Zions Bancorporation N.A (ZION) — Q4 2015 Earnings Call Transcript

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

Thank you, James, and welcome to all of you who are on the call today to discuss our fourth quarter and full year 2015 results. There is obviously a lot of focus on energy and we’ll talk about energy as we get further into the presentation, but I wanted to talk about a variety of things that we think are actually working very nicely before we get to that. From Slide 3 and the related slides that we’ve distributed, we’ve tried to highlight some of the initiatives that are working well and are within our expectations. I’ll touch on a few of these in my remarks here, but as an overarching comment, I would want to say that I’m quite encouraged with the positive operating leverage that we achieved in the quarter. The positive revenue trajectory, the stable expense levels, and the solid progress that we’ve made on the technology projects that we’re pursuing. We are highly focused on improving the profitability and growth profile of the Company and we made very tangible progress in 2015 towards those goals. Additionally, despite the weakness in energy commodity prices, we were able to maintain strong overall asset quality metrics and we experienced an encouraging improvement in the rate of loan growth compared to the prior quarter during the fourth quarter here. On Slide 4, we display our loans and deposits. Relative to the third quarter, we experienced improved loan growth in the fourth quarter of $536 million or about 5% annualized. Excluding the effects of expected energy loan attrition loan growth was more than $700 million or about 8% annualized. We were pleased with growth in areas that are targeted for growth specifically non-energy commercial and industrial and consumer loans. Deposit growth shown in the chart on the right has been a strong story for Zions for quite some time and the source of that growth has come primarily from the most viable source, which is non-interest bearing deposits. The value of those deposits should increase as rates rise and should lead to a strong increase in earnings if and when interest rates further increase. Thus far, we’ve been able to hold deposit rates quite flat. Turning to Slide 5, the most significant source of revenue for Zions is net interest income, which equals about 78% of the fourth quarter net revenue. Although a portion of the increase from the prior quarter was driven by interest income recoveries that may not occur in the first quarter of 2016, we expect the interest rate increase in December will offset that factor. Also, driving net interest income higher was the increase in both loans and securities, as well as a material reduction in the interest paid on debt. Accordingly, we expect we will experience similar if not slightly higher net interest income in the first quarter of 2016. On Slide 6, we’re encouraged with the results from the initiatives we’ve made to grow fee income. Managed fee income increased 4% from the 2014 year and we’re targeting a stronger growth rate in 2016. Managed fee income is defined by us as income sources we manage directly and excludes the effect of dividends, securities gains and losses, and other similar sources. The most significant increase in 2015 was from treasury management, which increased 13%. It also happens to be our strongest contributor to total fee income. Some of the headwinds include loan fees, which were down due in part to soft demand for energy lending, as well as overdraft fees, which is attributable at least in part to strengthening consumer balance sheets. On Slide 7, we have the cost savings initiative scorecard graph, with the bar on the left illustrating the commitment to achieve $120 million of gross cost savings by the end of 2017. The bar on the right illustrating the cost saves that were accomplished in 2015. We remain on-track to achieve the targeted cost reductions by 2017 having already realized more than half of the goal by the end of 2015. We’re encouraged with the achievement of holding non-interest expense to less than $1.6 billion in 2015. Additionally, our commitment is to hold that line item adjusted for certain restructuring costs to below $1.6 billion in 2016. We expect benefits in 2016 to include the simplification of operations that are due in part to the charter consolidation. Moving to Slide 8, we have achieved a portion of another key measure of our commitment to shareholders, which was to reduce the efficiency ratio to 70% or below for the second half of 2015. We’re encouraged with this achievement, and we are reiterating our commitment to achieve an efficiency ratio in 2016 of 66% or better, as well as those other targets that we first communicated on June 1st of last year. On Slide 9, we’re satisfied with the progress we have made on our technology projects. The general ledger transition and new reporting tool conversion are complete. The credit approval workflow system software is installed in most of our banks with the completion scheduled for the spring of this year. The same is true for the enterprise loan operations. We are tracking to a spring completion. Regarding our core systems replacement project, which we’ve dubbed FutureCore where we’ve partnered with Tata Consultancy Services we are expecting the consumer loan system to rollout later this year with commercial lending tracking for 2017 and the deposits module scheduled for 2018. In summary, we are making significant investments to provide a very strong technology foundation for our future. These are investments that will simplify our operating environment and give us the ability to be highly competitive in an industry where technology is obviously playing an increasingly important role. Finally as noted in the press release, the consolidation of our seven subsidiary banks to a single national bank charter was completed on December 31st. We’ll continue to emphasize our locally oriented leadership structure and the power of our strong local brands in each market we serve, but we’ll find some additional efficiency from this consolidation of charters. We’re very optimistic about the future operational and financial performance for Zions. With that brief overview, I’ll turn the call over to Paul Burdiss to review the financial results.

