10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

COMMISSION FILE NUMBER 001-12307

 

 

ZIONS BANCORPORATION

(Exact name of Registrant as specified in its charter)

 

 

 

UTAH   87-0227400

(State or other jurisdiction of

incorporation or organization)

 

(Internal Revenue Service Employer

Identification Number)

One South Main, 15th Floor

Salt Lake City, Utah

  84133
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (801) 524-4787

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

   Name of Each Exchange on Which
Registered

Guarantee related to 8.00% Capital Securities of Zions Capital Trust B

   New York Stock Exchange

6% Subordinated Notes due September 15, 2015

   New York Stock Exchange

Depositary Shares each representing a 1/40th ownership interest in a share of Series A Floating-Rate Non-Cumulative Perpetual Preferred Stock

   New York Stock Exchange

Depositary Shares each representing a 1/40th ownership interest in a share of Series C 9.5% Non-Cumulative Perpetual Preferred Stock

   New York Stock Exchange

Common Stock, without par value

   The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None.

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x      Accelerated filer  ¨      Non-accelerated filer  ¨      Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨    No  x

 

Aggregate Market Value of Common Stock Held by Non-affiliates at June 30, 2008

   $ 3,226,459,704

Number of Common Shares Outstanding at February 20, 2009

     115,337,627 shares

Documents Incorporated by Reference:

Portions of the Company’s Proxy Statement – Incorporated into Part III

 

 

 


Table of Contents

FORM 10-K TABLE OF CONTENTS

 

          Page
   PART I   
Item 1.   

Business.

   6
Item 1A.   

Risk Factors.

   11
Item 1B.   

Unresolved Staff Comments.

   13
Item 2.   

Properties.

   13
Item 3.   

Legal Proceedings.

   13
Item 4.   

Submission of Matters to a Vote of Security Holders.

   13
   PART II   
Item 5.   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

   14
Item 6.   

Selected Financial Data.

   17
Item 7.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

   18
Item 7A.   

Quantitative and Qualitative Disclosures About Market Risk.

   122
Item 8.   

Financial Statements and Supplementary Data.

   123
Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

   186
Item 9A.   

Controls and Procedures.

   186
Item 9B.   

Other Information.

   186
   PART III   
Item 10.   

Directors, Executive Officers and Corporate Governance.

   186
Item 11.   

Executive Compensation.

   186
Item 12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

   186
Item 13.   

Certain Relationships and Related Transactions, and Director Independence.

   187
Item 14.   

Principal Accounting Fees and Services.

   187
   PART IV   
Item 15.   

Exhibits, Financial Statement Schedules.

   188

Signatures

   193

 

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PART I

FORWARD-LOOKING INFORMATION

Statements in this Annual Report on Form 10-K that are based on other than historical data are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and include, among others:

 

   

statements with respect to the beliefs, plans, objectives, goals, guidelines, expectations, anticipations, and future financial condition, results of operations and performance of Zions Bancorporation (“the parent”) and its subsidiaries (collectively “the Company,” “Zions,” “we,” “our,” “us”);

 

   

statements preceded by, followed by or that include the words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “projects,” or similar expressions.

These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties and actual results may differ materially from those presented, either expressed or implied, in this Annual Report on Form 10-K, including, but not limited to, those presented in the Management’s Discussion and Analysis. Factors that might cause such differences include, but are not limited to:

 

   

the Company’s ability to successfully execute its business plans, manage its risks, and achieve its objectives;

 

   

changes in political and economic conditions, including the political and economic effects of the current economic crisis and other major developments, including wars, military actions and terrorist attacks;

 

   

changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts its operations, including without limitation, reduced rates of business formation and growth, commercial and residential real estate development and real estate prices;

 

   

fluctuations in markets for equity, fixed-income, commercial paper and other securities, including availability, market liquidity levels, and pricing;

 

   

changes in interest rates, the quality and composition of the loan and securities portfolios, demand for loan products, deposit flows and competition;

 

   

acquisitions and integration of acquired businesses;

 

   

increases in the levels of losses, customer bankruptcies, claims and assessments;

 

   

changes in fiscal, monetary, regulatory, trade and tax policies and laws, including policies of the U.S. Department of Treasury and the Federal Reserve Board;

 

   

the Company’s participation or lack of participation in governmental programs implemented under the Emergency Economic Stabilization Act (“EESA”) and the American Recovery and Reinvestment Act (“ARRA”), including without limitation the Troubled Asset Relief Program (“TARP”), the Capital Purchase Program (“CPP”), and the Temporary Liquidity Guarantee Program (“TLGP”) and the impact of such programs and related regulations on the Company and on international, national, and local economic and financial markets and conditions;

 

   

the impact of the EESA and the ARRA and related rules and regulations on the business operations and competitiveness of the Company and other participating American financial institutions, including the impact of the executive compensation limits of these acts, which may impact the ability of the Company and other American financial institutions to retain and recruit executives and other personnel necessary for their businesses and competitiveness;

 

   

the impact of certain provisions of the EESA and ARRA and related rules and regulations on the attractiveness of governmental programs to mitigate the effects of the current economic crisis, including the risks that certain financial institutions may elect not to participate in such programs, thereby decreasing the effectiveness of such programs;

 

   

continuing consolidation in the financial services industry;

 

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new litigation or changes in existing litigation;

 

   

success in gaining regulatory approvals, when required;

 

   

changes in consumer spending and savings habits;

 

   

increased competitive challenges and expanding product and pricing pressures among financial institutions;

 

   

demand for financial services in the Company’s market areas;

 

   

inflation and deflation;

 

   

technological changes and the Company’s implementation of new technologies;

 

   

the Company’s ability to develop and maintain secure and reliable information technology systems;

 

   

legislation or regulatory changes which adversely affect the Company’s operations or business;

 

   

the Company’s ability to comply with applicable laws and regulations;

 

   

changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or regulatory agencies; and

 

   

increased costs of deposit insurance and changes with respect to Federal Deposit Insurance Corporation (“FDIC”) insurance coverage levels.

The Company specifically disclaims any obligation to update any factors or to publicly announce the result of revisions to any of the forward-looking statements included herein to reflect future events or developments.

AVAILABILITY OF INFORMATION

We also make available free of charge on our website, www.zionsbancorporation.com, annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission.

GLOSSARY OF ACRONYMS

ABS – Asset-Backed Security

AFS – Available-for-Sale

ALCO – Asset/Liability Committee

ALM – Asset-Liability Management

AML – Anti-Money Laundering

ARM – Adjustable Rate Mortgage

ARRA – American Recovery and Reinvestment Act

ATM – Automated Teller Machine

BCBS – Basel Committee on Banking Supervision

BSA – Bank Secrecy Act

CDARS – Certificate of Deposit Account Registry System

CDO – Collateralized Debt Obligation

CMC – Capital Management Committee

COSO – Committee of Sponsoring Organizations of the Treadway Commission

CPFF – Commercial Paper Funding Facility

CPP – Capital Purchase Program

CRA – Community Reinvestment Act

 

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CRE – Commercial Real Estate

EESA – Emergency Economic Stabilization Act

EITF – Emerging Issues Task Force

ESOARS – Employee Stock Option Appreciation Rights Securities

FAMC – Federal Agricultural Mortgage Corporation

FASB – Financial Accounting Standards Board

FDIC – Federal Deposit Insurance Corporation

FHLB – Federal Home Loan Bank

FHLMC – Federal Home Loan Mortgage Corporation

FIN – FASB Interpretation

FINRA – Financial Industry Regulatory Authority

FNMA – Federal National Mortgage Association

FRB – Federal Reserve Board

FSP – FASB Staff Position

FTE – Full-Time Equivalent

GNMA – Government National Mortgage Association

HTM – Held-to-Maturity

ISDA – International Swap Dealer Association

LIBOR – London Inter-Bank Offering Rate

LTV – Loan-to-Value

MD&A – Management’s Discussion and Analysis

NPR – Notice of Proposed Rulemaking

NRSRO – Nationally Recognized Statistical Rating Organization

OCC – Office of the Comptroller of the Currency

OCI – Other Comprehensive Income

OREO – Other Real Estate Owned

OTC – Over-the-Counter

OTTI – Other-Than-Temporary-Impairment

PCAOB – Public Company Accounting Oversight Board

PDs – Probabilities of Default

QSPE – Qualifying Special-Purpose Entity

REIT – Real Estate Investment Trust

SBA – Small Business Administration

SBIC – Small Business Investment Company

SEC – Securities and Exchange Commission

SFAS – Statement of Financial Accounting Standards

TAF – Term Auction Facility

TARP – Troubled Asset Relief Program

TLGP – Temporary Liquidity Guarantee Program

VIE – Variable Interest Entity

 

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ITEM 1. BUSINESS

DESCRIPTION OF BUSINESS

Zions Bancorporation (“the Parent”) is a financial holding company organized under the laws of the State of Utah in 1955, and registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Parent and its subsidiaries (collectively “the Company”) own and operate eight commercial banks with a total of 513 domestic branches at year-end 2008. The Company provides a full range of banking and related services through its banking and other subsidiaries, primarily in Utah, California, Texas, Arizona, Nevada, Colorado, Idaho, Washington, and Oregon. Full-time equivalent employees totaled 11,011 at year-end 2008. For further information about the Company’s industry segments, see “Business Segment Results” on page 60 in Management’s Discussion and Analysis (“MD&A”) and Note 22 of the Notes to Consolidated Financial Statements. For information about the Company’s foreign operations, see “Foreign Operations” on page 58 in MD&A. The “Executive Summary” on page 18 in MD&A provides further information about the Company.

PRODUCTS AND SERVICES

The Company focuses on providing community banking services by continuously strengthening its core business lines of 1) small, medium-sized business and corporate banking; 2) commercial and residential development, construction and term lending; 3) retail banking; 4) treasury cash management and related products and services; 5) residential mortgage; 6) trust and wealth management; and 7) investment activities. It operates eight different banks in ten Western and Southwestern states with each bank operating under a different name and each having its own board of directors, chief executive officer, and management team. The banks provide a wide variety of commercial and retail banking and mortgage lending products and services. They also provide a wide range of personal banking services to individuals, including home mortgages, bankcard, other installment loans, home equity lines of credit, checking accounts, savings accounts, time certificates of various types and maturities, trust services, safe deposit facilities, direct deposit, and 24-hour ATM access. In addition, certain banking subsidiaries provide services to key market segments through their Women’s Financial, Private Client Services, and Executive Banking Groups. We also offer wealth management services through a subsidiary, Contango Capital Advisors, Inc. (“Contango”), and online brokerage services through Zions Direct.

In addition to these core businesses, the Company has built specialized lines of business in capital markets, public finance, and certain financial technologies, and is also a leader in Small Business Administration (“SBA”) lending. Through its eight banking subsidiaries, the Company provides SBA 7(a) loans to small businesses throughout the United States and is also one of the largest providers of SBA 504 financing in the nation. The Company owns an equity interest in the Federal Agricultural Mortgage Corporation (“Farmer Mac”) and is one of the nation’s top originators of secondary market agricultural real estate mortgage loans through Farmer Mac. The Company is a leader in municipal finance advisory and underwriting services. The Company also controls four venture capital funds that provide early-stage capital primarily for start-up companies located in the Western United States. Finally, the Company’s NetDeposit subsidiary is a leader in the provision of check imaging and clearing software.

COMPETITION

The Company operates in a highly competitive environment. The Company’s most direct competition for loans and deposits comes from other commercial banks, thrifts, and credit unions, including institutions that do not have a physical presence in our market footprint but solicit via the Internet and other means. In addition, the Company competes with finance companies, mutual funds, brokerage firms, securities dealers, investment banking companies, financial technology firms, and a variety of other types of companies. Many of these companies have fewer regulatory constraints and some have lower cost structures or tax burdens.

The primary factors in competing for business include pricing, convenience of office locations and other delivery methods, range of products offered, and the level of service delivered. The Company must compete effectively along all of these parameters to remain successful.

 

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SUPERVISION AND REGULATION

The Parent is a bank holding company that has elected to become a financial holding company under the BHC Act. The Gramm-Leach-Bliley Act of 1999 (“the GLB Act”) provides a regulatory framework for financial holding companies, which have as their umbrella regulator the Federal Reserve Board (“FRB”). The functional regulation of the separately regulated subsidiaries of a holding company is conducted by each subsidiary’s primary functional regulator. To qualify for and maintain status as a financial holding company, the Parent must satisfy certain ongoing criteria.

In addition, the Company’s subsidiary banks are subject to the provisions of the National Bank Act or the banking laws of their respective states, as well as the rules and regulations of the Office of the Comptroller of the Currency (“OCC”), the FRB, and the FDIC. They are also under the supervision of, and are continually subject to periodic examination by, the OCC or their respective state banking departments, the FRB, and the FDIC. Many of our nonbank subsidiaries are also subject to regulation by the FRB and other applicable federal and state agencies. Our brokerage and investment advisory subsidiaries are regulated by the Securities and Exchange Commission (“SEC”), Financial Industry Regulatory Authority (“FINRA”) and/or state securities regulators. Our other nonbank subsidiaries may be subject to the laws and regulations of the federal government and/or the various states in which they conduct business.

The Company is subject to various requirements and restrictions contained in both the laws of the United States and the states in which its banks and other subsidiaries operate. These regulations include but are not limited to the following:

 

   

Laws and regulations regarding the availability, requirements and restrictions of a number of recently enacted governmental programs in which the Company participates, including the TARP and its associated CPP, the TLGP, the Term Auction Facility (“TAF”) and the Commercial Paper Funding Facility (“CPFF”), as well as certain conditions imposed by the EESA and ARRA and programs thereunder, including limitations on dividends on common stock in the CPP, and on executive compensation contained in the ARRA. Some of these programs, including specifically the CPP, contain provisions that allow the U.S. Government to unilaterally modify any term or provision of contracts executed under the program.

 

   

Requirements for approval of acquisitions and activities. The prior approval is required, in accordance with the BHC Act of the FRB, for a financial holding company to acquire or hold more than 5% voting interest in any bank. The BHC Act allows, subject to certain limitations, interstate bank acquisitions and interstate branching by acquisition anywhere in the country. The BHC Act also requires approval for certain nonbanking acquisitions and restricts the Company’s nonbanking activities to those that are permitted for financial holding companies or that have been determined by the FRB to be financial in nature, incidental to financial activities, or complementary to a financial activity.

 

   

Capital requirements. The FRB has established capital guidelines for financial holding companies. The OCC, the FDIC, and the FRB have also issued regulations establishing capital requirements for banks. Additional capital requirements, including taking additional capital from the U.S. Treasury in amounts and on terms yet to be defined, to be determined by “stress tests” not yet designed, may be required by the U.S. Treasury for banks larger than the Company, and could become required of the Company. There also is a risk that regional bank companies like Zions which are not deemed to be systemically important will be disadvantaged by not being allowed to participate in future government capital programs. The federal bank regulatory agencies have adopted and are proposing risk-based capital rules described below. Failure to meet capital requirements could subject the Parent and its subsidiary banks to a variety of restrictions and enforcement remedies. See Note 19 of the Notes to Consolidated Financial Statements for information regarding capital requirements.

The U.S. federal bank regulatory agencies’ risk-based capital guidelines are based upon the 1988 capital accord (“Basel I”) of the Basel Committee on Banking Supervision (the “BCBS”). The BCBS is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines that each country’s supervisors can use to determine the

 

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supervisory policies they apply. The BCBS has been working for a number of years on revisions to Basel I. In December 2007, U.S. banking regulators published the final rule for Basel II implementation, requiring banks with over $250 billion in consolidated total assets or on-balance sheet foreign exposure of $10 billion (core banks) to adopt the Advanced Approach of Basel II while allowing other banks to elect to “opt in.”

Basel II provides two approaches for setting capital standards for credit risk – an internal ratings-based approach tailored to individual institutions’ circumstances and a standardized approach that bases risk weightings on external credit assessments to a much greater extent than permitted in existing risk-based capital guidelines. Basel II also sets capital requirements for operational risk and refines the existing capital requirements for market risk exposures. Operational risk is defined to mean the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems, or from external events. Basel I does not include separate capital requirements for operational risk.

We are not currently an “opt in” bank holding company, as the Company does not have in place the data collection and analytical capabilities necessary to adopt the Advanced Approach. However, we believe that the competitive advantages afforded to companies that do adopt the Advanced Approach may make it necessary for the Company to elect to “opt in” at some point. Whether or not this scenario emerges, our risk management will be well served by our continuing investment in more sophisticated analytical capabilities and in an enhanced data environment.

In July 2008, the U.S. banking regulators issued a proposed rule that would provide “non-core” banks with the option to adopt the Standardized Approach proposed in Basel II, replacing the previously proposed Basel 1A framework. While the Advanced Approach uses sophisticated mathematical models to measure and assign capital to specific risks, the Standardized Approach categorizes risks by type and then assigns capital requirements. We are evaluating the benefit of adopting the Standardized Approach and will make a decision following publication of the final rule.

Additional modifications of the Basel II regime continue to be proposed or adopted, but the requirements of the CPP and the ARRA appear to be “overriding” for the time being on any Basel II issues as they might apply to the Company.

 

   

Requirements that the Parent serve as a source of strength for its banking subsidiaries. The FRB has a policy that a bank holding company is expected to act as a source of financial and managerial strength to each of its bank subsidiaries and, under appropriate circumstances, to commit resources to support each subsidiary bank. In addition, the OCC may order an assessment of the Parent if the capital of one of its national bank subsidiaries were to fall below capital levels required by the regulators.

 

   

Limitations on dividends payable by subsidiaries. A substantial portion of the Parent’s cash, which is used to pay dividends on our common and preferred stock and to pay principal and interest on our debt obligations, is derived from dividends paid by the Parent’s subsidiary banks. These dividends are subject to various legal and regulatory restrictions as summarized in Note 19 of the Notes to Consolidated Financial Statements.

 

   

Cross-guarantee requirements. All of the Parent’s subsidiary banks are insured by the FDIC. Each commonly controlled FDIC-insured bank can be held liable for any losses incurred, or reasonably expected to be incurred, by the FDIC due to another commonly controlled FDIC-insured bank being placed into receivership, and for any assistance provided by the FDIC to another commonly controlled FDIC-insured bank that is subject to certain conditions indicating that receivership is likely to occur in the absence of regulatory assistance.

 

   

Safety and soundness requirements. Federal and state laws require that our banks be operated in a safe and sound manner. We are subject to additional safety and soundness standards prescribed in the Federal Deposit Insurance Corporate Improvement Act of 1991, including standards related to internal controls, information systems, internal audit, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, as well as other operational and management standards deemed appropriate by the federal banking agencies.

 

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Limitations on the amount of loans to a borrower and its affiliates.

 

   

Limitations on transactions with affiliates.

 

   

Restrictions on the nature and amount of any investments and ability to underwrite certain securities.

 

   

Requirements for opening of branches and the acquisition of other financial entities.

 

   

Fair lending and truth in lending requirements to provide equal access to credit and to protect consumers in credit transactions.

 

   

Provisions of the GLB Act and other federal and state laws dealing with privacy for nonpublic personal information of individual customers.

 

   

Community Reinvestment Act (“CRA”) requirements. The CRA requires banks to help serve the credit needs in their communities, including credit to low and moderate income individuals. Should the Company or its subsidiaries fail to adequately serve their communities, penalties may be imposed including denials of applications to add branches, relocate, add subsidiaries and affiliates, and merge with or purchase other financial institutions.

 

   

Anti-money laundering regulations. The Bank Secrecy Act (“BSA”) and other federal laws require financial institutions to assist U.S. Government agencies to detect and prevent money laundering. Specifically, the BSA requires financial institutions to keep records of cash purchases of negotiable instruments, file reports of cash transactions exceeding $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. Title III of the Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) substantially broadens the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, defining new crimes and related penalties, and expanding the extra-territorial jurisdiction of the United States. The U.S. Treasury Department has issued a number of implementing regulations, which apply various requirements of the USA Patriot Act to financial institutions. The Company’s bank and broker-dealer subsidiaries and private investment companies advised or sponsored by the Company’s subsidiaries must comply with these regulations. These regulations also impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.

The Parent is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, both as administered by the SEC. As a company quoted on the NASDAQ Stock Market LLC (“Nasdaq”) Global Select Market, the Parent is subject to Nasdaq listing standards for quoted companies.

The Company is subject to the Sarbanes-Oxley Act of 2002, which addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. Nasdaq has also adopted corporate governance rules, which are intended to allow shareholders and investors to more easily and efficiently monitor the performance of companies and their directors.

The Board of Directors of the Parent has implemented a comprehensive system of corporate governance practices. This system includes Corporate Governance Guidelines, a Code of Business Conduct and Ethics for Employees, a Directors Code of Conduct, and charters for the Audit, Credit Review, Compensation, and Nominating and Corporate Governance Committees. More information on the Company’s corporate governance practices is available on the Company’s website at www.zionsbancorporation.com. (The Company’s website is not part of this Annual Report on Form 10-K.)

The Company has adopted policies, procedures and controls to address compliance with the requirements of the banking, securities and other laws and regulations described above or otherwise applicable to the Company. The Company intends to make appropriate revisions to reflect any changes required.

 

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Regulators, Congress, and state legislatures continue to enact rules, laws, and policies to regulate the financial services industry and public companies and to protect consumers and investors. The nature of these laws and regulations and the effect of such policies on future business and earnings of the Company cannot be predicted.

GOVERNMENT MONETARY POLICIES

The earnings and business of the Company are affected not only by general economic conditions, but also by policies adopted by various governmental authorities. The Company is particularly affected by the monetary policies of the FRB, which affect short-term interest rates and the national supply of bank credit. The tools available to the FRB which may be used to implement monetary policy include:

 

   

open-market operations in U.S. Government securities;

 

   

adjustment of the discount rates or cost of bank borrowings from the FRB;

 

   

imposing or changing reserve requirements against bank deposits;

 

   

term auction facilities collateralized by bank loans; and

 

   

other programs to purchase assets and inject liquidity directly in various segments of the economy.

These methods are used in varying combinations to influence the overall growth or contraction of bank loans, investments and deposits, and the interest rates charged on loans or paid for deposits.

In view of the changing conditions in the economy and the effect of the FRB’s monetary policies, it is difficult to predict future changes in loan demand, deposit levels and interest rates, or their effect on the business and earnings of the Company. FRB monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.

 

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ITEM 1A. RISK FACTORS

The following list describes several risk factors which are significant to the Company including but not limited to:

 

   

The United States and other countries are facing a severe economic crisis. In response the United States and other governments have established a variety of programs and policies designed to mitigate the effects of the crisis. Many of these programs and policies are unprecedented and untested and may not be effective or may have adverse consequences, whether anticipated or unanticipated. If these programs and policies are ineffective or result in substantial adverse developments, the economic crisis may become more severe or may continue for a substantial period of time. Any increase in the severity or duration of the economic crisis would adversely affect the Company.

 

   

The Company has chosen to participate in a number of new programs sponsored by the U.S. Government during the current financial and economic crisis, and in the future may elect to or be required to participate in these or other, as not yet enacted, programs. The company is therefore subject to the risk that these programs may not be available in the future, or that it will be forced to participate in programs that it does not believe to be in its best interest or that of its shareholders. These programs, including the TARP and its associated CPP, the TLGP, the TAF, and the CPFF, as well as the ARRA and EESA, contain important limitations on the Company’s conduct of its business, including limitations on dividends, repurchases of common stock, acquisitions, and executive compensation contained in the CPP and the ARRA. These limitations may adversely impact the Company’s ability to attract nongovernmental capital and to recruit and retain executive management and other personnel and its ability to compete with other American and foreign financial institutions. One of these programs, the CPP, contains provisions that allow the U.S. Government to unilaterally modify any term or provision of contracts executed under the program.

 

   

Certain provisions of the ESSA and ARRA and related rules and regulations may lead certain financial institutions to elect not to participate in governmental programs designed to mitigate the current economic crisis, thereby decreasing the effectiveness of such programs and creating additional stresses on employees and customers of and investors in American financial institutions.

