Zions Bank Battered By Excesses in Subprime Market
by Paul Beebe and Steven Oberbeck
Salt Lake Tribune
June 21, 2009
Early in 2008, Harris Simmons wrote a letter to Zions Bancorp shareholders that would prove to be prophetic.
Reflecting on the year that had just ended, Simmons, chairman and CEO of the Intermountain West’s largest regional banking company, said 2007 had come in “like a lamb and went out like a lion” as storm clouds gathered over Zions and other financial services companies.
“Excesses in the ‘subprime’ mortgage market,” Simmons said, led to unusual levels of loan defaults early in the year that were putting profits under pressure at many financial institutions, including venerable Zions, whose origins date to 1873 and founder Brigham Young.
“The impact of the subprime mortgage crisis on the credit and housing markets did not become fully apparent until August,” Simmons wrote, ticking off a list of monetary train wrecks — frozen credit markets, deep troubles in the bond markets and the bursting of the real estate bubble — that pushed sales and prices to historic lows.
Massive defaults by borrowers with risky credit who’d been lavished with subprime loans had lit a blaze sweeping the financial world as Simmons penned his letter nearly two years ago. The firestorm eventually led to a wave of bank failures and forced sales that rattled the very foundations of banks large and small, plunging the financial world into the most serious upheaval since the Great Depression.
Even conservative Zions was swept up, raising questions about its survival that only now are being put to rest. Profits at the multistate bank holding company — the region’s top small business lender and banker to clients that include The Church of Jesus Christ of Latter-day Saints and transportation giant Flying J Corp. — fell 15 percent in 2007. Salt Lake City-based Zions is parent of Zions First National Bank and seven other banks across the West.
Earnings growth turned negative in the third quarter of that year and by the fourth quarter 2008, Zions was deep in the red. In just the past two quarters, Zions has lost $1.3 billion, wiping out what it earned in the previous 2½ years. The company’s stock price has skidded as much as 93 percent.
Despite its troubles, Zions is not in danger of collapse, many analysts say, although they hasten to add the company probably still faces substantial losses. Whether it has enough loan loss reserves — money it set aside to cover losses in its loan portfolio — and other assets to withstand the hit that may lie ahead is an open question. Simmons is confident Zions has taken the right steps to shore up its capital, and that it has enough muscle to make new loans and endure the worst-case scenarios that are the basis of so-called stress tests given to the nation’s biggest banks.
“They are alive. Their regulatory capital ratios are fine. For me, as a common shareholder, there’s great potential for growth,” said Brian Klock, senior vice president of equity research at investment bank Keefe Bruyette and Woods Inc.
Troubled waters ahead » Klock, however, repeats a concern voiced by other analysts that Zions will increase its loan-loss reserve by $860 million over the next nine months. And although problems with residential construction loans are largely behind it, the bank’s commercial and industrial loan portfolio is growing more troublesome, he said.
Still, Zions’ bread-and-butter customers haven’t withdrawn their money from the bank. Simmons said deposits are growing nicely.
And by taking $1.4 billion from the $700 billion Troubled Asset Relief Program created by Congress last October and making other moves, the company has fortified its finances, analysts say.
“Compared to their peers, I think they are doing quite well,” said J.P. O’Sullivan an analyst at research firm SNL Financial. “Looking at their delinquency rates, the most troubling are construction and land development loans. Everything else — home equity lines of credit, first lien mortgages, credit card loans and even commercial real estate — is below the average for delinquencies.”
Roller-coaster ride » The challenging times for Zions contrast sharply with the fat times leading into 2007. In 2001, after several years of flat earnings, the banking company’s profits began to mount rapidly. Earnings attributable to each share of common stock, a measure closely watched by investors, had risen 75 percent by the close of 2006, a year in which Simmons now says Zions was at the height of its powers. By nearly every measure, the company’s operating and financial results put Zions ahead of its peers.
From there, the road was downhill as the subprime crisis took hold.
“I had a sense that we were in for a real recession,” Simmons said, recalling a moment in 2007 when Jeff Thredgold, Zions’ well-regarded economist, predicted the U.S. would see modest economic growth in 2008, despite the gathering gloom.
“I went up to him afterward and I said, ‘I’ll bet you dinner we don’t. I’ll bet you we’re going to be in a recession in 2008,’ ” recollected Simmons, who has a master’s of business administration degree from Harvard Business School.
