy’s unpaid accrual for certain exit and termination costs as of the merger date was approximately $3.8 million.
4. LONG-TERM DEBT
On March 31, 2006, we filed an “automatic shelf registration statement” with the Securities and Exchange Commission (“SEC”) as a “well-known seasoned issuer.” The shelf registration replaced a previous shelf registration and covers security issuances 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 were 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.
11
On September 28, 2006 under the new shelf registration, we issued $145 million of floating rate senior notes due September 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 remaining $98.4 million of 6.50% subordinated notes due October 15, 2011 and redeemable October 15, 2006, and applied to the redemption of the $176.3 million of 8.536% trust preferred securities due December 15, 2026 and redeemable December 15, 2006. The Company will incur a premium of approximately $7.3 million on the expected redemption of the trust preferred securities, which will be charged to the statement of income in the fourth quarter of 2006.
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
Net
unrealized
on derivative
instruments
Minimum
pension
liability
Nine Months Ended September 30, 2006:
Net realized and unrealized holding losses during the period, net ofincome tax benefit of $6,897
Reclassification for net realized gains recorded in operations, net ofincome tax expense of $1,501
Net unrealized gains on derivative instruments, net ofreclassification to operations of $(27,568) and income taxexpense of $3,278
Other comprehensive income (loss)
Nine Months Ended September 30, 2005:
Net realized and unrealized holding losses during the period, net ofincome tax benefit of $5,650
Reclassification for net realized gains recorded in operations, net ofincome tax expense of $200
Net unrealized losses on derivative instruments, net ofreclassification to operations of $10,618 and income tax benefitof $20,991
12
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 6,679,070 shares are available for future grant as of September 30, 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.
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 December 31, 2005, 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.
The adoption of SFAS 123R, compared to the previous accounting for share-based compensation under APB 25, reduced the Company’s income before income taxes and minority interest and net income along with the related basic and diluted per common share amounts as follows (in thousands, except per share amounts):
Three Months
Ended
Nine Months
Reduction in:
As required by SFAS 123R, upon adoption, we reclassified $11.1 million of unearned compensation related to restricted stock from deferred compensation and common stock.
13
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- and nine-month periods ended September 30, 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 September 30, 2006, compensation expense not yet recognized for nonvested share-based awards was approximately $49.2 million, which is expected to be recognized over a weighted average period of 1.4 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- and nine month periods ended September 30, 2006, this requirement reduced net operating cash flows and increased net financing cash flows by approximately $2.7 million and $12.7 million, respectively.
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 vest 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 under which options were made available to substantially all employees; 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- and nine-month periods ended September 30, 2006, the additional compensation expense of $4.8 million and $12.9 million, respectively, for stock options under SFAS 123R is included in salaries and employee benefits in the statements of income with the corresponding increase, excluding the effects of stock option expense on subsidiary stock, included in common stock in shareholders’ equity. The related tax benefit recognized as a reduction of income tax expense was $1.2 million and $3.7 million, respectively, for the same periods.
During the three- and nine-month periods ended September 30, 2006, the amount of cash received from the exercise of stock options was $13.1 million and $68.5 million, respectively, and the tax benefit realized as a reduction of income taxes payable was $3.1 million and $14.4 million, respectively. Of these amounts, $0.4 million and $3.9 million reduced goodwill for the tax benefit of vested share-based awards converted in the Amegy acquisition that were exercised during the three- and nine-month periods, and $2.7 million and $10.5 million, respectively, were included in common stock as part of net stock options exercised.
14
Compensation expense was determined from the estimates of fair values of stock options granted using the Black-Scholes option-pricing model. We granted stock options in the second quarter of 2006, but did not grant any stock options in the first and third quarters of 2006. The following significant assumptions were used for options granted:
Weighted average of fair value for options granted
Weighted average assumptions used:
Expected dividend yield
Expected volatility
Risk-free interest rate
Expected life (in years)
The methodology used to estimate the fair values of stock options is consistent with the estimates used for the pro forma presentation in periods prior to the adoption of SFAS 123R. The preceding 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.