 

   

Credit risk is one of our most significant risks. The Company’s level of credit quality continued to weaken during 2008. The deterioration in credit quality is mainly related to the weakness in residential development and construction activity in the Southwest that started in the latter half of 2007. Although not to the degree experienced in the Southwestern states (generally Arizona, Nevada and California), some signs of deterioration began to surface in Utah and Idaho during the first quarter of 2008 and in the Texas market in the fourth quarter of 2008. Residential construction and land development loans in Arizona and Nevada remain the most troubled segments of the portfolio and account for the most meaningful declines in commercial real estate credit quality during the last half of 2008. We expect continued credit quality deterioration over the next few quarters. With the economy continuing to weaken, there is a risk that credit quality could be adversely impacted throughout our geographic footprint and for other loan types.

 

   

Net interest income is the largest component of the Company’s revenue. The management of interest rate risk for the Company and all bank subsidiaries is centralized and overseen by an Asset Liability Management Committee appointed by the Company’s Board of Directors. The Company has been successful in its interest rate risk management as evidenced by its achieving a relatively stable net interest margin over the last several years when interest rates have been volatile and the rate environment challenging. Factors beyond the Company’s control can significantly influence the interest rate environment and increase the Company’s risk. These factors include competitive pricing pressures for our loans and deposits, adverse shifts in the mix of deposits and other funding sources, and volatile market interest rates subject to general economic conditions and the policies of governmental and regulatory agencies, in particular the FRB.

 

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Funding availability, as opposed to funding cost, became a more important risk factor in the latter half of 2007 and in 2008, as a global liquidity crisis affected financial institutions generally, including the Company, and is expected to remain an issue in 2009. However, this global liquidity crisis was partially mitigated as the Company strengthened its capital and liquidity during the latter half of 2008, including raising approximately $300 million of common and preferred equity, a capital investment of $1.4 billion from the U.S. Treasury as part of the Treasury’s CPP, as well as its participation in the TAF, and the TLGP. See “Capital Management” on page 119 in MD&A and Notes 11 and 14 of the Notes to Consolidated Financial Statements for further information on funding availability.

 

   

It is expected that liquidity stresses will continue to be a risk factor in 2009 for the Company, the Parent and its affiliate banks, and for Lockhart Funding, LLC (“Lockhart”). Lockhart’s participation in the CPFF has mitigated these stresses for it; however, this program is currently scheduled to expire in October 2009.

 

   

Zions Bank sponsors an off-balance sheet qualifying special-purpose entity (“QSPE”), Lockhart, which funds its assets by issuing asset-backed commercial paper. Its assets include securities which are rated AAA and AA or guaranteed by the U.S. Government. Factors beyond the Company’s control can significantly influence whether Lockhart will remain as an off-balance sheet QSPE and whether the Company will be required to purchase, and possibly incur losses, on securities from Lockhart under the provisions of a Liquidity Agreement the Company provides to Lockhart. These factors include Lockhart’s inability to issue asset-backed commercial paper, expiration of the Federal Reserve’s CPFF without sufficient offsetting market demand for Lockhart’s commercial paper, rating agency downgrades of securities, and instability in the credit markets.

 

   

The Company’s on-balance sheet asset-backed securities investment portfolio includes collateralized debt obligations (“CDOs”) collateralized by trust preferred securities issued by banks, insurance companies, and real estate investment trusts (“REITs”) that may have some exposure to the subprime market and/or to other categories of distressed assets. In addition, asset-backed securities also include structured asset-backed collateralized debt obligations (“ABS CDOs”) (also known as diversified structured finance CDOs) purchased from Lockhart which have minimal exposure to subprime and home equity mortgage securitizations. Factors beyond the Company’s control can significantly influence the fair value of these securities and potential adverse changes to the fair value of these securities. These factors include but are not limited to rating agency downgrades of securities, defaults of debt issuers, lack of market pricing of securities, rating agency downgrades of monoline insurers that insure certain asset-backed securities, and continued instability in the credit markets. See “Investment Securities Portfolio” on page 85 for further details.

 

   

The Company is exposed to accounting, financial reporting, and regulatory/compliance risk. The Company provides to its customers a number of complex financial products and services. Estimates, judgments and interpretations of complex and changing accounting and regulatory policies are required in order to provide and account for these products and services. Identification, interpretation and implementation of complex and changing accounting standards as well as compliance with regulatory requirements, including the BSA and various Know Your Customer, Identity Theft Red Flag, and Anti-Money Laundering regulations, therefore pose an ongoing risk.

 

   

The Company is subject to risks associated with legal claims and litigation. The Company’s exposure to claims and litigation may increase as a result of stresses on customers, counterparties and others arising from the current economic crisis.

 

   

A failure in our internal controls could have a significant negative impact not only on our earnings, but also on the perception that customers, regulators and investors may have of the Company. We continue to devote a significant amount of effort, time and resources to improving our controls and ensuring compliance with complex accounting standards and regulations.

 

   

As noted previously, U.S. and international regulators have adopted new capital standards commonly known as Basel II. As a bank holding company with less than $250 billion in consolidated total assets

 

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and on-balance sheet foreign exposure of less than $10 billion, we can but are not required to adopt the Advanced Approach of Basel II. We have not as yet chosen to adopt it. However, these standards would apply to a number of our largest competitors and potentially give them a competitive advantage over banks that do not adopt these standards. Whether or not this competitive disparity emerges, the Company is continuing to develop systems, data and analytical capabilities that both enhance our internal risk management process and help facilitate Basel II adoption, if we choose to do so in the future.

 

   

From time to time the Company makes acquisitions. The success of any acquisition depends, in part, on our ability to realize the projected cost savings from the merger and on the continued growth and profitability of the acquisition target. We have been successful with most prior mergers, but it is possible that the merger integration process with an acquisition target could result in the loss of key employees, disruptions in controls, procedures and policies, or other factors that could affect our ability to realize the projected savings and successfully retain and grow the target’s customer base.

The Company’s Board of Directors established an Enterprise-Wide Risk Management policy and appointed an Enterprise Risk Management Committee in 2005 to oversee and implement the policy. In addition to credit and interest rate risk, the Committee also monitors the following risk areas: market risk, liquidity risk, operational risk, compliance risk, information technology risk, strategic risk, and reputation risk.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

At December 31, 2008, the Company operated 513 domestic branches, of which 269 are owned and 244 are leased. The Company also leases its headquarter offices in Salt Lake City, Utah. Other operation facilities are either owned or leased. The annual rentals under long-term leases for leased premises are determined under various formulas and factors, including operating costs, maintenance, and taxes. For additional information regarding leases and rental payments, see Note 18 of the Notes to Consolidated Financial Statements.

 

ITEM 3. LEGAL PROCEEDINGS

The information contained in Note 18 of the Notes to Consolidated Financial Statements is incorporated by reference herein.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

MARKET INFORMATION

The Company’s common stock is traded on the Nasdaq Global Select Market under the symbol “ZION.” The last reported sale price of the common stock on Nasdaq on February 20, 2009 was $9.00 per share.

The following table sets forth, for the periods indicated, the high and low sale prices of the Company’s common stock, as quoted on Nasdaq:

 

     2008    2007
     High     Low    High    Low

1st Quarter

   $ 57.05     39.31    88.56    81.18

2nd Quarter

     51.15     29.46    86.00    76.59

3rd Quarter

     107.21 1   17.53    81.43    67.51

4th Quarter

     47.94     21.07    73.00    45.70

 

1

This trading price was an anomaly resulting from electronic orders at the opening of the market on September 19, 2008 in response to the SEC’s announcement (prior to the market opening that day) of its temporary emergency action suspending short selling in financial companies. The closing price on September 19, 2008 was $52.83.

During September 8-11, 2008, the Company issued $250 million of new common stock consisting of 7,194,079 shares at an average price of $34.75 per share. Net of issuance costs and fees, this issuance added $244.9 million to common stock.

As of February 20, 2009, there were 6,224 holders of record of the Company’s common stock.

DIVIDENDS

The frequency and amount of common stock dividends paid during the last two years are as follows:

 

     1st Quarter    2nd Quarter    3rd Quarter    4th Quarter

2008

   $ 0.43    0.43    0.43    0.32

2007

     0.39    0.43    0.43    0.43

On January 26, 2009, the Company’s Board of Directors approved a dividend of $0.04 per common share payable on February 25, 2009 to shareholders of record on February 11, 2009. This is a reduction from prior dividend levels in response to the deteriorating outlook for the Company and generally for the industry and the economy as a whole. The Company expects to continue its policy of paying regular cash dividends on a quarterly basis, although there is no assurance as to future dividends because they depend on future earnings, capital requirements, and financial condition.

We have 3,000,000 authorized shares of preferred stock without par value and with a liquidation preference of $1,000 per share. As of December 31, 2008, 240,000, 46,949, and 1,400,000 of preferred shares series A, C, and D, respectively, have been issued. In general, preferred shareholders may receive asset distributions before common shareholders; however, preferred shareholders have only limited voting rights generally with respect to certain provisions of the preferred stock, the issuance of senior preferred stock, and the election of directors. Preferred stock dividends reduce earnings available to common shareholders and are paid quarterly in arrears. The redemption amount is computed at the per share liquidation preference plus any declared but unpaid dividends. The series A and C shares are registered with the SEC.

 

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The Series D Fixed-Rate Cumulative Perpetual Preferred Stock was issued on November 14, 2008 to the U.S. Department of the Treasury for $1.4 billion in a private placement exempt from registration. The EESA authorized the U.S. Treasury to appropriate funds to eligible financial institutions participating in the TARP Capital Purchase Program. The capital investment includes the issuance of preferred shares of the Company and a warrant to purchase common shares pursuant to a Letter Agreement and a Securities Purchase agreement (collectively “the Agreement”). The preferred shares are ranked pari passu with the Series A and C preferred shares. The dividend rate of 5% increases to 9% after the first five years. Dividend payments are made on the 15 th day of February, May, August, and November. The warrant allows the U.S. Treasury to purchase up to 5,789,909 shares of the Company’s common stock exercisable over a 10-year period at a price per share of $36.27. The preferred shares and the warrant qualify for Tier 1 regulatory capital. The Agreement subjects the Company to certain restrictions and conditions including those related to common dividends, share repurchases, executive compensation, and corporate governance.

We recorded the total $1.4 billion of the preferred shares and the warrant at their relative fair values of $1,292.2 million and $107.8 million, respectively. The difference from the par amount of the preferred shares is accreted to preferred stock over five years using the interest method with a corresponding adjustment to preferred dividends.

The Company cannot increase the common stock dividend above $0.32 per share without the consent of the U.S. Treasury until the third anniversary of the date of the investment, or November 14, 2011, unless prior to such third anniversary the senior preferred stock series D is redeemed in whole or the U.S. Treasury has transferred all of the senior preferred stock series D to third parties.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

The information contained in Item 12 of this Form 10-K is incorporated by reference herein.

SHARE REPURCHASES

The following table summarizes the Company’s share repurchases for the fourth quarter of 2008:

 

Period

   Total number of
shares
repurchased1
   Average price paid
per share
   Total number of
shares purchased
as part of
publicly announced
plans or programs
   Approximate
dollar value of
shares that
may yet be
purchased
under the plan

October

   100    $ 34.99                –    $ 56,250,315

November

   387      29.50         56,250,315

December

   8,918      25.97         56,250,315
               

Fourth quarter

   9,405      26.21      
               

 

1

All share repurchases during the fourth quarter of 2008 were made to pay for payroll taxes upon the vesting of restricted stock.

The Company has not repurchased any shares under the Common Stock Repurchase Plan since August 16, 2007. It is prohibited from repurchasing any common shares by terms of the CPP until the Company’s CPP capital has been repaid.

 

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PERFORMANCE GRAPH

The following stock performance graph compares the five-year cumulative total return of Zions Bancorporation’s common stock with the Standard & Poor’s 500 Index and the KBW Bank Index which includes Zions Bancorporation. The KBW Bank Index is a market capitalization-weighted bank stock index developed and published by Keefe, Bruyette & Woods, Inc., a nationally recognized brokerage and investment banking firm specializing in bank stocks. The index is composed of 24 geographically diverse stocks representing national money center banks and leading regional financial institutions. The stock performance graph is based upon an initial investment of $100 on December 31, 2003 and assumes reinvestment of dividends.

LOGO

 

     2003    2004    2005    2006    2007    2008

Zions Bancorporation

   100.0    113.3    128.4    142.7    82.7    45.1

KBW Bank Index

   100.0    110.3    113.7    133.0    104.1    54.9

S&P 500

   100.0    110.8    116.3    134.6    142.0    89.5

 

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ITEM 6. SELECTED FINANCIAL DATA

Financial Highlights

 

(In millions, except per share amounts)   2008/2007
Change
    2008     2007     2006     20054     2004  

For the Year

           

Net interest income

  +5 %   $ 1,971.6     1,882.0     1,764.7     1,361.4     1,160.8  

Noninterest income

  -54 %     190.7     412.3     551.2     436.9     431.5  

Total revenue

  -6 %     2,162.3     2,294.3     2,315.9     1,798.3     1,592.3  

Provision for loan losses

  +326 %     648.3     152.2     72.6     43.0     44.1  

Noninterest expense

  +5 %     1,475.0     1,404.6     1,330.4     1,012.8     923.2  

Impairment loss on goodwill

      353.8             0.6     0.6  

Income (loss) before income taxes and minority interest

  -143 %     (314.8 )   737.5     912.9     741.9     624.4  

Income taxes (benefit)

  -118 %     (43.4 )   235.8     318.0     263.4     220.1  

Minority interest

  -163 %     (5.1 )   8.0     11.8     (1.6 )   (1.7 )

Net income (loss)

  -154 %     (266.3 )   493.7     583.1     480.1     406.0  

Net earnings (loss) applicable to common shareholders

  -161 %     (290.7 )   479.4     579.3     480.1     406.0  

Per Common Share

           

Net earnings (loss) – diluted

  -160 %     (2.66 )   4.42     5.36     5.16     4.47  

Net earnings (loss) – basic

  -160 %     (2.67 )   4.47     5.46     5.27     4.53  

Dividends declared

  -4 %     1.61     1.68     1.47     1.44     1.26  

Book value1

  -10 %     42.65     47.17     44.48     40.30     31.06  

Market price – end

      24.51     46.69     82.44     75.56     68.03  

Market price – high2

      57.05     88.56     85.25     77.67     69.29  

Market price – low

      17.53     45.70     75.13     63.33     54.08  

At Year-End

           

Assets

  +4 %     55,093     52,947     46,970     42,780     31,470  

Net loans and leases

  +7 %     41,859     39,088     34,668     30,127     22,627  

Sold loans being serviced3

  -69 %     578     1,885     2,586     3,383     3,066  

Deposits

  +12 %     41,316     36,923     34,982     32,642     23,292  

Long-term borrowings

  +1 %     2,622     2,591     2,495     2,746     1,919  

Shareholders’ equity:

           

Preferred equity

  +559 %     1,582     240     240          

Common equity

  -3 %     4,920     5,053     4,747     4,237     2,790  

Performance Ratios

           

Return on average assets

      (0.50 )%   1.01 %   1.32 %   1.43 %   1.31 %

Return on average common equity

      (5.69 )%   9.57 %   12.89 %   15.86 %   15.27 %

Efficiency ratio

      67.47 %   60.53 %   56.85 %   55.67 %   57.22 %

Net interest margin

      4.18 %   4.43 %   4.63 %   4.58 %   4.27 %

Capital Ratios1

           

Equity to assets

      11.80 %   10.00 %   10.62 %   9.90 %   8.87 %

Tier 1 leverage

      9.99 %   7.37 %   7.86 %   8.16 %   8.31 %

Tier 1 risk-based capital

      10.22 %   7.57 %   7.98 %   7.52 %   9.35 %

Total risk-based capital

      14.32 %   11.68 %   12.29 %   12.23 %   14.05 %

Tangible common equity

      5.89 %   5.70 %   5.98 %   5.28 %   6.80 %

Tangible equity

      8.86 %   6.17 %   6.51 %   5.28 %   6.80 %

Selected Information

           

Average common and common-equivalent shares
(in thousands)

      109,145     108,523     108,028     92,994     90,882  

Common dividend payout ratio

      na     37.82 %   27.10 %   27.14 %   28.23 %

Full-time equivalent employees

      11,011     10,933     10,618     10,102     8,026  

Commercial banking offices

      513     508     470     473     386  

ATMs

      625     627     578     600     475  

 

1

At year-end.

2

The actual high price was $107.21. However, this trading price was an anomaly resulting from electronic orders at the opening of the market on September 19, 2008 in response to the SEC’s announcement (prior to the market opening that day) of its temporary emergency action suspending short selling in financial companies. The closing price on September 19, 2008 was $52.83.

3

Amount represents the outstanding balance of loans sold and being serviced by the Company, excluding conforming first mortgage residential real estate loans.

4

Amounts for 2005 include Amegy Corporation at December 31, 2005 and for the month of December 2005.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

MANAGEMENT’S DISCUSSION AND ANALYSIS

EXECUTIVE SUMMARY

Company Overview

Zions Bancorporation (“the Parent”) and subsidiaries (collectively “the Company,” “Zions,” “we,” “our,” “us”) together comprise a $55 billion financial holding company headquartered in Salt Lake City, Utah. As of September 30, 2008, the Company was the 19th largest domestic bank holding company in terms of deposits. At December 31, 2008, the Company operated banking businesses through 513 domestic branches and 625 ATMs in ten Western and Southwestern states: Arizona, California, Colorado, Idaho, Nevada, New Mexico, Oregon, Texas, Utah, and Washington. Our banking businesses include: Zions First National Bank (“Zions Bank”), in Utah and Idaho; California Bank & Trust (“CB&T”); Amegy Corporation (“Amegy”) and its subsidiary, Amegy Bank, in Texas; National Bank of Arizona (“NBA”); Nevada State Bank (“NSB”); Vectra Bank Colorado (“Vectra”), in Colorado and New Mexico; The Commerce Bank of Washington (“TCBW”); and The Commerce Bank of Oregon (“TCBO”).

The Company also operates a number of specialty financial services and financial technology businesses that conduct business on a regional or national scale. The Company is a national leader in Small Business Administration (“SBA”) lending, public finance advisory services, and software sales and cash management services related to “Check 21 Act” electronic imaging and clearing of checks. In addition, Zions is included in the Standard and Poor’s 500 (“S&P 500”) and NASDAQ Financial 100 indices.

In operating its banking businesses, the Company seeks to combine the front office or customer facing advantages that it believes can result from decentralized organization and branding, with those that can come from centralized risk management, capital management and operations. In its specialty financial services and technology businesses, the Company seeks to develop a competitive advantage in a particular product, customer, or technology niche.

 

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Distribution of Loans and Deposits

As shown in Charts 1 and 2 the Company’s loans and core deposits are widely diversified among the banking franchises the Company operates.

LOGO

LOGO

Note: Core deposits are defined as total deposits excluding

brokered deposits and time deposits $100,000 and over.

 

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The Company’s loan portfolio also is diversified as to type of loan. However, as shown in Chart 3, it does have a significant concentration of exposure to commercial real estate, including residential land, acquisition and development lending in Arizona, Nevada, and to a lesser degree, California and the Intermountain West, that have been under severe stress due to the ongoing declines in housing-related prices and in residential building.

LOGO

Business Strategies

We believe that the Company distinguishes itself by having a strategy for growth in its banking businesses that is unique for a bank holding company of its size. This growth strategy is driven by four key factors: (1) focus on high growth markets; (2) keep decisions that affect customers local; (3) centralize technology and operations to achieve economies of scale; and (4) centralize and standardize policies and management controlling key risks. These strategies are more fully set forth as follows:

Focus on High Growth Markets

Each of the states in which the Company conducts its banking businesses has experienced relatively high levels of historical economic growth and each ranks among the top one-third of states as ranked by population and household income growth projected by the U.S. Census Bureau. Despite slowdowns in population, employment, and key indicators of economic growth in some of these markets in 2008, which is expected to persist through much of 2009, the Company believes that over the medium to longer term all of these markets will continue to be among the fastest growing in the country.

 

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Schedule 1

DEMOGRAPHIC PROFILE

BY STATE

 

(Dollar amounts in
thousands)
  Number
of branches
12/31/2008
  Deposits at
12/31/20081
  Percent of
Zions’
deposit base
    Estimated
2008 total
population2
  Estimated
population
% change
2000-20082
    Projected
population
% change
2008-20132
    Estimated
median
household
income
20082
  Estimated
household
income

% change
2000-20082
    Projected
household
income
% change
2008-20132
 

Utah

  116   $ 13,825,330   33.46 %   2,677,229   19.23 %   12.57 %   $ 60.3   30.76 %   16.05 %

California

  90     7,933,186   19.20     37,873,407   11.44     6.84       61.8   28.71     16.17  

Texas

  83     8,625,056   20.88     24,627,546   17.51     11.32       52.4   30.15     18.32  

Arizona

  79     3,896,531   9.43     6,630,722   28.24     17.47       55.3   34.92     20.13  

Nevada

  77     3,512,195   8.50     2,730,425   35.35     20.00       58.1   29.19     16.17  

Colorado

  40     2,071,894   5.01     4,962,478   14.87     9.04       62.5   31.06     16.75  

Idaho

  25     781,523   1.89     1,549,062   19.06     12.67       50.4   32.55     20.34  

Washington

  1     602,731   1.46     6,628,203   12.06     7.98       60.8   31.75     15.96  

New Mexico

  1     32,647   0.08     2,029,633   11.21     7.66       44.7   29.69     18.71  

Oregon

  1     35,403   0.09     3,814,725   11.13     7.61       53.5   29.54     17.71  

Zions’ weighted average

          16.56     10.33       61.8   32.14     18.41  

Aggregate national

        309,299,265   9.59     6.30       54.7   28.82     16.97  

 

1

Excludes intercompany deposits.

2

Data Source: SNL Financial Database

The Company seeks to grow both organically and through acquisitions in these banking markets. Within each of the states where the Company operates, we focus on the market segments that we believe present the best opportunities for us. We believe that these states over time have experienced higher rates of growth, business formation, and expansion than other states. We also believe that over the long term these states will continue to experience higher rates of commercial real estate development as businesses provide housing, shopping, business facilities and other amenities for their growing populations. However, in the near term growth in many of our geographies and market segments has slowed markedly due to weakening economic conditions and loan demand. We have recently experienced net portfolio shrinkage in distressed residential real estate markets in the Southwest.

A common focus of all of Zions’ subsidiary banks is small and middle market business banking (including the personal banking needs of the executives and employees of those businesses) and commercial real estate development. In addition to our commercial business, we also provide a broad base of consumer financial products in selected markets, including home mortgages, home equity credit lines, auto loans, and credit cards. This mix of business often leads to loan balances growing faster than internally generated deposits; this was particularly true in much of 2008 as loan growth significantly outpaced low cost core deposit growth. In addition, it has important implications for the Company’s management of certain risks, including interest rate and liquidity risks, which are discussed further in later sections of this document.

Keep Decisions That Affect Customers Local

The Company operates eight different community/regional banks, each under a different name, and each with its own charter, chief executive officer and management team. This structure helps to ensure that decisions related to customers are made at a local level. In addition, each bank controls, among other things, most decisions related to its branding, market strategies, customer relationships, product pricing, and credit decisions (within the limits of established corporate policy). In this way we are able to differentiate our banks from much larger, “mass market” banking competitors that operate regional or national franchises under a common brand and often

 

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around “vertical” product silos. We believe that this approach allows us to attract and retain exceptional management, and that it also results in providing service of the highest quality to our targeted customers. In addition, we believe that over time this strategy generates superior growth in our banking businesses.

Centralize Technology and Operations to Achieve Economies of Scale

We seek to differentiate the Company from smaller banks in two ways. First, we use the combined scale of all of the banking operations to create a broad product offering without the fragmentation of systems and operations that would typically drive up costs. Second, for certain products for which economies of scale are believed to be important, the Company “manufactures” the product centrally or outsources it from a third party. Examples include cash management, credit card administration, mortgage servicing, and deposit operations. In this way the Company seeks to create and maintain efficiencies while generating superior growth.

