Zions Bancorporation N.A (ZION) — Q1 2015 Earnings Call Transcript

Thank you, Sayyed, and good evening. We welcome you to this conference call to discuss our first quarter 2015 earnings. Our primary participants today will be Harris Simmons, Chairman and Chief Executive Officer; Doyle Arnold, Vice Chairman and Chief Financial Officer; and Scott McLean, President. I would like to remind you that during this call, we will be making forward-looking statements, although actual results may differ materially. We encourage you to review the disclaimer in the press release dealing with forward-looking information, which applies equally to statements made in this call. A copy of the full earnings release is available at zionsbancorporation.com. We intend to limit the length of this call to one hour, which will include time for you to ask questions. During that Q&A section, we ask you to limit your questions to one primary and one follow-up related question to enable other participants to ask questions. I will now turn the time over to Harris Simmons.

Thanks very much, James, and I want to welcome all of you to the call today. Results for the first quarter 2015 were I think generally in line with our expectations and also those of, I think, most of the analyst community. Credit costs and operational expenses were somewhat better than expected, while revenue and loan growth experienced softer performance than expected. I want to turn right to the energy lending for just a moment and highlight how we've been managing that portfolio. It's probably the business that many of you are focused on right now. In the late fall, we were early to initiate the process of reviewing our energy loans and reaching out to all of our energy-related clients. We've completed the borrowing base redetermination of about one-fifth of our portfolio of exploration and production credits. We found that on a weighted average basis, the borrowing base declined by about 12%. A few experienced an increase in the borrowing base due to factors such as the development of additional reserves, while most experienced declines, as one would generally expect after a sharp reduction in the commodity price. We downgraded several credits and we know of several cases where we've reduced our loan grade before others and a bank syndicate have reduced the grades of the same loans, and therefore our results of classified energy credits may not be comparable to peers until later in the cycle. Most of the energy credits are held at our affiliate, Amegy Bank, and as mentioned in the release, we have added significantly to Amegy's allowance for credit losses in the last two quarters. As I mentioned in the earnings release, we are very encouraged with the response from the energy industry. Active oil drilling rigs have declined by 53% in the last six months and there's been a significant amount of capital raised by the industry, including both public and private equity offerings as well as subordinated debt, which has resulted in reduced senior bank lines of credit. Many of our energy services clients have aggressively cut costs and are rightsizing their businesses with the current operating environment. Several private equity sponsors have raised additional capital that will be used to support existing portfolio companies by either reducing leverage and/or taking market share. On a macro level, the rate of oil inventory that's been building very quickly may be showing early signs of moderating, which is likely a factor in oil prices increasing in the last few days. We expect that as the borrowing base redetermination process is completed in the next few weeks, we're likely to experience further downgrades. This shouldn't come as a surprise as we've been highlighting this since early December. In the prior cycle, our historical losses on energy credits were very modest with an annual peak loss of about 1%, despite a classified energy loans ratio of approximately 20% of total energy loans. We talk about expenses just for a moment before I turn the time over to Doyle Arnold. We're highly focused on expense control and we're very pleased with that performance in the first quarter coming in lower than our own budget and I think below most estimates. As technology advances, we expect to be able to reduce certain labor-intensive tasks, primarily in the back office, but also in the way customers interact with us such as through mobile banking. We're still fine-tuning our outlook for cost savings that should come from the initiative to overhaul and upgrade our technology systems and expect to provide you with an outlook within the next two to three months. We're still comfortable with our outlook of approximately $1.6 billion annually in core operating expenses and continue to look aggressively for redundancies or ways to improve efficiency within our system. Finally, as many of you are aware, we recently announced both the retirement of Doyle Arnold, our Chief Financial Officer and Vice Chairman, and the hiring of Paul Burdiss, who will be taking over the role of CFO. And I just want to take a moment and with all of you on the line to express my appreciation to Doyle for an enormous amount of hard work and a lot of thoughtful action and support over the last nearly 15 years. He's been a great part of the team and a great friend, and we're really going to miss Doyle and wish him the very best as he works on his golf game, among other things, which needs a lot of work.