The following summarizes our stock option activity for the nine months ended September 30, 2006:
Balance at December 31, 2005
Granted
Exercised
Expired
Forfeited
Balance at September 30, 2006
Outstanding options exercisable as ofSeptember 30, 2006
We issue new authorized shares for the exercise of stock options. During the three- and nine-month periods ended September 30, 2006, the total intrinsic value of options exercised was approximately $7.9 million and $44.3 million, respectively.
15
Additional selected information on stock options at September 30, 2006 follows:
Exercise price range
Weighted
average
exercise
price
remaining
contractual
life (years)
Number of
shares
$ 0.32 to $ 19.99
$ 20.00 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 $ 74.99
$ 75.00 to $ 82.92
For outstanding options at September 30, 2006, the aggregate intrinsic value was $156.7 million. For exercisable options at September 30, 2006, the aggregate intrinsic value was $131.8 million and the weighted average remaining contractual life was 3.6 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- and nine-month periods ended September 30, 2006, compensation expense recognized for issuances of restricted stock and included in salaries and employee benefits in the statement of income was $1.9 million and $4.8 million, respectively. Amounts for the corresponding periods in 2005 were $0.6 million and $1.0 million, respectively. 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 nine months ended September 30, 2006:
Nonvested restricted shares at December 31, 2005
Vested
Nonvested restricted shares at September 30, 2006
The total fair value of restricted stock vesting during the three- and nine-month periods ended September 30, 2006 was $0.4 million and $4.2 million, respectively. Amounts for the corresponding periods in 2005 were not significant.
16
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 September 30, 2006, the carrying value recorded by the Company as a liability for these guarantees was $4.7 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 September 30, 2006, the Parent has guaranteed approximately $476.1 million of debt issued 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 September 30, 2006, the book value of Lockhart’s securities portfolio was $4.7 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 September 30, 2006.
The FASB continues to deliberate other projects that propose to amend SFAS 140 in addition to those discussed in Note 2. These include criteria for legal isolation of transferred assets and restrictions on 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.
17
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):
Postretirement
benefits
Service cost (credit)
Interest cost (credit)
Expected return on plan assets
Amortization of net actuarial (gain) loss
Net periodic benefit cost (credit)
These disclosures include revisions made to the annual estimate of net periodic pension benefit cost by the Company’s actuary in the third quarters of 2006 and 2005.
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 health and welfare plan. As of September 30, 2006, we have contributed $472 thousand of this amount and expect to contribute the remaining portion during the rest of 2006. In September 2006, we contributed $10 million to the pension plan. As disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, the Company’s contributions for individual benefit payments in the postretirement plan were frozen in 2000 and 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 September 30, 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 111 branches in Utah and 24 in Idaho. CB&T operates 91 branches in California. Amegy operates 77 branches in Texas. NBA operates 53 branches in Arizona. NSB operates 72 branches in Nevada. Vectra operates 39 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- and nine month periods ended September 30, 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.
18
The following table presents selected operating segment information for the three months ended September 30, 2006 and 2005:
CONDENSED INCOME STATEMENT
Net interest income excluding hedge income
Hedge income recorded directly at subsidiary
Allocated hedge income
Other noninterest expense
Income tax expense (benefit)
Net income (loss)
AVERAGE BALANCE SHEET DATA
Assets
Net loans and leases
Deposits
Shareholder’s equity
Consolidated
Company
19
The following table presents selected operating segment information for the nine months ended September 30, 2006 and 2005:
20
OPERATIONS
FINANCIAL HIGHLIGHTS
(In thousands, except per share and ratio data)
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
21
FINANCIAL HIGHLIGHTS (Continued)
(In thousands, except share and ratio data)
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 andother real estate owned at period end
22
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 Report on Form 10-K of Zions Bancorporation filed with the Securities and Exchange Commission (“SEC”) and available at the SEC’s Internet site (http://www.sec.gov).
23
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 as noted below.