Centralize and Standardize Policies and Management Controlling Key Risks

We seek to standardize policies and practices related to the management of key risks in order to assure a consistent risk profile in an otherwise decentralized management model. Among these key risks and functions are credit, interest rate, liquidity, and market risks. Although credit decisions are made locally within each affiliate bank, these decisions are made within the framework of a corporate credit policy that is standard among all of our affiliate banks. Each bank may amend the policy in a more conservative direction; however, it may not amend the policy in a more liberal direction. In that case, it must request a specific waiver from the Company’s Chief Credit Officer; in practice only a limited number of waivers have been granted. Similarly, the Credit Examination function is a corporate activity, reporting to the Credit Review Committee of the Board of Directors, and administratively reporting to the Director of Enterprise Risk Management, who reports to the Company’s CEO. This assures a reasonable consistency of loan quality grading and loan loss reserving practices among all affiliate banks.

Interest rate risk management, liquidity and market risk, and portfolio investments also are managed centrally by a Board-designated Asset Liability Management Committee pursuant to corporate policies regarding interest rate risk, liquidity, investments and derivatives.

Internal Audit also is a centralized, corporate function reporting to the Audit Committee of the Board of Directors, and administratively reporting to the Director of Enterprise Risk Management, who reports to the Company’s CEO.

Finally, the Board established an Enterprise Risk Management Committee in late 2005, which is supported by the Director of Enterprise Risk Management. This Committee seeks to monitor and mitigate as appropriate these and other key operating and strategic risks throughout the Company.

MANAGEMENT’S OVERVIEW OF 2008 PERFORMANCE

The “sub-prime mortgage” crisis became a financial crisis in the latter half of 2007 and the economy entered into an increasingly severe economic recession during 2008. In 2008, both financing and capital became increasingly expensive and difficult for the Company to obtain as the year went on. Finally, in mid-September, which saw in rapid succession the effective nationalization of Fannie Mae and Freddie Mac, the failure of Lehman Brothers, and the Federal “rescue” of insurance giant, American International Group Inc (“AIG”), essentially all capital and financial markets world-wide became extremely disrupted.

As this crisis unfolded and became more severe, the Federal Reserve Board (“FRB”) and later the U.S. Treasury took a series of increasingly strong and less conventional actions to try to mitigate the crisis. Starting in mid-2007 the FRB aggressively lowered short term interest rates; after a brief pause in mid-2008, this aggressive reduction resumed and left the target Fed Funds rate at an all-time low of 0-0.25% at year-end 2008. In 2008 the FRB introduced a number of programs to directly provide greater liquidity to a financial system under severe stress, including trying to formally remove any stigma from Discount Window borrowings, followed by a series of

 

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programs to inject liquidity directly into the banking system, such as the Term Auction Facility (“TAF”), and later into financial markets more broadly. As capital levels in the banking system became increasingly strained, active and possibly abusive short-selling of financial stocks, including that of the Company, rose to unprecedented levels. This activity made it increasingly difficult for financial companies to raise additional capital without causing existing shareholders to incur high levels of ownership dilution, and led the Securities and Exchange Commission (“SEC”) to enact a series of temporary bans on short-selling of financial stocks and certain abusive short-selling practices in the fall of 2008. The Treasury’s Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”) to invest in preferred stock of financial institutions was launched in September, followed by the FRB’s Commercial Paper Funding Facility (“CPFF”) program and the Federal Deposit Insurance Corporation’s (“FDIC”) Temporary Liquidity Guarantee Program (“TLGP”) in November. The CPP provided for the direct investment of $350 billion of preferred equity into the banking system, while the TLGP provided a way for banks with maturing unsecured senior debt to refinance that debt with a guarantee provided by the FDIC. These programs and actions had the objective of preserving a functioning banking and financial system that could continue to finance economic activity during a time of severe financial and economic stress.

On October 3, 2008, the FDIC increased deposit insurance to $250,000 through December 31, 2009. In addition, the FDIC implemented a program to provide full deposit insurance coverage for noninterest-bearing transaction deposit accounts through December 31, 2009, unless insured banks elect to opt out of the program. The Company did not opt out of this program.

The crisis clearly adversely impacted the Company’s performance and management focused a great deal of attention on managing the impact of the crisis.

The Company reported a net loss of $266.3 million for 2008 as compared to net income of $493.7 million for 2007. Net loss applicable to common shareholders for 2008 was $290.7 million or $2.66 per diluted common share. This compares with net earnings applicable to common shareholders of $479.4 million or $4.42 per diluted share for 2007 and $579.3 million or $5.36 per share for 2006. Return on average common equity was (5.69)% and return on average assets was (0.50)% in 2008, compared with 9.57% and 1.01% in 2007 and 12.89% and 1.32% in 2006.

The key drivers of the Company’s performance during 2008 were as follows:

Schedule 2

KEY DRIVERS OF PERFORMANCE

2008 COMPARED TO 2007

 

Driver

   2008     2007     Change
better/(worse)
 
     (In billions)        

Average net loans and leases

   $ 41.0     36.8     11 %

Average total noninterest-bearing deposits

     9.1     9.4     (3 )%

Average total deposits

     37.6     35.8     5 %
     (In millions)        

Net interest income

   $ 1,971.6     1,882.0     5 %

Provision for loan losses

     (648.3 )   (152.2 )   (326 )%

Impairment and valuation losses on securities

     (317.1 )   (158.2 )   (100 )%

Goodwill Impairment

     (353.8 )       nm  

Net interest margin

     4.18 %   4.43 %   (25 )bp

Ratio of nonperforming assets to net loans and leases
and other real estate owned

     2.71 %   0.73 %   (198 )bp

Efficiency ratio

     67.47 %   60.53 %   (694 )bp

 

nm – not meaningful

bp – basis points

 

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The Company’s performance in 2008 compared to 2007 reflected the following:

 

   

Strong loan growth, in the first half of the year, followed by restrained loan growth throughout most of the second half of the year;

 

   

Lagging organic deposit growth, particularly the lack of noninterest-bearing deposit growth until late in the year, resulting in a greater dependence on market rate funds;

 

   

Net interest margin deterioration until the fourth quarter of the year, mainly due to financing loan growth with a more expensive mix of funding, the addition of lower net interest spread Lockhart Funding, LLC (“Lockhart”) commercial paper to the balance sheet, and pricing pressure on deposits in a difficult liquidity environment experienced by most of the domestic financial system;

 

   

An increased provision for loan losses stemming mainly from credit-quality deterioration in our Southwestern residential land acquisition, development and construction lending portfolios, but also some heightened provisions related to emerging credit quality stresses in other markets;

 

   

Significant impairment charges on the Company’s investment securities deemed “other-than-temporarily impaired” and valuation losses associated with securities purchased from Lockhart, a qualifying special-purpose entity (“QSPE”) securities conduit, pursuant to the Liquidity Agreement between Lockhart and Zions Bank. See “Off-Balance Sheet Arrangement” on page 96 for further details on Lockhart;

 

   

Goodwill impairment charges. In the fourth quarter the Company determined 100% of the goodwill at its NBA, NSB, and Vectra banking subsidiaries and nearly all of the goodwill at NetDeposit, LLC (“NetDeposit”) from merged company P5, Inc., (a small medical payments technology and services company) to be impaired.

We continue to focus on managing four primary drivers of our business performance: 1) loan and deposit growth, 2) credit quality, 3) interest rate risk, and 4) controlling expenses. However, in 2008 results also were significantly and adversely impacted by the effects of the global financial crisis on the Company’s securities portfolio, liquidity and capital levels.

Loan and Deposit Growth

Since 2004, the Company has experienced steady and strong loan growth and moderate deposit growth, augmented in 2005 and 2006 by the Amegy acquisition, in 2007 by the Stockmen’s acquisition, and in 2008 by the Silver State acquisition (deposits only). From 2004 through 2006, we consider this performance to be primarily a result of strong economic conditions throughout most of our geographical footprint, and of effectively executing our operating strategies. The continued strong organic loan growth in the latter half of 2007 may also have begun to reflect the increasing lack of nonbank sources of credit as global credit market conditions deteriorated sharply. Chart 4 depicts this growth.

LOGO

 

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The Company experienced little or no net organic loan growth in 2008 in its three Southwestern banks (CB&T, NBA, and NSB), which were most heavily impacted by deteriorating conditions in the residential real estate markets. In these banks repayments and charge-offs of residential acquisition and development loans largely offset some growth in other types of lending.

Despite credit quality deterioration and net loan portfolio shrinkage in these three banks, the Company experienced actual period-end to period-end loan growth of 7.1% in 2008. However, $1.2 billion of the total loan growth of $2.8 billion reflected the required purchase from Lockhart of small business loans made and securitized in prior years. These loans were purchased due to Lockhart’s inability to sell commercial paper and a ratings downgrade that resulted not from deterioration in the loans, but rather from a downgrade of bond insurance company MBIA, which provided the credit enhancement of the AAA-rated securitization tranches. Excluding these purchases, all of this organic loan growth totaled $1.6 billion, or 4.1%. All of this growth occurred in the first half of 2008. In the third quarter the Company actively held down net loan growth to mitigate the funding and capital strains mentioned earlier. In the fourth quarter, after funding strains and capital positions improved, the Company relaxed these self-imposed growth constraints. However, fourth quarter growth in many loan categories was offset by repayments and charge-offs in the Southwest residential acquisition and development portfolio. In 2008 net loan growth in our CB&T, NBA, and NSB subsidiaries was negative due to these repayments and charge-offs of real estate secured loans.

Reflecting trends throughout the banking industry, average core deposits grew only $1.8 billion or 5.7% from year-end 2007, including the effect of the Silver State acquisition, which lagged the growth rate of loans. In addition, average noninterest-bearing demand deposits decreased by $0.3 billion from year-end 2007. Thus, the Company increased its reliance on more costly sources of funding during the year.

In 2008 the Company reviewed opportunities to augment organic growth by the potential acquisition of several distressed and failed banks, but concluded only one—the purchase in September from the FDIC of the insured deposits and a minimal amount of loans of the failed Silver State Bank in Nevada. In February, 2009, the Company was the successful bidder in the FDIC disposition of the loans and deposits of the failed Alliance Bank in Southern California. This bid was made after the Company had conducted due diligence on the Alliance credit portfolio, and involved a credit loss sharing agreement with the FDIC. The Company believes that current economic stresses affecting a number of banking companies may result in more opportunities in 2009 to acquire distressed or failed banks, where risk can be mitigated, but this cannot be assured.

Credit Quality

The ratio of nonperforming assets to net loans and other real estate owned (“OREO”) increased to 2.71% at year-end, compared to 0.73% at the end of 2007. Net loan charge-offs for 2008 were $393.7 million, or 0.96% of average loans, compared to $63.6 million or 0.17% of average loans for 2007. Charts 7 and 8 highlight net charge-offs by loan purpose and bank affiliate. The provision for loan losses during 2008 increased significantly to $648.3 million compared to $152.2 million for 2007. While the Company’s ratio of nonperforming assets to net loans and OREO is now higher than peer averages (see Chart 5), its net charge-off rate remains well below peer averages (see Chart 6). We believe that both of these trends reflect the collateral secured nature of many of the Company’s problem loans, which lead to higher nonaccrual levels and lower net losses than, for example, portfolios of peers with large unsecured credit card or other consumer loan concentrations.

All of these trends largely reflect the impact of deteriorating credit quality conditions in residential land acquisition and development and construction lending in the Southwest. In addition in the latter part of 2008, the Company began to see evidence of spillover (as evidenced by, for example, rising delinquency rates) of this deterioration into other geographies and components of its portfolio, including some segments of its residential first mortgage portfolio, commercial and industrial lending, and nonresidential commercial real estate construction lending. Due to the continuing and worsening recessionary economic conditions that unfolded late in 2008 and into 2009, we believe that stresses on our credit portfolio likely will continue at least in the first half of 2009 and possibly throughout the year and into 2010.

 

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LOGO

Note: Peer group is defined as bank holding companies

with assets > $10 billion excluding banks providing

primarily trust services.

Peer data source: SNL Financial Database

LOGO

Note: Peer group is defined as bank holding companies

with assets > $10 billion excluding banks providing

primarily trust services.

Peer data source: SNL Financial Database

 

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LOGO

LOGO

Interest Rate Risk

Our focus in managing interest rate risk is to not take positions based upon management’s forecasts of interest rates, but rather to maintain a position of slight “asset-sensitivity.” This means that our assets, primarily loans, tend to reprice slightly more quickly than our liabilities, primarily deposits. The Company makes extensive use of interest rate swaps to hedge interest rate risk in order to seek to achieve this desired position. This practice has enabled us to achieve a relatively stable net interest margin during periods of volatile interest rates, which is depicted in Chart 9. However, due to changes in newly originated and renewed loan spreads, changes in the relationship between the prime rate and London Inter-Bank Offer Rate (“LIBOR”), changes in the pattern of prime rate behavior in several of our banks, and other factors, our hedging strategy was more difficult to conduct in 2008. In particular we incurred nonhedge derivative losses in noninterest income, and a number of our interest

 

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rate swaps became ineffective under the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities, and were terminated. Nonetheless, on the whole our interest rate risk management believes its actions continued to result in one of the highest and most stable net interest margins in the industry. We believe that our risk position at December 31, 2008 was more “asset sensitive” than has typically been the case, reflecting in part a lessening of hedging activity due to the historically low interest rate environment.

Taxable-equivalent net interest income in 2008 increased 4.6% over 2007. The net interest margin declined to a still high 4.18% for 2008, down from 4.43% for 2007. The Company was able to achieve this performance despite rising levels of nonaccrual loans and other nonperforming assets, adverse changes in its funding mix, and significant pressures on funding costs. These factors resulted in a fairly steady compression, until the fourth quarter, of the net interest margin.

LOGO

Note: Peer group is defined as bank holding companies

with assets > $10 billion excluding banks providing

primarily trust services.

Peer data source: SNL Financial Database

Throughout 2008 the relationships among a number of interest rates that are key drivers of the Company’s business deviated significantly, and for long periods, from normal. Of particular significance were the relationships between deposit rates, the prime rate, and LIBOR. Due to liquidity strains throughout the banking industry, rates on bank deposits remained higher than would have been expected despite the unprecedented FRB actions to reduce rates. In some cases deposit rates in the Company’s markets appear to have remained high in part due to the particular stresses being felt by several large institutions that later failed or were sold. These pressures, combined with the lack of lower cost core deposit growth, kept the Company’s cost of funding its loans and other assets higher than might have been expected. These same stresses were felt world-wide, and until very late in 2008 LIBOR rates stayed unusually high in relation to risk-free rates, and in relation to lending rates, which generally followed the Fed Funds rates down as the FRB aggressively pushed that rate lower.

Strong loan growth in the first half of 2008 thus was funded primarily with interest-bearing deposits and nondeposit funding. Noninterest-bearing deposits, as noted, actually declined during the year, which pressured the net interest margin. Mitigating these funding cost pressures were somewhat improved loan pricing spreads relative to LIBOR and prime rates during the year.

 

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See the section “Interest Rate Risk” on page 111 for more information regarding the Company’s asset-liability management (“ALM”) philosophy and practice and our interest rate risk management.

Controlling Expenses

During 2008, the Company’s efficiency (expense-to-revenue) ratio increased to 67.5% from 60.5% for 2007. The efficiency ratio is the relationship between noninterest expense and total taxable-equivalent revenue. The increase in the efficiency ratio to 67.5% for 2008 was primarily due to the effect on revenue of the impairment and valuation losses on securities as previously discussed. Because of the significant securities impairment and valuation losses, the Company believes that its efficiency ratio is not a particularly useful measure of how well operating expenses were contained in 2007 and 2008; nor does it believe that this measure is particularly useful for its peers, many of which also experienced large losses and impairment charges as a result of market turmoil and deteriorating credit conditions. The Company’s efficiency ratio was 58.9% and 56.7% if the impairment and valuation losses on securities are excluded for 2008 and 2007, respectively. Noninterest expense increased 5.0% in 2008 compared to 2007. Over half of this increase resulted from further charge-downs of OREO and OREO expense; excluding the effects of changes in OREO expense, noninterest expense grew 1.7% in 2008 compared to 2007.

LOGO

Note: Peer group is defined as bank holding companies

with assets > $10 billion excluding banks providing

primarily trust services.

Peer data source: SNL Financial Database

Effects of Global Financial Crisis on the Company

It is now well recognized that during the period of roughly 2004-2006 a speculative bubble developed in residential housing in some of the Company’s key markets (including Arizona, Southern Nevada, and parts of California), and elsewhere in the United States. The volume of mortgage debt outstanding grew at unprecedented rates, fueled by record low interest rates and increasingly lax lending standards as reflected by so-called subprime, Alt-A, and other alternative mortgages. Median housing prices and housing starts both increased to record levels during this period. Home equity lending standards also deteriorated as lenders were lulled by low default rates and rising home prices.

The Company itself never originated subprime mortgages, had almost no direct exposure to these loans, and never offered residential option adjustable rate mortgage (“ARM”) or “negative amortization” loans. However, the Company has a significant business in financing residential land acquisition, development and construction

 

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activity. The FRB began raising interest rates in 2005-2007 as it became increasingly apparent that the prevailing levels of housing activity were unsustainable. New housing starts hit a record of over 2 million units in each of 2005 and 2006. By December 2007, they had fallen to a revised annualized rate of approximately 1.1 million nationally, and by December 2008 had fallen further to about 550,000. This precipitous decline in housing activity has placed significant stress on a number of the Company’s homebuilder customers, and therefore on the Company’s loan portfolio in this sector. This portfolio peaked in mid-2006 as a percentage of the total loan portfolio and declined as a percentage of the total loan portfolio thereafter. Additionally, the portfolio began to shrink in dollar terms in the latter half of 2007 in the Southwestern markets, and continued to shrink throughout 2008 as a result of pay-downs, loan sales, charge-offs and foreclosures. Nonaccrual loans and provisions for loan losses began to increase significantly in late summer 2007, and continued to increase in 2008, as it became clearer that this housing slump would likely be longer and deeper than originally believed. It also became clear that in the latter months of 2008 the economic recession began to deepen and also became global, and likely would persist and possibly continue to deepen well into 2009. The Company therefore believes that nonaccrual loans, the provision for loan losses, and net charge-offs will likely remain elevated throughout this period.

A number of previously successful and respected financial institutions failed, were “rescued,” or acquired with governmental assistance in 2008, including in the United States: Bear Stearns in March, IndyMac Bank in July, Fannie Mae, Freddie Mac, Merrill Lynch and Lehman Brothers in September, and Wachovia and Washington Mutual in October. As this crisis unfolded, capital and funding markets became increasingly strained and eventually essentially ceased to function worldwide in mid-September. Market values of financial institutions globally, including that of the Company, plummeted, and issuance of new funding and capital became increasingly expensive or impossible.

Traditional markets for underwritten offerings of holding company unsecured senior debt effectively became closed to regional banking companies like Zions in the last few months of 2007 and remained closed through 2008. During this time, Zions had several hundred million dollars of senior debt funding that matured and needed to be replaced with new funding unless cash reserves were to be depleted. Zions successfully refunded or newly issued a total of $560 million of medium term senior notes from the second half of 2007 through August 2008 using its broker-dealer subsidiary, Zions Direct. During this time, it was one of a very few, if any, regional banking companies to successfully issue this type of debt financing. Similarly, the market for underwritten perpetual preferred stock offerings essentially closed to all regional banking companies after May 2008, but Zions again used Zions Direct to issue approximately $47 million of noncumulative perpetual preferred stock in July. Finally, in early September Zions became the last U.S. regional banking company to issue any significant amount of common equity in 2008 when it issued $250 million of common stock.

Beginning in January 2008, several of the Company’s affiliate banks began to bid for funds in the FRB’s TAF program and at a peak in December 2008, the Company had a total of $2.1 billion of such funds. By year-end this amount had declined to $1.8 billion and further declined to $0.5 billion by mid-February 2009. Lockhart also elected to participate in the FRB’s CPFF program, and at year-end had sold $80 million of its commercial paper to the FRB. In October the Company submitted an application for $1.4 billion of preferred capital under the Treasury’s CPP program, near the maximum $1.48 billion for which it was eligible. This application was approved and funded in November. In early December the Company and each of its affiliate banks elected to participate in the FDIC’s TLGP, and in January 2009 the Company issued the maximum amount of such debt for which it was eligible, $254.9 million. Taken together, these and other actions taken by the Company significantly improved both its holding company and bank liquidity and capital positions, and at year-end left the Company in a much stronger position to manage through the continuing economic downturn. However, as many normal capital and funding markets remained highly disrupted at the end of 2008, further stresses in 2009 may be anticipated.

These capital market stresses also had a significant impact on the Company’s investment securities portfolio. A total of $317 million of other-than-temporary-impairment (“OTTI”) and valuation charges were taken against earnings during 2008, compared to $158 million in 2007. In addition, reductions in fair value of

 

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this portfolio that were recorded in Other Comprehensive Income (“OCI”) totaled $246 million in 2008, compared to $111 million in 2007. Collateralized debt obligation (“CDO”) securities became increasingly difficult to value in 2008 as normal markets for them ceased to exist, and under the provisions of SFAS 157, the Company switched to Level 3 model valuations for the great majority of them by year-end 2008 (see page 37 for further discussion of the Company’s valuation of these securities). Since the weakening economy continues to place stress on the underlying bank, insurance, and real estate exposures in many of these securities, the Company believes it is possible that further impairment charges and/or OCI impact may occur in 2009.

Capital and Return on Capital

As regulated financial institutions, the Parent and its subsidiary banks are required to maintain adequate levels of capital as measured by several regulatory capital ratios. One of our goals is to maintain capital levels that are at least “well capitalized” under regulatory standards. The Company and each of its banking subsidiaries exceeded the “well capitalized” guidelines at December 31, 2008. In addition, the Parent and certain of its banking subsidiaries have issued various debt securities that have been rated by the principal rating agencies. As a result, another goal is to maintain capital at levels consistent with an “investment grade” rating for these debt securities. The Company has maintained its “investment grade” debt ratings as have those of its bank subsidiaries that have ratings.

At year-end 2008, the Company’s tangible common equity ratio increased to 5.89% compared to 5.70% at the end of 2007. As noted previously, amid very difficult capital market conditions in the latter half of 2008, the Company strengthened its capital position by issuing $47 million of noncumulative perpetual preferred stock and $250 million of common equity. In November 2008 the Company participated in the CPP (also known as TARP capital), and issued $1.4 billion of cumulative perpetual preferred stock with a common stock warrant attached to the U.S. Treasury. Further, in October 2008 the Company reduced the quarterly dividend on its common stock from $0.43 to $0.32 per share, and in January 2009 again reduced this dividend to $0.04 per share, in order to conserve capital in a highly uncertain environment.

LOGO

This series of actions resulted in capital ratios at Zions at year-end that were higher than in over a decade for all ratios except the tangible common equity ratio. At December 31, 2008, the Company’s tangible common equity ratio was 5.89% and its tangible equity ratio was 8.86%.

 

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LOGO

The Company expects that it (and the banking industry as a whole) may be required by market forces and/or regulation to operate with higher capital ratios than in the recent past. In addition, the CPP capital preferred dividend increases from 5% to 9% in 2013, making it much more expensive as a source of capital if not redeemed at or prior to that time. Thus, in addition to maintaining higher levels of capital, the Company’s capital structure may be subject to greater variation over the next few years than has been true historically.

In addition, we believe that the Company should engage or invest in business activities that provide attractive returns on equity. Chart 13 illustrates that as a result of earnings improvement, the exit of underperforming businesses and returning unneeded capital to the shareholders, the Company’s return on average common equity improved from 2004 to 2005. The decline in 2006 resulted from the additional common equity held due to the acquisition of Amegy. The further decline in the return on average common equity in 2007 and again in 2008 resulted primarily from goodwill impairment, securities impairment charges, and larger provision for loan losses discussed previously, as well as from the additional common equity issued to acquire Stockmen’s.

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As depicted in Chart 14, tangible return on average tangible common equity further improved in 2006 as the Company continued to improve its core operating results. However, it deteriorated significantly in 2007 and 2008 primarily as a result of the securities impairment and valuation losses and the increased provision for loan losses discussed previously.

LOGO

Note: Tangible return is net earnings applicable to common

shareholders plus after-tax amortization of core deposit and

other intangibles and impairment losses on goodwill.

