Zions Bancorporation (ZION)

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Neena Mishra

www.zacks.com

ZION Bancorporation (ZION) is a diversified financial service provider operating across 520 branches and about 628 ATMs, as of September 30, 2007, in 10 western and southwestern states (Utah, Idaho, California, Nevada, Arizona, Colorado, Texas, New Mexico, Washington, and Oregon). ZION operates under a community banking model, offering its services through local banking identities using local management teams. ZION offers a full range of traditional banking services, as well as small business administration lending, public finance advisory, and electronic bond trading. Tax-equivalent net interest income represented 76% of net revenue in 2006, with the balance coming primarily from service charges, loan sales and servicing, and other commissions and fees.

ZION's strategy centers on three key factors: (1) focus on high-growth markets (2) keep decisions about customers local and (3) centralize technology and operations to achieve economies of scale. In December 2005, ZION completed the purchase of Amegy Bancorporation (formerly Southwest Bancorp of Texas) for roughly $1.7 billion in stock and cash. This was a rather large bite to take (nearly a 25% increase in assets at the announcement date), but ZION wanted to get into Texas for some time, and there was a clear strategic fit. In January 2007, ZION completed the acquisition of Arizona-based Stockmen's Bancorp, Inc. in a $200 million all-stock deal, adding $700 million in net loans, $1.1 billion in deposits, and 43 offices, including some in smaller and more rural markets in Arizona and California. In September 2007, ZION completed the acquisition of Inter Continental Bank Shares Corporation located in San Antonio, Texas, which added $50 million in loans and $105 million in deposits including $98 million in core deposits, to the company's balance sheet.

ZION's loan portfolio is relatively diversified. As of September 30, 2007, it comprised of roughly 45% commercial loans (including owner-occupied), 36% commercial real estate (CRE), and 19% consumer loans (primarily residential real estate). The securities portfolio had a downward trend yet again on a relative basis, and was a manageable 12% of average earning assets in 3Q07. Non-interest-bearing and other low-cost deposits funded 60% of average earning assets in the quarter, while time / foreign deposits and borrowing funded 23% and 18%, respectively. As of September 30, 2007, ZION had $48.9billion in total assets, $37.2 billion in loans, and $35.8 billion in deposits.

To a large extent the ZION story remains one of location. ZION is located in some of the highest-growth markets in the U.S., where the population is growing much faster than the rest of U.S. as a whole. During the period 2000 through 2030, the population growth in states is forecasted at about 51% compared to the national average of 29% over this time. We favor the community banking model in general, and therefore expect ZION to continue stealing market share from its larger out-of-state competitors for the foreseeable future. The Amegy acquisition certainly fits in well with ZION's strategic plans, as Texas is another large, fast-growing market, and ZION had no presence there. Organic loan growth has been solid, consistent with the economic activity across ZION's diverse footprints.

As we have noted previously, ZION seems much more focused now than it was for a number of years. After restructuring the operations of Vectra Bank, closing its supermarket branches in Utah, and disposing of its e-commerce subsidiary, ZION is now consolidating the systems of its various community banks. ZION is also looking at innovative technological solutions to drive operational efficiencies in branch operations. Using GMT Corp.'s workforce optimization solution, ZION has been able to reduce staffing costs by almost 4.0%. The company recently completed its acquisition of Stockmen's Bancorp as well as the Intercontinental Bank Shares Corporation. Though small, the deals will enable ZION to gain additional foothold in some smaller and more rural markets of Arizona, Texas and California.

Competitive pressures are high throughout the banking industry. Over time, we would expect competition to reduce ZION's solid net interest margin, creating headwind on the revenue front. Loan growth has remained solid, but slowing growth in core deposits could cause a more negative mix shift than we have modeled, another negative for the NIM.

We were a bit disappointed with the Amegy transaction, though only time will tell how it all plays out. The deal looked expensive to us on nearly every metric, representing roughly a 40% premium to the pre-speculation market value of ABNK. Though we did not follow ABNK specifically, it appeared to have been struggling relative to the several Texas banks we did cover at the time, which may have prompted the sale. We fear that improvements (in net interest margin, for example) may ultimately prove less attractive than management projected (and that their terminal multiple assumption might have been a bit rich), and even their numbers only got to a 14% IRR (heavily back-end loaded). All-in-all, these were not the transaction economics we would expect from ZION. Though the Stockmen transaction was smaller and the details fewer this acquisition also appeared to be on the expensive side.

We are concerned about ZION's CRE exposure. CRE represents over one-third of ZION's overall loan portfolio, and roughly 4 times its tangible capital base. Current weakness in the residential development and construction activity in the Southwest is resulting in deterioration of credit metrics, with non-performing assets ending at 0.52% of related assets and net charge-offs at 0.19% of average loans (annualized) in 3Q07. We expect credit to further deteriorate industry-wide in the coming quarters.

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