Maintaining Discipline

Harris Simmons knows a thing or two about buying banks. Over the past six years, Simmons, chairman and chief executive officer at Salt Lake City, Utah-based Zions Bancorp., has acquired 23 banks throughout his eight-state western region. Most of the deals have been small, although Simmons did try unsuccessfully in 2000 to merge with Salt Lake City rival First Security Corp., a deal that fell apart for a number of reasons, including First Security’s declining profitability. Simmons has largely concentrated on acquiring well-run banks in high-growth markets like Arizona, Nevada, and California, although he has done his largest number of dealsu00e2u20ac”11u00e2u20ac”in Colorado. Above all, Simmons is a disciplined buyer who doggedly refuses to overpay for a deal.

“The premium that is paid becomes a common denominator for a multitude of sins, because what this all boils down to is how much you paid for what you got,” he says.

Zions is an unusual company in a couple of respects, beginning with its history. Zion’s Savings Bank and Trust Co. was founded in 1873 by none other than Brigham Young, who established the Mormon community in Utah and later became the territory’s first governor. A brief corporate history states that on the bank’s first day of business on Oct. 1, 1873, tellers recorded deposits of $5,876.20. The Church of Jesus Christ of Latter-day Saints eventually sold off its controlling interest in 1960, and Zions (the apostrophe in Zion’s had been dropped by 1890) was acquired by a group of local businessmen including Roy W. Simmons. The elder Simmons ran Zions until 1986, when the board appointed Harris Simmonsu00e2u20ac”then just 32 years oldu00e2u20ac”president of the holding company. The younger Simmons, who has an MBA from Harvard Business School, succeeded his father as CEO in 1990.

What makes Zions so distinctive today is its unique operating philosophy. With over 400 banking offices in Utah, Arizona, California, Colorado, Idaho, Nevada, New Mexico, and Washington, and $26.5 billion in assets, Zions is hardly a community banking organization. And yet it comes much closer to fitting that description than most other large regional banks. Zions does business under six different names in the eight states where it operates, including California Bank & Trust, National Bank of Arizona, and Nevada State Bank. Simmons watched as other regional banks throughout the West acquired well-run local banks and then homogenized themu00e2u20ac”losing that all-important local touch in the process.

Senior managers at Zions’ various banking subsidiaries enjoy a considerable amount of autonomy. Simmons’ theory is that giving free reign to their entrepreneurial energies will benefit the bank. So far, he hasn’t been disappointed.

“It has been a significant factor in allowing us to generate really good revenue-per-share growth over the last dozen years,” he says.

Like all bank CEOs today, Simmons faces a number of significant challenges. There is, for one, the enormous distraction of complying with the Sarbanes-Oxley Act, which imposes a number of new corporate governance requirements on all public companies. Simmons laments the amount of time that has been spent at Zions board meetings of late dealing with “the minutia of the law” and believes Sarbanes-Oxley missed the mark in some respects.

And like his counterparts at other banks, Simmons is waiting anxiously for an economic recovery, “which has been six months out for a year and a half now.” Simmons is reluctant to aggressively grow Zions’ loan portfolio in the current environment, so he’s taking other steps to ride out the storm. “We’re trying to tighten down on expenses,” he says. “We are working hard at cross selling on the deposit side of the business, and we’re trying to be very careful on the credit side. In a nutshell, that’s what we’re trying to do.”

We recently talked with Simmons about several issues facing banks today, among them, the new onus on boards following Sarbanes-Oxley.

How have the Sarbanes-Oxley Act and the increased concern about corporate governance issues affected Zions?
I daresay that every public company is going through the equivalent of boot camp with respect to Sarbanes-Oxley. Some companies come to boot camp more fit than others, but everybody’s going through a series of exercises revising committee charters and preparing to publish their code of ethics, their governance guidelines, and so on. There’s a litany of requirements, and I suspect that most public company CEOs are in the same situation I’m in. We’re getting summaries and white papers on various pieces of Sarbanes-Oxley from about six different sources; it is like being in a house of mirrors sometimes when I look through my mail.

We’re also hearing about it from a half a dozen different parties [including] the Securities and Exchange Commission, NASDAQ, the New York Stock Exchange, and the Financial Accounting Standards Board. FASB is digging through a heap of issues that came out of Enron and Worldcom, including off-balance-sheet entities and accounting for stock optionsu00e2u20ac”and the list will continue to evolve. It’s not on the screen today, but I expect that pension accounting will be another issue that we’ll all be dealing with as a result of what’s happening to pension assets in this country. So you have a lot of things going on that are taking a lot of time.

What’s your opinion about the new law?