Challenges to Operations

As we enter 2009, we see a number of significant challenges confronting the industry and our company.

Global capital and funding markets remain under significant stress, and most observers believe that the current U.S. and global economic recession may grow more severe at least through the first half of 2009. This continued economic weakness may lead to:

 

   

Further declines in value and potential OTTI charges on CDO securities we own that are largely collateralized by junior debt and trust preferred debt issued by banks and insurance companies.

 

   

Continued weakness in the residential housing construction markets, particularly in Arizona, Nevada and California, but also in Utah and Idaho, resulting in continued high levels of net charge-offs, loan loss provisions and nonperforming assets, as well as higher levels of OREO expense due to continued declines in real estate collateral values.

 

   

A spread of weaker credit conditions to other geographies served by the Company and to other types of loans. In the latter half of 2008, we began to see increasing delinquency rates in some parts of the loan portfolio, including some parts of the residential first mortgage portfolio, nonresidential commercial real estate construction, and commercial and industrial loans. These indications of weakness had not yet resulted in significantly higher levels of net charge-offs by year-end 2008, but continued weakness may lead to higher levels of provisions and losses in 2009.

Capital and funding markets remain highly disrupted as we enter 2009. Some funding markets improved somewhat late in 2008, but these improvements may be largely due to the unprecedented efforts of the FRB and FDIC to inject liquidity into the financial system. It is highly uncertain how those markets will develop in 2009 and how they will react if and when this governmental support begins to be withdrawn. While the Company by many measures has higher levels of capital and funding than it has had in a very long time, the Company, like all financial institutions, at some point may need to access capital and funding markets to support its operations. The conditions under which the Company can access those markets may remain highly uncertain in 2009.

These challenges and others are more fully discussed under “Risk Factors” on page 11.

 

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CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT ESTIMATES

The Notes to Consolidated Financial Statements contain a summary of the Company’s significant accounting policies. We believe that an understanding of certain of these policies, along with the related estimates that we are required to make in recording the financial transactions of the Company, is important in order to have a complete picture of the Company’s financial condition. In addition, in arriving at these estimates, we are required to make complex and subjective judgments, many of which include a high degree of uncertainty. The following is a discussion of these critical accounting policies and significant estimates related to these policies. We have discussed each of these accounting policies and the related estimates with the Audit Committee of the Board of Directors.

We have included sensitivity schedules and other examples to demonstrate the impact of the changes in estimates made for various financial transactions. The sensitivities in these schedules and examples are hypothetical and should be viewed with caution. Changes in estimates are based on variations in assumptions and are not subject to simple extrapolation, as the relationship of the change in the assumption to the change in the amount of the estimate may not be linear. In addition, the effect of a variation in one assumption is in reality likely to cause changes in other assumptions, which could potentially magnify or counteract the sensitivities.

Fair Value Accounting

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements and SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS 157 defines fair value, establishes a consistent framework for measuring fair value, and enhances disclosures about fair value measurements. Adoption of SFAS 157 for the measurement of all nonfinancial assets and nonfinancial liabilities was delayed one year until January 1, 2009. The adoption of SFAS 157 did not have a material effect on the Company’s consolidated financial statements, but significantly expanded the disclosure requirements for fair value measurements.

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. To measure fair value, SFAS 157 has established a hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:

Level 1 – Quoted prices in active markets for identical assets or liabilities; includes certain U.S. Treasury and other U.S. Government and agency securities actively traded in over-the-counter markets; certain securities sold, not yet purchased; and certain derivatives.

Level 2 – Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency securities; certain CDO securities; corporate debt securities; certain private equity investments; certain securities sold, not yet purchased; and certain derivatives. See “Accounting for Derivatives” on page 44 for further details on fair value accounting for derivatives.

Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Additionally, observable inputs such as nonbinding single dealer quotes that are not corroborated by observable market data are included in this category. This category generally includes certain private equity investments and certain CDO securities.

 

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The Company uses models when quotations are not available for certain securities or in markets where trading activity has slowed or ceased. When quotations are not available, and are not provided by third party pricing services, management judgment is necessary to determine fair value. In situations involving management judgment, fair value is determined using discounted cash flow analysis or other valuation models, which incorporate available market information, including appropriate benchmarking to similar instruments, analysis of default and recovery rates, estimation of prepayment characteristics and implied volatilities.

At December 31, 2008, approximately 6.0% of total assets, or $3.3 billion, consisted of financial instruments recorded at fair value on a recurring basis. Of this amount, $2.4 billion of these financial instruments used valuation methodologies involving market-based or market-derived information, collectively Level 1 and 2 measurements, to measure fair value. Approximately $895 million of these financial assets are measured using model-based techniques or nonbinding single dealer quotes, both of which constitute Level 3 measurements. At December 31, 2008, approximately 0.45% of total liabilities, or $221 million, consisted of financial instruments recorded at fair value on a recurring basis. At December 31, 2008, approximately 0.50% of total assets, or $276 million of financial assets were valued on a nonrecurring basis at Level 2.

Fair Value Option

SFAS 159 allows for the option to report certain financial assets and liabilities at fair value initially and at subsequent measurement dates with changes in fair value included in earnings. The option may be applied instrument by instrument, but is on an irrevocable basis. On January 1, 2008, the Company applied the fair value option to one available-for-sale real estate investment trust (“REIT”) trust preferred CDO security and three retained interests on selected small business loan securitizations. The REIT CDO and retained interests were valued using Level 3 models. The cumulative effect of adopting SFAS 159 reduced the beginning balance of retained earnings at January 1, 2008 by approximately $11.5 million, comprised of a decrease of $11.7 million for the REIT CDO and an increase of $0.2 million for the three retained interests. During 2008, the net change in fair value decreased pretax earnings by approximately $9.2 million, consisting of $7.1 million for the REIT CDO security and $2.1 million for the retained interests. These adjustments to fair value are included in fair value and nonhedge derivative income (loss) in the statement of income.

The Company elected the fair value option for the REIT CDO security as part of a directional hedging program in an effort to hedge the credit exposure the Company has to homebuilders in its REIT CDO portfolio. Management selected this security because it had the most exposure to the homebuilder market compared to the other REIT CDO securities in the Company’s portfolio, both in dollar amount and as a percentage, and was therefore considered the most suitable for hedging. The fair value option adoption for the REIT CDO allows the Company to avoid the complex hedge accounting provisions under SFAS 133 associated with the implemented hedging program.

On June 23, 2008, Zions Bank purchased $787 million of securities from Lockhart, which comprised the entire remaining small business loan securitizations created by Zions Bank and held by Lockhart. As a result, the three small business securitization retained interests elected under the fair value option were included in this transaction and were part of the premium amount recorded with the loan balances at Zions Bank. See “Off-Balance Sheet Arrangement” on page 96 for further discussion of these securities purchased.

Estimates of Fair Value

The Company measures or monitors many of its assets and liabilities on a fair value basis. Fair value is used on a recurring basis for certain assets and liabilities in which fair value is the primary basis of accounting. Examples of these include derivative instruments, available-for-sale and trading securities, and private equity investments. Additionally, fair value is used on a nonrecurring basis to evaluate assets or liabilities for impairment or for disclosure purposes in accordance with SFAS No. 107, Disclosures about Fair Value of Financial Instruments. Examples of these nonrecurring uses of fair value include loans held for sale accounted

 

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for at the lower of cost or fair value, impaired loans, long-lived assets, goodwill, and core deposit and other intangible assets. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating the instrument’s fair value. These valuation techniques and assumptions are in accordance with SFAS 157.

Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. If observable market prices are not available, then fair value is estimated using modeling techniques such as discounted cash flow analyses. These modeling techniques utilize assumptions that market participants would use in pricing the asset or the liability, including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset, and the risk of nonperformance. To increase consistency and comparability in fair value measures, SFAS 157 established a three-level hierarchy to prioritize the inputs used in valuation techniques between observable inputs that reflect quoted prices in active markets, inputs other than quoted prices with observable market data, and unobservable data such as the Company’s own data or single dealer nonbinding pricing quotes.

Fair values for investment securities, trading assets, and most derivative financial instruments are based on independent, third party market prices, or if identical market prices are not available they are based on the market prices of similar instruments if available. If market prices of similar instruments are not available, instruments are valued based on the best available data, some of which may not be readily observable in the market. The fair values of loans held for sale are typically based on quotes from market participants. The fair values of OREO and other repossessed assets are typically determined based on appraisals by third parties, less estimated selling costs.

Estimates of fair value are also required when performing an impairment analysis of long-lived assets, goodwill, and core deposit and other intangible assets. The Company reviews goodwill for impairment at the reporting unit level on an annual basis, or more often if events or circumstances indicate the carrying value may not be recoverable. The goodwill impairment test compares the fair value of the reporting unit with its carrying value. If the carrying amount of the Company’s investment in the reporting unit exceeds its fair value, an additional analysis must be performed to determine the amount, if any, by which goodwill is impaired. In determining the fair value of the Company’s reporting units, management uses discounted cash flow models which require assumptions about growth rates of the reporting units and the cost of equity. To the extent that adequate data is available, other valuation techniques relying on market data may be incorporated into the estimate of a reporting unit’s fair value. The selection and weighting of the various fair value techniques may result in a higher or lower fair value. Judgment is applied in determining the amount that is most representative of fair value. For long-lived assets and intangible assets subject to amortization, an impairment loss is recognized if the carrying amount of the asset is not likely to be recoverable and exceeds its fair value. In determining the fair value, management uses models which require assumptions about growth rates, the life of the asset, and/or the fair value of the assets. The Company tests long-lived assets for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable.

 

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Valuation of Collateralized Debt Obligations

The Company values CDO available-for-sale and held-to-maturity securities using several methodologies based on the appropriate fair value hierarchy consistent with currently available market information. At December 31, 2008, the Company valued substantially all of the CDO portfolio using Level 3 pricing methods as follows:

Schedule 3

CDO FAIR VALUES

 

     Held-to-maturity    Available-for-sale
(In millions)    Amortized
cost
   Estimated
fair value
   Amortized
cost
   Estimated
fair value

Trust preferred securities – bank and insurance:

           

Internal model

   $ 1,180    671    779    638

Third party models

     8    6      

Dealer quotes

         16    12

Level 2

         12    11
                     
     1,188    677    807    661

Trust preferred securities – real estate investment trusts:

           

Third party models

     36    21    27    24
                     
     36    21    27    24

Other:

           

Third party models

     76    51    4    4

Dealer quotes

         21    10

Monoline CDS spreads

         72    53

Level 2

         5    5
                     
     76    51    102    72
                     

Total

   $ 1,300    749    936    757
                     

Internal Model

Four developments during 2008 influenced the Company to use a level 3 cash flow modeling approach to value essentially all of its bank and insurance trust preferred securities at December 31, 2008.

 

   

Market activity in the sector became increasingly limited, illiquid, disordered and dominated by, if not limited to, distressed or forced sellers. It became increasingly difficult to substantiate actual trading levels and the “willingness” of sellers executing at those levels. The determination of inactivity/ illiquidity was based on discussion with dealers and CDO managers specializing in the sector as well as a review of bid lists, execution levels of forced trades, and any other information available on trades.

 

   

Bank failures and announced deferrals of interest payments on trust preferred securities contained within the CDOs impacted differently each tranche of each CDO held. Each tranche is unique in the amount of performing, deferring and defaulting collateral, remaining collateral quality and cash flow waterfall mechanics.

 

   

Rating agency watch listing and downgrading of CDO tranches occurred in May, July, August, and November. Each of S&P, Moody’s and Fitch either revised or were in the process of reassessing their ratings model assumptions. This resulted in an increasing lack of consistency in rating levels for CDO tranches. The matrix pricing methodology used from September 2007 to June of 2008 was dependent on securities being substantially similar. In management’s judgment, an operational definition of

 

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“substantially similar” securities capable of supporting the requirements of Level 2 pricing could no longer be created without the addition of significant adjustments based on unobservable inputs beginning in July of 2008 and continuing through year-end 2008.

 

   

Finally, a joint statement of the SEC Office of the Chief Accountant and the FASB staff on September 30, 2008 and FASB’s October 10, 2008 issuance of FASB Staff Position (“FSP”) FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active, provided additional guidance on determining fair value of financial assets when the market for such assets is not active. These statements clarified when and how an entity might, given an inactive market, appropriately determine that the use of an income approach valuation technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs may be equally or more representative of fair value than a market approach valuation.

In the third quarter of 2008, the Company began using a licensed third party model to value bank and insurance trust preferred CDOs. The model uses market-based estimates of expected loss for the individual pieces of underlying collateral to arrive at a pool-level expected loss rate for each CDO. These loss assumptions are applied to the CDO’s structure to generate cash flow projections for each tranche of the CDO. The fair value of each tranche is determined by discounting its resultant loss-adjusted cash flows with appropriate market based discount rates. At December 31, 2008, the discount rate determination referenced several market inputs including current collateralized loan obligation spreads obtained from a third party.

The method for deriving loss expectation for collateral underlying the CDOs depends on whether the collateral is from a public or private company. For public companies, a term structure of Probabilities of Default (“PDs”) is obtained from a commercially available service. The service estimates PDs using a proprietary reduced form model derived using logistic regression on a historical default database. Because the service’s model requires equity valuation related inputs (along with other macro and firm specific inputs) to produce default probabilities, the service does not produce results for private firms and some very small public firms that do not have readily available market data.

For private companies (and the few small public companies not evaluated by the service) PDs are estimated based on credit ratings. The credit ratings come from two external rating sources; one specific to banks, and the other to insurers. The Company has credit ratings for each piece of collateral whether private or public. Using the PD data on the public companies obtained from the commercial service, the Company calculates the average PD for each credit rating level by industry. The rating level average is then applied to all corresponding credits within each rating level that do not have a PD from the commercial service.

The PDs for the underlying collateral are then used to develop CDO deal-level expected loss curves. An external service which models the unique cash-flow waterfall and structure of each CDO deal is used to generate tranche-level cash flows using the Company’s derived CDO deal-level loss assumptions (along with other relevant assumptions). The resultant cash-flows are discounted using current market spreads approximated from related product markets; these spreads differ depending upon the rating agency ratings (usually the Fitch rating) of the CDO, with higher spreads being applied to lower rated CDOs.

The Company did find evidence of one forced trade during the third quarter of 2008 in a tranche of a CDO that is owned by the Company. The forced trade occurred at a price of 35% of face value. This particular deal had amortized down considerably from issuance and the tranche was currently the most senior in the CDO. At the time of the trade the underlying collateral consisted of only five bank obligations and a Freddie Mac zero-coupon principal-only security strip due 2031. Two of the five bank obligations were from Wells Fargo Corporation, which also has publicly available secondary market trading levels on a similar public trust preferred issuance. Even under the assumption that all three of the non-Wells Fargo obligations in the CDO immediately defaulted with no recovery, the projected tranche cash-flows, discounted at the yield of the public Wells Fargo trust preferred issue, resulted in a value of 68% of face value. Based on this analysis, the observed trade at 35% does

 

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not reflect the level at which an informed market participant would value the security. As a comparison, the Company’s model produced a price of 58%. The Company feels that the difference between the model price of 58% and the above outlined scenario price of 68% reflects an appropriate liquidity discount given the lack of activity in CDO markets compared to publicly traded trust preferred markets; this particular security is valued at December 31, 2008 by the Company at 55%.

The following schedule sets forth the sensitivity of the current CDO fair values using an internal model to changes in the most significant assumptions utilized in the model:

Schedule 4

SENSITIVITY OF BANK AND INSURANCE CDO VALUATIONS TO ADVERSE CHANGES OF CURRENT MODEL KEY VALUATION ASSUMPTIONS

 

           Bank and insurance
CDOs at Level 3
 
(Amounts in millions)          Held-to-
maturity
    Available-
for-sale
 

Fair value balance at December 31, 2008

     $ 671     $ 638  

Expected cumulative credit losses1

      

Weighted average:

      

Current defaulted or deferring securities2

       7.9 %     10.0 %

1-year

       12.1 %     14.5 %

5-year

       17.7 %     20.6 %

30-year

       25.3 %     28.6 %

Decrease in fair value due to adverse change

   20 %   $ (22.6 )   $ (1.6 )
   50 %     (61.2 )     (4.3 )

Discount rate3

      

Weighted average spread

       761bp       311bp  

Decrease in fair value due to adverse change

   +100 bp   $ (64.7 )   $ (67.2 )
   +200 bp     (120.0 )     (123.5 )

 

1

The Company uses an expected credit loss model which specifies cumulative losses at the 1-year, 5-year, and 30-year points from the data of valuation.

2

Weighted average percentage of collateral that is defaulted due to bank failures or deferring payment as allowed under the terms of security.

3

The discount rate is a spread over the LIBOR swap yield curve at the date of valuation.

The adverse changes in expected cumulative credit losses resulted in a larger decrease in fair value for held-to-maturity (“HTM”) than available-for-sale (“AFS”) securities because the AFS portfolio is composed primarily of more senior CDO tranches. In general these senior tranches receive accelerated principal payments under scenarios of high credit losses provided that the credit losses do not exceed the available subordination in the CDO deal. By contrast more junior tranches which are in our HTM portfolio absorb credit losses and defer principal and interest payments upon increasing credit losses.

Third Party Models

At December 31, 2008, the Company utilized third party valuation services for sixteen securities with an aggregate amortized cost of $151 million in the Asset-Backed Security (“ABS”) CDO and trust preferred asset classes. These securities continued to have insufficient observable market data available to directly determine prices. The Company reviewed the methodologies employed by third party models. This included a review of all relevant data inputs and the appropriateness of key model assumptions. These assumptions included, but were not limited to, probability of default, collateral recovery rates, discount rates, over-collateralization levels, and rating transition probability matrices from rating agencies. The model valuations obtained from third party services

 

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were evaluated for reasonableness including quarter to quarter changes in assumptions and comparison to other available data which included third party and internal model results and valuations. A range of value estimates is not provided because third party vendors utilized point estimates.

Dealer Quotes

The $37 million of asset-backed securities at amortized cost are valued using nonbinding and unadjusted dealer quotes. Multiple quotes are not available and the values provided are based on a combination of proprietary dealer quotes. Broker disclosure levels vary and the Company seeks to minimize dependence on this Level 3 source. Of the $37 million of securities, approximately $18 million are AAA rated.

Monoline CDS Spreads

A total of $72 million at amortized cost of insured securities purchased out of Lockhart were valued using the relevant monoline insurers’ credit derivative levels.

See Note 4 of the Notes to Consolidated Financial Statements and “Investment Securities Portfolio” on page 85 for further information.

Other-than-Temporary-Impairment – Debt Investment Securities

We review investment debt securities on an ongoing basis for the presence of OTTI with formal reviews performed quarterly. OTTI losses on individual investment securities are recognized as a realized loss through earnings when it is probable that the Company will not collect all of the contractual cash flows or the Company is unable to hold the securities to recovery. OTTI losses include credit losses and a discount for liquidity.

The Company’s OTTI evaluation process conforms with the rules contained in Emerging Issues Task Force (“EITF”) Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets, FSP No. EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20, and SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. These rules require the Company to take into consideration current market conditions, fair value in relationship to cost, extent and nature of change in fair value, issuer rating changes and trends, volatility of earnings, current analysts’ evaluations, all available information relevant to the collectability of debt securities, our ability and intent to hold investments until a recovery of fair value, which may be maturity, and other factors when evaluating for the existence of OTTI in our securities portfolio.

On January 12, 2009, the FASB issued FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20. This FSP is effective for interim and annual reporting periods ending after December 15, 2008, and shall be applied prospectively. The FSP amends EITF 99-20 by eliminating the requirement that a holder’s best estimate of cash flows be based upon those that “a market participant” would use. Instead, the FSP requires that OTTI be recognized as a realized loss through earnings when it is “probable” there has been an adverse change in the holder’s estimated cash flows from the cash flows previously projected, which is consistent with the impairment model in SFAS 115.

The Company recognized pretax OTTI losses of $304.0 million during 2008 and $108.6 million during 2007 on investment debt securities. All of the impairment for 2008 related to securities valued using Level 3 inputs. Management estimates that approximately $135 million of the impairment for 2008 related to credit impairment.

The decision to deem these securities OTTI was based on a specific analysis of the structure of each security and an evaluation of the underlying collateral using information and industry knowledge available to the Company. Future reviews for OTTI will consider the particular facts and circumstances during the reporting period in review.

 

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Allowance and Reserve for Credit Losses

Allowance for loan losses

The allowance for loan losses represents our estimate of the losses that are inherent in the loan and lease portfolios. The determination of the appropriate level of the allowance is based on periodic evaluations of the portfolios along with other relevant factors. These evaluations are inherently subjective and require us to make numerous assumptions, estimates and judgments.

In analyzing the adequacy of the allowance for loan losses, we utilize a comprehensive loan grading system to determine the risk potential in the portfolio and also consider the results of independent internal credit reviews. To determine the adequacy of the allowance, the Company’s loan and lease portfolio is broken into segments based on loan type. For commercial loans, we use historical loss experience factors by loan segment, adjusted for changes in trends and conditions, to help determine an indicated allowance for each segment based on individual loan grades. These factors are evaluated and updated using migration analysis techniques and other considerations based on the makeup of the specific portfolio segment. The other considerations used in our analysis include volumes and trends of delinquencies, levels of nonaccrual loans, repossessions and bankruptcies, trends in criticized and classified loans, and expected losses on loans secured by real estate. In addition, new credit products and policies, economic conditions, concentrations of credit risk, and the experience and abilities of lending personnel are also taken into consideration.

In addition to the segment evaluations, nonaccrual loans graded substandard or doubtful with an outstanding balance of $500 thousand or more are individually evaluated in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, to determine the level of impairment and establish a specific reserve. A specific allowance may also be established for adversely graded loans below $500 thousand when it is determined that the risk associated with the loan differs significantly from the risk factor amounts established for its loan segment and risk grade.

The allowance for consumer loans is determined using historically developed loss experience “roll rates” at which loans migrate from one delinquency level to the next higher level. Using average roll rates for the most recent twelve-month period and comparing projected losses to actual loss experience, the model estimates the expected losses in dollars for the forecasted period. By refreshing the model with updated data, it is able to project losses for a new twelve-month period each month, segmenting the portfolio into nine product groupings with similar risk profiles. This methodology is an accepted industry practice, and the Company believes it has a sufficient volume of information to produce reliable projections.

As a final step to the evaluation process, we perform an additional review of the adequacy of the allowance based on the loan portfolio in its entirety. This enables us to mitigate, but not eliminate, the imprecision inherent in loan- and segment-level estimates of expected credit losses. This review of the allowance includes our judgmental consideration of any adjustments necessary for subjective factors such as economic uncertainties and concentration risks.

There are numerous components that enter into the evaluation of the allowance for loan losses. Some are quantitative while others require us to make qualitative judgments. Although we believe that our processes for determining an appropriate level for the allowance adequately address all of the components that could potentially result in credit losses, the processes and their elements include features that may be susceptible to significant change. Any unfavorable differences between the actual outcome of credit-related events and our estimates and projections could require an additional provision for credit losses, which would negatively impact the Company’s results of operations in future periods. As an example, if a total of $1.0 billion of nonclassified loans were to be immediately classified as special mention, substandard and doubtful in the same proportion as the existing portfolio of the criticized and classified loans, the amount of the allowance for loan losses at December 31, 2008 would increase by approximately $64 million. This sensitivity analysis is hypothetical and has been provided only to indicate the potential impact that changes in the level of the criticized and classified

 

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loans may have on the allowance estimation process. We believe that given the procedures we follow in determining the potential losses in the loan portfolio, the various components used in the current estimation processes are appropriate.

We are in the process of developing potential changes to enhance our methodology for determining the allowance for loan losses. The potential changes include incorporating a two-factor grading system to include probability of default and loss given default. We currently anticipate that these changes will be phased in during 2009. Regardless of the methodology employed, we expect current economic conditions may result in increases to the ALLL throughout 2009.

Reserve for unfunded lending commitments

The Company has historically maintained a reserve for unfunded commitments, recorded in other liabilities. During the fourth quarter of 2008 refinements to this process were implemented to include all unfunded commitments, including the unfunded portions of partially funded credits, which were previously reserved for as part of the allowance for loan losses.