Thank you, Harris, and good afternoon everyone. I’ll begin on Slide 10. For the fourth quarter of 2015, Zions reported net earnings to common shareholders of $88 million or $0.43 per share. Relative to the third quarter, net interest income increased about 5.5%. Adjusted for recoveries of interest income and a linked-quarter increase in income from loans purchased from the FDIC, net interest income increased just under 3%. Actively managed non-interest income, which excludes investment-related items and securities gains and losses increased slightly from the prior quarter and as Harris noted earlier, increased about 4% for the full year 2015 when compared to the full year of 2014. At just over $400 million, non-interest expenses were higher in the fourth quarter when compared to the third quarter due in part to elevated levels of expenses in certain categories as detailed in the press release, which accompanies this call. We are encouraged by the efforts of our teammates to manage our cost of doing business. Our collective efforts allowed Zions to realize our goal of adjusted non-interest expense of less than $1.6 billion for 2015. Turning to the provision for loan and lease losses, we had expected a moderate build in the reserve for energy loans, partially offset by continued reserve release in the rest of the portfolio. Although throughout most of the quarter, we expected the provision for loan losses to be in line with the third quarter result, the decline in the price of oil near the end of the quarter resulted in a moderately higher provision. The energy loan portfolio continues to perform about as we had expected. As we progress through 2016, we expect quarterly provisions to be moderately higher than the fourth quarter results. The key driver of our expectation for an elevated provision in 2016 is the lower prevailing energy prices; actual results may therefore vary from expectations if energy prices remain volatile. Finally, I would like to highlight the return on tangible common equity. Although we're working to drive shareholder returns to a much higher level, I'll point out that our efforts over the past year have resulted in a better than 100 basis point increase in shareholder returns when compared to the same period a year ago, while capital levels have actually increased slightly during the period. Turning to Slide 11, I'll address some of the drivers of the net interest income beginning with volume. Details of our investment portfolio are shown here on Slide 11. We have been adding securities to our investment portfolio for the past year or so, reflecting the need for a permanent high-quality liquid asset position in order to manage our balance sheet liquidity more effectively in light of the recently established liquidity coverage ratio rules. Our efforts to build out the investment portfolio are expected to add revenue in the current and downside economic environments when compared to holding liquidity in the form of cash. During the fourth quarter we added $1.5 billion to our investment securities portfolio on average when compared to the third quarter. In light of a general market expectation for rising short-term rates, we're exercising caution with respect to the impact on overall balance sheet interest rate sensitivity, as we purchase fixed rate investments and duration extension risk inherent in the investment portfolio. The securities we are adding are relatively short in duration, just over three years. The duration of the entire securities portfolio is estimated to be 2.9 years to-date. If rates were to rise 200 basis points across the curve, our models indicate that the duration of the portfolio would extend only slightly to about 3.1 years. As expected, the addition of these fixed-rate investments reduced Zions’ asset sensitivity somewhat as shown in the table at the bottom-right of the page. Worth noting, the deposit beta assumptions employed in our slow case are in fact faster than we are seeing in the market today or in plain language, our slow scenario model assumes faster deposit re-pricing than we are currently observing in the market. So the improvement in net interest income from the December rate hike could and likely will be higher than that shown in the table on Slide 11.

Thank you, Paul. I'll begin with Slide 17. We did not include the table from our earnings release on Page 4 in the main section of this slide deck, but you can find it in the Appendix. Let me summarize some points. As mentioned in the press release, energy loan outstandings and commitments have significantly decreased from the previous quarter and compared to last year. We anticipated this decline throughout 2015. The outstandings dropped by about 450 million year-over-year, and commitments fell roughly 1 billion from the previous year. The classified energy loan balance rose by approximately 76 million compared to the last quarter and is actually better than we expected a year ago. Non-accrual energy loans decreased from the previous quarter mainly due to net charge-offs, which is not the preferred method of reduction, but it's worth noting that the level doesn't increase much when adjusted for these charge-offs. We have been actively managing the energy portfolio, with full attention from our executive team reviewing it frequently on a credit-by-credit basis, along with significant engagement with our customers. Based on this feedback and our models, we are revising our outlook for energy loan losses. As previously stated, our various methodologies suggested estimated energy loan losses of between 75 million to 125 million for the nine-quarter period ending in the fourth quarter of 2016. This estimate was made over a year ago based on oil prices around 50. Currently, the price of oil is much lower, with most of the decline occurring in December 2015 and January 2016. Therefore, it is necessary to update our loss expectation. Assuming oil prices around 30 dollars per barrel for the next few quarters, we now estimate energy loan losses to be between 75 million and 100 million in 2016. This is at the higher end of the initial range, driven by the drop in oil and gas prices compared to our initial expectations. As Paul mentioned, we anticipate total losses for the Company to remain manageable, with net charge-offs expected to range between 30 and 35 basis points for the entire consolidated portfolio.

Thank you. Our first question comes from Jennifer Demba of SunTrust. Your line is now open.

Could you guys, it’s a very healthy capital ratio. Just wondered if you have any interest in share repurchases once we get through CCAR given your stock has taken quite a hit in the last several weeks?

