Zions is ‘confident’ in credit despite Wall Street battering

• Key insight: Zions said its losses that led investors to sell off bank stocks en masse were an isolated incident.
• What’s at stake: Banks have been under the microscope in the last week following three instances of losses due to alleged fraud by separate borrowers.
• Supporting data: Excluding the $50 million charge-off it disclosed, Zions’ credit metrics improved in its third quarter.

Zions Bancorp. joined the chorus of banks fighting back against investors’ fears of souring credit, contending Monday that its own $50 million loss was a one-off.

The $89 billion-asset bank is working with a third party to review credit and collateral practices after disclosing a credit hit last week where it found “apparent irregularities and misrepresentations.” So far, the company hasn’t found any other concerning loans, CEO Harris Simmons said during Zions’ third-quarter earnings call.

“Our credit history over a number of years speaks for itself,” Simmons said. “This was a case where we had some unusual things going on that really are not commonplace. We’re going to continue reviewing with an external party to make sure that we’re learning from the experience and seeing what we can continue to improve upon.”

Chief Credit Officer Derek Steward added that he was “confident” the loss was an isolated incident.

Zions’ announcement last week — which marked the third instance in recent months of large losses at banks due to alleged fraud — prompted a rapid sell-off of bank stocks, as Wall Street raised flags on credit quality.

Simmons said Monday that the issue “was not something that came across the radar screen as early as we would have wished,” but he thinks credit underwriting and collateral review is generally one of Zions’ strengths.

“I think … one of the reasons that it got everybody’s attention is it was not the kind of thing you’d expect from us,” Simmons said.

The company’s stock fell some 14% last Thursday, but recovered and stabilized in the following days. Zions said Monday that due to active litigation, its comments on the issues would be limited.

Zions’ losses were tied to two commercial and industrial loans based in California. The borrowers, who, per their lawyer, “vehemently deny all the allegations of wrongdoing,” are connected to entities that are in a separate dispute with Phoenix-based Western Alliance Bancorp. Steward said Zions doesn’t have other exposure to the borrowers in question.

Both Western Alliance and Zions have sued the borrower entities to recover the debts, which amount to $100 million and $60 million, respectively.

Zions, which operates through eight subsidiaries across the western half of the country, said its affiliates each make credit decisions local to their geographies. In California, the Salt Lake City-based company’s division is California Bank & Trust.

“One of the strengths of our model is we try to have local decisioning at the affiliates … where they know the companies best,” Steward said.

Excluding the costs of the alleged fraud, Zions’ credit metrics improved from the prior quarter. Non-performing assets were stable, and criticized loans decreased.

Zions reeled in $221 million of net income in its latest quarter, or $1.48 of diluted earnings per share, beating the consensus analyst estimate of $1.44.

Last month, a handful of banks logged credit hits ranging from $20 million to $200 million in connection with Tricolor Holdings, a subprime auto lender that has filed for bankruptcy and been accused of fraud by lenders. A few weeks later, the auto parts maker First Brands Group also filed for bankruptcy amid allegations of defrauding financial institutions.

As banks have released their quarterly financial results over the last several days, many have doubled down on their conviction in the quality of their loan portfolios. But the recent smattering of losses has also driven finger-pointing at the rapidly growing non-depository financial institution lending, or NDFI, sector — to which each of the three allegedly fraudulent borrowers is connected.

Simmons said he doesn’t think there’s a specific relationship between the three cases, but understands the concern. While some types of NDFI lending are quite safe, he said, others, like the rapidly growing private credit business, are at least “a yellow flag.”

“The greater risk, I think, is going to be the spillover risk if or when that private credit sector finds itself in a period of stress,” Simmons said. “They don’t have the structural backstop of liquidity that the banking sector does. So again, given the high rate of growth in the sector, I think it’s not unreasonable to think that it could pose some increased risk in credit markets.”

The NDFI sector is one of the fastest-growing loan categories across the banking industry, and now makes up some 10% of all bank loans.

Zions offered a more detailed snapshot of its NDFI business this quarter, which at $2 billion is about 3% of its total loans. The company said the portfolio is generally evenly balanced across the types of lending, such as business credit, mortgage credit and consumer credit.

Steward said the Utah company has been in the business for a long time, and doesn’t intend to increase its exposure significantly.

Even with the latest losses, Zions upped its loan growth guidance for next year from “slightly increasing” to “slightly to moderately increasing.”

“We’re going to continue doing underwrite the way we’ve done historically,” Steward said. “So [the losses] will not change how we look at growth now. Can we learn? Sure. But we’re going to continue doing what we’ve been doing.”