Nonmarketable Equity Securities

The Company either directly, through its banking subsidiaries or through its Small Business Investment Companies (“SBIC”), owns investments in venture funds and other capital securities that are not publicly traded and are not accounted for using the equity method. Since these nonmarketable securities have no readily ascertainable fair values, they are reported at amounts we have estimated to be their fair values. In estimating the fair value of each investment, we must apply judgment using certain assumptions. Initially, we believe that an investment’s cost is the best indication of its fair value, provided that there have been no significant positive or negative developments subsequent to its acquisition that indicate the necessity of an adjustment to a fair value estimate. If and when such an event takes place, we adjust the investment’s cost by an amount that we believe reflects the nature of the event. In addition, any minority interests in the Company’s SBICs reduce its share of any gains or losses incurred on these investments.

As of December 31, 2008, the Company’s total investment in nonmarketable equity securities not accounted for using the equity method was $133.0 million, of which its equity exposure to investments held by the SBICs, net of related minority interest of $26.4 million, was $39.2 million. In addition, exposure to non-SBIC equity investments not accounted for by the equity method was $67.4 million.

The values we have assigned to these securities where no market quotations exist are based upon available information and may not necessarily represent amounts that ultimately will be realized on these securities. Key information used in valuing these securities include the projected financial performance of these companies, the evaluation of the investee company’s management team, and other industry, economic and market factors. If there had been an active market for these securities, the carrying value may have been significantly different from the amounts reported. In addition, since Zions Bank and Amegy are the principal business segments holding these investments, they would experience the largest impact of any changes in the fair values of these securities.

Accounting for Goodwill

Goodwill arises from business acquisitions and represents the value attributable to the unidentifiable intangible elements in our acquired businesses. Goodwill is initially recorded at fair value and is subsequently evaluated at least annually for impairment in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. The Company performs this annual test as of October 1 of each year. Evaluations are also performed on a more frequent basis if events or circumstances indicate impairment could have taken place. Such events could include, among others, a significant adverse change in the business climate, an adverse action by a regulator, an unanticipated change in the competitive environment, and a decision to change the operations or dispose of a reporting unit.

 

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The first step in this evaluation process is to determine if a potential impairment exists in any of the Company’s reporting units and, if required from the results of this step, a second step measures the amount of any impairment loss. The computations required by steps 1 and 2 require us to make a number of estimates and assumptions. In completing step 1, we determine the fair value of the reporting unit that is being evaluated. In determining the fair value, we generally calculate value using a combination of up to three separate methods: comparable publicly traded financial service companies in the Western and Southwestern states; comparable acquisitions of financial services companies in the Western and Southwestern states; and the discounted present value of management’s estimates of future cash or income flows. Critical assumptions that are used as part of these calculations include:

 

   

selection of comparable publicly traded companies, based on location, size, and business composition;

 

   

selection of market comparable acquisition transactions, based on location, size, business composition, and date of the transaction;

 

   

the discount rate applied to future earnings, based on an estimate of the cost of capital;

 

   

the potential future earnings of the reporting unit;

 

   

the relative weight given to the valuations derived by the three methods described;

 

   

the control premium associated with reporting units.

We use a similar methodology in evaluating impairment in nonbank subsidiaries but generally use companies and acquisition transactions nationally in the analysis.

If step 1 indicates a potential impairment of a reporting unit, step 2 requires us to estimate the “implied fair value” of the goodwill of the reporting unit. This process estimates the fair value of the unit’s individual assets and liabilities in the same manner as if a purchase of the reporting unit were taking place. To do this, we must determine the fair value of the assets, liabilities and identifiable intangible assets of the reporting unit based upon the best available information. We estimate the fair market value of all of the tangible assets, identifiable intangible assets and liabilities of the associated reporting units in accordance with the principals of SFAS 157. Loans, deposits with maturities, and debt are fair valued using standard software and assumptions used by Zions in its interest rate risk management processes and using other estimates such as credit assumptions to comply with SFAS 157. Deposits with no maturities are valued at book value. Larger occupied properties are appraised, while for smaller properties and furniture, fixtures and equipment, it is assumed that depreciated book value approximates fair market value. If the implied fair value of goodwill calculated in step 2 is less than the carrying amount of goodwill for the reporting unit, an impairment is indicated and the carrying value of goodwill is written down to the calculated value.

The Company applies a control premium to the market comparables pricing metrics used in the model to determine the reporting units’ equity values. Control premiums represents the ability of a controlling shareholder to benefit from synergies and other intangible assets that arise from control that might cause the fair value of a reporting unit as a whole to exceed its market capitalization. Based on a review of recent bank transactions within the Company’s geographic footprint, comparing market values 30 days prior to the announced transaction to the deal value, the Company determined that a control premium of 25% was appropriate.

Since estimates are an integral part of the impairment computations, changes in these estimates could have a significant impact on any calculated impairment amount. Factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, changes in discount rates, changes in stock and mergers and acquisitions market values, and changes in industry or market sector conditions.

During the fourth quarter of 2008, we performed our annual goodwill impairment evaluation for the entire organization, effective October 1, 2008, and we also rolled forward our goodwill impairment evaluation to December 31, 2008 due to Company’s performance deterioration and market decline from October 1, 2008. This

 

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roll-forward resulted in the recognition of additional impairment in the fourth quarter, compared to the impairment if only the October 1 analysis had been used. Step 1 was performed by using both market value and transaction value approaches for all reporting units and, in certain cases, the discounted cash flow approach was also used. In the market value approach, we identified a group of publicly traded banks using primarily size, location and business mix compared to Zions’ subsidiary banks. We then used valuation multiples, including a control premium, developed from this group to apply to our subsidiary banks. In the transaction value approach, we reviewed the purchase price paid in recent mergers and acquisitions of banks similar in size, location and business mix to Zions’ subsidiary banks. From these purchase prices we developed a set of valuation multiples, which we applied to our subsidiary banks. In instances where the discounted cash flow approach was used, we discounted projected cash flows to their present value to arrive at our estimate of fair value.

Upon completion of step 1 of the evaluation process, we concluded that potential impairment existed at the Company’s NBA, Vectra, NSB, and P5 reporting units. Step 2 was completed with the assistance of an independent valuation consultant and the Company’s internal valuation resources and resulted in $353.8 million of impairment losses. All the goodwill associated with NBA, Vectra and NSB and essentially all the goodwill at P5 was determined to be impaired. This evaluation process required us to make estimates and assumptions with regard to the fair value of the Company’s reporting units and actual values may differ significantly from these estimates. Such differences could result in future impairment of goodwill that would, in turn, negatively impact the Company’s results of operations and the business segments where the goodwill is recorded. Significant remaining amounts of goodwill at December 31, 2008 were as follows: Amegy – $1,249 million, CB&T – $379 million, and Zions Bank – $20 million.

At December 31, 2008, the Company’s book value exceeded the market value by approximately $2.1 billion. The Company reconciled book equity and market equity values as of December 31, 2008 in our year-end evaluation of any potential additional impairment by attempting to identify items priced into the market equity value but not in the book value of the Company. These reconciling items were based on market expectation of fair value between book and market equity including discounts to the loan portfolio, the Company’s exposure to Lockhart holding unrealized losses related to the off-balance sheet securities, and unrecognized and unrealized losses related to HTM securities held on balance sheet. We believe applying a 25% control premium associated with Company or reporting units and the above mentioned factors explains the $2.1 billion difference between book and market equity values.

We expect that the current disrupted market conditions may require us to evaluate goodwill more frequently, including quarterly, as the circumstances warrant. Any differences between estimated fair values and carrying values could result in future impairment of goodwill.

Accounting for Derivatives

Our interest rate risk management strategy involves hedging the repricing characteristics of certain assets and liabilities so as to mitigate adverse effects on the Company’s net interest margin and cash flows from changes in interest rates. While we do not participate in speculative derivatives trading, we consider it prudent to use certain derivative instruments to add stability to the Company’s interest income and expense, to modify the duration of specific assets and liabilities, and to manage the Company’s exposure to interest rate movements.

Additionally, the Company executes derivative instruments, including interest rate swaps and options, forward currency exchange contracts, and energy commodity swaps, with commercial banking customers to facilitate their respective risk management strategies. Those derivatives are immediately hedged by offsetting derivative contracts, such that the Company minimizes its net risk exposure resulting from such transactions. The Company does not use credit default swaps in its investment or hedging operations.

As of December 31, 2008, the recorded amounts of derivative assets, classified in other assets, and derivative liabilities, classified in other liabilities, were $642.3 million and $178.1 million, respectively. When quoted market prices are not available, the valuation of derivative instruments is determined using widely

 

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accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, foreign exchange rates, commodity prices, and implied volatilities. The estimates of fair value are made by an independent third party using a standardized methodology that nets the discounted expected future cash receipts and cash payments (based on observable market inputs). These future net cash flows, however, are susceptible to change due primarily to fluctuations in interest rates (most significantly), foreign exchange rates, and commodity prices. As a result, the estimated values of these derivatives will change over time as cash is received and paid and also as market conditions change. As these changes take place, they may have a positive or negative impact on our estimated valuations. Based on the nature and limited purposes of the derivatives that the Company employs, fluctuations in interest rates have only had a modest effect on its results of operations. As such, fluctuations are generally expected to be countered by offsetting changes in income, expense and/or values of assets and liabilities. However, the Company retains basis risk due to changes between the prime rate and LIBOR on nonhedge derivative basis swaps.

In addition to making the valuation estimates, we also face the risk that certain derivative instruments that have been designated as hedges and currently meet the strict hedge accounting requirements of SFAS 133, may not qualify in the future as “highly effective,” as defined by the Statement, as well as the risk that hedged transactions in cash flow hedging relationships may no longer be considered probable to occur. Further, new interpretations and guidance related to SFAS 133 may be issued in the future, and we cannot predict the possible impact that such guidance may have on our use of derivative instruments going forward.

Although the majority of the Company’s hedging relationships have been designated as cash flow hedges, for which hedge effectiveness is assessed and measured using a “long haul” approach, the Company also had five fair value hedging relationships outstanding as of December 31, 2008 that were designated using the “shortcut” method, as described in SFAS 133, paragraph 68. The Company believes that the shortcut method continues to be appropriate for those hedges because we have precisely complied with the documentation requirements and each of the applicable shortcut criteria described in paragraph 68. During 2008, an immaterial amount of hedge ineffectiveness was required to be reported in earnings on the Company’s outstanding cash flow hedging relationships. In addition, the Company reclassified a loss of $1.7 million from other comprehensive income to earnings during 2008, as the hedged forecasted transactions related to certain terminated cash flow hedging relationships became probable not to occur. This loss is included in fair value and nonhedge derivative income (loss).

Derivative contracts can be exchange-traded or over-the-counter (“OTC”). The Company’s exchange-traded derivatives consist of forward currency exchange contracts, which are part of the Company’s services provided to commercial customers. Exchange-traded derivatives are classified as Level 1 in the fair value hierarchy, as the values of these derivatives are obtained from quoted prices in active markets for identical contracts.

The Company’s OTC derivatives consist of interest rate swaps and options, as well as energy commodity derivatives for customers. The Company has classified its OTC derivatives in Level 2 of the fair value hierarchy, as the significant inputs to the overall valuations are based on market-observable data or information derived from or corroborated by market-observable data, including market-based inputs to models, model calibration to market-clearing transactions, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. Where models are used, the selection of a particular model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. The Company generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model inputs can generally be verified and model selection does not involve significant management judgment.

To comply with the provisions of SFAS 157, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in

 

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the fair value measurements of its OTC derivatives. The credit valuation adjustments are calculated by determining the total expected exposure of the derivatives (which incorporates both the current and potential future exposure) and then applying each counterparty’s credit spread to the applicable exposure. For derivatives with two-way exposure, such as interest rate swaps, the counterparty’s credit spread is applied to the Company’s exposure to the counterparty, and the Company’s own credit spread is applied to the counterparty’s exposure to the Company, and the net credit valuation adjustment is reflected in the Company’s derivative valuations. The total expected exposure of a derivative is derived using market-observable inputs, such as yield curves and volatilities. For the Company’s own credit spread and for counterparties having publicly available credit information, the credit spreads over LIBOR used in the calculations represent implied credit default swap spreads obtained from a third party credit data provider. For counterparties without publicly available credit information, which are primarily commercial banking customers, the credit spreads over LIBOR used in the calculations are estimated by the Company based on current market conditions, including consideration of current borrowing spreads for similar customers and transactions, review of existing collateralization or other credit enhancements, and changes in credit sector and entity-specific credit information. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, current threshold amounts, mutual puts, and guarantees. Additionally, the Company actively monitors counterparty credit ratings for significant changes.

As of December 31, 2008, the net credit valuation adjustments reduced the settlement values of the Company’s derivative assets and liabilities by $12.5 million and $5.0 million, respectively. During 2008, the Company recognized a loss of $3.1 million related to credit valuation adjustments on nonhedge derivative instruments, which is included in noninterest income. Various factors impact changes in the credit valuation adjustments over time, including changes in the credit spreads of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2008, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has classified its OTC derivative valuations in Level 2 of the fair value hierarchy.

When appropriate, valuations are also adjusted for various factors such as liquidity and bid/offer spreads, which factors were deemed immaterial by the Company as of December 31, 2008.

Share-Based Compensation

As discussed in Note 17 of the Notes to Consolidated Financial Statements, effective January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of income based on their fair values.

The Company used the Black-Scholes option-pricing model to estimate the value of stock options for all stock option grants prior to 2007 and off cycle stock option grants during 2007 and 2008. The assumptions used to apply this model include a weighted average risk-free interest rate, a weighted average expected life, an expected dividend yield, and an expected volatility. Use of these assumptions is subjective and requires judgment as described in Note 17.

From April 24–25, 2008, the Company successfully conducted an auction of its Employee Stock Option Appreciation Rights Securities (“ESOARS”). As allowed by SFAS 123(R), the Company used the results of that auction to value its primary grant of employee stock options issued on April 24, 2008. The value established was $5.73 per option, which the Company estimates is approximately 24% below its Black-Scholes model valuation

 

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on that date. The Company recorded the related estimated future settlement obligation of ESOARS as a liability in the balance sheet. The 2008 stock option expense for these grants was $2.2 million. If the ESOARS value was 10% lower, the expense would be $2.0 million and if the ESOARS value was 10% higher, the expense would be $2.4 million. Additionally, the primary grant of options in 2007 was valued with the results of an ESOARS auction in 2007. The number of stock options granted at the primary grant date on May 4, 2007 and April 24, 2008 were 963,680 and 1,542,238, respectively, or 91.4% and 60.8% of the total stock options granted in 2007 and 2008, respectively.

On October 22, 2007, the Company announced it had received notification from the SEC that its ESOARS are sufficiently designed as a market-based method for valuing employee stock options under SFAS 123(R). The SEC staff did not object to the Company’s view that the market-clearing price of ESOARS in the Company’s auction was a reasonable estimate of the fair value of the underlying employee stock options.

The accounting for stock option compensation under SFAS 123(R) decreased income before income taxes by $13.1 million and net income by approximately $9.2 million for 2008, or $0.08 per diluted share. See Note 17 for additional information on stock options and restricted stock.

Income Taxes

The Company is subject to the income tax laws of the United States, its states and other jurisdictions where it conducts business. These laws are complex and subject to different interpretations by the taxpayer and the various taxing authorities. In determining the provision for income taxes, management must make judgments and estimates about the application of these inherently complex laws, related regulations, and case law. In the process of preparing the Company’s tax returns, management attempts to make reasonable interpretations of the tax laws. These interpretations are subject to challenge by the tax authorities upon audit or to re-interpretation based on management’s ongoing assessment of facts and evolving case law.

On a quarterly basis, management assesses the reasonableness of its effective tax rate based upon its current best estimate of net income and the applicable taxes expected for the full year. Deferred tax assets and liabilities are also reassessed on a quarterly basis if business events or circumstances warrant. Reserves for contingent tax liabilities are reviewed quarterly for adequacy based upon developments in tax law and the status of examinations or audits. During 2008, the Company reduced its liability for unrecognized tax benefits by approximately $9.6 million, net of any federal and/or state tax benefits. Of this reduction, $5.2 million decreased the Company’s tax provision for 2008 and $4.4 million reduced tax-related balance sheet accounts. The Company has tax reserves at December 31, 2008 of approximately $6.6 million, net of federal and/or state benefits, for uncertain tax positions primarily for various state tax contingencies in several jurisdictions.

Pending Adoption of Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“141(R)”), which replaces SFAS No. 141, Business Combinations. SFAS 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any resulting goodwill, and any noncontrolling interest in the acquiree. SFAS 141(R) will require the Company to record fair value estimates of contingent consideration and certain other potential liabilities during the original purchase price allocation, expense acquisition costs as incurred, and does not permit certain restructuring activities previously allowed under EITF Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination, to be recorded as a component of purchase accounting. SFAS 141(R) also provides for disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for the first annual reporting period beginning on or after December 15, 2008 and must be applied prospectively to business combinations completed on or after that date. The Company will adopt SFAS 141(R) as of January 1, 2009, as required. We have not determined the effect that the adoption of SFAS 141(R) will have on our consolidated financial statements, but the effect will generally be limited to future acquisitions in 2009, except for certain tax treatment of previous acquisitions.

 

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SFAS 141(R) amended SFAS No. 109, Accounting for Income Taxes, and FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes. Previously, SFAS 109 and FIN 48, respectively, generally required post-acquisition adjustments to business combination related deferred tax asset valuation allowances and liabilities related to uncertain tax positions to be recorded as an increase or decrease to goodwill. SFAS 141(R) does not permit this accounting and generally will require any such changes to be recorded in current period income tax expense. Thus, after SFAS 141(R) is adopted, all changes to valuation allowances and liabilities related to uncertain tax positions established in acquisition accounting (whether the combination was accounted for under SFAS 141 or SFAS 141(R)) must be recognized in current period income tax expense.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of Accounting Research Bulletin No. 51, which establishes accounting and reporting standards for noncontrolling interests (“minority interests”) in subsidiaries. SFAS 160 clarifies that a noncontrolling interest in a subsidiary should be accounted for as a component of equity (separate) from the parent’s equity, rather than in the liability or mezzanine section between liabilities and equity. Upon adoption, at December 31, 2008 and 2007 the Company will reclassify $27.3 million and $30.9 million respectively, from minority interest to a new line item, noncontrolling interests, to be in included in shareholders’ equity. Additionally, SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. SFAS 160 also requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. Currently, net income attributable to the noncontrolling interest generally is reported as an expense or other deduction in arriving at consolidated net income. SFAS 160 is effective for the first annual reporting period beginning on or after December 15, 2008 and must be applied prospectively, except for the presentation and disclosure requirements, which will apply retrospectively. The Company will adopt SFAS 160 as of January 1, 2009, as required. Other than the reclassification described above, the Company does not anticipate that SFAS 160 will have a material effect on the Company’s consolidated financial statements.

In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, with respect to nonfinancial assets and nonfinancial liabilities which are not recognized or disclosed at fair value in the financial statements on a recurring basis. Therefore, we have deferred application of SFAS 157 to such nonfinancial assets and nonfinancial liabilities until January 1, 2009.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133, which establishes enhanced disclosures about an entity’s derivative and hedging activities. SFAS 161 requires contextual discussion of the objectives and strategies for using derivative instruments for risk management purposes in terms of primary underlying risk, disclosure of volume of derivative activity, and enhanced credit risk disclosures. Also, SFAS 161 requires additional tabular disclosures of fair value amounts, financial performance, financial position, and gains and losses on derivative and related hedged items. The Company will adopt SFAS 161 as of January 1, 2009, as required.

In June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This FSP was issued to clarify that unvested share-based payment awards with a right to receive nonforfeitable dividends are participating securities. This FSP also provides guidance on how to allocate earnings to participating securities and compute basic earnings per share using the two-class method. This FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company will adopt the FSP as of January 1, 2009, as required.

RESULTS OF OPERATIONS

Net Interest Income, Margin and Interest Rate Spreads

Net interest income is the difference between interest earned on assets and interest incurred on liabilities. Taxable-equivalent net interest income is the largest component of Zions’ revenue. For the year 2008, it was 91.3% of our taxable-equivalent revenues, compared to 82.2% in 2007 and 76.4% in 2006. The increased

 

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percentage for 2008 and 2007 was mainly due to the impairment and valuation losses on securities which reduced total taxable-equivalent revenues by $317.1 million and $158.2 million, respectively. On a taxable-equivalent basis, net interest income for 2008 was up $87.3 million or 4.6% from 2007, which was up $119.1 million or 6.7% from 2006. The increase in taxable-equivalent net interest income for 2008 and 2007 was mainly due to increased interest-earning assets driven by loan growth partially offset by declines of 25 basis points in the net interest margin for 2008 and 20 basis points during 2007. The incremental tax rate used for calculating all taxable-equivalent adjustments was 35% for all years discussed and presented.

By its nature, net interest income is especially vulnerable to changes in the mix and amounts of interest-earning assets and interest-bearing liabilities. In addition, changes in the interest rates and yields associated with these assets and liabilities significantly impact net interest income. See “Interest Rate and Market Risk Management” on page 110 for a complete discussion of how we manage the portfolios of interest-earning assets and interest-bearing liabilities and associated risk.

A gauge that we use to measure the Company’s success in managing its net interest income is the level and stability of the net interest margin. The net interest margin was 4.18% in 2008 compared with 4.43% in 2007 and 4.63% in 2006. For the fourth quarter of 2008, the Company’s net interest margin was 4.20%, which benefited primarily from the capital investment from the U.S. Treasury, reduced deposit rates, and significantly lower borrowing costs.

The decreased net interest margin for 2008 compared to 2007 resulted from increased nonperforming assets reducing average asset yields, loan yields dropping more than deposit rates, a decline in noninterest-bearing demand deposits, competitive pricing pressures, and purchases of low yielding Lockhart commercial paper. Average loans and leases increased $4.2 billion and average money market investments increased $1.1 billion due to the impact of the capital investment from the U.S. Treasury and purchases of commercial paper from Lockhart. Average interest-bearing deposits increased $2.0 billion from 2007, with the increase being driven primarily by higher cost Internet money market, brokered deposits and foreign deposits. Average borrowed funds increased $3.0 billion compared to 2007 primarily due to increased borrowing from the Federal Home Loan Bank (“FHLB”) and the Federal Reserve. Average noninterest-bearing deposits declined $257 million compared to 2007 and were 24.3% of total average deposits for 2008, compared to 26.2% for 2007.

The margin compression for 2007 compared to 2006 resulted from the Company’s strong loan growth being funded mainly by higher cost deposit products and nondeposit borrowings, a decline in noninterest-bearing demand deposits, competitive pricing pressures, and purchases of Lockhart commercial paper. Higher yielding average loans and leases increased $4.4 billion from 2006 while lower yielding average money market investments and securities decreased slightly by $32.4 million. Average interest-bearing deposits increased $3.2 billion from 2006 with most of the increase in higher cost Internet money market, time and foreign deposits. Average borrowed funds increased $850 million compared to 2006.

The Company expects to continue its efforts to maintain a slightly “asset-sensitive” position with regard to interest rate risk. However, our estimates of the Company’s actual position are highly dependent upon changes in both short-term and long-term interest rates, modeling assumptions, and the actions of competitors and customers in response to those changes.

Throughout 2008, the FRB lowered the federal funds rate seven times by approximately 400 basis points. This decrease had a rapid impact on loans tied to LIBOR and the prime rate as these rates were lowered. Competitive pressures on deposit rates impeded our ability to fully reprice deposits as the FRB lowered rates, and rates paid to consumers for their deposits were lowered less than 400 basis points. This rate compression between loans and deposits had a negative impact on the net interest margin during 2008. We expect that these competitive pricing pressures may continue into 2009. See “Interest Rate Risk” on page 111 for further information.

Schedule 5 summarizes the average balances, the amount of interest earned or incurred and the applicable yields for interest-earning assets and the costs of interest-bearing liabilities that generate taxable-equivalent net interest income.