Thank you, Harris. I want to remind you that nobody wants a CFO with a low golf handicap. So I hope you think the weakness in my golf game was offset by my strength as the CFO. Okay. Overview, let's see. So, as noted in the press release, the net income available to common for the first quarter was $75.3 million or $0.37 per diluted common share. This is up from $66.8 million or $0.33 per diluted common share last quarter. The largest positive driver for the increased earnings was non-interest expense, which improved by $25 million to $398 million from $423 million prior quarter. Reduced costs related to our CCAR submission for various consultants was the biggest single driver, and I would say the fourth quarter numbers were probably artificially high because we made sure that we accrued for everything that was out there in that quarter. This one may be a little bit on the low side but we hope to do closer to the $400 million number than the $423 million and think we will in future quarters. Other significant positive differences in the first quarter compared to the fourth was provision expense, which decreased $13 million; basically back to a net zero first quarter. The change in provision was due to a few large recoveries in the quarter, in total about $20 million higher than the recent rate of recoveries. If not for the large recoveries, we would have experienced a positive provision in the first quarter because, as we'll talk about later, we actually did increase the allowance in the first quarter. I'll move on now to a brief review of the some key revenue drivers. Turning first to net interest income. In the loan category, average loans held for investment increased $333 million compared to the prior quarter, while period end loan balances increased $116 million. As we noted on our last earnings call, we did not see a sharp late fourth quarter increase in loans last year, which had been a pattern that we've seen for several years. And by the same token, the first few weeks of the new year did not see a reversal of a run-up; we didn't have a sharp seasonal runoff that we've seen in some recent prior years. So the pattern was a little more smooth around the year-end this year. We reduced some energy services loans primarily as a result of additional capital raised by participants in that sector, and this reduction was a contributor to the slower first quarter loan growth. Additional risk-reduction efforts and limiting commercial real estate commitment growth and the continued runoff of loans from our national real estate group resulted in softer loan growth than we might experience if not for active risk-management efforts. Our line managers are reporting general strength within pipelines, although prepayment rates also remain high due to a variety of reasons and as such, we expect loan growth to be moderate in 2015 as we expect to see softness in loan growth in Texas and improving strength in some of the other economies within our footprint. Net interest income for the first quarter, total net interest income was $417 million, a decline of about $13 million from the prior quarter, but essentially unchanged from the year-ago period. Much of the linked quarter decline is attributable to a decrease in the day count between the fourth and the first quarters, accounting for about $9 million of the $13 million. The remainder of the decline is largely attributable to a decline in loan income, which was partially offset by a sequential quarter increase in interest income from securities and we expect to continue growth in interest income from building the medium duration agency MBS of that portfolio as we've discussed with you previously. Turning to the net interest margin and loan pricing. Compared to the prior quarter, the NIM decreased 3 basis points to 3.22%. The minor decline is primarily due to continued pressure on loan yields, which you'll see on the average balance sheet where loan yields declined 10 basis points compared to the prior quarter. Principal causes of declining loan yields are the repricing of new loans at lower rates than the loans that are maturing or prepaying and, to a lesser degree, fewer fees that were amortized through the interest income line such as prepayment penalty income. New loan pricing was generally stable with the prior quarter with a weighted average coupon of 3.65%. Looking at the components of the portfolio, C&I and owner-occupied loan production accounted for more than 60% of loan production and within that, we do see and are hearing of increased price pressure in the last six months on the smaller loans which had been fairly stable previously. Pricing on larger loans has been in a fairly tight range and appears to be stable by most reports across our footprint. Nevertheless, the gap between the coupon on total new loan production in the overall book of business is about 25 basis points. This gap is consistent with the gap over the past several quarters; it's not widened or narrowed appreciably. If competitive pricing holds and there's no shift in interest rates by the Federal Reserve, we would expect some further NIM pressure from the effects I just described on the loan portfolio. However, we expect the net interest income to actually increase slightly over the next year as the pressures from loan pricing should be more than offset by further moderate loan growth, continued purchases of residential MBS and the reduction of high-cost debt that is maturing in the second half of 2015.

Joe, this is Scott McLean. I would just echo Doyle's comments. This process of taking a reservoir analysis that's nearly six months old and putting new sensitivity pricing in it is a very imprecise process, but we did this rigorously across the entire reserve-based portfolio and determined that there was a collection of reserve-based credits that we thought because of the degree that they were advanced and the science associated with their reserves warranted downgrades. And I'll tell you, though, that having completed a portion of our reserve base redeterminations already that we've had about a handful of those redeterminations that have come in more favorably than the sensitivity analysis that we ran, which just simply makes the point of the crudeness of this process.

Well, the borrowing base in the reserve redetermination are looking out multiple years; and that's a discounted value; and hedges that are in place are taken into account. But generally, they do not last beyond a few quarters to two years.

Thanks so much, and Doyle, congratulations on your retirement. Certainly, wish you the best.

Thank you, Joe.

So just a follow-up to Joe's question on non-energy loan deterioration specifically in Houston, just curious as to what you're seeing, Scott, in the economy there in Houston right now and in your commercial real estate credits. Could you just give us a little more color there?

Sure, Jennifer. On the CRE side, you just have to go through each category, but obviously, we're watching office and multifamily most closely. The single-family construction, Houston will probably have 25,000 to 30,000 housing starts this year, and just because of the very conservative underwriting that came out of the 2008, 2009 downturn, I think residential will be very manageable in Texas and in Houston, specifically. Our office exposure is pretty manageable and we really only have a couple of credits that are less than $25 million in total exposure each and in one case, well less but they're with first-tier sponsors and great locations. So our office exposure is I think very manageable and multifamily is really the place where we're watching it closely.

Well, as I mentioned, the biggest change in the other non-interest expense line was the fact that there was a pretty large litigation settlement that we accrued in that line in the fourth quarter of a much smaller number in the first quarter and we think that was a very abnormal expense.

Thank you very much.

Thank you.

Hey, everybody. Doyle, best of luck again.

Thank you, Ken.

Yes. Hi, good afternoon. And, Doyle, good luck in lowering that handicap.

Thank you.

You mentioned that you will come back to us in two or three months with some thoughts on the cost saves you could get from technology initiatives. What sort of process you're going through internally to figure those out? What are sort of areas that you're looking at and how do you think about calculating the type of saves you could realize?

Well, it's – I'll tell you as we have a number of people involved in putting those numbers together and assessing both the magnitude and the expected timing of benefits we're expecting to see from some of those – from these projects but that's the best I can tell you.

With that, let me once again say thank you to all of you. I was sincere when I said that your questions have been thoughtful, sometimes tough. That's what you're supposed to do, and I've learned from them as well as from answering them most of the time at least and I really do appreciate the association. Wish you all well.

Thanks very much. That will conclude our first quarter 2015 earnings review and we look forward to seeing you at a future conference or at next earnings conference call in July. Thanks so much.