Share-Based Compensation
Note 6 of the Notes to Consolidated Financial Statements discusses the Company’s adoption on January 1, 2006 of SFAS No. 123R, Share-Based Payment (“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 granted under SFAS 123R and for the pro forma presentations in prior periods. Use of the assumptions described in Note 6 is subjective and requires judgment. The adoption of SFAS 123R decreased income before income taxes and net income by approximately $4.8 million and $3.6 million, respectively, for the three months ended September 30, 2006, or $0.03 per diluted share, and $12.9 million and $9.2 million, respectively for the nine months ended September 30, 2006, or $0.08 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. See Note 6 for additional information on stock options and restricted stock.
Securitization Transactions
During the third quarter of 2006, the Company adjusted its valuation assumptions for retained beneficial interests under the rules contained in Emerging Issues Task Force Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets, (“EITF 99-20”). These rules require the Company to periodically update its assumptions used to compute estimated cash flows for its retained beneficial interests and compare the net present value of these cash flows to the carrying value. The Company complies with EITF 99-20 by evaluating and updating its default assumption as compared to the historical credit losses and the credit loss expectation of the portfolio and its prepayment speed assumption as compared to the historical prepayment speeds and prepayment rate expectation. During this re-evaluation, the Company also decreased its discount rate from 15% to a range of 13%-14% on the eight SBA retained interest securities based on an analysis as required by EITF 99-20. An impairment charge is required under EITF 99-20 if the estimated market yield is lower than the current accretable yield and the security has a market value less than its carrying value.
The Company’s portfolio has eight SBA retained interest securities and four of the securities required impairment charges at September 30, 2006 following the application of EITF 99-20. As a result, the Company recorded an impairment loss on the value of the retained beneficial interests of $4.1 million before income taxes resulting in a $2.5 million reduction of net income or $(0.02) per diluted share. The primary factor that influenced the impairment of the four securities was higher prepayment speeds than was previously estimated.
24
RESULTS OF OPERATIONS
As previously disclosed, the Company completed its acquisition of Amegy Bancorporation, Inc. in December 2005. All comparisons to 2005 periods reflect the effects of the Amegy acquisition.
Zions Bancorporation (“the Parent”) and subsidiaries (collectively “Zions,” “the Company,” “we,” “our”) reported net income of $153.7 million, or $1.42 per diluted share for the third quarter of 2006 compared with $123.0 million, or $1.34 per diluted share for the third quarter of 2005. The annualized return on average assets was 1.36% for the third quarter of 2006 compared to 1.47% for the third quarter of 2005. For the same comparative periods, the annualized return on average common equity was 13.41% compared to 16.41%. The efficiency ratio for the third quarter of 2006 was 55.2% compared to 57.4% for the second quarter of 2006 and 54.3% for the third quarter of 2005. However, the efficiency ratio this quarter was favorably impacted by the inclusion in revenue of the full amount of venture capital gains discussed under “Noninterest Income.” When adjusted to exclude from revenue the minority interest related to these venture capital gains, the efficiency ratio would be 56.1%.
Net income for the first nine months of 2006 was $436.6 million or $4.04 per diluted share, compared to $352.0 million or $3.84 per diluted share for the first nine months of 2005. For the first nine months of 2006, the annualized return on average assets was 1.34% compared to 1.45% for the same period of 2005. For the same comparative periods, the annualized return on average common equity was 13.18% compared to 16.27%. The efficiency ratio for the first nine months of 2006 was 56.9% compared to 55.2% for 2005.
Net Interest Income, Margin and Interest Rate Spreads
Taxable-equivalent net interest income for the third quarter of 2006 increased 30.9% to $452.6 million compared with $345.8 million for the comparable period of 2005. The increase reflects primarily the acquisition of Amegy and strong growth in the loan portfolio. For the first nine months of 2006, net interest income on a fully taxable-equivalent basis was $1.3 billion, an increase of 32.1% compared to $1.0 billion in 2005. The incremental tax rate used for calculating all taxable-equivalent adjustments is 35% for all periods presented.