 

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Schedule 5

DISTRIBUTION OF ASSETS, LIABILITIES, AND SHAREHOLDERS’ EQUITY

AVERAGE BALANCE SHEETS, YIELDS AND RATES

 

    2008     2007  
(Amounts in millions)   Average
balance
    Amount of
interest1
  Average
rate
    Average
balance
    Amount of
interest1
  Average
rate
 

ASSETS:

           

Money market investments

  $ 1,889     47.8   2.53 %   $ 834     43.7   5.24 %

Securities:

           

Held-to-maturity

    1,516     101.3   6.68       684     47.7   6.97  

Available-for-sale

    3,266     162.1   4.97       4,661     269.2   5.78  

Trading account

    43     1.9   4.41       61     3.3   5.40  
                           

Total securities

    4,825     265.3   5.50       5,406     320.2   5.92  
                           

Loans:

           

Loans held for sale

    182     10.1   5.52       233     14.9   6.37  

Net loans and leases2

    40,795     2,674.4   6.56       36,575     2,852.7   7.80  
                           

Total loans and leases

    40,977     2,684.5   6.55       36,808     2,867.6   7.79  
                           

Total interest-earning assets

    47,691     2,997.6   6.29       43,048     3,231.5   7.51  
               

Cash and due from banks

    1,380           1,477      

Allowance for loan losses

    (546 )         (391 )    

Goodwill

    1,937           2,005      

Core deposit and other intangibles

    137           181      

Other assets

    3,163           2,527      
                       

Total assets

  $ 53,762         $ 48,847      
                       

LIABILITIES:

           

Interest-bearing deposits:

           

Savings and NOW

  $ 4,446     35.6   0.80     $ 4,443     41.4   0.93  

Money market

    13,739     335.0   2.44       11,962     437.9   3.66  

Time under $100,000

    2,695     96.2   3.57       2,529     110.7   4.38  

Time $100,000 and over

    4,382     161.9   3.69       4,779     231.2   4.84  

Foreign

    3,166     84.2   2.66       2,710     130.5   4.81  
                           

Total interest-bearing deposits

    28,428     712.9   2.51       26,423     951.7   3.60  
                           

Borrowed funds:

           

Securities sold, not yet purchased

    33     1.5   4.82       30     1.4   4.56  

Federal funds purchased and security repurchase agreements

    2,733     53.3   1.95       3,211     148.5   4.62  

Commercial paper

    110     4.2   3.84       256     13.8   5.41  

FHLB advances and other borrowings:

           

One year or less

    4,589     119.8   2.61       1,099     55.0   5.00  

Over one year

    128     7.4   5.73       131     7.6   5.77  

Long-term debt

    2,449     103.1   4.21       2,365     145.4   6.15  
                           

Total borrowed funds

    10,042     289.3   2.88       7,092     371.7   5.24  
                           

Total interest-bearing liabilities

    38,470     1,002.2   2.61       33,515     1,323.4   3.95  
               

Noninterest-bearing deposits

    9,145           9,401      

Other liabilities

    578           647      
                       

Total liabilities

    48,193           43,563      

Minority interest

    29           36      

Shareholders’ equity:

           

Preferred equity

    432           240      

Common equity

    5,108           5,008      
                       

Total shareholders’ equity

    5,540           5,248      
                       

Total liabilities and shareholders’ equity

  $ 53,762         $ 48,847      
                       

Spread on average interest-bearing funds

      3.68 %       3.56 %
                   

Taxable-equivalent net interest income and net yield on interest-earning assets

    1,995.4   4.18 %     1,908.1   4.43 %
                       

 

1

Taxable-equivalent rates used where applicable.

2

Net of unearned income and fees, net of related costs. Loans include nonaccrual and restructured loans.

 

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2006     2005     2004  
Average
balance
    Amount of
interest1
  Average
rate
    Average
balance
    Amount of
interest1
  Average
rate
    Average
balance
    Amount of
interest1
  Average
rate
 
               
$ 479     24.7   5.16 %   $ 988     31.7   3.21 %   $ 1,463     16.4   1.12 %
               
  645     44.1   6.83       639     44.2   6.93       500     34.3   6.86  
  4,992     285.5   5.72       4,021     207.7   5.16       3,968     174.5   4.40  
  157     7.7   4.91       497     19.9   4.00       732     29.6   4.04  
                                       
  5,794     337.3   5.82       5,157     271.8   5.27       5,200     238.4   4.59  
                                       
               
  261     16.5   4.80       205     9.8   4.80       159     5.1   3.16  
  32,134     2,463.9   6.80       23,804     1,618.0   6.80       20,887     1,252.8   6.00  
                                       
  32,395     2,480.4   6.78       24,009     1,627.8   6.78       21,046     1,257.9   5.98  
                                       
  38,668     2,842.4   6.40       30,154     1,931.3   6.40       27,709     1,512.7   5.46  
                     
  1,476           1,123           1,026      
  (349 )         (285 )         (272 )    
  1,887           746           648      
  181           66           65      
  2,379           1,799           1,760      
                                 
$ 44,242         $ 33,603         $ 30,936      
                                 
               
               
$ 5,129     75.3   1.47     $ 4,347     36.7   0.84     $ 4,245     24.4   0.58  
  10,721     330.0   3.08       9,131     183.9   2.01       8,572     96.8   1.13  
  2,065     77.4   3.75       1,523     41.7   2.74       1,436     27.5   1.92  
  3,272     142.6   4.36       1,713     54.7   3.19       1,244     29.2   2.35  
  2,065     95.5   4.62       737     23.3   3.16       338     4.4   1.30  
                                       
  23,252     720.8   3.10       17,451     340.3   1.95       15,835     182.3   1.15  
                                       
               
  66     3.0   4.57       475     17.7   3.72       625     24.2   3.86  
  2,838     124.7   4.39       2,307     63.6   2.76       2,682     32.2   1.20  
  220     11.4   5.20       149     5.0   3.36       201     3.0   1.51  
               
  479     25.3   5.27       204     5.9   2.90       252     2.9   1.14  
  148     8.6   5.80       228     11.5   5.05       230     11.7   5.08  
  2,491     159.6   6.41       1,786     104.9   5.88       1,659     74.3   4.48  
                                       
  6,242     332.6   5.33       5,149     208.6   4.05       5,649     148.3   2.62  
                                       
  29,494     1,053.4   3.57       22,600     548.9   2.43       21,484     330.6   1.54  
                     
  9,508           7,417           6,269      
  697           533           501      
                                 
  39,699           30,550           28,254      
  34           26           23      
               
  16                          
  4,493           3,027           2,659      
                                 
  4,509           3,027           2,659      
                                 
  $44,242         $ 33,603         $ 30,936      
                                 
    3.78 %       3.97 %       3.92 %
                           
  1,789.0   4.63 %     1,382.4   4.58 %     1,182.1   4.27 %
                                 

 

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Schedule 6 analyzes the year-to-year changes in net interest income on a fully taxable-equivalent basis for the years indicated. For purposes of calculating the yields in these schedules, the average loan balances also include the principal amounts of nonaccrual and restructured loans. However, interest received on nonaccrual loans is included in income only to the extent that cash payments have been received and not applied to principal reductions. In addition, interest on restructured loans is generally accrued at reduced rates.

Schedule 6

ANALYSIS OF INTEREST CHANGES DUE TO VOLUME AND RATE

 

     2008 over 2007     2007 over 2006  
     Changes due to     Total
changes
    Changes due to     Total
changes
 
(Amounts in millions)    Volume     Rate1       Volume     Rate1    

INTEREST-EARNING ASSETS:

            

Money market investments

   $ 26.7     (22.6 )   4.1     18.6     0.4     19.0  

Securities:

            

Held to maturity

     55.6     (2.0 )   53.6     2.7     0.9     3.6  

Available for sale

     (69.5 )   (37.6 )   (107.1 )   (18.9 )   2.6     (16.3 )

Trading account

     (0.8 )   (0.6 )   (1.4 )   (4.7 )   0.3     (4.4 )
                                      

Total securities

     (14.7 )   (40.2 )   (54.9 )   (20.9 )   3.8     (17.1 )
                                      

Loans:

            

Loans held for sale

     (2.8 )   (2.0 )   (4.8 )   (1.7 )   0.1     (1.6 )

Net loans and leases2

     275.1     (453.4 )   (178.3 )   345.7     43.1     388.8  
                                      

Total loans and leases

     272.3     (455.4 )   (183.1 )   344.0     43.2     387.2  
                                      

Total interest-earning assets

   $ 284.3     (518.2 )   (233.9 )   341.7     47.4     389.1  
                                      

INTEREST-BEARING LIABILITIES:

            

Interest-bearing deposits:

            

Savings and NOW

   $     (5.8 )   (5.8 )   (6.3 )   (27.6 )   (33.9 )

Money market

     43.2     (146.1 )   (102.9 )   41.1     66.8     107.9  

Time under $100,000

     5.9     (20.4 )   (14.5 )   19.0     14.3     33.3  

Time $100,000 and over

     (14.4 )   (54.9 )   (69.3 )   71.5     17.1     88.6  

Foreign

     12.1     (58.4 )   (46.3 )   31.0     4.0     35.0  
                                      

Total interest-bearing deposits

     46.8     (285.6 )   (238.8 )   156.3     74.6     230.9  
                                      

Borrowed funds:

            

Securities sold, not yet purchased

     0.1         0.1     (1.6 )       (1.6 )

Federal funds purchased and security repurchase agreements

     (9.3 )   (85.9 )   (95.2 )   17.1     6.7     23.8  

Commercial paper

     (5.6 )   (4.0 )   (9.6 )   1.9     0.5     2.4  

FHLB advances and other borrowings:

            

One year or less

     91.1     (26.3 )   64.8     31.0     (1.3 )   29.7  

Over one year

     (0.1 )   (0.1 )   (0.2 )   (1.0 )       (1.0 )

Long-term debt

     3.5     (45.8 )   (42.3 )   (7.8 )   (6.4 )   (14.2 )
                                      

Total borrowed funds

     79.7     (162.1 )   (82.4 )   39.6     (0.5 )   39.1  
                                      

Total interest-bearing liabilities

   $ 126.5     (447.7 )   (321.2 )   195.9     74.1     270.0  
                                      

Change in taxable-equivalent net interest income

   $ 157.8     (70.5 )   87.3     145.8     (26.7 )   119.1  
                                      

 

1

Taxable-equivalent income used where applicable.

2

Net of unearned income and fees, net of related costs. Loans include nonaccrual and restructured loans.

In the analysis of interest changes due to volume and rate, changes due to the volume/rate variance are allocated to volume with the following exceptions: when volume and rate both increase, the variance is allocated proportionately to both volume and rate; when the rate increases and volume decreases, the variance is allocated to the rate.

 

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Provisions for Credit Losses

The provision for loan losses is the amount of expense that, based on our judgment, is required to maintain the allowance for loan losses at an adequate level based upon the inherent risks in the portfolio. The provision for unfunded lending commitments is used to maintain the reserve for unfunded lending commitments at an adequate level. In determining adequate levels of the allowance and reserve, we perform periodic evaluations of the Company’s various portfolios, the levels of actual charge-offs, and statistical trends and other economic factors. See “Credit Risk Management” on page 99 for more information on how we determine the appropriate level for the allowance for loan and lease losses and the reserve for unfunded lending commitments.

For the year 2008, the provision for loan losses was $648.3 million, compared to $152.2 million for 2007 and $72.6 million for 2006. The increased provision for 2008 resulted mainly from significant deterioration in our credit quality, particularly from our exposure to residential land development and construction activity in the Southwest, with Arizona, California, and Nevada being most severely impacted, and also weakening in commercial loan portfolios. See “Nonperforming Assets” and “Allowance and Reserve for Credit Losses” on pages 104 and 106 for further details. Net loan and lease charge-offs increased to $393.7 million in 2008 up from $63.6 million in 2007 and $45.8 million in 2006. The $330.1 million increase during 2008 was driven by increased charge-offs of $133.6 million at NBA, $68.9 million at NSB, $61.4 million at Zions Bank and $38.7 million at CB&T, primarily related to residential land development and construction loans. Including the provision for unfunded lending commitments, the total provision for credit losses was $649.7 million for 2008, $154.0 million for 2007, and $73.8 million for 2006. The provision for loan losses was $285.2 million for the fourth quarter of 2008 and net charge-offs for the quarter were $179.7 million.

The Company’s expectation is that credit conditions will continue to soften in most of our markets due to continued weakening in general economic conditions. We expect provisioning and net charge-offs to continue at elevated levels for at least the next several quarters.

Noninterest Income

Noninterest income represents revenues the Company earns for products and services that have no interest rate or yield associated with them. Noninterest income for 2008 comprised 8.7% of taxable-equivalent revenues reflecting the $317.1 million of impairment and valuation losses on securities which reduced noninterest income for 2008, compared to 17.8% for 2007 and 23.6% for 2006. Schedule 7 presents a comparison of the major components of noninterest income for the past three years.

 

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Schedule 7

NONINTEREST INCOME

 

(Amounts in millions)    2008     Percent
change
    2007     Percent
change
    2006

Service charges and fees on deposit accounts

   $ 207.0     12.7 %   $ 183.6     14.2 %   $ 160.8

Other service charges, commissions and fees

     167.7     (1.7 )     170.6     13.6       150.2

Trust and wealth management income

     37.7     3.3       36.5     21.7       30.0

Capital markets and foreign exchange

     49.9     14.4       43.6     10.4       39.5

Dividends and other investment income

     46.4     (8.8 )     50.9     27.6       39.9

Loan sales and servicing income

     24.4     (36.6 )     38.5     (29.0 )     54.2

Income from securities conduit

     5.5     (69.8 )     18.2     (43.5 )     32.2

Fair value and nonhedge derivative income (loss)

     (48.0 )   (235.7 )     (14.3 )   (2,483.3 )     0.6

Equity securities gains, net

     0.8     (95.5 )     17.7     (0.6 )     17.8

Fixed income securities gains, net

     0.8     (73.3 )     3.0     (53.1 )     6.4

Impairment losses on investment securities and valuation losses on securities purchased from Lockhart Funding

     (317.1 )   (100.4 )     (158.2 )        

Other

     15.6     (29.7 )     22.2     13.3       19.6
                          

Total

   $ 190.7     (53.7 )%   $ 412.3     (25.2 )%   $   551.2
                          

Noninterest income for 2008 decreased $221.6 million or 53.7% compared to 2007. The largest component of this decrease was the $158.9 million increase in impairment and valuation losses on securities. Other significant components contributing to the noninterest income decrease in 2008 included loan sales and servicing income, income from securities conduit, fair value and nonhedge derivative loss, and net equity securities gains. Noninterest income for 2007 decreased $138.9 million or 25.2% compared to 2006 also reflecting the impact of $158.2 million of impairment and valuation losses on securities.

Service charges and fees on deposit accounts increased $23.4 million in 2008 and $22.8 million in 2007. The increase was mainly due to the impact of fee increases across the Company, and reduced deposit account earnings credits due to lower interest rates. The increase in 2007 was mainly due to the impact of fee increases across the Company and the acquisition of Stockmen’s.

Other service charges, commissions, and fees, which is comprised of Automated Teller Machine (“ATM”) fees, insurance commissions, bankcard merchant fees, debit card interchange fees, cash management fees, lending commitments, syndication and servicing fees and other miscellaneous fees, decreased $2.9 million, or 1.7% from 2007, which was up 13.6% from 2006. The decrease in 2008 was principally due to lower lending related fees and official check fees offset by increased accounts receivable factoring fees, debit card fees, and cash management related fees. The cash management fees include remote check imaging fees, third-party ACH transaction fees, and web-based medical claims transaction fees. The increase in 2007 was primarily driven by debit card fees, and cash management related fees. The increase was offset by decreased insurance income of $5.0 million resulting from the sale of the Company’s Grant Hatch insurance agency and certain other insurance assets completed during the first quarter of 2007.

Trust and wealth management income for 2008 increased 3.3% compared to 2007, which was up 21.7% compared to 2006. The modest increase for 2008 was from slower organic growth in the trust and wealth management business and declines in fees due to lower balances of assets under management, primarily as a result of declines in market values of a number of asset classes. The increase for 2007 was from organic growth in the trust and wealth management business, including growth related to our Contango wealth management and associated trust business, as well as growth in the Amegy trust and wealth management business.

Capital markets and foreign exchange include trading income, public finance fees, foreign exchange income, and other capital market related fees and increased 14.4% from 2007, which was up 10.4% from 2006.

 

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The increase in 2008 was primarily driven by increased trading income partially offset by lower public finance fees. The increase in 2007 was primarily the result of higher public finance fees.

Dividends and other investment income consist of revenue from the Company’s bank-owned life insurance program and revenues from other investments. Revenues from other investments include dividends on FHLB stock, Federal Reserve Bank stock, and earnings from unconsolidated affiliates including certain alternative venture investments, and were $15.6 million in 2008, $23.0 million in 2007, and $13.3 million in 2006. The decreased income from other investments in 2008 is primarily due to a $14.1 million decrease in equity in earnings of Farmer Mac offset by a $6.0 million increase in earnings from Amegy’s alternative investments program. The decrease in earnings from Farmer Mac is mainly due to their losses in securities holdings in Lehman Brothers and Fannie Mae. Revenue from bank-owned life insurance programs was $30.7 million in 2008, $27.9 million in 2007, and $26.6 million in 2006.

Loan sales and servicing income includes revenues from securitizations of loans, gains and losses from sales of loans, as well as revenues that we earn through servicing loans that we sold to third parties. For 2008, loan sales and servicing income decreased 36.6% compared to 2007 and decreased 29.0% between 2007 and 2006. The decreased income for 2008 is mainly due to reduced servicing fees on securitized small business loans. Upon dissolution of securitization trusts as described in “Off-Balance Sheet Arrangement” on page 96, these loans were recorded on Zions Bank’s balance sheet and not serviced for investors. The decrease for 2007 compared to 2006 mainly resulted from lower servicing fees from lower loan balances, and retained interest impairment write-downs of $12.6 million in 2007. These write-downs resulted primarily from higher than expected loan prepayments, increased default assumptions, and changes in the interest rate environment as determined from our periodic evaluation of beneficial interests as required by EITF 99-20. As of December 31, 2008, the Company had no retained interests in small business securitizations recorded on the balance sheet. See Note 6 of the Notes to Consolidated Financial Statements for additional information on the Company’s securitization programs.

Income from securities conduit decreased $12.7 million or 69.8% for 2008 compared to 2007 and decreased 43.5% between 2007 and 2006. This income represents fees we receive from Lockhart, a QSPE securities conduit. The decrease in income is due to the higher cost of asset-backed commercial paper used to fund Lockhart resulting from the disruptions in the credit markets which began in August of 2007 and a decrease in the size of Lockhart’s securities portfolio. The book value of Lockhart’s securities portfolio declined to $738 million at December 31, 2008 from $2.1 billion at December 31, 2007, and from $4.1 billion at December 31, 2006 due to Zions’ required purchase of securities out of Lockhart and repayments of principal. We expect that the book value of the Lockhart portfolio will continue to decrease. Income from securities conduit will depend both on the amount of securities held in the portfolio and on the cost of the commercial paper used to fund those securities. See “Off-Balance Sheet Arrangement” on page 96, “Liquidity Management Actions” on page 116, and Note 6 of the Notes to Consolidated Financial Statements for further information regarding securitizations and Lockhart.

Fair value and nonhedge derivative income (loss) consists of the following:

Schedule 8

FAIR VALUE AND NONHEDGE DERIVATIVE INCOME (LOSS)

 

(Amounts in millions)    2008     Percent
change
    2007     Percent
change
    2006  

Nonhedge derivative income (loss)

   $ (36.2 )   (139.7 )%   $ (15.1 )   (2,257.1 )%   $ 0.7  

Fair value decreases on SFAS 159 instruments

     (9.2 )                    

Derivative fair value credit adjustments

     (3.1 )                    

Other

     0.5     (37.5 )     0.8     900.0       (0.1 )
                            

Total

   $ (48.0 )   (235.7 )%   $ (14.3 )   (2,483.3 )%   $ 0.6  
                            

 

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The losses on nonhedge derivatives for 2008 and 2007 resulted from decreasing spreads between LIBOR and the prime rate during the second half of 2007. In an effort to employ the most liquid instrument available for Zions’ hedging program and execute transactions with the most economically favorable terms, it has been Zions’ practice to use LIBOR as the floating index on swaps executed with external counterparties. As a significant portion of the Company’s loan assets are prime rate floating loans, many of the Company’s swaps are structured with a prime floating rate. In conjunction with the execution of swaps in which the Company receives a fixed rate and pays prime, Zions also executes a swap in which it pays LIBOR plus a spread and receives prime. The Company therefore has chosen to retain the prime-LIBOR basis risk in this hedging activity.

Net equity securities gains in 2008 were $0.8 million compared to net gains of $17.7 million in 2007 and $17.8 million in 2006. Net gains for 2008 included a $12.4 million gain on the VISA stock offering, a $7.7 million gain on the sale of an interest in a mutual fund management company, an $11.0 million impairment loss on the Company’s investment in Farmer Mac, and net losses of $8.4 million on venture capital equity investments. Net gains for 2007 included a $2.5 million gain on the sale of an investment in a community bank and net gains on venture capital equity investments of $15.4 million. Net of related minority interest of $5.4 million, income taxes and other expenses, venture capital investments contributed $2.6 million to net losses in 2008, compared to net income of $3.4 million for 2007 and $4.1 million for 2006.

Impairment losses on investment securities and valuation losses on securities purchased from Lockhart were $317.1 million in 2008 compared to $158.2 million in 2007. The 2008 losses consisted of impairment losses of $304.0 million on ABS, REIT trust preferred, and bank and insurance trust preferred CDOs and valuation losses of $13.1 million on securities purchased from Lockhart. During 2007 impairment losses on REIT trust preferred CDO securities were $108.6 million and valuation losses on securities purchased from Lockhart were $49.6 million. See “Other-than-Temporary-Impairment – Debt Investment Securities” on page 40, “Investment Securities Portfolio” on page 85 , and “Off-Balance Sheet Arrangement” on page 96 for further discussion.

Other noninterest income for 2008 was $15.6 million, compared to $22.2 million for 2007 and $19.6 million for 2006. The decrease in 2008 included reduced scanner sales to third party financial institutions. The increase in 2007 included a $2.9 million gain on the sale of the Company’s insurance business during 2007.

Noninterest Expense

Noninterest expense for 2008 increased 5.0% over 2007, which was 5.6% higher than in 2006. The 2008 increase was impacted by the increased other real estate expense due to the deterioration in the Company’s loan credit quality. Excluding other real estate expense noninterest expense increased $24.4 million or 1.7% over 2007. Schedule 9 summarizes the major components of noninterest expense and provides a comparison of the components over the past three years.

 

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Schedule 9

NONINTEREST EXPENSE

 

(Amounts in millions)    2008    Percent
change
    2007    Percent
change
    2006

Salaries and employee benefits

   $ 810.5    1.3 %   $ 799.9    6.4 %   $ 751.7

Occupancy, net

     114.2    6.3       107.4    7.8       99.6

Furniture and equipment

     100.1    3.7       96.5    8.8       88.7

Other real estate expense

     50.4    1,045.5       4.4    4,300.0       0.1

Legal and professional services

     45.5    3.9       43.8    9.2       40.1

Postage and supplies

     37.5    2.7       36.5    10.3       33.1

Advertising

     30.7    14.1       26.9    1.5       26.5

FDIC premiums

     19.9    206.2       6.5    20.4       5.4

Impairment losses on long-lived assets

     3.1             nm       1.3

Merger related expense

     1.6    (69.8 )     5.3    (74.1 )     20.5

Amortization of core deposit and other intangibles

     33.2    (26.1 )     44.9    4.4       43.0

Other

     228.3    (1.8 )     232.5    5.5       220.4
                        

Total

   $ 1,475.0    5.0 %   $ 1,404.6    5.6 %   $ 1,330.4
                        

 

nm – not meaningful

The Company’s efficiency ratio was 67.5% for 2008 compared to 60.5% for 2007 and 56.9% for 2006. The increase in the efficiency ratio for 2008 and 2007 was primarily due to the previously discussed impairment and valuation losses on securities. The efficiency ratio was 58.9% for 2008 and 56.7% for 2007 excluding the impairment and valuation losses on securities.