Once more, Simmons’ prediction was on the mark. In December 2007, the economy had entered a deep recession. Many of the hardest-hit states were in the Southwest, where housing, assisted by free-wheeling mortgage lending, had been instrumental in boosting the economies of Arizona, Nevada and Southern California, all states where Zions owns banks.
During the housing expansion, job growth flourished, especially in housing construction and related industries. Consumers drew on home equities and tapped credit cards to buy everything from cars to high-end electronics.
Zions suffered when the housing bubble popped, even though the company’s eight subsidiaries did little, if any, subprime lending. The banks focused mostly on loans to real estate developers who were required to make heavy down payments, Simmons said, insisting that Zions’ underwriting rules were conservative. Even so, Zions couldn’t avoid the damage done by unregulated mortgage brokers who were less scrupulous.
“It wasn’t just subprime. It was also these other exotic products. There were options [adjustable-rate mortgages] that allowed borrowers to get larger mortgages than maybe they would otherwise be inclined to get. And that created demand for larger homes than they maybe would be able to afford otherwise,” Simmons said.
“That was really [the cause of] this bubble building … and so anybody in any of these markets who’s engaged in any kind of real estate financing has been hurt.”
A healthy pulse? » Simmons advances several arguments to support his claim that Zions is healthy. Capital reserves are at unsurpassed high. Net interest margin — the difference between interest income and interest expense, and Zions’ biggest source of earnings — is better than almost any large bank.
Zions’ loan-loss rate is tied with Wells Fargo for best performance in the industry, Simmons said. And most of Zions’ losses in the past six months were of the nonoperating variety — mainly a goodwill write-down of the value of a Texas bank Zions acquired in 2005. Zions also lowered the value of some securities it owns, but expects their value to return when the economy improves.
Simmons said Zions took TARP money to maintain its capital-to-asset ratios. When credit markets shut down last year, borrowers turned to conventional banks such as Zions for help. At one point, new bank loans were increasing at a 20 percent clip. “We were telling [loan officers] you need to pull back — we can’t be growing at this pace,” Simmons said.
Zions accepted TARP cash for a darker reason. The bank worried that it might send a signal that it didn’t qualify for government bailout funds, which might have encouraged a takeover. PNC Corp. acquired National City, a $120 billion Zions peer bank in Cleveland in October, three days after the Treasury Department rejected its request for TARP funds.
“So the implications back then of not participating [in TARP] were that probably life was going to be reasonably short if you were a large bank [like Zions],” Simmons asserted.
A family bank » As CEO and president of Zions since 1990, Simmons has plenty on the line when it comes to the banking company’s future. He was named chairman in 2002, and at age 54, is its biggest single investor, with almost 478,000 shares of common stock. In a real sense, Zions is a family bank. It was his father, Roy, who with some business partners acquired a controlling interest in Zions First National Bank in 1960 and later created Zions Bancorp as its holding company. Roy Simmons took the company public in 1966 and served as CEO until 1990. By the time he retired as chairman in 2002, Zions had grown close to its present size.
Despite his upbeat assessment of Zions future, Harris Simmons faces some daunting challenges. Last month, Fox-Pitt Kelton analyst Albert Savastano released a study of Zions’ loan portfolio that found almost 11 percent of its construction loans were in default or close to default. The highest concentrations were in Nevada and Arizona, where 18.6 were delinquent. California and Utah were also singled out as problem areas.
“They have some markets that are really struggling,” Savastano said in an interview. “It’s a matter of how bad commercial real estate gets to determine if they have enough [capital], but at this point we think they have enough.”
Rough as the credit crisis and recession have been on Zions, Simmons doesn’t think the calamity has been as difficult as the late 1980s, when Zions endured back-to-back annual losses. At the time, the company was much more Utah-focused, and the state’s economy was in the tank. Bad loans as a percentage of the bank’s total portfolio were higher than they are today, Simmons said.
Looking back, Zions’ CEO tells of how the bank in part dealt with that crisis by building up its loan-loss reserves.
“We were building reserves like crazy back then,” Simmons said, explaining that in the late 1980s Zions set aside so much in reserves that regulators eventually contacted the company and forbid them from putting any more aside until they said it was OK. “And that lasted for five years.”
Zions is doing the same today, having put aside in just the first quarter of this year nearly $300 million in loan loss reserves. And once the economy improves, Zions may not have to put as much aside in their reserve account, which would help its bottom line.
“We probably have the best footprint in the nation in terms of exposure to growth markets,” Simmons said. “We have a fabulous franchise, a great balance sheet with good margins and I think life looks pretty good once we get through this cycle.”
pbeebe@sltrib.com steve@sltrib.com