The Company’s net interest margin was 4.58% for the third quarter of 2006, compared to 4.64% for the second quarter of 2006 and 4.59% for the third quarter of 2005. The net interest margin has remained relatively stable during the last twelve months, although the strong loan growth coupled with weaker low-cost deposit growth has required the use of alternative, more expensive sources of funding in recent quarters. This has placed downward pressure on the net interest margin since its recent peak in the first quarter of 2006.
One of the challenges we continue to face in 2006 is an increase in pricing pressures on both loans and deposits as the economy expands and competition for good business increases. Reflecting this pricing pressure and the changing composition of funding sources just described, the spread on average interest-bearing funds for the third quarter for 2006 was 3.69%, down from 3.81% and 3.93% from the second quarter of 2006 and third quarter of 2005, respectively. The yield on average earning assets increased 21 basis points during the third quarter of 2006 compared to the second quarter and 99 basis points compared to the third quarter of 2005. The average rate paid this quarter on interest-bearing funds increased 33 basis points from the second quarter and 123 basis points from the third quarter of 2005.
The Company expects to continue its efforts to maintain a slightly “asset sensitive” position with regard to interest rate risk. However, our estimates of the Company’s actual position are highly dependent upon changes in both short-term and long-term interest rates, modeling assumptions, and the actions of competitors and customers in response to those changes.
25
CONSOLIDATED AVERAGE BALANCE SHEETS, YIELDS AND RATES
Average
balance
Amount of
interest (1)
rate
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.
26
CONSOLIDATED AVERAGE BALANCE SHEETS, YIELDS AND RATES (Continued)
Taxable-equivalent net interest income andnet yield on interest-earning assets
27
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 third quarter was $14.4 million compared to $12.1 million for the same period in 2005. On an annualized basis, the provision was 0.17% and 0.20% of average loans for the third quarters of 2006 and 2005, respectively. The provision for unfunded lending commitments was $1.0 million for the third quarter of 2006 compared to $0.4 million for the third quarter of 2005. When combined, the provisions for credit losses for the third quarter of 2006 were $15.4 million compared to $12.5 million for the third quarter of 2005.
The provision for loan losses for the first nine months of 2006 was $45.9 million, 39.5% greater than the $32.9 million provision for the first nine months of 2005. The increased loan loss provision for the nine months is primarily impacted by strong net loan growth of $3.6 billion during the first nine months of 2006, which includes Amegy, as compared to $1.3 billion net loan growth during the first nine months of 2005. The provision for unfunded lending commitments was $0.5 million for the first nine months of 2006 compared to $3.1 million for the same period in 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.
Noninterest Income
Compared with the third quarter of 2005, noninterest income for the third quarter of 2006 increased 31.5%, or $34.8 million. The increases in total and individual categories of noninterest income for the third quarter of 2006 compared to the third 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.
Excluding Amegy, loan sales and servicing income decreased $10.0 million for the third quarter of 2006 compared to the third quarter of 2005. The decrease includes a $4.1 million impairment loss on capitalized residual cash flows from certain previous small business loan securitizations and lower servicing income due to lower loan balances being serviced during the third quarter of 2006. In addition, the Company recognized a gain of $2.6 million during the third quarter of 2005 from the securitization of small business loans; however, the Company did not securitize any loans during the third quarter of 2006.
Net equity securities gains increased $12.1 million to $13.2 million for the third quarter of 2006 compared to $1.1 million for the third quarter of 2005. The increase was primarily due to $12.9 million of net gains on venture capital investments. Net of related minority interest of $9.5 million, income taxes and other expenses, venture capital investments contributed $1.7 million to net income in the third quarter of 2006. Fixed income securities gains were $1.6 million for the third quarter of 2006 compared to $0.3 million for the comparative period of 2005.
28
Noninterest income for the first nine months of 2006 of $411.3 million increased 28.8% from $319.3 million for the first nine months of 2005. Explanations previously provided for the quarterly changes also apply to the year-to-date changes. Additional explanations of variances follow.