Salary costs for 2008 increased 4.2% over 2007, which were up 5.8% from 2006. The increases for 2008 resulted mainly from merit pay salary increases offset by reductions in variable pay. The salary costs for 2008 also included share-based compensation expense of approximately $31.8 million, up from $28.3 million for 2007. The increases for 2007 resulted mainly from merit pay salary increases and increased staffing related to other business expansion. Employee health and insurance benefits for 2008 decreased 10.5% from 2007, which increased 24.2% from 2006. Employee health and insurance expense for 2008 included an adjustment which reduced expense by approximately $3.0 million to reflect the elimination of a health insurance benefit. Retirement expense for 2008 decreased primarily because no accrual was required for the Company’s profit sharing plan. Salaries and employee benefits are shown in greater detail in Schedule 10.

Schedule 10

SALARIES AND EMPLOYEE BENEFITS

 

(Dollar amounts in millions)    2008    Percent
change
    2007    Percent
change
    2006

Salaries and bonuses

   $ 706.5    4.2 %   $ 678.1    5.8 %   $ 641.1
                        

Employee benefits:

            

Employee health and insurance

     37.7    (10.5 )     42.1    24.2       33.9

Retirement

     20.6    (43.3 )     36.3    (4.0 )     37.8

Payroll taxes and other

     45.7    5.3       43.4    11.6       38.9
                        

Total benefits

     104.0    (14.6 )     121.8    10.1       110.6
                        

Total salaries and employee benefits

   $ 810.5    1.3 %   $ 799.9    6.4 %   $ 751.7
                        

 

Full-time equivalent (“FTE”) employees at December 31

     11,011    0.7 %     10,933    3.0 %     10,618

 

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Occupancy expense increased $6.8 million or 6.3% compared to 2007 which was up 7.8% from 2006. The 2008 increase was impacted by higher facilities rent expense and higher facilities maintenance and includes $1.7 million of expense associated with damage to branches and other facilities caused by Hurricane Ike in the third quarter of 2008. The 2007 increase was impacted by higher facilities rent expense, higher facilities maintenance and utilities expense, and the impact of the acquisition of Stockmen’s.

Furniture and equipment expense for 2008 increased $3.6 million or 3.7% compared to 2007, which was up 8.8% from 2006. The increase in 2007 was mainly due to increased maintenance contract costs related to technology and operational assets.

Other real estate expense increased to $50.4 million compared $4.4 million for 2007 and $0.1 million for 2006. The increase is primarily due to increased OREO balances and write-downs resulting from declining property values, mainly in Arizona and Nevada.

Advertising expense was $30.7 million in 2008, $26.9 million in 2007 and $26.5 million in 2006. The increased expense in 2008 included increased Internet related advertising expenses.

FDIC premiums for 2008 increased $13.4 million or 206.2% compared to 2007, which was up 20.4% from 2006. We expect this expense to increase in 2009.

Other noninterest expense for 2008 decreased $4.2 million or 1.8% compared to 2007, which was up 5.5% from 2006. The increase in 2007 included an $8.1 million Visa litigation accrual and a $4.0 million write-down on repossessed equipment, which was collateral for an equipment lease. The Visa litigation accrual represents an estimate of the Company’s proportionate share of a contingent obligation to indemnify Visa Inc. for certain litigation matters. During 2008 the Company reduced the Visa accrual by $5.6 million as a result of Visa funding a litigation escrow account and settling certain covered litigation.

Impairment Losses on Goodwill

During the fourth quarter of 2008, 2007 and 2006, the Company completed the annual goodwill impairment analysis as required by SFAS 142. The annual goodwill impairment analysis completed in the fourth quarter of 2008 resulted in total impairment losses on goodwill of $353.8 million at the NBA, Vectra, NSB, and P5 reporting units.

The primary causes of the impairment losses on goodwill in three of our reporting units as of December 31, 2008 were declines in market values of comparable companies, declines in acquisition transaction values, and reduced earnings at the reporting units, which resulted primarily from deterioration in credit quality of loan portfolios. See “Accounting for Goodwill” on page 42 for further discussion of the goodwill impairment.

Foreign Operations

Six of our subsidiary banks each operate a foreign branch in Grand Cayman, Grand Cayman Islands, B.W.I. The branches only accept deposits from qualified domestic customers. While deposits in these branches are not subject to FRB reserve requirements or FDIC insurance requirements, there are no federal or state income tax benefits to the Company or any customers as a result of these operations.

Foreign deposits at December 31, 2008, 2007 and 2006 totaled $2.6 billion, $3.4 billion and $2.6 billion, respectively, and averaged $3.2 billion for 2008, $2.7 billion for 2007, and $2.1 billion for 2006. All of these foreign deposits were related to domestic customers of the banks. See Schedule 32 on page 93 for foreign loans outstanding.

 

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Income Taxes

The Company’s income tax benefit for 2008 was $43.4 million compared to income tax expense of $235.7 million for 2007 and $318.0 million for 2006. The Company’s effective income tax rates, including the effects of minority interest, were 14.0% in 2008, 32.3% in 2007, and 35.3% in 2006. See Note 15 of the Notes to Consolidated Financial Statements for more information on income taxes.

The average effective tax rate in 2008 was lower than in prior years mainly because of the nondeductible goodwill impairment charges. Also increased securities impairment charges, loan loss provision, and OREO charge-downs recorded in 2008 affected taxable revenue, thereby increasing the proportion of nontaxable income relative to total income. During 2008, the Company reduced its liability for unrecognized tax benefits by approximately $9.6 million, net of any federal and/or state tax benefits. Of this reduction, $5.2 million decreased the Company’s tax provision for 2008 and $4.4 million reduced tax-related balance sheet accounts.

During the fourth quarter of 2007, the Company reduced its liability for unrecognized tax benefits by approximately $12.2 million, net of any federal and/or state tax benefits. Of this reduction, $9.1 million decreased the Company’s tax provision for 2007 and $3.1 million reduced goodwill. The primary cause of the decrease was the closing of various state statutes of limitations and tax examinations. As a result of the recognition of certain tax benefits, accrued interest payable on unrecognized tax benefits was also reduced by approximately $2.8 million, net of any federal and/or state benefits. Since the Company classifies interest and penalties related to tax matters as a component of tax expense, the reduction in interest on unrecognized tax benefits also resulted in a decrease to the Company’s tax provision for 2007. The average effective tax rate in 2007 also was lower than in prior years because the securities impairment charges recorded in 2007 affected taxable revenue, thereby increasing the proportion of nontaxable income relative to total income.

In 2004, the Company signed an agreement that confirmed and implemented its award of a $100 million allocation of tax credit authority under the Community Development Financial Institutions Fund set up by the U.S. Government. Under the program, Zions has invested $100 million as of December 31, 2008, in a wholly-owned subsidiary which makes qualifying loans and investments. In return, Zions receives federal income tax credits that will be recognized over seven years, including the year in which the funds were invested in the subsidiary. Zions invested $10 million in its subsidiary in 2006 and a final contribution of $10 million under the terms of our agreement during 2007. Income tax expense was reduced by $5.8 million for 2008, $5.6 million for 2007, and $4.5 million for 2006 as a result of these tax credits. We expect that we will be able to reduce the Company’s federal income tax payments by a total of $39 million over the life of this award, which is expected to be for the years 2004 through 2013.

 

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BUSINESS SEGMENT RESULTS

The Company manages its banking operations and prepares management reports with a primary focus on geographical area. Segments, other than the “Other” segment that are presented in the following discussion are based on geographical banking operations. The Other segment includes the Parent, Zions Management Services Company (“ZMSC”), nonbank financial service and financial technology subsidiaries, other smaller nonbank operating units, TCBO, which was opened during the fourth quarter of 2005 and is not yet significant, and eliminations of intercompany transactions.

Operating segment information is presented in the following discussion and in Note 22 of the Notes to Consolidated Financial Statements. The accounting policies of the individual segments are the same as those of the Company. The Company allocates centrally provided services to the business segments based upon estimated or actual usage of those services.

Zions Bank

Zions Bank is headquartered in Salt Lake City, Utah and is primarily responsible for conducting the Company’s operations in Utah and Idaho. Zions Bank is the 2nd largest full-service commercial bank in Utah and the 6th largest in Idaho, as measured by domestic deposits in the state. Zions Bank operates 112 full-service traditional branches and 29 banking centers in grocery stores. During the third quarter of 2008, Zions Bank entered into an agreement to exit 21 banking centers in grocery stores during the first quarter of 2009. The leases on these banking centers are being assumed by another bank and all loans and deposits will be transferred to nearby Zions Bank branch locations. Zions Bank includes most of the Company’s Capital Markets operations, which include Zions Direct, Inc., fixed income trading, correspondent banking, public finance, trust and investment advisory, liquidity and hedging services for Lockhart. Zions Bank also includes Western National Trust Company. On January 1, 2008, Welman Holdings, Inc. (“Welman”), the parent of Contango Capital Advisors, Inc. (“Contango”), became a subsidiary of the Parent. Results of operations for Zions Bank for 2007 and 2006 include Welman. In 2007 and 2006, Welman experienced after tax losses of $8.8 million and $7.9 million, respectively.

During 2008, the Utah economy added 2,500 new jobs or 0.2%, which was a much slower rate of increase than in the prior several years. Utah’s overall unemployment rate increased from 2.7% in 2007 to 3.7% in 2008. The goods production sector, including construction, contributed to the increased unemployment rate. Utah’s service sector did far better, adding approximately 12,000 jobs during 2008. Other growth areas in employment included education, health services and government and professional business services. Idaho ended 2008 with an unemployment rate of 6.6% and a loss of 27,000 non-farm jobs. Both Utah and Idaho still significantly outperformed the national unemployment rate of 7.2% as of December 2008. Softening home prices and slower real estate sales in both states contributed to the economic decline in 2008 and are expected to continue to be challenging through 2009.

 

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Schedule 11

ZIONS BANK

 

(In millions)    2008     2007     2006

CONDENSED INCOME STATEMENT

      

Net interest income

   $ 662.5     551.4     472.3

Impairment losses on investment securities and valuation losses on securities purchased from Lockhart Funding

     (92.5 )   (59.7 )  

Other noninterest income

     207.3     236.8     263.7
                  

Total revenue

     777.3     728.5     736.0

Provision for loan losses

     163.1     39.1     19.9

Noninterest expense

     463.4     463.2     426.1
                  

Income before income taxes and minority interest

     150.8     226.2     290.0

Income tax expense

     44.0     72.2     98.1

Minority interest

     0.1     0.2     0.1
                  

Net income

   $ 106.7     153.8     191.8
                  

YEAR-END BALANCE SHEET DATA

      

Total assets

   $ 20,778     18,446     14,823

Total securities

     1,698     2,039     1,360

Net loans and leases

     14,734     12,997     10,702

Allowance for loan losses

     214     133     108

Goodwill, core deposit and other intangibles

     20     24     27

Noninterest-bearing demand deposits

     2,198     2,445     2,320

Total deposits

     16,118     11,644     10,450

Preferred equity

     250        

Common equity

     1,044     1,048     972

Net income for Zions Bank decreased 30.6% to $106.7 million for 2008 compared to $153.8 million for 2007 and $191.8 million for 2006. The increase in the provision for loan losses of $124.0 million and the increase in impairment and valuation losses on securities of $32.8 million were the main factors causing the decrease in net income.

Nonperforming assets were $412.4 million at December 31, 2008 compared to $45.0 million one year ago, an increase of $367.4 million or 816.4%. This deterioration can be attributed to real estate secured loans which account for 79% of nonperforming loans. The ratio of nonperforming assets to net loans and other real estate owned at December 31, 2008 was 2.79% compared to 0.35% at December 31, 2007.

Net loan and lease charge-offs were $75.4 million for 2008 compared to $14.0 million for 2007 and $18.9 million for 2006. Total real estate secured net loan charge-offs were $35.3 million or 46.8% of total net charge-offs, including $29.9 million of net charge-offs related to construction and land development loans. Remaining net charge-offs are composed of $26.9 million in commercial loans and $13.2 million in consumer loans. The loan loss provision was $163.1 million for 2008 compared to $39.1 million for 2007 and $19.9 million for 2006.

The ratio of the allowance for loan losses to net loans and leases was 1.45%, 1.02% and 1.01% at December 31, 2008, 2007 and 2006, respectively.

Net interest income at Zions Bank for 2008 increased 20.1%, or $111.1 million. Average earning assets in 2008 compared to 2007 are up $3.4 billion or 23.8%. During 2008, $1.2 billion in securities were purchased and recorded on the balance sheet as loans, as required by the Liquidity Agreement between Zions Bank and Lockhart. The primary trigger for these repurchases was the ratings downgrade of the monoline insurer that

 

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provided the credit enhancement on the senior tranche of securitized small business loans. A smaller amount of securities were repurchased as required due to downgrades of the securities themselves. Finally, during 2008 Zions Bank also purchased varying amounts of commercial paper issued by Lockhart to fund its assets. Purchasing these securities and commercial paper contributed to the growth in average earning assets. The net interest margin was 3.77% for 2008, compared to 3.90% for 2007 and 3.89% for 2006. The biggest impact on margin compression has been the increase in nonperforming assets and increased cost of deposits.

Noninterest income decreased 35.2% to $114.8 million compared to $177.1 million for 2007 and $263.7 million for 2006. The bank recognized impairment and valuation losses on securities of $92.5 million in 2008 and $59.7 million in 2007. Loan sales and servicing income declined to $17.3 million in 2008 compared to $30.6 million in 2007, due to a decrease in average loans sold and serviced. Fair value and nonhedge derivative loss was $28.6 million in 2008 compared to a loss of $15.0 million in 2007 and a gain of $0.7 million in 2006. The declines were mainly due to decreasing spreads between LIBOR and the prime rate which decreased nonhedge derivative income. Income from securities conduit was $5.5 million in 2008 compared to $18.2 million in 2007 and $32.2 million in 2006. The decrease in this income can be attributed to smaller spreads and average assets of the conduit being down significantly year over year. Trading income increased $8.6 million in 2008 over 2007 primarily caused by the increased spreads on corporate bond trading.

Noninterest expense was $463.4 million in 2008, $463.2 million in 2007 and $426.1 million in 2006. Noninterest expense in 2007 and 2006 included $17.6 million and $14.3 million, respectively from Welman. Salaries and employee benefits are down $17.8 million in 2008 compared to 2007. Welman’s salary and benefits expense was $12.0 million in 2007. Reductions in variable pay and employee benefits also contributed to this year over year decrease. Credit and OREO expenses are up $8.8 million. FDIC insurance increased $4.7 million. This is due to increased rates charged by FDIC as well as overall deposit growth. Bankcard expense increased $4.9 million caused by an increase in transaction volume as more customers utilize electronic payment methods. The efficiency ratio was 59.04% for 2008, as compared to 62.82% for 2007 and 57.15% for 2006.

 

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Schedule 12

ZIONS BANK

 

(Dollar amounts in millions)    2008     2007     2006  

PERFORMANCE RATIOS

      

Return on average assets

     0.55 %   0.98 %   1.39 %

Return on average common equity

     9.90 %   15.04 %   21.47 %

Tangible return on average tangible common equity

     10.12 %   15.49 %   22.27 %

Efficiency ratio

     59.04 %   62.82 %   57.15 %

Net interest margin

     3.77 %   3.90 %   3.89 %

RISK-BASED CAPITAL RATIOS

      

Tier 1 leverage

     6.91 %   6.22 %   6.50 %

Tier 1 risk-based capital

     8.32 %   6.84 %   7.26 %

Total risk-based capital

     11.33 %   10.75 %   11.30 %

CREDIT QUALITY

      

Provision for loan losses

   $ 163.1     39.1     19.9  

Net loan and lease charge-offs

     75.4     14.0     18.9  

Ratio of net charge-offs to average loans and leases

     0.53 %   0.12 %   0.20 %

Allowance for loan losses

   $ 214     133     108  

Ratio of allowance for loan losses to net loans and leases

     1.45 %   1.02 %   1.01 %

Nonperforming assets

   $ 412.4     45.0     17.1  

Ratio of nonperforming assets to net loans and leases and other real estate owned

     2.79 %   0.35 %   0.16 %

Accruing loans past due 90 days or more

   $ 83.5     36.5     8.5  

Ratio of accruing loans past due 90 days or more to net loans and leases

     0.57 %   0.28 %   0.08 %

OTHER INFORMATION

      

Full-time equivalent employees

     2,525     2,668     2,687  

Domestic offices:

      

Traditional branches

     112     109     107  

Banking centers in grocery stores

     29     29     29  

Foreign office

     1     1     1  
                    

Total offices

     142     139     137  

ATMs

     176     184     165  

Net loans and leases grew $1.7 billion or 13.4%. Commercial lending increased $1.1 billion, commercial real estate loans are up $0.5 billion and consumer loans are up $0.1 billion in 2008 over 2007. Growth numbers include purchased securities that were recorded on balance sheet as loans as previously discussed.

Total deposits increased $4.5 billion or 38.4% in 2008 compared to 2007. $2.6 billion or 59.1% of this increase came from brokered deposits, inter-bank affiliate CDs were up $0.5 billion and money market deposits were up $0.9 billion over 2007. Our retail branch network saw significant improvement as well in growth during 4th quarter of 2008. The ratio of noninterest-bearing deposits to total deposits was 13.6% in 2008 and 21.0% in 2007.

Total securities declined $341 million or 16.7% in 2008 compared to 2007. This decrease is mainly due to OTTI losses taken on securities that were subsequently sold to the Parent at fair value.

The total risk-based capital ratio at December 31, 2008 was 11.33% compared to 10.75% and 11.30% at December 31, 2007 and December 31, 2006, respectively. The increase in the total risk-based capital ratio for 2008 was mainly due to the issuance of qualifying tier 1 capital preferred stock of $250 million to the Parent in December 2008, a $159 million net decrease of qualifying tier 2 capital subordinated debt due to the Parent, and net income of $106.7 million.

 

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During 2008, Zions Bank ranked as Utah’s top SBA 7(a) lender for the 15th consecutive year and ranked 1st in Idaho’s Boise District for the seventh consecutive year. US Banker Magazine awarded Zions Bank the #2 Women’s Banking Team in the nation. Zions Bank received Greenwich Excellence Awards in Overall Satisfaction (national and western region) and Overall Satisfaction with Treasury Management (national and western region).

California Bank & Trust

California Bank & Trust is headquartered in San Diego, California, and is the eleventh largest full-service commercial bank in California as measured by domestic deposits in the state. CB&T operates 90 full-service traditional branches throughout the state. CB&T manages its branch network by a regional structure, allowing decision-making to remain as close as possible to the customer. These regions include San Diego, Los Angeles, Orange County, San Francisco, Sacramento, and the Central Valley. In addition to the regional structure, core businesses are managed functionally. These functions include retail banking, corporate and commercial banking, construction and commercial real estate financing, and SBA lending. CB&T plans to continue its emphasis on relationship banking providing commercial, real estate and consumer lending, depository services, international banking, cash management, and community development services.

California represents about 13% of the nation’s GDP. Like other parts of the Southwest, it has been experiencing significant declines in real estate values and the adverse effects of a recessionary economy. The state faces a serious budget shortfall that has been estimated at more than $40 billion. Its unemployment rate is 9.3% as of December 31, 2008. Any turnaround in economic prospects is not likely to happen quickly. Unemployment, home foreclosures, and bank credit problems are all increasing. CB&T is focused on maintaining its underwriting and pricing standards as it endeavors to develop new customer relationships among small business and middle market companies.

 

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Schedule 13

CALIFORNIA BANK & TRUST

 

(In millions)    2008     2007     2006

CONDENSED INCOME STATEMENT

      

Net interest income

   $ 414.3     434.8     469.4

Impairment losses on investment securities

     (118.0 )   (79.2 )  

Other noninterest income

     82.6     87.3     80.7
                  

Total revenue

     378.9     442.9     550.1

Provision for loan losses

     82.9     33.5     15.0

Noninterest expense

     239.0     230.8     244.6
                  

Income before income taxes

     57.0     178.6     290.5

Income tax expense

     18.4     71.2     117.9
                  

Net income

   $ 38.6     107.4     172.6
                  

YEAR-END BALANCE SHEET DATA

      

Total assets

   $ 10,137     10,156     10,416

Total securities

     654     951     1,255

Net loans and leases

     7,867     7,792     8,092

Allowance for loan losses

     116     105     95

Goodwill, core deposit and other intangibles

     386     390     400

Noninterest-bearing demand deposits

     2,338     2,509     2,824

Total deposits

     7,964     8,082     8,410

Preferred equity

     158        

Common equity

     1,097     1,067     1,123

Net income for CB&T decreased 64.1% to $38.6 million for 2008 compared to $107.4 million for 2007 and $172.6 million for 2006. The decrease in net income was primarily due to recognition of impairment losses on investment securities, increased provision for loan losses and to a lesser extent a decrease in net interest income.

Nonperforming assets were $147.0 million at December 31, 2008 compared to $62.4 million one year ago, an increase of $84.6 million or 135.6%. Nonperforming assets include $135.0 million of nonperforming loans and $12.0 million of OREO for 2008 compared to $62.3 million of nonperforming loans and no OREO for 2007. The majority of the increase in nonperforming loans is attributable to deterioration of commercial real estate, construction, and land development loans. CB&T experienced moderate increases in nonperforming commercial and mortgage loans. The ratio of nonperforming assets to net loans and other real estate owned at December 31, 2008 was 1.87% compared to 0.80% at December 31, 2007.

Net loan and lease charge-offs were $61.8 million for 2008 compared with $23.1 million for 2007 and $10.9 million for 2006. Net charge-offs in 2008 were primarily construction, land and commercial real estate loans. The loan loss provision was $82.9 million for 2008 compared to $33.5 million for 2007 and $15.0 million for 2006. The ratio of the allowance for loan losses to net loans and leases was 1.48% and 1.35% at December 31, 2008 and 2007, respectively.

Net interest income at CB&T for 2008 decreased 4.7%, or $20.5 million. This decrease was caused by the yield on earning assets declining more than the rate on interest-bearing funding sources. Average earning assets were $9.2 billion for 2008, essentially unchanged from $9.1 billion for 2007. Average interest-bearing deposits and borrowings grew modestly, being $6.7 billion and $6.4 billion for 2008 and 2007, respectively. The net interest margin was 4.51% for 2008, compared to 4.76% for 2007 and 4.81% for 2006. Considering that the Federal Funds rate declined by 400 basis points during 2008, CB&T’s net interest margin was relatively stable decreasing only 25 basis points compared to 2007. The margin stability was achieved through managing interest rate risk by utilizing interest rate swaps as hedges and pro-active product management.

 

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Noninterest income, excluding impairment losses on securities, decreased 5.4% to $82.6 million compared to $87.3 million for 2007 which was up from $80.7 million for 2006. The bank recognized OTTI losses on securities of $118.0 million for 2008 compared to $79.2 million for 2007. The Parent purchased the impaired securities at fair value.

Noninterest expense for 2008 increased $8.2 million or 3.6% to $239.0 million from $230.8 million for 2007 and $244.6 million for 2006. At the time of CB&T’s data processing conversion to the Zion’s platform in August 2007, many functions were transferred to ZMSC. Primarily as a result of the transfer of personnel, centralization of functions and termination of outsourced data processing contracts, salaries and employee benefits, occupancy, and data processing for 2008 in aggregate decreased by $12.5 million to $151.4 million compared to $163.9 million for 2007. This decrease was offset by an increase in other expenses, including allocated affiliate services, of $20.7 million. Furniture and equipment and amortization of core deposit and other intangibles in aggregate decreased $4.8 million in 2008 compared to 2007 while advertising and OREO expense in aggregate increased $4.8 million in 2008 compared to 2007. The efficiency ratio was 63.03% for 2008 compared to 52.07% for 2007 and 44.42% for 2006. The pro forma efficiency ratio without the impairment losses on securities was 48.07% for 2008 and 44.18% for 2007.