At the end of the day the changes probably are good, but I don’t think they will ultimately solve the kinds of problems that came out of Enron. All of the rule making in the world is no substitute for selecting directors who have a desire to build the right kind of company over the long term, for having a healthy culture within your company and within your board, and for having a board that promotes the creation of real value as opposed to hitting short-term earnings targets. Maybe what’s conspicuously absent from Sarbanes-Oxley is a requirement that boards make sure there’s plenty of time for discussion in board meetings on how the company is actually creating value for customers and for shareholders.

If I have one worry, it’s that companies are spending lots of time on the minutia of the law. Some of what is coming out of Sarbanes-Oxley is very healthy, [like] getting boards refocused on how their companies recognize revenue and what kind of risks they have off-balance-sheet. Those are all very healthy derivative discussions, but it can’t stop there. It really needs to get to the heart of understanding a company’s value proposition and how you create value, and then how you leverage that and multiply it for your shareholders.

Will the fact that bank CEOs and chief financial officers are required to certify that their companies’ financial filings are accurate promote more conservative banking practices?

The real seminal event for banks was the FDIC Improvement Act [of 1991], not Sarbanes-Oxley. It was a response to the savings and loan crisis in the same way that Sarbanes-Oxley is a reaction to what happened at Enron. One of the things that came out of it was a heightened set of requirements for audit committees in banks and bank holding companies, and it brought with it its own set of certification [requirements] for banks over $500 million [in assets]. And it brought rather severe penalties for violations. That law hit this industry over the head with a club. At the time we went out and made some significant changes in our audit committee. I selected a board member who was a retired audit partner from a major accounting firm. He had bank audit experience, so I figured he had both the time and the background to really devote to this. We put in place differential compensation for audit committee members, recognizing that their task and potential exposure was greater than that of other board members.

We did a lot of things back in 1991 that the rest of corporate America is wrestling with today. So I actually view the banking industry as being way ahead of most companies in terms of their preparedness to deal with Sarbanes-Oxley. As far as the certifications themselves go, I think most bankers who sign reports to the Federal Reserve have always felt that the penalties for knowingly misrepresenting what went into a call report are pretty severe.

What’s your outlook for M&A this year, and where do you see Zions fitting into that?

I continue to think it’s going to be a pretty slow market overall. As you go through cycles in terms of price/earnings ratios, it’s always going to be slower when you’re in a trough, as we are now. It simply takes time for expectations to readjust on the part of sellers. We are seeing far fewer seller-initiated transactions and opportunities in recent months than we’ve seen in some time, and I don’t see anything that’s likely to change that this year. I think everybody’s very nervous about the war in Iraq and what that does to the economy.

We’re entering the fourth year of a down market and that tends to stifle a lot of activity that would otherwise be taking place. Buyers are less likely to be using their stock to do deals and sellers are looking at the prices that can be had today, and they’re simply not as attractive as they were a couple of years ago. I think a lot of banks that would otherwise be sellers are on the sidelines waiting for pricing to improve.

What do you look for when you look at a bank deal?

First and foremost we look at how the prospective acquiree fits with our existing business or extends it in a complementary way. These days, mostly what we’re looking at are fill-in acquisitions, so we’re interested in how this would strengthen our existing franchise. What we find ourselves looking at are community banks in some of the faster growing western states. We look at their mix of business; we’re interested in the nature of the business they’re doing and how much franchise value there is to it. Is it relationship business? For example, a bank that is heavily into indirect auto lending would diminish the value of its franchise, as we would perceive it.

If they have a lot of small-business relationships, that would be a major plus. And the consumer business they may be doing, depending on where they’re located, can be a real plus. It really depends on whether we already have a strong consumer business going in their market. My view is that, as a general rule, the value of a franchise is highly correlated with the quality and the number of relationships that a bank has with high-value customersu00e2u20ac”small businesses being among the higher valued customers because there are opportunities to sell multiple products, and there are probably better margins on the credit side.

We’re interested in the growth prospects for any bank that we’re acquiring and so we look at the demographics of the market that it’s serving. That kind of view has taken us into markets like Nevada, Arizona, and Southern California, which have had higher growth rates. I think about accretion and dilution, not only in terms of what it does to us on a per-share basis but also what it does to the growth rate of our company. Does it more highly correlate us with high-growth markets?

Dilution, from an earnings-per-share perspective, is certainly a problem that has dogged many bank acquirers over the years. The problem seems to be that too many banks overpaid for their deals.

The premium that is paid becomes a common denominator for a multitude of sins, because what this all boils down to is how much you paid for what you got. The flip side of that coin is there are a lot of problems that can be cured through purchase price. In our own history, the best example is when we acquired Sumitomo Bank of California, a franchise that had not performed well. It had a high cost structure, and with respect to credit relationships, it had not developed much of a franchise.

