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Zions Bancorp. (ZION - Analyst Report) reported adjusted third quarter 2012 earnings of 46 cents per share, substantially ahead of the Zacks Consensus Estimate of 32 cents. Also, this compares favorably with the prior-quarter earnings of 40 cents a share.

After considering non-cash effects of the discount amortization on convertible subordinated debt as well as additional accretion on acquired loans and discount amortization pertaining to redemption of remainder of Troubled Asset Relief Program (TARP) preferred stock, Zions’ third-quarter net income came in at $62.3 million or 34 cents per share. This was also higher than the last quarter earnings of $55.2 million or 30 cents per share.

Zions’ results benefited from growth in net interest income, decrease in operating expenses and lower preferred stock dividends as a result of repayment of the remaining TARP money in the quarter. However, these positives were partially offset by fall in non-interest income. Further, continuously improving credit quality, growth in average deposits and loans were among the tailwinds.

On September 26, Zions’ redeemed the remaining $700 million of its Fixed Rate Cumulative Perpetual Preferred Stock, Series D, issued to the U.S. Department of the Treasury as part its participation to the TARP. With this redemption, the company completed the full repayment of $1.4 billion in TARP fund.  

Performance in Detail

Zions’ total revenue was $634.2 million, down 1.1% from $641.3 million in the previous quarter. Yet, total revenue substantially surpassed the Zacks Consensus Estimate of $557.0 million.

Net interest income increased 2.8% sequentially to $444.2 million. The growth was mainly attributable to lower interest expenses. However, net interest margin inched up 1basis points (bps) from the last quarter’s level to 3.63%.

Non-interest income stood at $119.2 million, decreasing 3.1% from $123.0 million in the prior quarter. The fall was primarily attributable to lower trust and wealth management income, capital markets and foreign exchange income along with reduced dividends and other investment income, net gains on fixed income securities and noncredit-related losses on securities not expected to be sold (recognized in other comprehensive income).

Non-interest expense was $395.0 million, 1.7% lower than $401.7 million in the previous quarter. The decline was mainly a result of significantly lower other real estate expense, provision for unfunded lending commitments, as well as fall in salaries and employee benefit expenses. However, these were partly mitigated by increases in net occupancy costs, credit related expenses, advertising expenditure and Federal Deposit Insurance Corporation (FDIC) premiums.

Asset Quality

Credit quality continued to show marked improvement during the third quarter, with the ratio of non-performing lending-related assets to net loans and leases and other real estate owned dropping 30 bps sequentially and 120 bps year over year to 2.23%.

Net loan and lease charge offs were $38.6 million as of September 30, 2012, down nearly 11.0% from $43.3 million as of June 30, 2012 and 62.1% from $101.9 million as of September 30, 2011. Net-charge offs decreased mainly in commercial and industrial loans and home equity credit line loans.

Allowance for credit losses as a percentage of net loans and leases stood at 2.77% at the end of the quarter, down from 2.92% at the end of the prior-quarter and 3.40% at the end of the year-ago quarter. Provision for loan losses was benefit of $1.9 million, compared with provisions of $10.9 million in the prior-quarter and $14.6 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 FDIC supported loans, were $36.6 billion, up 1.1% from $36.2 billion in the previous quarter. The augmentation largely came from commercial and industrial loans, 1-4 family residential loans and term commercial real estate loans. Moreover, average loans and leases excluding FDIC supported loans inched up 1.1% to $36.5 billion, from $36.1 billion in the prior quarter.

Average deposits for the quarter inched up 1.2% to $43.5 billion from $42.9 billion in the prior quarter. The increase was primarily due to the higher level of average non-interest-bearing demand deposits.

The ratio of loans to deposits stood at 84.9% as of September 30, 2012, marginally up from 85.4% as of June 30, 2012.

Profitability and Capital Ratios

Zions’ profitability and capital ratios exhibit a modestly cautious approach. As of September 30, 2012, tier 1 leverage ratio was 11.04% versus 12.31% in the previous quarter and 13.48% in the year-ago quarter. Likewise, tier 1 risk-based capital ratio was 13.46% compared with 15.03% as of June 30, 2012 and 16.10% as of September 30, 2011.

The annualized return on average assets improved to 0.82% in the reported quarter, rising from 0.70% in the prior quarter, but marginally declining from 0.84% in the prior-year quarter. As of September 30, 2012, tangible common equity ratio climbed to 7.17%, from 6.91% in the prior quarter and 6.90% in the year-ago quarter.

Book value per share as of September 30, 2012 stood at $26.05, up from $25.48 as of June 30, 2012 and $24.78 as of September 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. Entire repayment 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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