Schedule 14

CALIFORNIA BANK & TRUST

 

(Dollar amounts in millions)    2008     2007     2006  

PERFORMANCE RATIOS

      

Return on average assets

     0.38 %   1.06 %   1.59 %

Return on average common equity

     3.59 %   9.83 %   15.40 %

Tangible return on average tangible common equity

     5.95 %   16.02 %   24.68 %

Efficiency ratio

     63.03 %   52.07 %   44.42 %

Net interest margin

     4.51 %   4.76 %   4.81 %

RISK-BASED CAPITAL RATIOS

      

Tier 1 leverage

     8.77 %   6.97 %   7.36 %

Tier 1 risk-based capital

     8.33 %   7.33 %   7.19 %

Total risk-based capital

     11.05 %   11.58 %   11.50 %

CREDIT QUALITY

      

Provision for loan losses

   $ 82.9     33.5     15.0  

Net loan and lease charge-offs

     61.8     23.1     10.9  

Ratio of net charge-offs to average loans and leases

     0.78 %   0.29 %   0.14 %

Allowance for loan losses

   $ 116     105     95  

Ratio of allowance for loan losses to net loans and leases

     1.48 %   1.35 %   1.17 %

Nonperforming assets

   $ 147.0     62.4     27.1  

Ratio of nonperforming assets to net loans and leases and other real estate owned

     1.87 %   0.80 %   0.34 %

Accruing loans past due 90 days or more

   $ 7.4     13.0     3.5  

Ratio of accruing loans past due 90 days or more to net loans and leases

     0.09 %   0.17 %   0.04 %

OTHER INFORMATION

      

Full-time equivalent employees

     1,474     1,572     1,659  

Domestic offices:

      

Traditional branches

     90     90     91  

Foreign office

     1          
                    

Total offices

     91     90     91  

ATMs

     103     103     103  

 

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Net loans and leases marginally increased $75 million or 1.0% in 2008 compared to 2007. Commercial loans, commercial real estate term loans, and consumer home equity loans grew $175 million, $188 million and $32 million, respectively, in 2008 compared to 2007, while construction and land development and 1-4 family residential loans declined $218 million and $95 million, respectively, for the same periods. Changing the mix of these major loan categories helped CB&T diversify its credit risks, particularly lowering the concentration in land and construction loans. CB&T continues to emphasize growing the commercial and small business loan portfolios and managing the run-off of construction and land development loans.

Total deposits declined $118 million or 1.5% in 2008 compared to 2007. The ratio of noninterest-bearing deposits to total deposits was 29.4% in 2008 and 31.0% in 2007. CB&T’s goal of relationship banking includes providing customers with checking accounts, treasury management services, sweep accounts and other deposit products. CB&T generally does not rely on noncore deposits such as brokered funds.

Total securities declined $297 million or 31.2% in 2008 compared to 2007. The change was driven primarily by the sales of the impaired securities to the Parent.

At December 31, 2008 tier 1 leverage, tier 1 risk-based and total risk-based capital ratios were 8.77%, 8.33% and 11.05%, respectively, compared to 6.97%, 7.33% and 11.58%, respectively, at December 31, 2007. The improvement in the tier 1 ratios was primarily due to the issuance of preferred stock to the Parent of $157.5 million in December 2008. Tier 1 capital was $873 million at the end of 2008 compared to $689 million at 2007. Total risk-based capital was $1.2 billion at the end of 2008 compared to $1.1 billion at 2007. This small change was due to the offsetting effects of the issuance of the preferred stock and the net redemption of $132.5 million of subordinated debt (which qualified as tier 2 capital) due to the Parent. The total risk-based capital ratio decreased due to an increase of risk-weighted assets to $10.5 billion compared to $9.4 billion at the end of 2008 and 2007, respectively.

Subsequent to year-end, on February 6, 2009, CB&T was the winning bidder for the assets and deposits of the failed Alliance Bank in Southern California. Alliance operated five branches and CB&T acquired approximately $1.1 billion of loans and $0.9 billion of deposits (including $0.4 billion of brokered deposits that we do not expect to retain) from the FDIC under a loss sharing agreement that affords significant credit risk protection to CB&T.

Amegy Corporation

Amegy is headquartered in Houston, Texas and operates Amegy Bank, the 8th largest full-service commercial bank in Texas as measured by domestic deposits in the state. Amegy offers 69 full-service traditional branches and three banking centers in grocery stores in the Houston metropolitan area, six traditional branches in the Dallas metropolitan area and five traditional branches in San Antonio. Amegy also operates a mortgage company (“Amegy Mortgage Company”), a broker-dealer (“Amegy Investments”), an insurance agency (“Amegy Insurance Agency”), and a trust and private banking group.

The Texas economy continued to outperform the nation with employers adding 153,600 jobs in the past 12 months, compared with job losses of 2.6 million nationwide during the same period. Among the 15 states that reported employment growth from November 2007 to November 2008, Texas accounted for 71% of entire job gains. Amegy’s three primary markets – Houston, Dallas and San Antonio – continued to experience job growth in 2008, as well. Together, they and other markets in Texas, have kept the state’s unemployment rate at or below the national average for 24 consecutive months. Recognized as an international business leader, the Houston Metropolitan Statistical Area (“MSA”) gained 57,300 jobs from December 2007 to December 2008, growing 2.2% to a total of more than 2.6 million jobs. Houston outperformed the state, which grew 1.5%. The Dallas-Fort Worth-Arlington MSA, driven by the trade, transportation and utilities industries, had job growth of 1.4% to a total of more than 3 million. A strong and growing healthcare industry helped San Antonio increase jobs by 1.8% to nearly 860,000 jobs.

 

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Schedule 15

AMEGY CORPORATION

 

(In millions)    2008    2007    2006

CONDENSED INCOME STATEMENT

        

Net interest income

   $ 370.1    331.3    304.7

Noninterest income

     192.9    126.7    114.9
                

Total revenue

     563.0    458.0    419.6

Provision for loan losses

     71.9    21.2    7.8

Noninterest expense

     305.2    295.6    283.5
                

Income before income taxes and minority interest

     185.9    141.2    128.3

Income tax expense

     60.5    46.7    39.5

Minority interest

     0.3    0.1    1.8
                

Net income

   $ 125.1    94.4    87.0
                

YEAR-END BALANCE SHEET DATA

        

Total assets

   $ 12,406    11,675    10,366

Total securities

     693    895    1,266

Net loans and leases

     9,129    7,902    6,352

Allowance for loan losses

     116    68    55

Goodwill, core deposit and other intangibles

     1,334    1,355    1,370

Noninterest-bearing demand deposits

     2,709    2,243    2,245

Total deposits

     8,625    8,058    7,329

Preferred equity

     80      

Common equity

     2,049    1,932    1,805

Net income for Amegy increased 32.5% to $125.1 million for 2008 compared to $94.4 million for 2007 and $87.0 million for 2006. The increase in net income was primarily due to continued robust loan growth, gains realized on the termination of interest rate swap contracts (which were recognized immediately at the bank level, but which are being amortized over the remaining life of the contracts at the consolidated Zions Bancorporation level as described in the “Other” segment on page 82), strong fee income generation and only moderate increases in operating expenses. These positive factors were partially offset by an increased provision for loan losses and a decrease in the net interest margin.

Nonperforming assets were $56.7 million at December 31, 2008 compared to $45.6 million one year ago, an increase of $11.1 million or 24.3%. The increase in nonperforming assets was due to deterioration in the segment of the loan portfolio related to home builders, lot developers, and income producing property developers. Nonperforming assets to net loans and other real estate owned at December 31, 2008 was 0.62% compared to 0.58% at December 31, 2007.

Net loan and lease charge-offs were $24.1 million for 2008 compared with $9.0 million for 2007 and $1.9 million for 2006. Net loan and lease charge-offs in 2008 were primarily in the commercial and industrial loan portfolio. The loan loss provision was $71.9 million for 2008 compared to $21.2 million for 2007 and $7.8 million for 2006. The ratio of the allowance for loan losses to net loans and leases was 1.27% at December 31, 2008 and 0.86% and 0.87% at December 31, 2007 and 2006, respectively.

Net interest income increased by 11.7% for 2008 due to a 17.1%, or $1.4 billion increase in average earning assets and a reduction in the cost of funds. The net interest margin was 3.92% for 2008, compared to 4.13% for 2007 and 4.36% for 2006.

Noninterest income increased 52.2% to $192.9 million compared to $126.7 million for 2007 and $114.9 million for 2006. The largest increases in noninterest income were due to the income received from

 

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ineffectiveness and the early termination of interest rate hedges of $36.6 million, an $11.8 million or 28.9% increase in service charge income and a $5.9 million or 189.7% increase in income on other equity investments.

Noninterest expense was actively managed during 2008 increasing only $9.6 million or 3.2% from 2007. Increases for 2008 included a $6.2 million or 4.7% increase in salaries and benefits, a $3.4 million increase in the cost of FDIC insurance and $1.7 million in expenses related to the recovery from Hurricane Ike in September. The efficiency ratio improved to 53.80% in 2008 from 63.83% in 2007 and 66.79% in 2006. The change in the efficiency ratio was largely due to the gains realized on the termination of interest rate swap contracts as well as from strict expense management and the benefits derived from the sharing of technology resources with Zions.

Schedule 16

AMEGY CORPORATION

 

(Dollar amounts in millions)    2008     2007     2006  

PERFORMANCE RATIOS

      

Return on average assets

     1.04 %   0.91 %   0.93 %

Return on average common equity

     6.28 %   5.10 %   4.87 %

Tangible return on average tangible common equity

     21.43 %   22.46 %   26.25 %

Efficiency ratio

     53.80 %   63.83 %   66.79 %

Net interest margin

     3.92 %   4.13 %   4.36 %

RISK-BASED CAPITAL RATIOS1

      

Tier 1 leverage

     8.67 %   7.58 %   7.64 %

Tier 1 risk-based capital

     8.10 %   6.90 %   7.19 %

Total risk-based capital

     11.13 %   10.94 %   10.35 %

CREDIT QUALITY

      

Provision for loan losses

   $ 71.9     21.2     7.8  

Net loan and lease charge-offs

     24.1     9.0     1.9  

Ratio of net charge-offs to average loans and leases

     0.28 %   0.13 %   0.03 %

Allowance for loan losses

   $ 116     68     55  

Ratio of allowance for loan losses to net loans and leases

     1.27 %   0.86 %   0.87 %

Nonperforming assets

   $ 56.7     45.6     15.7  

Ratio of nonperforming assets to net loans and leases and other real estate owned

     0.62 %   0.58 %   0.25 %

Accruing loans past due 90 days or more

   $ 5.5     3.8     9.7  

Ratio of accruing loans past due 90 days or more to net loans and leases

     0.06 %   0.05 %   0.15 %

OTHER INFORMATION

      

Full-time equivalent employees

     1,756     1,694     1,599  

Domestic offices:

      

Traditional branches

     80     79     70  

Banking centers in grocery stores

     3     8     8  

Foreign office

     1     1     1  
                    

Total offices

     84     88     79  

ATMs

     140     142     129  

 

1

Capital ratios are for Amegy Bank N.A.

Net loans and leases expanded $1.2 billion or 15.5% to $9.1 billion in 2008 compared to $7.9 billion in 2007. Most categories of loans grew in 2008 compared to 2007, with over half of the total growth concentrated in the commercial lending portfolio. Amegy continues to be active in new loan originations by seeking borrowers meeting both its pricing and credit criteria.

 

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Total deposits grew $567 million or 7.0% in 2008 compared to 2007, $466 million of this growth was in noninterest-bearing deposits. The ratio of noninterest-bearing deposits to total deposits was 31.4% in 2008 and 27.8% in 2007. Amegy continues to be a leader in providing treasury management services to commercial clients and in serving the retail and small business enterprises through its branch network.

Total securities declined $202 million or 22.6% in 2008 compared to 2007 through maturities, calls and principal pay-downs. This change was driven by a continuing effort to maximize balance sheet efficiency. Amegy did not recognize any impairment or valuation losses in its securities portfolio in either 2008 or 2007.

The total risk-based capital ratio at December 31, 2008 was 11.13% compared to 10.94% and 10.35% at December 31, 2007 and December 31, 2006, respectively. The increase in the total risk-based capital ratio for 2008 was mainly due to the issuance of qualifying tier 1 capital preferred stock of $80 million to the Parent in December 2008, a $133 million net decrease of qualifying tier 2 capital subordinated debt due to the Parent and net income of $125.1 million.

National Bank of Arizona

National Bank of Arizona is headquartered in Tucson, Arizona, and is the 4th largest full-service commercial bank in Arizona as measured by domestic deposits in the state. NBA operates 79 full-service traditional branches and provides a full range of banking services to its customers. During 2008, NBA expanded its depository base through the acquisition of certain Arizona depository customers held by Silver State Bank branches, a failed financial institution. The acquisition comprised less than 5% of the total deposit balance of NBA at the date of purchase.

The Arizona economy has been contracting since the 3rd quarter of 2007. Normally, the state’s economy follows the national economy; however, in this current recession, Arizona, along with many Western states lead this decline. The decline continued to be fairly severe during 2008. The state’s unemployment grew by over 56% to 6.1% in the twelve months ending October 31, 2008. The state’s population grew slightly in the same twelve month period by 1.6% to over 6.4 million. However, the pace of quarterly net migration into the state slowed to just over 8,000 in the third quarter of 2008, nearly a fourth of the level experienced in the same quarter in 2007. Statewide residential building permits dropped to just over 27,000, a decline of 43% in the fiscal year. Indications are that 2009 will remain challenging, as unemployment is expected to rise to nearly 8%, population growth is anticipated to decline to 1.2% and residential building permits are expected to decline approximately 22%. Projections for 2010 and beyond reflect a more positive trend, although remain modest in comparison to factors experienced by the state during a growth period of 2003-2006.

 

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Schedule 17

NATIONAL BANK OF ARIZONA

 

(In millions)    2008     2007    2006

CONDENSED INCOME STATEMENT

       

Net interest income

   $ 219.5     250.8    214.9

Noninterest income

     46.8     33.4    25.4
                 

Total revenue

     266.3     284.2    240.3

Provision for loan losses

     211.8     30.5    16.3

Noninterest expense

     161.2     142.4    103.0

Impairment loss on goodwill

     168.6       
                 

Income (loss) before income taxes

     (275.3 )   111.3    121.0

Income tax expense (benefit)

     (56.7 )   43.5    47.8
                 

Net income (loss)

   $ (218.6 )   67.8    73.2
                 

YEAR-END BALANCE SHEET DATA

       

Total assets

   $ 4,864     5,279    4,599

Total securities

     204     258    199

Net loans and leases

     4,146     4,585    4,066

Allowance for loan losses

     124     65    43

Goodwill, core deposit and other intangibles

     22     195    66

Noninterest-bearing demand deposits

     916     1,100    1,160

Total deposits

     3,923     3,871    3,695

Preferred equity

     430       

Common equity

     355     581    346

NBA experienced a net loss of $218.6 million in 2008, compared to net income of $67.8 million for 2007 and $73.2 million for 2006. The decrease in the net results for NBA was primarily due to recognition of goodwill impairment totaling $168.6 million. As of December 31, 2008 all of NBA’s goodwill has been written off. Additionally, with the worsening economic trends in Arizona, as noted above, credit-related costs increased significantly in the year. During the year, the Company recorded a total loan loss provision of $211.8 million, and nearly doubled to $124 million the allowance for loan losses at year-end.

As clearly reflected in the year’s loan loss provision, NBA’s credit quality worsened in the year. The steady decline in almost every sector of the Arizona economy, especially notable in the real estate sector, caused stress on the bank’s portfolio. Nonperforming assets were $273.0 million at December 31, 2008 compared to $76.1 million one year prior, an increase of $196.9 million or 258.7%. The bank’s exposure to real estate lending, both commercial and residential, contributed to the majority of the increase in nonperforming assets for the year. Nonperforming assets to net loans and other real estate owned at December 31, 2008 was 6.49% compared to 1.66% at December 31, 2007.

Net loan and lease charge-offs were $147.2 million for 2008 compared with $13.6 million for 2007 and $11.3 million for 2006. Net loan and lease charge-offs in 2008 were primarily related to the bank’s real estate portfolio, including real estate construction, land development and land loans. The loan loss provision was $211.8 million for 2008 compared to $30.5 million for 2007 and $16.3 million for 2006. The ratio of the allowance for loan losses to net loans and leases was 2.98% and 1.42% at December 31, 2008 and 2007, respectively.

Net interest income at NBA for 2008 declined by 12.5%, or $31.3 million as compared to 2007. This decrease resulted from a 4.5% decline in NBA’s average earning assets, compression in the net margin arising from a highly competitive marketplace for deposit acquisition and retention, and increased nonperforming loans.

 

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The net interest margin was 4.64% for 2008, compared to 5.08% for 2007 and 5.20% for 2006. Most short-term benchmark interest rates declined during the year; however, our ability to reduce customer deposit rates in tandem was hampered by heightened bank competition for liquidity.

Noninterest income increased 40.1% to $46.8 million compared to $33.4 million for 2007 and $25.4 million for 2006. This increase is principally due to the recognition of income from interest rate swaps which became ineffective during the year. The bank maintains swap positions to hedge against interest rate risks, hedged against certain portfolio loans. When these positions are deemed ineffective, the swap is cancelled and the income or loss is recognized in noninterest income. During 2008, the income from this activity was $14.4 million compared with a minor loss in 2007. Additionally, noninterest income includes fees earned from customers on their transaction accounts, offset by customer earnings credit. With the interest rate market decline, the net fees earned by the bank increased. Bank service charges, which include net charges on transaction accounts and other fees, increased to $17.0 million, an increase of 15.5% when compared with 2007.

Noninterest expense for 2008 increased $18.8 million or 13.2% from 2007. The increase is principally the result of increases in OREO expense of $27.6 million and increased credit and collection costs of $2.8 million. The increase in OREO expense was primarily the result of continued declines in the value of foreclosed properties. Other significant components of noninterest expense include salaries and employee benefits, occupancy costs, and advertising, all of which were near or below levels experienced in 2007. The efficiency ratio was 60.45% for 2008, as compared to 49.90% for 2007 and 42.81% for 2006.

Schedule 18

NATIONAL BANK OF ARIZONA

 

(Dollar amounts in millions)    2008     2007     2006  

PERFORMANCE RATIOS

      

Return on average assets

     (4.25 )%   1.25 %   1.66 %

Return on average common equity

     (39.40 )%   11.36 %   22.49 %

Tangible return on average tangible common equity

     (15.44 )%   18.55 %   28.76 %

Efficiency ratio

     60.45 %   49.90 %   42.81 %

Net interest margin

     4.64 %   5.08 %   5.20 %

RISK-BASED CAPITAL RATIOS

      

Tier 1 leverage

     15.19 %   7.29 %   6.37 %

Tier 1 risk-based capital

     17.49 %   7.51 %   7.03 %

Total risk-based capital

     18.76 %   10.95 %   10.83 %

CREDIT QUALITY

      

Provision for loan losses

   $ 211.8     30.5     16.3  

Net loan and lease charge-offs

     147.2     13.6     11.3  

Ratio of net charge-offs to average loans and leases

     3.34 %   0.29 %   0.29 %

Allowance for loan losses

   $ 124     65     43  

Ratio of allowance for loan losses to net loans and leases

     2.98 %   1.42 %   1.06 %

Nonperforming assets

   $ 273.0     76.1     12.2  

Ratio of nonperforming assets to net loans and leases and other real estate owned

     6.49 %   1.66 %   0.30 %

Accruing loans past due 90 days or more

   $ 17.0     11.8     2.3  

Ratio of accruing loans past due 90 days or more to net loans and leases

     0.41 %   0.26 %   0.06 %

OTHER INFORMATION

      

Full-time equivalent employees

     1,100     1,137     911  

Domestic offices:

      

Traditional branches

     79     76     53  

Foreign office

     1          
                    

Total offices

     80     76     53  

ATMs

     73     69     55  

 

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Net loans and leases contracted $439 million or 9.6% in 2008 compared to 2007. Over 75% of this contraction occurred in commercial real estate loans as the bank reduced its exposure to real estate related transactions during 2008. NBA expects a similar decrease during 2009 as compared with 2008, due to continued reductions in commercial real estate loan exposure and lack of demand in this sector. The allowance for loan losses grew by $59 million for the year taking into account the challenging local economic conditions. The bank expects to continue its management and focus its attention on controlling its real estate portfolio exposure, while maintaining a positive and growing influence in the commercial sector of the market.

Total deposits increased by $52 million or 1.3% in 2008 compared to 2007. The ratio of noninterest-bearing deposits to total deposits was 23.3% in 2008 and 28.4% in 2007. During the year, the bank increased its level of brokered deposits to $136.6 million, which represents approximately 3.5% of total deposits for the organization. The bank anticipates a reasonable level of growth in deposits in 2009, despite its plan to reduce the level of brokered deposits.

The total risk-based capital ratio at December 31, 2008 was 18.76% compared to 10.95% and 10.83% at December 31, 2007 and December 31, 2006, respectively. The increase in the total risk-based capital ratio for 2008 was mainly due to the issuance of qualifying tier 1 capital preferred stock of $430 million to the Parent in December 2008, a $110 million decrease of qualifying tier 2 capital subordinated debt due to the Parent and the net loss of $64.2 million, excluding the after-tax goodwill impairment.

Nevada State Bank

Nevada State Bank is headquartered in Las Vegas, Nevada, and is the fifth largest full-service commercial bank in Nevada as measured by domestic deposits in the state. Nevada State Bank operates 44 full-service traditional branches and 32 banking centers in grocery stores throughout the State of Nevada and provides banking services to Nevada’s small and mid-sized businesses as well as retail consumers, with a focus on relationship banking.

During the third quarter of 2008 NSB entered into an agreement to exit 28 grocery store banking centers during the first quarter of 2009, with an eye towards improving our efficiencies and controlling costs while maintaining a vibrant branch network to service our customer base. The leases on these banking centers are being assumed by another bank and all loans and deposits will be transferred to nearby NSB branch locations. To compensate for the reduction of branch locations, we entered into an agreement with a national retailer to place ATMs at 45 of their locations and planned additions of 5 branches in proximity to former grocery store locations that had heavy customer volume.

During 2008, NSB acquired the insured deposits of Silver State Bank in an FDIC-assisted transaction. Total deposits acquired through this acquisition were $563 million, including certificates of deposits totaling $465 million. NSB retained 5 former Silver State Bank branches in the Las Vegas area.

The markets in which we operate are heavily dependent on travel/tourism and construction. During spring 2008, financial conditions in these sectors began to deteriorate dramatically. As of December 2008 and compared to December 2007, gaming revenues are down 22.3%, airline passenger count is down 13.3% and visitor volume is down 10.2%. During the same period in Clark County and Washoe County, NSB’s two biggest market areas, residential construction permits have declined 87.7% and 57.4%, respectively, and commercial construction permits declined 55.0% and 52.9%, respectively. These declining metrics have led to an increase in the Nevada unemployment rate to 7.9% at November 2008 compared to 5.3% one year earlier and a decline in the overall employment numbers of 1.2% during the same period. The consensus outlook for 2009 is that Nevada’s economy will remain challenged as residential foreclosures continue to mount and overall consumer spending, which correlates to travel and tourism spending, is expected to remain suppressed given nationwide higher unemployment and general uncertainty about the economy.

 

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Schedule 19

NEVADA STATE BANK

 

(In millions)    2008     2007    2006

CONDENSED INCOME STATEMENT

       

Net interest income

   $ 159.0     182.5    197.5

Impairment losses on investment securities

     (2.0 )     

Other noninterest income

     42.8     32.9    31.2
                 

Total revenue

     199.8     215.4    228.7

Provision for loan losses

     100.3     23.3    8.7

Noninterest expense

     137.9     111.8    110.8

Impairment loss on goodwill

     21.0       
                 

Income (loss) before income taxes

     (59.4 )   80.3    109.2

Income tax expense (benefit)

     (13.6 )   27.9    38.1
                 

Net income (loss)

   $ (45.8 )   52.4    71.1
                 

YEAR-END BALANCE SHEET DATA

       

Total assets

   $ 4,063     3,903    3,916

Total securities

     194     412    415

Net loans and leases

     3,200     3,231    3,214

Allowance for loan losses

     82     56    35

Goodwill, core deposit and other intangibles

     8