Trust and investment management income for the first nine months of 2006 increased 29.7% compared to the same period in 2005 as a result of increases in fees from the Amegy acquisition and increased fees from the trust and investment management business. Excluding the Amegy acquisition, trust and investment management income for the first nine months of 2006 increased 11.9%.
Dividends and other investment income for the first nine months of 2006, excluding Amegy, decreased $3.3 million or 14.8% compared with the same period in 2005. The decrease is primarily due to lower equity earnings from various investments in unconsolidated companies.
Noninterest Expense
Noninterest expense for the third quarter of 2006 of $330.0 million increased $82.3 million or 33.2% over the $247.7 million for the third quarter of 2005. The increases in total and individual categories of noninterest expense for the third quarter of 2006 compared to the third quarter of 2005 were mainly due to the Amegy acquisition. The Company’s efficiency ratio was 55.2% for the third quarter of 2006 compared to 54.3% for the same period of 2005. However, the efficiency ratio this quarter was favorably impacted by the inclusion in revenue of the full amount of venture capital gains noted previously. When adjusted to exclude from revenue the minority interest related to these venture capital gains, the efficiency ratio would be 56.1%. 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. Significant changes and trends in noninterest expense categories not resulting from the Amegy acquisition are discussed as follows.
Salaries and employee benefits increased $48.0 million or 33.6%, compared to the third quarter of 2005. Excluding Amegy-related salaries and employee benefits of $34.1 million and share-based compensation expense of $4.8 million due to the adoption of SFAS 123R, salaries and employee benefits increased $9.1 million or 6.4%. In addition to salary increases and increased staffing levels in selected areas, this increase was also due to increased staffing for sales and business development and to the redeployment of technical staff from the Amegy conversion to other systems conversions.
Noninterest expense for the first nine months of 2006 of $987.5 million increased 35.5% from $729.0 million for the first nine months of 2005. The Company’s efficiency ratio was 56.9% for the first nine months of 2006 compared to 55.2% for the same period of 2005. Explanations previously provided for the quarterly changes also apply to the year-to-date changes. Additional explanations of variances follow.
Excluding the impact of the Amegy acquisition, salaries and employee benefits for the first nine months of 2006 increased $39.2 million or 9.4% when compared to the same period in 2005, primarily as a result of share-based compensation costs due to the adoption of SFAS 123R, salary increases, and increased staffing levels in selected areas.
See Note 3 of Notes to Consolidated Financial Statements for an explanation of the $18.3 million of Amegy merger related expenses incurred during the first nine months of 2006.
At September 30, 2006, the Company had 10,255 full-time equivalent employees, 470 domestic branches, and 575 ATMs, compared to 7,977 full-time equivalent employees, 389 domestic branches, and 475 ATMs at September 30, 2005.
29
Income Taxes
The Company’s income tax expense increased to $83.8 million for the third quarter of 2006 compared to $68.2 million for the same period in 2005. The Company’s effective income tax rates, including the effects of minority interest, were 35.3% and 35.7% for the third quarters of 2006 and 2005, respectively. The effective income tax rates for the first nine months of 2006 and 2005 were 35.3% and 35.6% 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 a seven-year period from the year of the investment. The effect of these tax credits was to reduce income tax expense by $3.2 million for the first nine months of 2006 and $2.6 million for the first nine months of 2005. The effective tax rates reflect a lower proportion of tax exempt income to total income, offset by the increased tax credits.
30
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 September 30, 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 30.3% to $38.2 billion for the nine months ended September 30, 2006 compared to $29.3 billion for the comparable period in 2005. Interest-earning assets comprised 87.3% of total average assets for the first nine 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 interest-earning assets as a percentage of total average assets for the third quarter of 2006 was 87.7% compared to 87.4% for the second quarter and 86.9% for the first quarter.
Average money market investments, consisting of interest-bearing deposits, federal funds sold and security resell agreements, decreased 44.2% to $482.6 million for the first nine months of 2006 compared to $865.2 million for the first nine months of 2005. Reductions in money market instruments have been used to fund new loan growth. Average net loans and leases for the first nine months of 2006 increased by 36.4% when compared to the same period in 2005.