I would tell you that I would certainly expect so. We have not developed the capital plan that will accompany our submission of our stress test and through the CCAR process, which is just getting underway. But we would expect to be more aggressive than we’ve been, certainly in the last cycle in terms of what we’ll hope to accomplish in the way of capital returns. And that I expect that would be on the table, Jennifer, but obviously that’s we are aboard to contemplate and determine in consultation with the management team here and then it goes through the CCAR process, but that’s what I would sort of expect we will be doing.

Well Jennifer, I think as you know that’s not something that we typically disclose as Scott said, however, we do believe we have a healthy reserve at over 5% of loans.

Scott, could you provide more details about the pay downs you observed in the energy sector during the quarter? I'm interested in the nature of these pay downs and whether you're seeing any signs of private equity involvement or energy companies acquiring one another. I'm trying to understand the potential directions for these pay downs and their origins.

Sure Brad, no, good question. Actually the pay downs are coming much more, they are more heavily weighted to the services portfolio, number one. Number two, you’re going to see a natural contraction in the reserve base outstandings as the redetermination came down during the quarter. The borrowing bases were re-determined down we saw some natural payoffs there. But those would be the two primary areas. And we saw continued term amortization, recall that on the services side of our portfolio about 35% of the portfolio is term, it’s amortizing on a little less than a five year basis. And so we’re continuing to see reductions there. And then the last comment I would make is that during the year, we had approximately $140 million of capital contributed by private equity firms and that didn’t all go to support reductions, but it, a portion of it did. And additionally, we saw about 150 million in loan commitments reduce as a result of restructurings that we did. So really it’s across the board and it’s all pretty healthy type reductions that you would anticipate.

First question, just in terms of the investing of the cash into securities, could you just walk us through the thinking of what changed in your minds, I mean, I know we had the rate hike, but it doesn’t seem like security yields would have been all that much higher now versus say a month or five months ago? Why get more aggressive with security purchases?

Yes, this is Paul. I assume when you say more aggressive, just there was a slight acceleration in the fourth quarter relative to what we’ve seen previously, is that correct?

I was thinking like the 1.6 billion that I think I saw referenced for the full year.

Okay, yes. I think we’ve been pretty consistent in saying that over the course of two to three years, we would be investing approximately $6 billion of cash into the investment portfolio. And the timing of that may change. So I wouldn’t say that there was any particular view on the yield curve, but we are trying to be somewhat thoughtful about the timing of those investments. But looking forward I would expect to continue kind of in the range or the pace of the purchases that we have been making.

I think it's also just fair to say that I mean we just continued to see growth in deposits, and particularly non-interest bearing deposits and so that’s facilitated a little faster build up.

Yes Erica we’re particularly mindful of the LCR and the securities that we’re putting on we're adding in the context of HQLA, so either level 1 or level 2 in the appropriate proportions. I don't believe we disclosed our LCR, but I will say that we are comfortably in excess of the requirement.

Just wondered if you could give us a little more color to the drivers to the pick in the loan growth in the fourth quarter and any notable geographic trends you saw and related to that also just curious the run-off that you would expect to see in the national real estate portfolio in 2016?

The growth during the quarter was strong, with significant family mortgage growth across the entire franchise as our mortgage initiative continues to mature, and we anticipate this trend will carry into the New Year. Additionally, we experienced solid commercial and industrial growth that exceeds the decline from the energy portfolio.

Thank you. And our next question comes from the line of Ken Usdin of Jefferies. Your line is now open.

Just a couple of more clarifications on credit, so just understanding if the outlook for charge-offs is 30 to 35 basis points, because I calculate that's around 120 million to 145 million or so of charge-offs, and I am just wondering on top of that are you also saying that you'll provide for some loan growth and then is there also potential for additional reserve build, if there is additional deterioration in the energy credits as you mentioned on the slide?

Actually we believe with the provision that we've guided you towards that that should fully cover this level of charge-offs and growth in the portfolio.

A big part of my question John had and I think more from a qualitative standpoint than a quantitative standpoint, just curious if we’ve seen some bankruptcies fail recently and I know that every borrower is very-very different. But I am just curious if what we seen recently would cause any reason to change your expectations when it comes to loss severities when you do see evolve?

On the energy portfolio? Yes. Again these four models that we use are pretty aggressive in terms of the negative assumptions that we use or the very conservative assumptions that we use. So, we believe we have baked that in. I mean it was very different list of assumptions this year than last year and the way we’ve refined our models has been especially helpful.

Just a quick question, I was wondering if you performed the goodwill impairment evaluation last quarter, last year you did it in October. The reason I ask is about 60% of your building dollars of goodwill is connected to Amegy?

Yes this is Paul. In accordance with GAAP, we are required as you know to continually monitor the valuation of the relative components of that relative to goodwill. So, yes in fact we have dutifully performed that in the fourth quarter.

Thank you very much everyone for joining the call today. Thank you, Sabrina for hosting and we appreciate all of your attendance. Please feel free to send additional questions to me and we'll try to get back to you within a reasonable period of time tomorrow for sure. Thank you again for your time and have a great evening.