Midday Update: First Security's Warning Imperils Zions Merger

In a development that could unravel its long-delayed merger with Zions Bancorp, First Security Corp. warned Friday that its first-quarter results would fall well short of expectations, hit by pressure from rising interest rates and the after-effects of a botched computer system upgrading.

Though Zions reiterated its support for the merger between the two Utah banking companies, the news produced blistering criticism from institutional shareholders, several of whom demanded that Zions at least reconsider, and perhaps walk away from, the deal.

First Security pointed to several sources for its projection that revenue could fall 8% in the quarter, dragging income down by 7 cents to 9 cents from the 33 cents it earned in the fourth quarter.

Brad Hardy, First Security's chief financial officer, said that for the past few quarters the bank's mortgage origination business had been under pressure and that pressure increased in January. First Security is not alone in that problem. Early last week, First Tennessee National Corp. also disclosed that slowness in its mortgage business would hurt first-quarter results.

Adding to the mortgage problems, which occurred mostly on the wholesale side and accounted for about 25% of the reduction in earnings estimates, the bank experienced more margin compression from costlier short-term funding. The bank also saw a January bubble in chargeoffs in its indirect auto and consumer lending business after installing a systems enhancement in October.

In a heated conference call following the announcement, investors made no bones about their dismay that First Security's revelations were poisoning the value of their stakes in Zions.

One after another, investors questioned why the news didn't constitute a "material adverse development" - a legal term a party can use to try to break a contract - and why Zions would want to proceed with the merger, given the recent findings.

Calling the deal "tainted," one institutional shareholder said, "there's no doubt you'll have to walk away from this deal."

Friday's earnings warnings come just before March 22, when Zions and First Security shareholders are to vote on the deal, and many investors questioned whether the recent news could disrupt Zions plans.

"There's a good chance of the merger not going through," said James Bradshaw of D.A. Davidson in Portland. Zions stock fell 24.5% and First Security shares sank by 37.9%.

But Zions executives said the bank remains steadfastly behind the merger, which stands to create the second-largest bank headquartered in the West, with $40 billion of assets. "We do not believe this is a material adverse change," said Dale Gibbons, chief financial officer for Zions.

Lower earnings at First Security are the latest problem to plague the matchup since Zions announced its intention to buy the bank in June. In mid-December, the Justice Department gave Zions specific requirements for divesting its branches, which cut into expected cost-savings.

Later that month, Zions was forced to delay a shareholder vote after the Securities and Exchange Commission asked it to restate the reporting of its financial results for the past three years.

Executives said little to explain how First Security's lowered results could affect the earnings of the combined bank and how they would counter any opposition by Zions shareholders to the deal.

"This is an example of what not to do on a conference call," Michael S. Mayo, an analyst at Credit Suisse First Boston. Glaring was the failure to give new pro forma earnings guidance, he said. He was also unhappy with the silence of chief executive Spencer F. Eccles on the call.

"When it comes to something like this, the CEO should deliver the bad news, instead of the underlings' facing the firing squad," Mr. Mayo said.

Tania Padgett contributed to this report.

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