Investment Securities Portfolio
The following table presents the Company’s held-to-maturity and available-for-sale investment securities:
2006
December 31,
2005
Amortized
cost
Estimatedmarket
value
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
Total
The amortized cost of investment securities at September 30, 2006 decreased 3.4% from the amount at December 31, 2005 but was up 24.7% from the balance at September 30, 2005 as a result of the Amegy acquisition. During the first nine months of 2006, some proceeds from maturities and prepayments of investment securities were used in part to fund new loan growth.
31
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 third quarter of 2006.
The investment securities portfolio at September 30, 2006 includes $954 million of nonrated, fixed income securities, compared to $1,035 million at December 31, 2005 and $1,054 million at September 30, 2005. These securities include nonrated municipal securities as well as nonrated, asset-backed subordinated tranches. The securities primarily are a result of the Company’s municipal finance advisory business and its small business loan securitizations.
Loan Portfolio
Net loans and leases at September 30, 2006 were $33.7 billion, an annualized increase of 15.8% from December 31, 2005 and an increase of 40.9% over the balance at September 30, 2005. The Company’s strong loan growth continued in the third quarter with net loans and leases increasing $1.0 billion.
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
Term
Total commercial real estate
Consumer:
Home equity credit line and other consumer real estate
1-4 family residential
Bankcard and other revolving plans
Total consumer
Foreign loans
Other receivables
Total loans
The strong loan growth for commercial and commercial real estate lending was widely diversified across our geographical footprint and consistent with the economic activity in that area. However, in recent quarters loan growth rates have slowed at CB&T, NBA and NSB, and have increased at Amegy, Zions Bank and Vectra. Management believes it is likely this loan growth will remain strong, but may slow somewhat in the next few quarters.
32
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 securitized and sold a portion of the loans that it originates, and in many instances provides the servicing on these loans as a condition of the sale.
Residual interests
on balance sheet at September 30, 2006
Home equity credit lines
Small business loans
SBA 7(a) loans
Farmer Mac
Securitized loans being serviced for others totaled $2.8 billion at the end of the third quarter of 2006, $3.4 billion at December 31, 2005 and $3.6 billion at September 30, 2005.
As of September 30, 2006, the Company had recorded assets, comprised of subordinated retained interests and capitalized residual cash flows, in the amount of $329 million in connection with the $2.8 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 $231 million at September 30, 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 $98 million primarily represent the present value of the excess cash flows that have been projected over the lives of the sold loans.
As of September 30, 2006, conforming long-term first mortgage real estate loans being serviced for others were $1,238 million, compared with $1,274 million at December 31, 2005 and $423 million at September 30, 2005. The increase from September 30, 2005 reflects the acquisition of Amegy.
Other Noninterest-Bearing Investments
As of September 30, 2006, the Company had $1,006 million of other noninterest-bearing investments compared with $939 million at December 31, 2005 and $708 million at September 30, 2005.
Bank-owned life insurance
Federal Home Loan Bank and Federal Reserve stock
SBIC investments (1)
Non-SBIC investment funds
Other public companies
Other nonpublic companies
Trust preferred securities
33
The increases in other noninterest-bearing investments at December 31, 2005 compared to September 30, 2005 are mainly the result of the Amegy acquisition.
Total deposits at the end of the third quarter of 2006 increased to $33.6 billion, an annualized increase of 4.1% from the balances reported at December 31, 2005, and increased 32.4% over the September 30, 2005 amounts. Core deposits at September 30, 2006 decreased 0.44%, annualized, compared to the December 31, 2005 balance and increased 27.7% compared to the balance at September 30, 2005. Time and foreign deposits accounted for most of the deposit growth during the first nine months of 2006, with noninterest-bearing demand and savings and money market balances declining during the period.
At the end of the third quarter of 2006, demand, savings and money market deposits comprised 76.0% of total deposits, compared with 79.7% and 83.3% as of December 31, 2005 and September 30, 2005, respectively. The decrease in this ratio at December 31, 2005 as compared to September 30, 2005 is primarily a result of the mix of deposits at Amegy. The decrease during 2006 is due to the change in deposit mix as previously described.
