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Zions Bancorp. (ZION - Analyst Report) reported adjusted second quarter 2012 earnings of 40 cents per share, exceeding the Zacks Consensus Estimate of 33 cents. Also, this compares favorably with the prior-quarter earnings of 22 cents.

After considering non-cash effects of the discount amortization on convertible subordinated debt as well as additional accretion on acquired loans and accelerated amortization on convertible subordinated debt, Zions’ second quarter net income came in at $55.2 million or 30 cents per share. This was also significantly higher than the prior-quarter earnings of $25.5 million or 14 cents per share.

Zions’ better-than-expected results benefited from growth in non-interest income as well as lower preferred stock dividends as a result of repayment of 50% of TARP money in the prior quarter. However, these positives were partially offset by lower net interest income and rise in operating expenses. Moreover, continuous improvement in credit quality, growth in average deposits and loans and stable capital ratios were among the positives.

Performance in Detail

Zions’ total revenue was $641.3 million, up 1.7% from $630.7 million in the previous quarter. Moreover, total revenue substantially surpassed the Zacks Consensus Estimate of $552.0 million.

Net interest income declined 2.3% sequentially to $432.0 million. The fall was mainly attributable to lower interest income and higher interest expenses. Similarly, net interest margin dipped 11 basis points from the last quarter to 3.62%.

Non-interest income stood at $123.0 million, increasing 15.0% from $107.0 million in the prior quarter. Higher dividends and other investment income from private equity investments primarily at Amegy primarily uplifted the fee income.

Non-interest expense was $401.7 million, 2.4% higher than $425.0 million in the previous quarter. The rise was mainly a result of significantly higher provision for unfunded lending commitments, partly mitigated by a slight decline in salaries and employee benefit expenses.

Asset Quality

Credit quality continued to improve during the second quarter, with the ratio of nonperforming lending-related assets to net loans and leases and other real estate owned dropping to 2.53% compared with 2.79% in the previous quarter and 4.06% in the year-ago quarter.

Net loan and lease charge offs were $43 million as of June 30, 2012, down 21.8% from $55 million as of March 31, 2012 and 61.9% from $113 million as of June 30, 2011. Net-charge offs decreased mainly in commercial and industrial and term commercial real estate loans.

Allowance for credit losses as a percentage of net loans and leases stood at 2.92% at the end of the second quarter as against 3.03% at the end of the prior-quarter and 3.63% at the end of the year-ago quarter. Provision for loan losses was $10.9 million compared with $15.7 million in the prior-quarter and $1.3 million in the year-ago quarter.

Loans and Deposits

Zions witnessed a surge in its loan portfolio in the reported quarter. Loans and leases, excluding Federal Deposit Insurance Corporation (FDIC) supported loans, were $36.2 billion, up $328 million from $35.9 billion in the previous quarter. The augmentation largely came from commercial and industrial and 1-4 family residential loans. Average loans and leases excluding FDIC supported loans was $36.1 billion, almost in line with the prior quarter.

Average deposits for the quarter inched up 1.3% to $42.9 billion from $42.4 billion in the prior quarter. The increase was primarily due to the higher level of average non-interest-bearing demand deposits.

Profitability and Capital Ratios

Zions’ profitability and capital ratios exhibit a modestly cautious approach. As of June 30, 2012, tier 1 leverage ratio was 12.30% versus 12.17% in the previous quarter and 13.44% in the year-ago quarter. Likewise, tier 1 risk-based capital ratio was 15.01% compared with 14.83% as of March 31, 2012 and 15.87% as of June 30, 2011.  

The annualized return on average assets improved to 0.70% in the reported quarter from 0.69% in the prior quarter and 0.57% in the prior-year quarter. As of June 30, 2012, tangible common equity ratio was 6.91% slightly up from 6.89% in the prior quarter but down from 6.95% in the year-ago quarter.

Book value per share as of June 30, 2012 stood at $25.48 compared with $25.25 as of March 31, 2012 and $24.88 as of June 30, 2011.

Our Viewpoint

We believe that Zions remains well positioned for loan and deposit growth considering its well diversified portfolio. Moreover, the company’s cost control efforts will drive future growth. Repayment of half of the TARP dues without diluting its shareholders value and its preparation to meet the Basel III requirements has boosted the company’s profile.

However, we remain concerned about the prevailing low interest rate environment, sluggish economic growth, Zions’ asset sensitive balance sheet, losses related to CDO exposure and regulatory pressures.

Zions currently retains a Zacks # 3 Rank, which translates into a short-term Hold rating. One of its peers, City National Corp. (CYN - Snapshot Report) retains a Zacks #2 Rank (a short-term Buy rating).

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