Its real target market was the Asian American community in California, but it had determined that it wanted to build a commercial loan business and had done that primarily through buying participations in syndicated credits. It also wanted to strengthen its consumer lending business and had done that primarily through making mortgages and putting them into portfolio. Neither of those activities are real value creators in terms of developing the kinds of relationships where you’re going to sell a lot of additional products, or where there’s even a lot of margin to begin with.

Typically we wouldn’t do a deal like that, but it gave us a critical mass in terms of branch locations and a deposit base that was actually reasonably good. We’ve worked hard to strengthen it from where it was, but it gave us a foundation to expand further in California and that has proven to be very useful. In that case, we were able to overcome our other concerns because we paid a very conservative price for the bank, which on a premium-to-deposit basis was about 2.7%.

One of the problems that I would always be wary of trying to cure with price would be a fundamental credit problem. In my experience, it’s reasonably difficult, at least with the level of due diligence that you’re able to do in an acquisition, to really figure out how deep credit problems are, or if there’s a credit culture that is just fundamentally broken. A couple of times with regard to some very small institutionsu00e2u20ac”where they had significant credit problems and we thought we could get them fixedu00e2u20ac”those deals just haven’t worked out for us very well. There are a lot of things that you can fix with price, but acquiring a bank with credit problems is usually the equivalent of diving headfirst into muddy water.
Are you more concerned about the immediate impact on your bank financially, or are you more concerned about the long-term strategic potential of an acquisition?

I’d like to think our focus is on what it would do for us long term. It gets back to my thoughts about the nature of the market that we’re going into. To use an example, are we talking about Las Vegas or are we talking about Casper, Wyoming? If I were looking at a bank in Casper, there’s a price at which it would make sense, but I’d be factoring into the equation the fact that the growth rate is going to be much less than in a market like Las Vegas. We’ve tended to go into markets where the growth rate is more attractive because to the extent that you’re trying to pay back a premium, it’s easier to do it in a market that’s growing and where you can add some people and leverage a franchise. So I think you have less margin for error in a slow growth market. We’re certainly interested in what an acquisition will do to earnings per share over the next couple of years, but we’re more interested in whether this will fit well with our organization. Will it allow us to grow over the next decade?

One of the distinctive things about Zions is your operating philosophy. You do business under different names in different states and give the management teams there more autonomy than most other large regional banks. Why do you run the bank this way?

A lot of this philosophy comes from having seen what transpired here in Utah, and in markets throughout the West over the past 15 years. Before interstate banking, you had three to six really good regional banks in virtually every western state in which we operate, and they had fabulous franchises. Typically they had CEOs who were extremely well connected in their markets. There was great customer loyalty to those institutions, but as the industry has consolidated, my own view is that the strength of some of those relationships has weakened. With very large institutions, you have kind of a revolving door at the local level. I remember first seeing that here in Utah with First Interstate [Bancorp], which had a fabulous franchise in the West. But when it began centralizing the bank and running it by line of business, what I saw locally was that you had a string of [local managers] coming and going, and they became very detached from the community. If you had asked business people in Salt Lake City who, on any given day, was running First Interstate in Utah, most of them wouldn’t have known.

So our determination was to do something different that would recreate the kind of local franchise that had a lot of appeal to customers. And that has allowed us to attract some very good people to run these franchises for us, people that would not find themselves happy working in a very large organization. I think they are by nature more entrepreneurial and we give them license to be more entrepreneurial. And I think that has been a significant factor in allowing us to generate really good revenue-per-share growth over the last dozen years.

How much autonomy do local Zions managers have?

Well, we have a management team in California that is headed by David Blatford, a very aggressive but seasoned credit guy, who is doing a fabulous job in bringing in the right people and building a great bank there. That team basically has responsibility for marketing, for product, for pricing, and for credit decisions. We have a central credit administration function within our organization and the parent company has a representative or two on the credit committee in California. But the process is all driven and handled locally. We reserve the right to override [local credit decisions], but as a practical matter, that doesn’t happen if you have good people.

We’ve recently hired a new head of our commercial lending group in California, and that determination was made by Blatford. I didn’t even meet the individual we’d hired until after he’d come on board, nor had anybody here centrally. That’s the kind of decision that is David’s responsibility to make. Where they place branches, where they close themu00e2u20ac”those are their decisions to make. We also have a uniform and centralized audit function, so the fundamental controls are consistent throughout the company. But in terms of how they go out and make money, we [at the parent company] try to stay out of the way as much as we can.