We expect deposit growth to continue to be less than loan growth for the foreseeable future. As a result, we will continue to use alternative funding sources as necessary to fund the additional loan growth.
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.
34
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 the policy. Historically, only a limited number of such exceptions have been approved. This entire process has been designed to place an emphasis on strong underwriting standards and 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 September 30, 2006 no single loan type exceeded 23.2% of the Company’s total loan portfolio.
% of
total loans
We believe the Company’s potential risk from concentration in owner occupied commercial loans is 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 geographical footprint of its banking subsidiaries. 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 third quarter of 2006 compared to historical standards.
35
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 a 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.
The following table sets forth the Company’s nonperforming assets:
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 decreased 16.0% as of September 30, 2006 compared with the balance at December 31, 2005. Given the historically low level of nonperforming assets, we do not believe this further decrease is particularly meaningful.
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 price of the loan, or the fair value of the collateral securing the loan.
The Company’s total recorded investment in impaired loans was $43 million at September 30, 2006, compared with $31 million at December 31, 2005 and $35 million at September 30, 2005. Estimated losses on impaired loans are included in the allowance for loan losses. At September 30, 2006, the allowance for loan losses included $6 million for impaired loans with a recorded investment of $23 million. At December 31, 2005, the allowance included $3 million for impaired loans with a recorded investment of $14 million, and at September 30, 2005 the allowance included $4 million for impaired loans with a recorded investment of $14 million.
36
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:
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 Company has initiated a comprehensive review of its allowance for loan losses methodology with a view toward updating and conforming this methodology across all of its banking subsidiaries.
37
The following table shows the changes in the allowance for loan losses and a summary of loan loss experience:
(Amounts in millions)
Twelve Months
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 third quarter of 2006 were $6.5 million and 0.08%.
The allowance for loan losses at the end of the first nine months of 2006 increased $17.9 million from the level at year-end 2005. The amount of the allowance for loan losses attributable to the commercial loan portfolio increased $19.3 million when compared to year-end 2005. During the first nine months of 2006, the Company experienced a slight increase in the total amount of its criticized and classified loans; however, as a percentage of total loans, criticized and classified loans declined slightly. As a result, the amount of the allowance for loan losses indicated for criticized and classified loans increased when compared to year-end 2005 by approximately $3.2 million. Both commercial real estate loans and the commercial lending portfolio contributed to this increase. In addition, we had a $16.1 million increase in the level of the allowance indicated for noncriticized and classified loans as a result of $3.3 billion of commercial and commercial real estate loan growth since year-end 2005. The allowance for consumer loans at September 30, 2006 decreased by $1.4 million when compared to the allowance at December 31, 2005, principally as a result of improving consumer loan delinquencies.
38
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 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:
(In millions)
Allowance of company acquired
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, Zions 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. However, in recent months, competitive pressures and market conditions have resulted in higher deposit costs, slower deposit growth, and increases in borrowed funds, resulting in some contraction of the net interest margin.
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.
39
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 expected changes in the market values of equity in response to changes in interest rates. In the income simulation method, we analyze the expected changes in income in response to changes in interest rates. For income simulation, Company policy requires that interest sensitive income from a static balance sheet is 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 the dates indicated, the following table shows the Company’s estimated range of duration of equity and percentage change in interest sensitive income in the first year after the rate change if interest rates were to sustain an immediate parallel change of 200 basis points; the “low” and “high” results differ based on the assumed speed of repricing of administered-rate deposits (money market, interest-on-checking, and savings):
Duration of equity
Range (in years)
Income simulation – change in interest sensitive income:
Increase interest rates by 200 bp
Decrease interest rates by 200 bp
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 September 30, 2006 the Company had $93 million of trading account assets and $54 million of securities sold, not yet purchased compared with $102 million and $352 million of trading assets and $65 million and $332 million of securities sold, not yet purchased at December 31, 2005 and September 30, 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. VAR information is not disclosed due to limited risk in fixed income trading and market making after recent reductions in the scale of the Company’s trading operations.
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 the 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 each 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.
40
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.
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 nine months of 2006, the Parent received $250.0 million in dividends from its subsidiaries. At September 30, 2006, $449.4 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 nine months of 2006, operations contributed $656.0 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 September 28, 2006 under the new shelf registration, we issued $145 million of floating rate senior notes due September 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 remaining $98.4 million of 6.50% subordinated notes due October 15, 2011 and redeemable October 15, 2006, and applied to the redemption of the $176.3 million of 8.536% trust preferred securities (Zions Institutional Capital Trust A) due December 15, 2026 and redeemable December 15, 2006. The Company will incur a premium of approximately $7.3 million on the expected redemption of the trust preferred securities, which will be charged to the statement of income in the fourth quarter of 2006.
41
The Parent also has a program to issue short-term commercial paper. At September 30, 2006, outstanding commercial paper was $265.8 million. In addition, at September 30, 2006, the Parent had a secured revolving credit facility with a subsidiary bank totaling $40 million. No amount was outstanding on this facility at September 30, 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 September 30, 2006, these core deposits, in aggregate, constituted 89.3% of consolidated deposits, compared with 92.3% of consolidated deposits at December 31, 2005. For the first nine months of 2006, increases in deposits resulted in net cash inflows of $1.0 billion.
The Federal Home Loan Bank (“FHLB”) system is also a significant source of liquidity for the Company’s subsidiary banks. Zions Bank and TCBW are members of the FHLB of Seattle. CB&T, NBA and NSB 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 nine months of 2006, the activity in short-term FHLB borrowings resulted in a net cash inflow of approximately $294.5 million. Amounts of unused lines of credit available for additional FHLB advances were approximately $6.4 billion at September 30, 2006.
The Company has used asset securitizations to sell loans, which have provided an alternative source of funding for the subsidiaries and have enhanced flexibility in meeting their funding needs. During the first nine months of 2006, previous loan sales (other than loans held for sale) provided $188.0 million in cash inflows.
At September 30, 2006, the Company managed approximately $2.8 billion of securitized assets that were originated or purchased by its subsidiary banks. Of these, approximately $1.7 billion were credit-enhanced by a third party insurance provider and held in Lockhart Funding, LLC, which is a qualifying special-purpose entity securities conduit and has been 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 September 30, 2006, the book value of Lockhart’s securities portfolio was $4.7 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 September 30, 2006, December 31, 2005 or September 30, 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
42
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. Investment securities activities resulted in a decrease in investment securities holdings and a net increase of cash in the amount of $24.1 million for the third quarter and $206.9 million for the first nine months of 2006.
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 nine months of 2006, loan growth resulted in a net cash outflow of $3.8 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.
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
Zions 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 September 30, 2006 was $4.6 billion, up 9.6% from $4.2 billion at December 31, 2005 and 54.8% from $3.0 billion at September 30, 2005, reflecting the Amegy acquisition. The Company’s capital ratios were as follows as of the dates indicated:
43
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 at September 30, 2006 compared to December 31, 2005 both mainly result from the Amegy acquisition. The averages used in determining the ratios at 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 currently anticipates that it will resume the repurchase of shares early in 2007.
The Parent and its subsidiary banks are required to maintain adequate levels of capital as measured by several regulatory capital ratios. As of September 30, 2006, the Company and each of its banking subsidiaries met the “well capitalized” guidelines under regulatory standards.
The Company paid dividends of $0.36 per common share in both the third quarters of 2006 and 2005. For the three months ended September 30, 2006, the Company paid $38.4 million in common stock dividends compared to $32.5 million in the same period of 2005.
On October 27, 2006, the Company’s Board of Directors declared a dividend of $0.39 per share of common stock payable on November 22, 2006 to shareholders of record on November 8, 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.
44
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 third quarter of 2006.
Period
July
August
September
Quarter
(1) Includes 3,700 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.
45
Description
46
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: November 9, 2006
47